Law360 - June 2, 2015
When a debtor defaults on a loan secured by personal property, the secured lender has several options for repayment. One option is to sell the collateral securing the debt pursuant to Article 9 of the Uniform Commercial Code (UCC).[1] From the senior secured lender’s viewpoint, an Article 9 sale may be a preferred option to maximize its recovery because the process is expedited, avoids the administrative costs and delays associated with an alternative bankruptcy sale, and divests junior security interests by operation of law. From the debtor’s perspective, cooperating with an under-secured senior creditor to repay its debt (in whole or in part) through an Article 9 sale may prove advantageous, especially if the debtor can negotiate a release of deficiency claims, personal guarantees or specific collateral to distribute to remaining creditors. A debtor’s cooperation may also be consistent with its contractual obligation under its loan documents. With the right type of collateral and business circumstances, an Article 9 sale supported by the debtor and the secured lender can maximize the secured lender’s recovery and at the same time discharge the debtor’s duties and obligations to its creditors. This article discusses the procedures of an Article 9 sale as well as the advantages and pitfalls.
Sale Remedy — Personal Property
UCC 9-610(a) provides that “[a]fter default, a secured party may sell, lease, license or otherwise dispose of any or all of the collateral in its present condition or following any commercially reasonable preparation or processing.”[2] Article 9 thus offers broad flexibility to the secured lender in the sale of its collateral. The guiding principle, however, is that “every aspect” of a sale, “including the method, manner, time, place and other terms, must be commercially reasonable.”[3] Whether a sale is commercially reasonable is a question of fact.[4] Therefore, the secured lender’s adherence to the procedures delineated in Article 9 is crucial.
Mechanics
Public vs. Private Sale — Personal Property
Generally, a secured lender cannot purchase collateral in a private sale unless the collateral is “of a kind customarily sold on a recognized market” or “the subject of widely distributed standard price quotations."[5] Therefore, in certain instances, a public sale is required. A public sale must be advertised in a commercially reasonable manner and accessible to the public to create an “opportunity for competitive bidding.”[6] If the secured lender is not interested in owning the collateral and a single purchaser has expressed sufficient interest, a private sale to that third party purchaser is likely the preferred path forward. An Article 9 private sale can be consummated expeditiously because there is no requisite marketing process. However, the sale must still follow the statutory rules for notification and must be commercially reasonable.
Notice
Article 9 specifically requires an “authenticated notification of disposition.” Notice must be reasonable with respect to timing, manner and content.[7] The notice parties include the debtor, any secondary obligor and certain other parties. The parties entitled to notice are: (i) any person who has notified the foreclosing lender that it claims an interest in the collateral; (ii) any other secured party who has perfected a security interest or other lien on the collateral by filing in the appropriate office(s) of a financing statement that described the collateral and is indexed under the debtor’s name; and (iii) any other secured party who has perfected a security interest or other lien on the collateral pursuant to 9-311(2) of the UCC.[8] With respect to the foregoing clause (ii), where the foreclosing lender performs a UCC lien search in the appropriate filing office between 20 and 30 days prior to the date of notification of the sale, the safe harbor provisions will insulate the foreclosing lender in the event other secured parties are later discovered. While notice must be reasonable, the foreclosing lender is deemed compliant under a safe harbor provision if notice is given to the notice parties 10 days or more prior to the date of sale. It should be noted that judicial lien creditors are not included as parties to be notified under UCC 9-611 but their liens, if subordinate, are divested by the sale.[9] As such, prudent practitioners nevertheless may notice such lien holders.
The notice must include: (i) a description of the debtor; (ii) a description of the secured party; (iii) a description of the collateral to be sold; (iv) a statement of the method of intended disposition; (v) a statement that the debtor is entitled to an accounting of the outstanding debt; and (vi) if a public sale, the time and place of the sale, or, if a private sale, the date after which the collateral will be sold.[10]
Commercial Reasonableness
Article 9 requires that every aspect of the sale “including the method, manner, time, place, and other terms” must be commercially reasonable.[11] A sale is commercially reasonable if conducted “in the usual manner” or “at the current price” of “any recognized market” or “in conformity with the reasonable commercial practices among dealers in the type of property” sold.[12] Generally, evidence that a higher price for the collateral “could have been obtained” does not “preclude” a finding of commercial reasonableness, but “a court should scrutinize” aspects of a sale of collateral where the price is suspect.[13] Courts consider factors such as whether the foreclosing lender sought to obtain the best price, whether the sale was private or public, the condition of the collateral, efforts to enhance the collateral value, the marketing involved, the number of bids received, and the method of soliciting bids.[14] While there is no specific marketing process to be followed for a private sale, to satisfy the reasonableness standard, parties may still hire brokers, contact customers, competitors and other potential bidders to meet their burden and at the same time enhance the prospect of a higher return. Thus, even though the foreclosing lender is not required to procure the best price for the collateral, taking steps to maximize recovery will help to ensure the sale is commercially reasonable.
Buyer Takes Free and Clear of Certain Liens
Upon completion of a properly conducted Article 9 sale, the buyer takes whatever rights the debtor had in the collateral, and the foreclosing party’s security interest and “subordinate security interests” and liens are discharged.[15] Senior security interests and liens remain.[16]
Applying the Proceeds
Proceeds of the sale are applied first to expenses,[17] then to the satisfaction of the secured lender’s outstanding debt,[18] and, thereafter, to the satisfaction of any debts secured by junior security interests.[19] Any surplus must be remitted to the debtor.[20] If the proceeds are insufficient to satisfy the secured lender’s debt after paying expenses, the secured lender may pursue a claim against the debtor (and other secondary obligors, if any) to collect the deficiency.[21] The secured lender must follow any applicable deficiency judgment statutes to preserve its deficiency claim.
Advantages
An Article 9 private sale of personal property can be advantageous to the buyer, the debtor and the secured lender. For example, the initial interested buyer at a private sale may be able to avoid the impact, expense and delay of competitive bidding associated with a bankruptcy auction process. Indeed, buyers often are willing to accept potential and limited fraudulent transfer risks in an out-of-court secured creditor sale. This is especially true where a lender’s secured debt is far in excess of the value of the collateral being sold because a Chapter 7 trustee or creditors’ committee in a subsequently filed bankruptcy generally will not challenge the sale as a fraudulent transfer because of the absence of damages to unsecured creditors.
From the lender’s perspective, an Article 9 private sale has several advantages. First, timing can be critical. Some distressed businesses cannot survive even an accelerated bankruptcy process without significant deterioration in the asset value. Because an Article 9 private sale is an out-of-court process, it can occur quickly. This process avoids the post-petition administrative costs and expenses associated with a Chapter 11 bankruptcy, including a carveout for debtor and committee professionals fees. Another benefit to the Article 9 private sale is that it eliminates the risk that some bankruptcy courts will not allow a sale to proceed in circumstances where only the secured lender benefits. An additional advantage is that the lender can deliver the collateral to the buyer free and clear of junior liens.[22] While challenges may still be asserted against the senior lender, out-of-the-money junior lien creditors lack incentive to incur litigation costs to challenge an Article 9 sale when the collateral values do not support a recovery for them.
From the debtor’s perspective, an insolvent debtor has a duty to maximize the value of its assets. In most instances, a debtor will have a contractual duty under its loan documents to turn over the collateral to its secured lender upon default. Consequently, where a secured lender holds a blanket lien on all assets, and where an alternative sale process or other strategy will not yield any recovery for other creditors (but rather will simply reduce the available proceeds for the secured creditor), the debtor arguably has satisfied its duty in cooperating with an Article 9 sale. An Article 9 sale may provide an opportunity for the debtor to negotiate the release of personal guarantees, deficiency claims or specific collateral in exchange for cooperation. Not surprisingly, some debtors may hesitate to file a bankruptcy petition where there is no value to distribute to unsecured creditors after the secured creditor is paid because a bankruptcy case provides a forum for litigation. In a bankruptcy context, with no available assets, a Chapter 7 trustee or a creditors’ committee may target their investigation against the directors and officers of an insolvent company. Avoiding bankruptcy under these circumstances eliminates the readily available forum for litigation.
Pitfalls
Real Property
An Article 9 sale is not always a feasible alternative. An Article 9 sale cannot be used for real property. Where the buyer desires to assume the leasehold rights of the debtor, Article 9 does not provide a mechanism to transfer the leasehold estates. Absent a lessor’s consent to the transfer, the parties may be relegated to a bankruptcy filing.
Strict Adherence to Article 9
Failure to adhere to the statutory requirements or follow commercially reasonable standards may result in challenges to the sale. A court may order or restrain the sale.[23] Statutory damages may apply if the collateral is consumer goods.[24] Further, the secured lender may be liable for any loss it has caused by its noncompliance.[25] In reality, however, establishing the value of the loss caused by the secured lender’s noncompliance is difficult. Often times, the price at which the collateral would have sold but for the secured lender’s noncompliance is usually unknown. Note that the secured party’s failure to comply with Article 9 in the sale process will not affect the rights of the transferee that acts in good faith.[26]
Rebuttable Presumption
The secured lender’s noncompliance with the statutory requirements of Article 9 may result in the elimination or reduction of its deficiency claim. If the secured lender’s compliance is questioned, Article 9’s rebuttable presumption rule places the burden of proving compliance on the secured lender.[27] If the secured lender fails to meet its burden, its deficiency claim “is limited to an amount by which the sum of the secured obligations, expenses, and attorney’s fees exceeds the greater of the proceeds of the [sale] or the amount of proceeds that would have been realized had the non-complying secured [lender] proceeded in accordance with the specified provisions of [Article 9].”[28] Unless the secured lender can prove that the collateral, at the time of the sale, was worth less than the amount of its outstanding debt, its recovery will be limited to the amount of the sale proceeds.[29] Since actual value is difficult to establish, the presumption places a burden on the secured lender and its application can result in either the elimination or reduction of the secured lender’s deficiency claim.
Successor Liability
Another sale consideration for a buyer is successor liability. If a buyer has concerns about successor liability, it may desire the additional protections afforded by a bankruptcy court “free and clear” order. In many states, four exceptions to the general rule that a buyer of assets is not liable for the debts of the seller apply: (1) whether the buyer agreed to assume the liabilities, (2) whether there was a de facto merger of the buyer and the seller, (3) whether the buyer is a mere continuation of the seller, and (4) whether the sale was intended to avoid the seller’s liabilities and thereby defraud its creditors.[30] The first exception may be avoided by expressly providing in the agreement that the buyer is not assuming the seller’s liabilities. The other exceptions are less easily avoided. For example, the mere continuation exception can arise where the buyer has owners or managers in common with the seller or retains employees of the seller and continues the business. Additionally, an inadequate sale price might trigger the fraud exception. Again, the type of business, past operations and assets to be sold will dictate whether successor liability is a risk that warrants an alternative strategy.
Nonconsensual Foreclosure
An Article 9 sale may not be practical if the debtor is unwilling to cooperate. For example, issues may arise as to gaining possession of and physically conveying or delivering the collateral to the buyer. Additionally, an uncooperative debtor is more likely to challenge the sale based on lack of commercial reasonableness or to file a bankruptcy petition before the sale is consummated.
Conclusion
A sale under Article 9 may be ideal where the defaulting borrower is a small or mid-sized company that is willing to cooperate and where any fair sale value would be less than the secured lender’s outstanding debt. This situation is ripe for the secured lender to maximize its recovery by avoiding judicial involvement and the time and cost of a sale in bankruptcy. To be sure, there are pitfalls and risks, but a secured lender should consider the economic and practical benefits of an Article 9 sale when forced to look to its collateral to satisfy a debt.
Footnotes
[1] See U.C.C. § 9-610(a) (2014).
[2] Id. § 9-610(a).
[3] Id. § 9-610(b).
[4] See, e.g., Colonial Pacific Leasing Corp. v. N & N Partners, 981 F.Supp.2d 1345, 1350 (N.D. Ga. 2013) (explaining that commercial reasonableness is “normally a question of fact”).
[5] Id.
[6] Id. § 9-610 cmt. 7.
[7] Id. § 9-611 cmt. 2.
[8] Id. § 9-611(c) (A), (B) & (C).
[9] Id. § 9-617.
[10] Id. § 9-610(1).
[11] Id.§ 9-610(b).
[12] Id. § 9-627(b).
[13] Id. § 9-627(a); id. § 9-627 cmt. 2.
[14] See, e.g., Colonial Pacific Leasing Corp. v. N & N Partners, LLC, 981 F.Supp.2d 1345, 1350 (N.D. Ga. 2013). See also, What’s “Commercially Reasonable” for Article 9 Foreclosure Sales, Blank Rome LLP (Jan. 16, 2014), http://www.blankrome.com/index.cfm?contentID=37&itemID=3243 for a discussion of a case decided under Delaware law holding that the public sale of a debtor’s assets to a private equity firm was commercially reasonable.
[15] U.C.C. § 9-617(a).
[16] See id. § 9-617(c).
[17] Id. § 9-615(a)(1).
[18] Id. § 9-615(a)(2).
[19] Id. § 9-615(a)(3).
[20] Id. § 9-615(d)(1).
[21] Id. § 9-615(d)(2).
[22] Id. § 9-617(a)(3).
[23] Id. § 9-625(a).
[24] Id. § 9-625(c).
[25] Id. § 9-625(b).
[26] Id. § 9-617(b).
[27] Id. § 9-626 cmt. 3. The rebuttable presumption rule does not apply in consumer transactions. Id. § 9-626(a).
[28] Id. § 9-626(a)(3).
[29] Id. § 9-626(a)(4).
[30] Call Center Techs., Inc. v. Grand Adventures Tour and Travel Publ’g Corp., 635 F.3d 48, 52 (2d Cir. 2011) (holding that genuine issues of material fact existed regarding successor liability where, among other things, buyer’s business retained some senior managers and thirty one of fifty one employees, operated in the same building, and provided many of the same services as seller’s business); see also Auto. Innovations, Inc. v. J.P. Morgan Chase Bank, N.A., No. A-1473-12T3, 2014 WL 7745773 (N.J. Super. Ct. App. Div. Feb. 5, 2015) (holding purchaser of collateral could not use Revised Article 9 to shield itself from successor liability as judgment creditors’ lien was not discharged by § 9-622 because a judgment does not become a lien on personal property until there is a levy which did not occur in this case).
"A Look at the Friendly Foreclosure Option," by Regina Stango Kelbon and Jillian Zvolensky appeared in Law360 on June 2, 2015. Reprinted with permission. To view the article online, please click here. The original version of this article was presented at the ABA Business Law Section Spring Meeting in April 2015. Click here to learn more.
