In re Pillowtex, Inc.

Duke Energy Royal LLC (Duke) (plaintiff) and Pillowtex Corporation (Pillowtex) (defendant) entered a Master Energy Services Agreement (MESA). Under it, Duke obtained and installed energy-savings equipment, including light fixtures and a hot-water heating system in facilities operated by Pillowtex. In exchange, Pillowtex agreed to make predetermined monthly payments for the equipment for eight years. The monthly payments were tied to Pillowtex’s energy savings, but the agreement provided that all of Duke’s costs would be repaid within five years. The useful life of the equipment was between 20 and 25 years. The parties intended the transaction to be a true lease. At the end of the term, Duke had four options: (1) remove the equipment and replace it with equipment equivalent to the original equipment, (2) abandon the equipment, (3) extend the agreement on mutually agreeable terms, or (4) sell the equipment to Pillowtex for a mutually agreeable price. Under the first option, all costs associated with the removal and replacement were to be paid by Duke. An official of Pillowtex testified that the understanding of the parties was that Duke would exercise the second option, due to the cost associated with removal and replacement. Two years into the agreement, Pillowtex filed for bankruptcy and stopped making payments. Duke moved the bankruptcy court to compel Pillowtex to make the payments, arguing that the transaction was a lease. Pillowtex argued that the transaction created a security interest, which was unperfected. The district court determined that the transaction created a security interest, based upon the economic-realities test, and denied Duke’s motion. Duke appealed to the United States Court of Appeals for the Third Circuit.