Moritt Hock & Hamroff recently reported on the impact of the COVID-19 pandemic on Uniform Commercial Code (“UCC”) Article 9 sales. Now, a second significant decision on this issue has been published. While our last alert concerned whether Article 9 sales may proceed in light of Governor Andrew Cuomo’s Executive Order precluding foreclosures (and reported a decision holding such Article 9 sales may proceed), this latest decision addresses the Article 9 “commercial reasonableness” standard in the present environment, holding that the sale terms established by the lender in question were not reasonable and staying the sale for at least thirty (30) days.
Under the Uniform Commercial Code (“UCC”), “[e]very aspect of a disposition of collateral, including the method, manner, time, place, and other terms, must be commercially reasonable.” See N.Y. U.C.C. § 9-610(b). This raises the question of what is “commercially reasonable” in the COVID-19 environment? In a decision issued on June 23, 2020 in the case of D2 Mark LLC v. OREI VI Investments, LLC, Index No. 652259/2020, Justice Andrea Masley of Commercial Division of the New York State Supreme Court in Manhattan held that a sale scheduled on only thirty-six (36) days’ notice, requiring the winning bidder to make a non-refundable deposit of 10% of the purchase price, pay the remainder within 24 hours, and preventing the borrower from bidding, was commercially unreasonable – particularly in light of the present COVID-19 pandemic.
The loan at issue is a mezzanine loan secured by membership interests in an entity that owns the Mark Hotel located at Madison Avenue and East 77th Street. There are two loans on the property – a $230 million senior loan, and the $35 million mezzanine loan at issue. In light of the COVID-19 pandemic and the shuttering of New York City, the borrower was late on a single payment on the mezzanine loan (the payment due in May 2020), and failed to make two payments on the senior loan (April and May 2020), which resulted in a cross default under the mezzanine loan. As a result of the late and missed payments, the lender declared an Event of Default and scheduled a UCC Article 9 sale.
The borrower alleged that the property was worth upwards of $600 million — well in excess of the senior and mezzanine loans combined — and that the mezzanine lender was using the COVID-19 pandemic, and the unreasonable auction sale procedures it utilized, to buy the property on the cheap. The Article 9 sale procedures in question included:
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- Only 36 days’ notice – the sale notice was issued May 18, 2020, and the sale was to proceed June 24, 2020. The borrower alleged that generally auctions are done on 60-90 days’ notice.
- Requiring the winning bidder to pay a non-refundable deposit of 10% of the purchase price.
- Requiring the winning bidder to pay the remaining amount of the purchase price within 24 hours of the end of the auction.
- Prohibiting the borrower from bidding (although this restriction was lifted June 8, 2020).
- Prohibiting any potentially interested party from communicating with the borrower.
- Not making sufficient accommodations regarding the actual auction in light of COVID-19 (including potentially having the auction live at the lender’s attorneys’ offices).
- Effectively precluding any potentially interested party from visiting the hotel until June 15, 2020, when the Mark Hotel was allowed to re-open.
- Allowing the lender to “credit bid,” or bid the amount of the outstanding loan plus interest and costs, before or after third party bidding closed.
The Court agreed these terms were commercially unreasonable. Indeed, the Court noted that there were only 2 bidders that proceeded to the stage where they were required to provide financials. The Court therefore ordered that the June 24, 2020 auction must be canceled, that the sale be must re-noticed, that the auction cannot proceed for at least thirty (30) days, and that bidders must have the option of participating virtually.
This decision highlights the importance of insuring that Article 9 sales are commercially reasonable, particularly in the present COVID-19 environment. Moritt Hock & Hamroff’s creditors rights’ team continues to follow the courts’ diverging views on navigating foreclosures in New York and how to best satisfy the commercial reasonableness requirement under the facts and circumstances of each particular situation.
Key Takeaways:
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- In the COVID-19 environment, there will likely be a number of defaults under mezzanine financing agreements.
- If you plan to notice an Event of Default and schedule an Article 9 sale, you need to insure that the terms of the sale are “commercially reasonable.”
- Court are likely to be more stringent regarding the commercial reasonableness requirement in the present COVID-19 environment.
- To insure that the sale is deemed commercially reasonable, some measures to take include (i) insuring there is enough time between the notice of the sale and the actual auction; (ii) insuring the auction notice is published in a manner intended to reach as many potential bidders as possible; (iii) insuring the bidders have either access to the property or where that is not feasible, reasonable data on the property and its condition; (iv) insuring that the financial terms of the auction are not onerous; (v) insuring that the borrower is not precluded from bidding; and (vi) insuring that bidders may participate virtually.
