                             In the
 United States Court of Appeals
               For the Seventh Circuit
                          ____________

Nos. 05-1460, 05-1461 & 05-1462
IN RE: UNITED AIR LINES, INC.,
                                                            Debto r.
UNITED AIR LINES, INC.,
                                                        Ap p ellant,
                                 v.

U.S. BANK NATIONAL ASSOCIATION, INC.,
CITY OF LOS ANGELES, et al.,
                                                        Ap p ellees.
                          ____________
             Appeals from the United States District Court
         for the Northern District of Illinois, Eastern Division.
    Nos. 04 C 3357, 04 C 3359 & 04 C 3358—John W. Darrah, Jud ge.
                          ____________
      ARGUED FEBRUARY 16, 2006—DECIDED MAY 4, 2006
                     ____________



  Before BAUER, EASTERBROOK, and MANION, Circuit Jud ges.
  MANION, Circuit Jud ge. To fund improvements at its
facilities in the Los Angeles International Airport, United
Air Lines, Inc., entered into a transaction with a bond-
issuing, public entity named the Regional Airports Improve-
ment Corporation (“RAIC”). Through this transaction, RAIC
“subleases” certain airport facilities to United. After United
entered bankruptcy, the true nature of the transaction was
2                             Nos. 05-1460, 05-1461 & 05-1462

called into question. In adversary proceedings before the
bankruptcy court against RAIC and two related parties (the
City of Los Angeles and an indenture trustee), United
sought to have the transaction treated as a loan rather than
a lease for purposes of § 365 of the Bankruptcy Code, 11
U.S.C. § 365. The bankruptcy court ruled in United’s favor,
but the district court reversed. United appeals. We ad-
dressed a substantially similar matter concerning the San
Francisco International Airport in United Airlines, Inc. v.
HSBC Bank USA, N.A., 416 F.3d 609 (7th Cir. 2005), cert.
d enied , 126 S. Ct. 1465 (2006). As in the San Francisco
appeal, we agree with United that the Los Angeles transac-
tion is not a lease for § 365 purposes. We therefore reverse
the district court’s decision to the contrary.
  Before detailing the Los Angeles transaction, it is helpful
to reiterate the importance of the lease-versus-loan distinc-
tion in this context. When a lease is at issue, “[a] lessee must
either assume the lease and fully perform all of its obliga-
tions, or surrender the property. 11 U.S.C. § 365. A borrower
that has given security, by contrast, may retain the property
without paying the full agreed price. The borrower must
pay enough to give the lender the economic value of the
security interest; if this is less than the balance due on the
loan, the difference is an unsecured debt. See 11 U.S.C.
§ 506(a) and § 1129(b)(2)(A).” United Airlines, 416 F.3d
        1
at 610.


1
  We add a brief word about United’s plan of reorganization,
which the bankruptcy court confirmed on February 1, 2006,
thereby enabling United to “exit” bankruptcy. At oral argument,
United informed us that, under the plan of reorganization, the
disputed transaction here is provisionally treated as a lease,
consistent with the most recent judicial ruling on the matter, that
                                                    (continued...)
Nos. 05-1460, 05-1461 & 05-1462                                 3

  Since at least 1982, United has leased its space in the Los
Angeles airport from the City of Los Angeles. In order to
arrange financing to improve and construct facilities in that
space, United worked with RAIC, which, as a public entity,
could issue tax-exempt bonds. RAIC was formed by the
City, but it is a separate legal entity. United’s lease with the
City anticipated that United would use RAIC’s bond-issuing
authority to fund the development of the airport facilities.
On November 15, 1982, United and RAIC executed a
transaction to achieve that end.
  Two agreements are at the heart of the United-RAIC
transaction. The first agreement is termed the “partial
assignment,” through which United assigned a portion of its
leasehold (i.e., its interest under its lease with the City) to
RAIC. In return, RAIC issued tax-exempt bonds, raising
$75,750,000 to develop the facilities in question. Administra-
tive matters related to these bonds, such as distributing
payments to bondholders, are handled by an indenture
trustee, currently U.S. Bank N.A.
  The second agreement is entitled the “facilities sublease.”
Under this agreement, RAIC “leased” back the then to-be-
developed facilities to United. In exchange, United pays
“rent” that is equal to the amount necessary to cover the
payments to the underlying bondholders plus administra-
tive costs. Currently, the bondholders receive periodic
interest-only payments and are also entitled to balloon


(...continued)
of the district court. Furthermore, United conditionally assumed
this “lease.” Nevertheless, according to United, this conditional
assumption will terminate if, in the end, this transaction is
judicially determined to be a loan. In which case, it will then be
treated as pre-petition debt. Accordingly, we have a live,
justiciable controversy before us.
4                           Nos. 05-1460, 05-1461 & 05-1462

payments for the outstanding principal, now $59,390,000,
when the bonds mature. United has already redeemed
bonds totaling $16,360,000 of the original $75,750,000.
Presently, there are two sets of bonds outstanding. One set,
with a balloon payment of $34,390,000 is due to mature on
November 15, 2012, and the other, with a balloon payment
of $25,000,000, is due to mature on November 15, 2021.
These periodic and balloon “rental” payments from United
go through the indenture trustee to the bondholders. The
term of the sublease is completely dependent upon United’s
payment or redemption of the bonds. As such, the sublease
is scheduled to expire in 2021 with the payment of the final
set of outstanding bonds unless United redeems all the
bonds earlier.
  In the earlier appeal regarding United’s dealings at the
San Francisco airport, we resolved two key issues for
deciding whether a transaction, such as the one before us, is
a lease under § 365 of the Bankruptcy Code. The first issue
was whether the form of the document should be control-
ling in this situation—that is, whether a transaction should
be treated as a lease simply because the parties titled it a
“lease” and used terms such as “rent.” Agreeing with a
number of other circuits’ opinions, we concluded that § 365
mandates that the substance of the transaction trumps the
form of the transaction. See United Airlines, 416 F.3d at 612
(citing In re PCH Asso cs., 804 F.2d 193, 198-200 (2d
Cir.1986); In re Pillo w tex, Inc., 349 F.3d 711, 716 (3d Cir.
2003); In re Mo reggia & So ns, Inc., 852 F.2d 1179, 1182-84
(9th Cir. 1988); In re Pac. Exp ress, Inc., 780 F.2d 1482,
1486-87 (9th Cir. 1986)). We reasoned: “It is unlikely that the
Code makes big economic effects turn on the parties’ choice
of language rather than the substance of their transaction;
why bother to distinguish transactions if these distinctions
can be obliterated at the drafters’ will?” United Airlines, 416
Nos. 05-1460, 05-1461 & 05-1462                                 5

F.3d at 612. Accordingly, we held that, as a matter of federal
law, the genuine nature of a transaction will prevail over the
titles and terms used. See id . at 612-14.
   The second issue we tackled in the prior case was whether
federal or state law governed the lease-versus-loan
determination—in other words, to which law should courts
look to ascertain the “aspects of substance” that are impor-
tant in deciding whether a transaction is a lease. Id . at 614.
Because the Bankruptcy Code is silent on which economic
features should shape the inquiry, we determined that, in
general, the state law is controlling. See id . at 615 (“All of
the states have devoted substantial efforts to differentiating
leases from secured credit in commercial and banking law.
Leases are state-law instruments, after all, and the norm in
bankruptcy law is that contracts (of which leases are a
species) and property rights in general have the same force
they would have in state court, unless the Code overrides
the state entitlement.”). There is, however, an exception to
this general rule. State law will not control if it conflicts with
federal law by requiring a formalistic rather than a func-
tional approach as described above. See id . This exception
is not a concern in the present appeal. The applicable state
law here is that of California, and, as we already determined
in the San Francisco appeal, California law does not conflict
with federal law in this regard. See id . at 615-16 (explaining
Burr v. Cap ital Reserve Co rp ., 458 P.2d 185 (Cal. 1969) and
Beeler v. Am . Trust Co ., 147 P.2d 583 (Cal. 1944)); see also
Milana v. Cred it Disco unt Co ., 163 P.2d 869, 871 (Cal. 1945)
(“[I]f [achieving a loan is] the intent of the parties the
transaction will be deemed a loan regardless of its form.”).
  The similarities between the substance of the present
transaction (described above) and the substance of the
transaction in our earlier opinion concerning the San
Francisco airport are important. In the prior case, United
6                             Nos. 05-1460, 05-1461 & 05-1462

had a long-running, traditional airport lease with the City
and County of San Francisco. See United Airlines, 416 F.3d
at 611. Then, to improve its facilities at the San Francisco
airport, United worked with a bond-issuing, public entity
named the California Statewide Communities Development
Authority (“CSCDA”). See id . Through a series of agree-
ments, CSCDA gave United $155 million in bond revenues
to develop airport facilities. See id . at 611-12. The deal called
for United to “sublease” a portion of its underlying lease-
hold with the City and County of San Francisco to CSCDA.
See id . at 611. Then, CSCDA “leased” this same portion back
to United in exchange for United’s promise to make peri-
odic “rental” payments that equated to the amounts needed
to pay interest on the aforementioned bonds plus some
administrative fees. See id . Additionally, United had to
make a $155 million balloon payment at the end of the
“lease” in order to retire the bonds. See id . An indenture
trustee, HSBC Bank USA, N.A., administered bond-related
matters for CSCDA, which included receiving United’s
“rental” payments and distributing those payments to the
bondholders. See id . at 612.
  There, like here, after United entered bankruptcy, the
parties disputed whether the United-CSCDA transaction
concerning the San Francisco airport was a lease under
§ 365. In our review of the substance of that transaction
under California law, we concluded that it was a secured
loan and not a lease based upon five aspects of the transac-
tion: (1) the fact that United’s “rental” payments were tied
to the amount borrowed from the bondholders; (2) the
presence of a balloon payment; (3) the presence of a “hell or
high water” clause, meaning United had to pay the full
“rental” amount if even the property became unusable; (4)
the fact that prepayment of United’s obligations would end
the United-CSCDA arrangement; and (5) the fact that
Nos. 05-1460, 05-1461 & 05-1462                             7

CSCDA did not have a remaining interest in the property at
the end of the transaction. See id . at 617.
  Each of these factors is present in this case as well.
Accordingly, for the reasons discussed below, we likewise
conclude that the United-RAIC transaction involving the
Los Angeles airport is not a lease for § 365 purposes. We
will examine each point in turn.
  First, in the San Francisco transaction, United’s “rent” was
based not upon the market value of the property in question
but rather upon the amount United borrowed to develop its
airport facilities. See id . at 617. Similarly here, United’s
“rent” is linked to the amount it borrowed, albeit indirectly,
from the bondholders. Although RAIC claims that United’s
“rental” payments represent market-value compensation to
RAIC for the use of the facilities, the United-RAIC sublease
explicitly equates “rent” to the sum needed “to pay the
interest on, premium, if any, and principal of the Bonds.”
The substance here is thus more indicative of loan payments
rather than traditional rental payments that compensate the
lessor for the lessee’s consumption of the lessor’s property.
See id . at 616-17; Beeler, 147 P.2d at 592 (linking rental
payments to an interest rate “constitute[d] a ‘strong circum-
stance’ tending to show that the ‘rent’ under the lease
agreement was in reality an interest payment consistent
with the character of the transaction as a loan”); Ro chester
Cap ital Leasing Co rp . v. K & L Litho Co rp ., 91 Cal. Rptr.
827, 830 (Cal. Ct. App. 1970) (supposed “ ’rental’ amounts
were calculated with an eye upon [the supposed lessor’s]
expected rate of return on its investment” thereby indicating
that the disputed transaction was a loan); Go ld en State
Lanes v. Fo x, 42 Cal. Rptr. 568, 569, 571-72 (Cal. Ct. App.
1965).
  Second (and closely related to the first point), the San
Francisco transaction involved a balloon payment, and there
8                           Nos. 05-1460, 05-1461 & 05-1462

we observed that “the balloon payment has no parallel in a
true lease, though it is a common feature of secured credit.”
United Airlines, 416 F.3d at 617. Here as well, United is
required to make balloon payments to retire the outstanding
principal when the bonds mature in 2012 and 2021. At its
core, “[a] loan of money is the delivery of a sum of money
to another under a contract to return at some future time an
equivalent amount.” Sw . Co ncrete Pro d s. v. Go sh Co nstr.
Co rp ., 798 P.2d 1247, 1249 (Cal. 1990); see also Milana, 163
P.2d at 871. The balloon payments here are tremendously
revealing in this regard. They make plain that, at the outset,
United borrowed $75,750,000 and promised to return that
same $75,750,000 in the future. United’s balloon obligations
are thus powerful evidence that the design of this transac-
tion is that of a loan. See United Airlines, 416 F.3d at 617;
Go ld en State, 42 Cal. Rptr. at 569, 571-72 (disputed transac-
tion held to be a loan when the supposed lessee received
$150,000 to fund a construction project, was then obligated
to pay $30,000 per year for eight years (i.e., interest), and
was further obligated to return the $150,000 at the end of the
eight-year term (i.e., principal)).
  Third, the San Francisco transaction contained a “hell or
high water” clause which showed a telling disjoint between
rental value and United’s actual financial obligations. See
United Airlines, 416 F.3d at 617. A similar clause is present
here. Under the sublease, United must continue paying
“rent” to service and ultimately retire the bonds even if the
premises at issue are condemned, destroyed, or otherwise
become unusable. The clause characterizes United’s “rental”
obligation as “absolute and unconditional.” See Go ld en
State, 42 Cal. Rptr. at 571-72 (disputed transaction held to be
a loan when the supposed lessee was “unconditionally
obligated” to make periodic payments and “absolutely
bound” to repay an identical sum that had been advanced
to it at the outset of the transaction). This clause stands in
Nos. 05-1460, 05-1461 & 05-1462                             9

stark contrast to the more typical provision in the underly-
ing lease between United and the City of Los Angeles. In
that lease, if the premises are destroyed, the City must abate
United’s rent while the premises are unusable. Further,
United may, in certain situations, terminate the lease if the
City, when required to do so, cannot make the necessary
repairs within a reasonable time. At bottom, the “hell or
high water” clause in the United-RAIC sublease is further
evidence that the “rent” here is not payment for the value of
using the facilities but rather is for the value of the money
borrowed. See United Airlines, 416 F.3d at 617; Go ld en
State, 42 Cal. Rptr. at 571-72.
   Fourth, in the San Francisco transaction, if United prepaid
its financial obligations, the prepayment terminated the
lease arrangement in that transaction. See United Airlines,
416 F.3d at 617. Likewise here, the United-RAIC sublease
will immediately terminate if United prepays the bonds.
Such a prepayment provision has a useful purpose in the
financing context. In the event interest rates become more
favorable, a borrower would ordinarily prefer a prepayment
option in an agreement so as to have the opportunity to
refinance its debt. By contrast, such a prepay-
ment/termination provision would be superfluous in the
context of a lease. It would make little economic sense for a
lessee to prepay its full rental obligations and thereby cause
its lease to terminate and the value of its prepayment to
evaporate. Rather, with such a prepayment, the lessee
would want to see the lease to its natural end, either to
occupy or to sublet the premises for the prepaid period.
Consequently, the prepayment-termination nexus in this
arrangement further shows that the substance here is that of
a loan, not a lease. See id .
  Fifth, in the San Francisco case, the fact that CSCDA did
not have a remaining interest in the property at the end of
10                           Nos. 05-1460, 05-1461 & 05-1462

the transaction was another indicator of a loan. See id . RAIC
is in the same position here. RAIC acquired its interest here
through the partial assignment from United, and, under its
terms, the assignment terminates when United retires the
bonds and thereby terminates the United-RAIC sublease.
RAIC, therefore, has no reversionary interest when the deal
ends—much like a lender when a secured loan is paid off.
See id .; Go ld en State, 42 Cal. Rptr. at 572 (disputed transac-
tion held to be a loan when the supposed lessor was bound
to fully reconvey the property upon repayment of the sum
it had initially advanced to the supposed lessee). This factor
is yet another reason to view this transaction as a secured
loan and not a lease. Separately, RAIC points out that at the
end of the United-RAIC arrangement, the property at issue
reverts the underlying landlord, the City of Los Angeles.
However, this circumstance does not negate the fact that
RAIC does not have a reversionary interest. To combat this
conclusion, RAIC further attempts to cast itself and the City
as one in the same. However, as mentioned above, RAIC is
an independent legal entity under California law. See Rid er
v. City o f San Diego , 959 P.2d 347, 349, 350-52 (Cal. 1998).
  RAIC raises an additional point that bears mentioning. In
the San Francisco transaction, the bond-financed develop-
ments were not built upon the portion of United’s leasehold
that United “subleased” to CSCDA to secure the deal. See
United Airlines, 416 F.3d at 611. Here, by contrast, the bond-
financed developments are constructed upon the property
that United assigned to RAIC. RAIC contends that this
difference establishes that United’s payments are true rental
payments in that they show that the payments were com-
pensating RAIC for United’s use of the facilities and not for
the value of borrowed money. However, the property
disconnect in the San Francisco case only made it more
obvious that United’s payments were not rental payments.
Nos. 05-1460, 05-1461 & 05-1462                            11

The lack of a similar disconnect here does not override the
discussion above. In other words, it does not alter the fact
(1) that the United-RAIC sublease expressly ties United’s so-
called rent to the interest and principal payments on the
bonds, (2) that the arrangement required United to return
the $75,750,000 initially advanced, (3) that the deal uncondi-
tionally obligated United to make payments even if the
premises became unusable, (4) that United’s prepayment
would terminate the supposed sublease, and (5) that RAIC
has no reversionary interest in the property at the conclu-
sion of the arrangement. The presence of these consider-
ations here strongly points to the existence of a secured loan
and not a lease.
  Each side raises additional points in support of their
respective positions, but they do not compel elaboration
here. It suffices to say that United’s Los Angeles transaction
with RAIC has all the hallmarks of a secured loan that were
critical to our decision in the San Francisco appeal. In a
fashion similar to the San Francisco arrangement, United
used a leasehold interest to acquire financing from bond-
holders, and United’s payments to the bondholders do not
resemble true rental payments. We see no grounds to treat
the San Francisco and Los Angeles transactions differently
in this context. Accordingly, the transaction between United
and RAIC concerning the Los Angeles airport is a secured
loan and not a lease for purposes of § 365. The judgment of
the district court is REVERSED, and the case is REMANDED for
further proceedings consistent with this opinion.
12                     Nos. 05-1460, 05-1461 & 05-1462

A true Copy:
       Teste:

                     _____________________________
                   Clerk o f the United States Co urt o f
                     Ap p eals fo r the Seventh Circuit




                USCA-02-C-0072—5-4-06
