Finance Lessors Not Subject to Strict Products Liability

Until today, there were no appellate cases decided by the California courts on the issue of whether Lessors of equipment under finance leases could be liable in strict products liability for injuries caused by defective leased equipment. Today, Finance Lessors can rest easy, knowing that, just like the courts in the other jurisdictions that have considered the question, the California courts have held that Finance Lessors cannot be held liable for product defects in the products that are subject to their leases. The case is Arriaga v. Citicapital Commercial Corporation (Decided November 3, 2008).

Some background is helpful to understanding this decision and whether it applies to a given situation. The law of Strict Product Liability is founded on the notion that costs of injuries resulting from defective products should be borne by the manufacturers, retailers and others who play an integral part of the overall producing and marketing enterprise. Just who fits that "others" category is not clearly defined. But the court have applied a three part test to determine if someone other than a manufacturer or retailer can also be held strictly liable for a defective product. Those three factors are 1) that the person received a direct financial benefit from its activities and the sale of the product; 2) that the person's role was integral to the business enterprise such that his conduct was a necessary factor in bringing the product to the initial consumer market; and 3) that the person had control over, or a substantial ability to influence, the manufacturing or distribution process.

Applying this three part test, the courts in California have previously found that Lessors of personal property, wholesale and retail distributors, and licensors can all be subject to strict products liability. The general rubric of the court is that these people place the goods on the market, knowing that they will be used without inspection for defects. So, why wouldn't Finance Lessors also be liable?

To understand, we have to look at the policy considerations that justify strict products liability in the first place and see how those policies would be furthered by holding Finance Lessors liable in strict products liability.

The policy justifying strict products liability is that such liability enhances product safety, maximizes protection to the injured parties and apportions costs among all those in the chain of distribution.

There are a number of characteristics that make Finance Lessors different. First and foremost is the fact that the Finance Lessor's product is the lending of money and not the introduction of goods into the marketplace. A Finance Lessor does not select the equipment subject to the lease. The Finance Lessor does not usually have any ongoing relationship with a particular manufacturer. In the typical finance lease, the Finance Lessor negotiates a "Lease Line" with the Lessee and the Lessee then selects equipment that the Lessor then purchases and leases to the Lessee. The Lessor never takes possession of the equipment and never has any opportunity to inspect the equipment. The Lessor disclaims any warranties, including that of merchantability. Under the California Commercial Code, the Lessee is entitled to the benefits of the warranties of the original manufacturer.

Because of these characteristics of a Finance Lease, the Finance Lessor has no ability to exert any pressure on the manufacturer to enhance the safety of the product, plays no roll in the producing or marketing enterprise of the product and so the policies that justify strict products liability simply do not apply to finance lessors.

Now, there is one troubling section in today's decision. The decision talks about a finance lease as a disguised security interest, a secured installment sales contract, or a lease intended as security. While some finance leases are indeed disguised security agreements, most finance leases are not. Most require more than a token payment at the end of the lease term in order for the lessee to acquire title to the equipment. And although I don't think that this characterization of finance leases as ones that might also be disguised security interests is determinative to the question of liability, it is troubling that the court apparently misunderstood the true definition of a finance lease, when it is so clearly defined in the California Commercial Code.

Now, the reason I think it makes no difference to the decision, is that the true defining characteristics of a finance lease are the things that the court talked about when it evaluated whether or not a finance lessor could be subject to strict products liability - that the lessor does not select, manufacture or supply the goods, that the lessor acquires the goods in connection with the lease and that the lessee is informed about or approves the contract by which the lessor acquires the goods.