Welcome to the September/October 2008 edition of
Business Leasing and Finance News (BLFN)

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FOUNDER'S NOTE
By David G. Mayer 

 Rescue Derailed

Subprime mortgage defaults have caused so much financial damage to investment banks, insurance companies, and other financial institutions as to cause an unprecedented loss of confidence in the U.S. economy. The confidence gap is so broad and deep that the U.S. government has worried that the economy could grind a halt.

To stave off a further economic meltdown, the Treasury Department proposed $700 billion rescue plan on September 20, 2008. See Proposed Treasury Authority to Purchase Troubled Assets, News Release, U.S. Dept. of Treas., hp-1150 (Sept. 20, 2008). On September 28, 2008, the leadership of the U.S. House of Representatives and the U.S. Senate and the Bush Administration agreed to support passage of the “Emergency Economic Stabilization Act of 2008.” However, the House of Representatives defeated the bill on

September 29th, leaving an undeniable mess of our financial system.

Assuming a similar plan ultimately becomes law, will the plan work to settle markets? I doubt anyone knows, but the stock market has gyrated wildly since the announcement of the plan (rising to show support and dropping to indicate doubt about the plan). In essence, the federal government will buy bad mortgages and conduits from the holders. This action is intended to stem the losses and revive the business operations of institutions that originated, insured, or marketed the mortgages and related securities.

Patton Boggs has explained this incredibly important and complex legislation in a summary available online as of September 29 titled: “Update: Text Of "The Emergency Economic Stabilization Act Of 2008" Authorizing The Treasury Secretary To Purchase Up To $700 Billion In Troubled Assets And For Other Purposes; Rejected By The House Of Representatives 205-228” (Update). The plan includes the following important elements for lenders and lessors:

• Funds. The bill proposed that Treasury have authority to purchase up to $700 billion of Treasury securities to finance the purchase of troubled assets, with immediate approval for the first $250 billion and further approvals and reports necessary to access the remaining amounts. The bill increases the statutory limit on the public debt to $11.315 trillion from $10 trillion.
  
  
• Covered Assets & Institutions. The bill covers the following troubled assets: residential and commercial mortgages, securities, obligations or other instruments related to such mortgages, together with any other illiquid financial instruments determined by the Secretary to be necessary to promote financial market stability, which could include car loans, equipment leases and student loans. U.S. financial institutions will qualify as sellers, as will private foreign financial institutions with significant operations in the U.S.
  
  
• Scope & Deadline. Assets must be originated or issued on or before March 14, 2008. However, any asset originated or issued after March 14, 2008 may be covered if the purchase of such asset is deemed necessary to promote financial and market stability.
  
  
• Management. The assets will likely be managed by private asset managers at the direction of Treasury to meet statutory program objectives. The bill provides that the Secretary will prepare rules relating to conflict of interests and the hiring of such asset managers.
  
  
• Reporting and Transparency. The bill contains significant reporting and transparency provisions. The bill establishes the Financial Stability Oversight Board to review all exercises of authority by the Secretary and Office of Financial Stability and the Office of the Special Inspector General for the Troubled Asset Relief Program to supervise audits and investigations relating to the program. The bill requires the Secretary to make available to the public, a description, amounts, and pricing of assets acquired, within 2 business days or purchase, trade, or other disposition.

What do this plan and related events mean for typical financing by asset-based lenders, lessors, and other financial institutions? The plan is unsettled for lenders and lessors to evaluate. However, what is apparent already is that many banks and other financial institutions have hit the brakes on credit transactions. They have reduced credit lines, exited syndicated loan participations, and initiated new, highly-selective evaluation of new commercial loan transactions. See Credit Lines in Jeopardy, CFO.com (Sept. 11, 2008). Other financial institutions have required capital infusions to shore up balance sheets before lending a dime. Small companies have encountered a rough road on their routine trips to the bank for funding. See Small Firms Seeing Financing Harder to Get, The Wall Street Journal, SW Ed., Page A:8, Col. 6 (Sept. 16, 2008). If these challenges are not enough, many lenders/lessors lack sufficient liquidity to extend credit to qualified borrowers or lessees or lack the confidence to do so. However, all is not lost. Asset-based and mezzanine lenders seem to be more active in meeting some of the borrowing demand.

The economic environment we now face is sobering at best. Never in my 30-year legal career have I seen an economic turndown and financial crisis of this type or dimension. For me, the reality is now clear. The credit markets have not yet resolved their potential losses and grave challenges, despite the government’s rescue plan. More banks and other financial institutions will likely fail before this crisis ends. FBI investigations may reveal fraud that will, in this election year, anger voters, including financiers. With some exceptions, those of us in the financial services sector must redouble our efforts to achieve our goals this year. Ultimately, we all should know our goals, but the real question is how we will get there amid the incredible market tumult and historic rescue efforts of the U.S. government.

Thanks to Bizunesh Scott of the Patton Boggs Government Investigations and Litigation Group, for reviewing the above description of the new rescue legislation; and thanks to each of you for reading BLFN. Good luck to you in the balance of September and October. Look for BLFN’s next bi-monthly issue in November (new publications schedule as of July 1, 2008).

1. Court Ruling Expands Texas Property Tax on Aircraft and Other Assets

Texas counties face a substantial budget shortfall as a result of lost property tax revenue and Dallas County may be chief among them. See Dallas Morning News, Property tax losses create bigger gap in Dallas County budget, (August 20, 2008).

To share the pain, a very recent Texas court ruling expands the way Dallas and other Texas counties can impose more property taxes on aircraft and other moveable assets in Texas. In Alaska Flight Services, LLC v. Dallas Central Appraisal District, --- S.W.3d ---, 2008 WL 3906389 (Tex. App. – Dallas 2008, no pet. h.), the Dallas Court of Appeals:

• Expanded the authority of Texas counties to collect property tax revenue from personal property.
  
  
• Clarified when moveable personal property, such as aircraft, is “used continually” in the state, thereby becoming subject to the assessment of property taxes.
  
  
• Concluded that property is “used continually” in the state if it is used while present in the state during some period of the tax year. An aircraft having more than 23% of its total yearly departures from Texas satisfied this criteria.

The same principles apply to other moveable personal property used in Texas, including tractors, trailers, and other vehicles.

Case Background

Alaska Flight Services, LLC (AFS), based in Dallas, acquired the aircraft in August 2001. According to flight logs for the aircraft, the owner operated and based the aircraft in Colorado for most of 2001. While AFS owned it, the aircraft made 42 total departures in 2001, and 9 or 10 of those departures occurred from locations in Texas. In November 2001, the owner flew the aircraft to Dallas Love Field to prepare it for lease. AFS leased the aircraft to an Alaskan company for 36 months beginning on January 1, 2002. On January 11, 2002, after completing repairs and modifications to the aircraft at Love Field, lessee flew to Alaska. Aside from the single flight on January 11, all of the aircraft’s 254 departures in 2002 were from locations in Alaska.

Issues

The Court faced two questions:

FIRST: What is the relevant year for determining when moveable personal property is used continually in the state?

SECOND: How does Texas get the right to tax moveable personal property?

Outcome/Decision of the Court

The Dallas Court of Appeals affirmed the trial court’s decision that 2001 was the correct year to analyze in deciding whether Texas had authority to tax the aircraft for the 2002 tax year. The Court also agreed with the trial court that during 2001, the aircraft was used continually in the state within the meaning of the Property Tax Code outlining when Texas has the authority to tax tangible personal property.

Texas Law on Property Tax

The Texas Constitution states that “all real property and tangible personal property in the State…shall be taxed in proportion to its value.” Tex. Const. Art. VIII, § 1. The Property Tax Code limits the State’s jurisdiction to tax tangible personal property, however. Section 11.01 of the Texas Property Tax Code states that Texas has jurisdiction to tax tangible personal property if the property is:

(1) located in this state for longer than a temporary period;

(2) temporarily located outside this state and the owner resides in this state; or

(3) used continually, whether regularly or irregularly, in this state.

Tex. Tax Code Ann. § 11.01(c) (Vernon 2006). In addition, this section of the Tax Code states that tangible personal property is not taxable in Texas if the property is operated or located exclusively outside of Texas during the year preceding the tax year and on January 1 of the tax year. Tex. Tax Code Ann. § 11.01(d) (Vernon 2006).

*Technical Point: The jurisdiction of the State of Texas to tax tangible personal property is based on whether the property is in Texas during the relevant year and, if so, for how long. See Fairchild Aircraft, Inc. v. Bexar Appraisal Dist., 47 S.W.3d 577, 580 (Tex. App. – San Antonio 2001, pet. denied). Texas’s jurisdiction to tax tangible personal property should not be confused with the property’s taxable “situs” in the State. In other words, even if the State has jurisdiction to tax the property, the local taxing authorities in Texas counties must also have their own authority to tax the property. See Fairchild Aircraft, 47 S.W.3d at 580. The taxable situs of the property determines whether a county can tax the property and the Tax Code has separate provisions related to identifying the taxable situs of tangible personal property. See Tex. Tax Code Ann. § 21.02(a) (Vernon 2006).

Before reaching the question of whether the State has jurisdiction to tax tangible personal property, a taxpayer must first decide which year is the relevant year to consider the property’s location and use. In Alaska Flight Services, the owner located the aircraft in Texas in 2001 and, for that year, it had more than 23% of its total departures from locations within Texas. However, in early January 2002, the owner flew the aircraft from Texas to Alaska where all of its other 2002 departures occurred.

*Tip: Look at the dates that your property is (and has been) located, used, and operated in Texas. January 1 is a critical date. Jurisdiction to tax tangible personal property in any given tax year depends on the location and use of the property in the preceding year. Consider the following:

• Appraise property by January 1. Property located in Texas must be appraised for property tax purposes as of January 1 of the tax year. Tex. Tax Code Ann. § 23.01 (Vernon 2006).
  
  
• Determine jurisdiction by January 1. Each county appraisal unit must determine by January 1 whether it has jurisdiction to tax the property.
  
  
• Tax based on previous year’s location. A county appraisal unit must look to the location and use of the property in the year prior to January 1 of the relevant tax year.
  
  
• Avoid tax if property is used exclusively outside of Texas. Property is not taxable in Texas if it is operated or located exclusively outside of Texas during the year preceding the tax year and on January 1 of the tax year. Tex. Tax Code Ann. § 11.01(d) (Vernon 2006).

*Technical Point: If you look to the year preceding the tax year to determine whether property is not taxable, it makes sense to look at the same year to determine whether property is taxable.

Property Used Continually in Texas Is Taxable

The next issue is the interpretation of the statute allowing the State to tax tangible personal property that is “used continually, whether regularly or irregularly, in this state.” See Tex. Tax Code Ann. § 11.01(c)(3) (Vernon 2006). The plain meaning of the words controls. Also, the words used must be considered in the context of the rest of the statute to determine the meaning and intent.\

*Technical Point: In Alaska Flight Services, the Court chose to rely on Webster’s Ninth New Collegiate Dictionary which defines the root word of continually – or continue – in four ways:

(1) to maintain without interruption a condition, course, or action (the boat continued downstream);

(2) to remain in existence; endure (the tradition continues);

(3) to remain in a place or condition; stay (cannot continue here much longer);

(4) to resume an activity after interruption (we’ll continue after lunch).

Webster’s Ninth New Collegiate Dictionary 284 (1985).

Because the general rule in Texas is that jurisdiction to tax depends on how long the property is located in the State, the third definition above is the most appropriate to use. Further, the third definition addresses presence in a location, which is most critical to the jurisdictional question, whereas, the other definitions address movement (the first), endurance (the second), and resumption of activity (the fourth).

As used in Section 11.01 of the Tax Code, the word “continually” means while present in the State, though not necessarily exclusively, for some period of the tax year.

*Warning: For tax purposes, tangible personal property is “used continually, whether regularly or irregularly, in this state” if the property is used while it is present in Texas, during the tax year. The use of the property can be regular or irregular in pattern or amount, so long as the property is used over the course of the tax year.

A person uses aircraft, at a minimum, for takeoffs and flying to other locations. As the Dallas Court of Appeals concluded in Alaska Flight Services, an aircraft having more than 23% of its total departures from Texas is a significant percentage for property tax purposes.

*Warning: A lower percentage of departures could be deemed sufficient to establish taxable jurisdiction over an aircraft. Even a few departures could be enough for taxable jurisdiction to exist.

Why Case Matters

Alaska Flight Services is an important case for taxpayers because it is the first time a Texas court has addressed when moveable tangible personal property is “used continually” in the state. A conclusion that property is used continually in Texas will be subject to property taxes. In effect, the decision gives, for Texas counties more leeway to assess taxes on more personal property. As more Texas counties face budget shortfalls like that in Dallas County, there is little doubt they will use as much leeway as possible to capture more property tax revenue.

Nevertheless, it is important to understand that:

Rule May Not Apply. Section 11.01(c) will not always apply. The specific facts of each case will determine whether it applies to your situation, especially those facts surrounding the location and use of the property.

Taxpayer Can Allocate Tax Liability. Assuming jurisdiction exists to tax tangible personal property, the taxpayer may still be entitled to an allocation of taxes if the property is also taxable in other states.

*Tip: Evaluate the allocation of tax early in the appraisal and assessment process to protect your own interests.

Conclusion

As the cities and counties around Texas take the hit from the mortgage crisis and other reductions in revenue, these jurisdictions can be expected to fight for ways to tax personal property such as aircraft and vehicles. The case, Alaska Flight Services, LLC v. Dallas Central Appraisal District, suggests clearly that a wise taxpayer with such property in Texas will plan for and actively counter the relentless effort by tax authorities to lighten the taxpayer’s pockets to meet county revenue shortfalls.

Thanks to Robert A. Hawkins, a litigator at Patton Boggs LLP, located in Dallas, for contributing the article, and to Jason Forshee, a tax attorney at Patton Boggs LLP, also located in Dallas, for editing this article.

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2. Top Five Conditions to Financing a Natural Gas Storage Facility

As consumers pump gasoline from underground tanks at persistently high prices, natural gas storage projects pump gas into storage reservoirs at market rates. Increasingly in demand, gas storage reservoirs provide a useful method to store, trade, and facilitate shipment of supplies of natural gas to various customers for use in homes and businesses as the need arises.

According to the U.S. Federal Energy Regulatory Commission (FERC), there are three major types of underground reservoir facilities used to store gas in today’s market. The first and most common type is underground storage in depleted gas or oil fields. The second type of underground storage is aquifer storage, made possible by injecting gas in formations filled with water and displacing that water with the natural gas. The third type is salt cavern storage, which requires the removal of layers of salt and brine, thereby creating a cavern in which to store gas. See Novel Pad Gas Lease Supports Project Financing of Natural Gas Storage Facility, Business Leasing and Finance News (Oct. 2006).

Natural gas demand continues to rise, but available gas storage remains limited. The development of independent gas storage projects is severely constrained by challenging geological formations and limited availability of pipeline infrastructure to transport the gas.

*Terms to Know: Pad Gas refers to the volume of natural gas injected into a storage reservoir that must remain in the storage facility to provide the required pressurization to extract the remaining gas. In effect, pad gas creates a permanent lining or base in an underground gas storage reservoir into which other gas, called working gas, is deposited Working gas may be injected, withdrawn, and sold in the gas marketplace for use in heating, electricity generation, and other typical applications by industry and other gas suppliers, marketers, or users.

To finance these projects, lenders typically examine a myriad of elements of a natural gas storage project to determine whether the project is financeable under a project financing structure.

*Term to Know: ” Project financing refers to funding a project, such as a gas storage facility, in which the lender structures and approves a transaction on the assumption that the cash flow from the project will alone be sufficient to pay for the lender’s debt service and other costs of operating the project. The lender also assumes that it will have no recourse (non-recourse) to the borrower for repayment of its debt, but will acquire a security interest in the tangible projects assets and project documents.

Typically, lenders will make a construction loan to build a storage facility, including extraction/injection equipment, as well as equipment that maintains and manages the flow of natural gas. The construction loan may convert into a term loan from the same lender or a group of lenders. Other lenders may “take out” the construction lender for permanent financing.

A sponsor can lease pad gas from an owner/lessor as a method of managing the project’s balance sheet, shifting ownership to the owner/lessor, and potentially improving the willingness of debt and equity players to invest in a storage project. See Unique Pad Gas Lease Supports Project Financing and Development of Gas Storage Facility in U.S., by David G. Mayer (with Fortis Capital Corp.), Asset-Based Lending Review, Financier Worldwide (Nov. 2006).

*Warning: Hedge agreements fix the price of the sale of natural gas at the end of the term of the hedge (which, if possible, should coincide with the expiration of the lease term). Pad gas lease hedge agreements should be structured carefully to fix the value of pad gas that a lessor recovers at the end of the lease term. The value supports the economic assumptions in the project proforma. As a lessee, evaluate the hedges that your lenders and lessors require because you will almost always have to pay any shortfall in the payments due to the lessor to make it whole.

Significant risks exist in the development and financing of natural gas storage facilities and leasing pad gas in those facilities. As a result, a project lender and pad gas lessor will impose significant conditions on the project to qualify for advances with respect to the construction of the facility and its permanent financing. The discussion below assumes that the project is funded as a project financing.

Although subject to debate, depending on the circumstances and type of project, the following general areas constitute the top five conditions to funding a gas storage facility:

1) Proforma and Budget. The financial projections for a project must demonstrate that the cash flows from customers will pay for the debt service, including all operating costs, with a margin to spare. The most important element of the proforma/budget is to reflect long-term, creditworthy off-take customers, such as utility companies, that pay for the storage of their working gas.

*Insight Point: From the standpoint of an underground storage sponsor (i.e., an equity provider), however, long-term contracts may not always be optimal. These contracts tend to attract customers who want long-term storage for strategic/contingency and other reasons. This approach may severely limit customers who will pay higher rates for shorter-term storage. Given this dynamic, sponsors may ask the higher-paying capacity takers to invest some equity in the project and thereby potentially avoid or limit the use of bank financing.

2) Technology/Engineering. The design and viability of the storage facility must satisfy lenders/lessors that the facilities will perform as represented by the developer and as reflected in the proforma/budget. The engineering aspects of the facility should satisfy rigorous review by independent engineering consultants with emphasis on the capability of the reservoir(s) to hold natural gas without significant losses. Also, the developer must demonstrate that the storage reservoirs will accept injections and withdrawals at the rate per day (or other metric) assumed in the proforma.

*Insight Point: Some sponsors believe that salt cavern facilities with their shorter extraction/filling times (as compared to depleted fields and aquifers) are more valuable in that they tend to be favored by traders who will pay higher rates to the sponsors.

3) Real Estate/Mineral Rights. One of the most time-intensive aspects of a project is acquiring real estate and access rights for the reservoirs. Lenders/lessors must confirm that developers/borrowers/lessees have obtained adequate real estate rights to operate the project. In a default, lenders will also need assurance that they can exercise remedies and take over real estate rights that enable them (or, more likely, their designee) to operate the facility without interference from local property owners. The rights must include easements and or leases for access to the project site and for delivery of the natural gas to its owners or buyers. Developers/borrowers/lessees should plan to obtain title opinions or title insurance as one of the most important aspects of meeting this condition.

4) Permits and Approvals. All parties must cope with the constraints from the regulatory regime affecting storage of natural gas, including FERC (in the U.S.), environmental laws, and local laws. Lenders/lessors must be satisfied that the project has all permits and approvals to complete the design and construction and developers/borrowers/lessees must secure such permits and approvals to sanction full operation and maintenance of the facility. Typically, this condition includes a lender/lessor request that the developer deliver legal opinions confirming that the developer possesses all required permits and approvals.

5) Project and Credit Documents. Project and credit documentation will typically be very extensive. These documents are important because they assure the lenders/lessors and operators that the project is subject to written requirements consistent with the operating budget, proforma projections, and business plans hashed out by the parties. Working gas customers sign the most important contracts because those contracts provide the cash flow (payment for storage and other services provided by the project) to pay all costs of the project, including the payment obligations to lenders/lessors. For example, lenders will expect to review and obtain a security interest in such project documents as customer working gas agreements, a fixed-price construction contract (with appropriate bonding and liquidated damage provisions), gas transportation and interconnection agreements, and an operating and maintenance (or management services) agreement. Risk management in each project is crucial. Thus, the inclusion of proper insurance coverage and evidence of documentation is critical to protect the interests of all parties. The conditions should reflect all of these requirements.

*Tip: Although the list above offers five of the major conditions to financing a natural gas storage facility, each gas storage project requires the insight and experience of knowledgeable business people, lawyers, consultants, and engineers, among others, to design, contstruct from and operate, and finance these projects. See Unique Pad Gas Lease Supports Project Financing and Development of Gas Storage Facility in U.S., by David G. Mayer (with Fortis Capital Corp.), Asset-Based Lending Review, Financier Worldwide (Nov. 2006).

As the number of natural gas storage facilities increases, so too will competition among lenders, lessors, consultants, and other parties involved in the financing of these projects. However, the conditions list will remain largely the same, varying primarily to fit the particular project characteristics. Consequently, pricing and other factors, such as unique experience of bidders, could determine which lenders and/or lessors will win a mandate to finance these transactions. That realization will promote the design, construction, operation, and financing of gas storage projects in the years to come.

Thanks to Mark Reid, Head of Oil and Gas, London, Energy, Commodities, and Transportation, Merchant Banking at Fortis Bank, for contributing to this article.

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3. Case & Comment: U.S. Court of Appeals Upholds Graves Amendment in Garcia v. Vanguard

Lessors can breathe a bit easier about potential liability for accidents of their lessees of motor vehicles. See Garcia v. Vanguard Car Rental USA, Inc., 2008 WL 3842963 (C.A.11 2008). Although this case does not answer all the questions pertaining to lessor liability in these instances, it represents the first time a federal appellate court has handed down a decision concerning the Graves Amendment (describes below).

Congress enacted the Graves Amendment in August 2005 to bar vicarious liability claims against long-term lease and rental car companies. The U.S. Court of Appeals for the Eleventh Circuit found Congress had the authority to enact the Graves Amendment under the Commerce Cause of the U.S. Constitution.

BACKGROUND: The Garcia case arose from a three-car accident involving a rental car. Jose Garcia and Nelson Ruiz died from the accident and Israel Lopez suffered severe injuries. The car rental company anticipated a claim for vicarious liability and therefore filed a declaratory judgment action seeking a declaration that the Graves Amendment preempts such claims. The estates and surviving spouses of Jose Garcia and Nelson Ruiz then filed wrongful death actions against the car rental company

ISSUES: Does the Graves Amendment preempt the claims asserted by the estates and spouses of Jose Garcia and Nelson Ruiz? Did Congress have the authority to enact the Graves Amendment?

OUTCOME/DECISION: The answer to both issues is “yes.”The Court of Appeals affirmed the grant of summary judgment in favor of the car rental company, finding the claims asserted by the estates and spouses of Jose Garcia and Nelson Ruiz are preempted by the Graves Amendment and are not within its savings clause. The court also found that Congress had the power to enact the Amendment.

LAW OF THE CASE: In this case, the suit against the car rental company was based upon the dangerous instrumentality doctrine and not upon any action of the car rental company.

*Term to Know: Under the dangerous instrumentality doctrine, strict vicarious liability is imposed upon the owner of a motor vehicle who voluntarily entrusts that motor vehicle to an individual whose negligent operation causes damage to another. This doctrine applies to lessors of vehicles like the car rental company involved in the Garcia case.

In 1999, the Florida legislature imposed statutory caps on the amount of vicarious liability car rental companies could face under this doctrine. The statute provides, in part, that:

The lessor, under an agreement to rent or lease a motor vehicle for a period of less than 1 year, shall be deemed the owner of the vehicle for the purpose of determining liability for the operation of the vehicle or the acts of the operator in connection therewith only up to $100,000 per person and up to $300,000 per incident for bodily injury and up to $50,000 for property damage. If the lessee or operator of the vehicle is uninsured or has any insurance with limits less than $500,000 combined property damage and bodily injury liability, the lessor shall be liable for up to an additional $500,000 in economic damages only arising out of the use of the motor vehicle.

See Fla. Stat. §324.021(9)(b)(2). This statute clearly imposes strict liability against a car rental company for the negligent acts of its lessee while placing a cap on the damages that can be awarded. The estates and spouses of Jose Garcia and Nelson Ruiz rely on this statute to sue the car rental company. The first issue questioned is whether or not the Graves Amendment preempts this statute and precludes the estates and spouses of Jose Garcia and Nelson Ruiz from bringing wrongful death suits against the car rental company?

The Graves Amendment has two operative provisions, a preemption clause and a savings clause. The preemption clause provides:

An owner of a motor vehicle that rents or leases the vehicle to a person (or an affiliate of the owner) shall not be liable under the law of any State or political subdivision thereof by reason of being the owner of the vehicle (or an affiliate of the owner) for harm to persons or property that results or arises out of the use, operation, or possession of the vehicle during the period of the rental or lease, if (1) the owner (or an affiliate of the owner) is engaged in the trade or business of renting or leasing motor vehicles, and (2) there is no negligence or criminal wrongdoing on the part of the owner (or an affiliate of the owner).

49 U.S.C. §30106(a). The claims the estates and spouses of Jose Garcia and Nelson Ruiz assert against the car rental company are clearly within the scope of this provision. Therefore, the Graves Amendment preempts these claims unless they fall within the statute's savings clause.

The savings clause provides:

Nothing in this section supersedes the law of any state or political subdivision thereof-

(1) imposing financial responsibility or insurance standards on the owner of a motor vehicle for the privilege of registering and operating a motor vehicle; or

(2) imposing liability on business entities engaged in the trade or business of renting or leasing motor vehicles for failure to meet the financial responsibility or liability insurance requirements under state law.

See 49 U.S.C. §30106(b). The savings clause exempts from preemption laws that impose financial responsibility or insurance standards, or laws that penalize the failure to meet the financial responsibility or liability insurance requirements under state law. Therefore, states may suspend the license and registration of, or otherwise penalize, a car owner who fails to meet the financial responsibility requirement, or who fails to pay a judgment resulting from a collision, but they cannot impose judgments against rental car companies based solely on the negligence of their lessees. The estates and spouses of Jose Garcia and Nelson Ruiz did not rely upon the financial responsibility statutue. Therefore, the Graves Amendment preempts the liability claims against the lessor under the Florida statute.

The next issue questioned is whether Congress can enact this preemptive legislation under the Commerce Clause. Under the Commerce Clause, Congress may regulate purely intrastate activities when they “substantially affect” or have a “substantial relation to” interstate commerce. The commercial leasing of cars is, in the aggregate, an economic activity with substantial effects on interstate commerce. This categorization stems from the size and national scope of the industry, and because rental cars are frequently employed as instrumentalities of interstate commerce. For regulation of intrastate activities to survive review under an aggregation analysis, Congress need only have a rational basis for concluding that the intrastate activity would undermine the lawful Commerce Clause goals of a federal statute if left untouched. Congress could have perceived strict vicarious liability for the acts of lessees as a burden on the commercial leasing of cars industry because the costs of strict vicarious liability against rental car companies are borne by someone, most likely the customers, owners, and creditors of rental car companies. This liability would make rental cars more expensive and thereby inhibit interstate commerce. Additionally, if the costs are passed on to the owners of car rental companies, it could drive less-competitive companies out of the marketplace and inhibit entry into the market, potentially reducing options for consumers. Therefore, Congress had a rational basis for enacting the Graves Amendment and Congress had the authority to enact same.

The Garcia case is an important case of first impression. No other federal appellate court has analyzed the preemptive scope of the Graves Amendment or its constitutionality. The decision in Garcia is binding over federal cases originating in the states of Alabama, Florida, and Georgia. It is not binding upon federal cases originating in other states, but is persuasive authority for district courts in other states and for other United States Courts of Appeal. Until and unless the United States Supreme Court reverses this decision or overrules this decision in another case, the focus in future cases is likely to be whether the statute at issue is a financial responsibility or a strict liability statute.

*Tip: Lessors of vehicles should maintain insurance that meets or exceeds the insurance coverage requirements to demonstrate financial responsibility under applicable state law and to avoid the uncertainty of exposure to strict liability for a lessee’s accidents.

Depending upon the outcome of the upcoming elections, plaintiffs’ lawyers may lobby heavily for a change in legislation. But for now the Graves Amendment lives and the findings that the Graves Amendment preempts strict vicarious liability claims far outweigh findings to the contrary.

Thanks to Connie Ariagno, a litigation Partner in the Dallas office of Patton Boggs, for contributing this article.

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4. BLFN’s Leasing 101: What Is a “Severability Provision” in an Insurance Policy?

Lessors can breathe a bit easier about potential liability for accidents of their lessees of motor vehicles. See Garcia v. Vanguard Car Rental USA, Inc., 2008 WL 3842963 (C.A.11 2008). Although this case does not answer all the questions on lessor liability in these instances, it represents the first time a federal appellate court has handed down a decision concerning the Graves Amendment (describes below).

Congress enacted the Graves Amendment in August 2005 to bar vicarious liability claims against long-term lease and rental car companies. The U.S. Court of Appeals for the Eleventh Circuit found Congress had the authority to enact the Graves Amendment under the Commerce Cause of the U.S. Constitution.

BACKGROUND: The Garcia case arose from a three-car accident involving a rental car. Jose Garcia and Nelson Ruiz died from the accident and Israel Lopez suffered severe injuries. The car rental company anticipated a claim for vicarious liability and therefore filed a declaratory judgment action seeking a declaration that the Graves Amendment preempts such claims. The estates and surviving spouses of Jose Garcia and Nelson Ruiz then filed wrongful death actions against the car rental company

ISSUES: Does the Graves Amendment preempt the claims asserted by the estates and spouses of Jose Garcia and Nelson Ruiz? Did Congress have the authority to enact the Graves Amendment?

OUTCOME/DECISION: The answer to both issues is “yes.”The Court of Appeals affirmed the grant of summary judgment in favor of the car rental company, finding the claims asserted by the estates and spouses of Jose Garcia and Nelson Ruiz are preempted by the Graves Amendment and are not within its savings clause. The court also found that Congress had the power to enact the Amendment.

LAW OF THE CASE: In this case, the suit against the car rental company was based upon the dangerous instrumentality doctrine and not upon any action of the car rental company.

*Term to Know: Under the dangerous instrumentality doctrine, strict vicarious liability is imposed upon the owner of a motor vehicle who voluntarily entrusts that motor vehicle to an individual whose negligent operation causes damage to another. This doctrine applies to lessors of vehicles like the car rental company involved in the Garcia case.

In 1999, the Florida legislature imposed statutory caps on the amount of vicarious liability car rental companies could face under this doctrine. The statute provides, in part, that:

The lessor, under an agreement to rent or lease a motor vehicle for a period of less than 1 year, shall be deemed the owner of the vehicle for the purpose of determining liability for the operation of the vehicle or the acts of the operator in connection therewith only up to $100,000 per person and up to $300,000 per incident for bodily injury and up to $50,000 for property damage. If the lessee or operator of the vehicle is uninsured or has any insurance with limits less than $500,000 combined property damage and bodily injury liability, the lessor shall be liable for up to an additional $500,000 in economic damages only arising out of the use of the motor vehicle.

See Fla. Stat. §324.021(9)(b)(2). This statute clearly imposes strict liability against a car rental company for the negligent acts of its lessee while placing a cap on the damages that can be awarded. The estates and spouses of Jose Garcia and Nelson Ruiz rely on this statute to sue the car rental company. The first issue questioned is whether or not the Graves Amendment preempts this statute and precludes the estates and spouses of Jose Garcia and Nelson Ruiz from bringing wrongful death suits against the car rental company?

The Graves Amendment has two operative provisions, a preemption clause and a savings clause. The preemption clause provides:

An owner of a motor vehicle that rents or leases the vehicle to a person (or an affiliate of the owner) shall not be liable under the law of any State or political subdivision thereof by reason of being the owner of the vehicle (or an affiliate of the owner) for harm to persons or property that results or arises out of the use, operation, or possession of the vehicle during the period of the rental or lease, if (1) the owner (or an affiliate of the owner) is engaged in the trade or business of renting or leasing motor vehicles, and (2) there is no negligence or criminal wrongdoing on the part of the owner (or an affiliate of the owner).

49 U.S.C. §30106(a). The claims the estates and spouses of Jose Garcia and Nelson Ruiz assert against the car rental company are clearly within the scope of this provision. Therefore, the Graves Amendment preempts these claims unless they fall within the statute's savings clause.

The savings clause provides:

Nothing in this section supersedes the law of any state or political subdivision thereof-

(1) imposing financial responsibility or insurance standards on the owner of a motor vehicle for the privilege of registering and operating a motor vehicle; or

(2) imposing liability on business entities engaged in the trade or business of renting or leasing motor vehicles for failure to meet the financial responsibility or liability insurance requirements under state law.

See 49 U.S.C. §30106(b). The savings clause exempts from preemption laws that impose financial responsibility or insurance standards, or laws that penalize the failure to meet the financial responsibility or liability insurance requirements under state law. Therefore, states may suspend the license and registration of, or otherwise penalize, a car owner who fails to meet the financial responsibility requirement, or who fails to pay a judgment resulting from a collision, but they cannot impose judgments against rental car companies based solely on the negligence of their lessees. The estates and spouses of Jose Garcia and Nelson Ruiz did not rely upon the financial responsibility statutue. Therefore, the Graves Amendment preempts the liability claims against the lessor under the Florida statute.

The next issue questioned is whether Congress can enact this preemptive legislation under the Commerce Clause. Under the Commerce Clause, Congress may regulate purely intrastate activities when they “substantially affect” or have a “substantial relation to” interstate commerce. The commercial leasing of cars is, in the aggregate, an economic activity with substantial effects on interstate commerce. This categorization stems from the size and national scope of the industry, and because rental cars are frequently employed as instrumentalities of interstate commerce. For regulation of intrastate activities to survive review under an aggregation analysis, Congress need only have a rational basis for concluding that the intrastate activity would undermine the lawful Commerce Clause goals of a federal statute if left untouched. Congress could have perceived strict vicarious liability for the acts of lessees as a burden on the commercial leasing of cars industry because the costs of strict vicarious liability against rental car companies are borne by someone, most likely the customers, owners, and creditors of rental car companies. This liability would make rental cars more expensive and thereby inhibit interstate commerce. Additionally, if the costs are passed on to the owners of car rental companies, it could drive less-competitive companies out of the marketplace and inhibit entry into the market, potentially reducing options for consumers. Therefore, Congress had a rational basis for enacting the Graves Amendment and Congress had the authority to enact same.

The Garcia case is an important case of first impression. No other federal appellate court has analyzed the preemptive scope of the Graves Amendment or its constitutionality. The decision in Garcia is binding over federal cases originating in the states of Alabama, Florida, and Georgia. It is not binding upon federal cases originating in other states, but is persuasive authority for district courts in other states and for other United States Courts of Appeal. Until and unless the United States Supreme Court reverses this decision or overrules this decision in another case, the focus in future cases is likely to be whether the statute at issue is a financial responsibility or a strict liability statute.

*Tip: Lessors of vehicles should maintain insurance that meets or exceeds the insurance coverage requirements to demonstrate financial responsibility under applicable state law and to avoid the uncertainty of exposure to strict liability for a lessee’s accidents.

Depending upon the outcome of the upcoming elections, plaintiffs’ lawyers may lobby heavily for a change in legislation. But for now the Graves Amendment lives and the findings that the Graves Amendment preempts strict vicarious liability claims far outweigh findings to the contrary.

Thanks to Connie Ariagno, a litigation Partner in the Dallas office of Patton Boggs, for contributing this article.

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About Patton Boggs LLP

Patton Boggs LLP is a law firm of approximately 600 attorneys and other professionals located in Washington DC, Northern Virginia, New Jersey, New York, Dallas, Denver, Anchorage, and internationally in Abu Dhabi, United Arab Emirates and Doha, Qatar.

Patton Boggs has major practice areas in Business, Intellectual Property, Public Policy, and Litigation. These areas are composed of many practice groups designed specifically to meet client needs and the trends in developing legal markets. David G. Mayer often focuses on aviation, energy, transportation, infrastructure, and technology transactions.

The firm provides a broad array of skills in domestic and international business transactions, including equipment finance and leasing, corporate finance, secured transactions, syndications, mezzanine finance, aviation and transactions law, federal leasing, project finance, real estate, health care, pharmaceuticals, technology transactions, and public policy work.

Partial List of Publications

The following is a partial list of articles written or co-authored by David G. Mayer:

‘Perfect Pay’ Provisions In Troubled Credit Markets, by Chuck Cross and David G. Mayer, LNJ Leasing Newsletter (Feb. 2007)

Equipment Leasing and CERCLA Liability, by Russell V. Randle and David G. Mayer, LNJ Leasing Newsletter (Dec. 2007).

Navigating the New Reality of Equipment Leasing and CERCLA Liability, by Russell V. Randle and David G. Mayer, LNJ Leasing Newsletter (Nov. 2007).

Managed Service Providers Use Innovative Capital Structures to Fund CAPEX, Financier Worldwide, by David G. Mayer (May 2007).

The USA PATRIOT Act Renewed: Reassessing Money Laundering Risk in Finance Transactions, by Stephen J. McHale and David G. Mayer, LNJ Leasing Newsletter (Two Parts: Nov. & Dec. 2006).

Unique Pad Gas Lease Supports Project Financing and Development of Gas Storage Facility in U.S., by David G. Mayer (with Fortis Capital Corp.), Asset-Based Lending Review, Financier Worldwide (Nov. 2006).

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I would like to thank BLFN’s team at Patton Boggs LLP. The team includes the Patton Boggs staff: our Senior Writer, Jennifer Becker, our Marketing Manager, Mark Holub, our Project Manager, Melissa Green, my assistant, Michelle Sims, and our designers, Winston Jackson and Kiasha Sullivan. Thanks also to Douglas C. Boggs, a Business Group/Securities partner and web site reviewer for BLFN, and our Marketing Chief, Mary Kimber, for assisting BLFN through our firm’s editing, design, and posting process.

All the best,

David

David G. Mayer

Founder: Business Leasing and Finance News
(formerly Business Leasing News)
Partner: Patton Boggs LLP
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Suite 3000
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© David G. Mayer 2008

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