How do courts use the 'residual position' to differentiate between a lease and a loan?

The concept of the "residual position" is essential in determining whether an agreement is a lease or a loan. When evaluating the terms of a leasing agreement, courts consider whether the lessee has an option to purchase the leased property at a substantially favorable rate compared to its market value at the end of the lease term. If the lease includes a provision that permits the lessee to buy the asset at a price that is significantly below its fair market value, it can create an impression that the agreement functions more like a loan rather than a traditional lease.

In this context, a "substantial purchase option" indicates that the lessee is effectively being given an incentive to purchase the asset at a price that does not reflect its actual market value, which aligns more with the characteristics of a loan. A lease generally should not offer such a significant financial advantage for purchasing the asset because it typically provides the right to use the asset without the intent to acquire ownership for a substantial discount.

The other choices present scenarios that do not adequately capture the essence of how the residual position influences the classification between lease and loan. Therefore, understanding the implications of a substantial purchase option is key to navigating these classifications effectively.