Personal Property Foreclosures: Navigating the Commercially Reasonable Standard
Foreclosure of personal property is a necessary evil for lenders in the commercial default context, and the foreclosure and sale must meet the commercially reasonable standard to withstand later scrutiny by competing creditors and unrequited borrowers. While the uncertainty associated with this standard can be daunting, it is not insurmountable if the sale meets the statutory requirements for notice and is otherwise the product of an arms’ length negotiation or bid process. The following guide is meant to help navigate the basic requirements of Article 9 of the Uniform Commercial Code (UCC) in commercial transactions.
Getting Possession of the Property
The first step in liquidating personal property is obtaining possession of it. Under § 9-609, this does not have to be done through a judicial process if the repossession can be done peacefully and without any threat of physical force. (If not, the creditor risks liability for conversion, breach of the peace and potential other tort-like claims.) Appropriate ways of repossessing property are factually dependent and should be suitable for the collateral at issue, but the general rule of thumb is that secured creditors have the right to immediate possession of the collateral upon default.
The next threshold requirement for a personal property foreclosure or sale is to ensure that notice of the sale is proper and reasonable. The goal of reasonable notice is to give the debtor an opportunity to exercise its right of redemption and to also allow parties in interest to protect their interests prior to the sale.
Required Notice Parties
Section 9-611 requires a secured creditor to send the debtor and any “secondary obligor” (every guarantor) an “authenticated notification of disposition” before proceeding with disposition of the collateral, unless the right to notice has been waived after default under § 9-624. The foreclosing creditor must also send notice to any person or entity from whom the creditor has received a claim of interest in the collateral, and any other security interest-holders in the property that filed a proper financing statement within 10 days of the date that the notice is sent. (UCC § 9-611 does include a safe-harbor provision to protect secured parties who make a reasonable attempt to find all interested parties.) The only exceptions to the notification requirements found in § 9-611 are for collateral that is perishable, that threatens to rapidly decline in value, or that is sold on a recognized market, such as publicly traded stocks and bonds.
Content of the Notice
At a minimum, § 9-613 requires that the notice (1) identify the debtor and the secured party conducting the sale; (2) describe the property; (3) state the method of sale; (4) disclose the debtor’s entitlement to an accounting of the unpaid debt, as well as the cost associated with preparing such accounting; (5) be signed by the secured party (when applicable, an electronic signature is acceptable under § 9-102(7)); and (6) if the property is being sold via a public sale, include the time and place of the sale. If the property is being sold privately, the notice must also give the debtor a deadline to redeem the property under § 9-623. Section 9-613 contains a safe-harbor form of Notification of Disposition of Collateral that will suffice as a matter of law. In addition, the official comments to § 9-613 provide that notification of a public disposition conducted electronically will be sufficient if the notice “states the time when the disposition is scheduled to begin and ... Internet address where the site of the public disposition can be accessed.” A proper notice must also comply with any applicable state-specific or federal law requirements.
Method and Timeliness of Notice
Section 9-611(b) only requires that notice be “sent”; thus, notices may be mailed, faxed or emailed, provided that they can reasonably be expected to reach the intended party. If sent in good faith, a notice sent to a person’s last known address will be sufficient, even if not received. A notification sent after default and at least 10 days before the date of the intended sale are within the safe harbor set forth in § 9-612.
Commercially Reasonable Sale
The specific property at issue will dictate what process is commercially reasonable under the circumstances. While the commercially reasonable standard is somewhat fluid and certainly imprecise, the more the transaction is tested in the marketplace, the more likely it is that the sale will withstand later scrutiny. Private sales are permitted; however, public sales are generally more successful at surviving challenges of compliance, and the circumstances under which the secured party may purchase the collateral in a private sale are very limited under § 9-610(c)(2).
The primary benefit of proceeding by public sale is that courts will generally find that a true public sale (i.e., one where the public is invited to attend — think real advertising dollars being spent on publicizing the opportunity) is per se commercially reasonable, provided notice was proper. This almost-bulletproof presumption can make the added cost attendant to proceeding by public sale worth every penny. In a public sale, competitive bidding will usually be permitted, with the sale being awarded to the highest and best bidder. It is also better if the sale can be held at a place where the property is able to be inspected.
If privately sold, the property should either be sold on a recognized market, or the value of the property should be reasonably ascertainable in the marketplace. Even with a private sale, the time, place and manner of selecting a buyer must be reasonable for the type of property, and the sale should be an arms’ length transaction. To best protect themselves, a client should engage a dealer or auctioneer who regularly deals with the type of property at issue.
Consequences of Failure to Conduct Commercially Reasonable Sale
Most often what is at stake with personal property sales under the UCC is the preservation of the deficiency. In fact, the failure to conduct a commercially reasonable sale may result in the deficiency being $0 as set forth in § 9-626, which also provides that if a secured party’s compliance with the statutes is placed at issue, it is the secured party’s burden to show that the proper procedure was followed. In addition to concerns about protecting the right to pursue any deficiency, a secured party who does not conduct a personal property foreclosure in compliance with the UCC directives risks liability for losses caused by the noncompliance, including “loss resulting from the debtor’s inability to obtain, or increased costs of, alternative financing.”Finally, a flawed sale may generate claims for fraudulent conveyance, successor liability, subordination and other consequential damages. Lenders, beware.
Acceptance of Collateral in Satisfaction of Debt
If, instead of selling the property at a public auction, a secured party wishes to retain the property and accept it as satisfaction of the debt, it may do so under § 9-620, otherwise known as a “strict foreclosure.” Under a strict foreclosure, the client must obtain actual or implied consent from the debtor. Similar to a foreclosure sale, the client must also notify other interested parties, and these parties have the right to object to the secured creditor’s acceptance and thereby derail this process. However, unlike a foreclosure sale, there is no safe-harbor provision under strict foreclosure, so the secured creditor must be very careful to notify all appropriate parties.