The Uniform Commercial Code (UCC) provides a number of post-default remedies a secured lender can pursue without commencing litigation or any judicial intervention whatsoever. This alert, Part 1, and Part 3 to follow describe some of these remedies.
Often, the first thing people think of when it comes to realizing on collateral is sale. The UCC gives a secured party the right to obtain possession of and sell its collateral—but there are conditions and pitfalls to watch out for.1
Obtaining Possession of Collateral
Under the UCC, upon default, the secured party can direct the debtor to assemble the collateral and make it available to the secured party at a reasonably convenient place selected by the secured party. Unfortunately, once a default has occurred, a borrower is often less than cooperative when it comes to helping the lender exercise its remedies.
Fortunately, the UCC also allows a secured party to take possession of its collateral and, without removal, render equipment unusable without borrower cooperation or assistance. The secured party can do this on its own (i.e., self-help) as long as this can be done without “breach of the peace.” Unfortunately, “breach of the peace” is not defined in the statute, and court decisions have set a low bar for when a secured lender’s actions cross that threshold. A lender pursuing these self-help remedies should work closely with experienced legal counsel to help ensure its actions do not cross the line. Under the right circumstances, an appropriate agreement with the landlord entered into at the time the loan was made can help in this situation by, for example, giving the lender access to its collateral in the leased premises when the tenant-borrower is no longer in possession. If the lender cannot obtain possession of the collateral without breaching the peace, it must seek judicial assistance.
Once the lender has possession of collateral, it must use reasonable care in its custody and preservation. The UCC provides more detailed guidance with respect to certain types of collateral. Reasonable expenses incurred by the secured party—including, but not limited to, the cost of insurance and payment of taxes—are chargeable to the debtor and are secured by the collateral.
Disposition of Collateral
After default, a secured lender may sell, lease, license, or otherwise dispose of its collateral, with sale being the most common method of disposition. In determining how to dispose of collateral, a secured lender faces a number of factors and considerations.
Commercially Reasonable
The overarching standard is that every aspect of the disposition, including the time, place, method, manner, and other terms, must be commercially reasonable. Although the UCC provides certain general guidance regarding actions that will constitute a commercially reasonable disposition,2 there is no universal method. What constitutes an appropriate disposition depends on the nature of the collateral and other facts and circumstances. For this reason, in almost all cases, a secured lender should work with experienced legal counsel and other professionals in formulating its plan to dispose of collateral.
First, it is important to remember that the obligation to conduct a commercially reasonable disposition pertains to the method and terms of sale not the price obtained (although courts have sometimes looked at the price obtained as one factor when addressing a claim that the disposition was not commercially reasonable). The UCC expressly states that the fact that a higher price could have been obtained by a different method is not sufficient to show that a disposition was not commercially reasonable. A lender should avoid imprecise language when communicating about a sale of collateral, especially with the borrower. For example, the lender is not obligated to obtain fair market value or highest and best value, and these types of terms should be avoided so as not to create incorrect expectations.
A lender can sometimes look to the underlying loan documents for guidance when disposing of collateral. The UCC allows the parties to determine by agreement the standards by which reasonableness is to be measured as long as those standards are not manifestly unreasonable. A lender should strongly consider including in its loan documents detailed and sometimes collateral-specific language regarding reasonable methods of disposition. This is especially true in the case of unique collateral.
Finally, the UCC explicitly permits the secured party to disclaim the warranties that would otherwise accompany the disposition of collateral by operation of law. These may include, among other things, warranties relating to title, possession, and quiet enjoyment.
Condition of Property
A secured party may dispose of collateral in its then-existing condition or following any commercially reasonable preparation or processing. In many circumstances, the lender can simply sell the collateral in its existing condition; however, depending on the circumstances, it may be necessary for the secured party to prepare or process the collateral before disposition.3 Again, this is an area where the loan documents may provide guidance if an appropriate provision is included. If the lender chooses to prepare or process the collateral, the reasonable expenses are payable from the proceeds of the disposition.
Type of Sale
The lender must also decide whether to dispose of the collateral in a private or public sale (i.e., auction). The factors for commercial reasonableness differ for each type of sale. Another difference is that the secured party can purchase at a public sale but can only purchase at a private sale if the collateral is of a kind that is customarily sold on a recognized market (publicly traded stock being the easiest example) or the subject of widely distributed standard price quotations (e.g., gold and other precious metals).
Notice4
In most circumstances, the secured party must send prior written notice of the disposition to the debtor, any secondary obligor (e.g., a co-borrower or guarantor), and other secured parties.5 No advance notice is required if the collateral is perishable, threatens to decline speedily in value, or is of a type customarily sold on a recognized market.
In a commercial transaction, the notice must describe the debtor, the secured party, and the collateral; state the method of disposition (i.e., public or private); state the time and place of a public disposition or the time after which any other disposition is to be made; and describe the debtor’s right to an accounting of the unpaid indebtedness.6
The notice must be sent within a reasonable time before the disposition. Often, the security agreement itself specifies the time period. In commercial transactions, the UCC provides that a notification sent after default and at least 10 days before the earliest time of disposition is reasonable.
The UCC provides a variety of non-judicial and self-help tools that can assist a secured lender in realizing on its collateral after default without the time and expense of litigation. This alert, together with Part 1 and upcoming Part 3, which will cover strict foreclosure, describe the general procedures and outcomes for these tools. Experienced legal counsel can help the lender select the appropriate remedy, navigate the specific requirements, and avoid potential pitfalls and problems.
The Thought Leadership Committee of Barclay Damon’s Restructuring, Bankruptcy & Creditors’ Rights Practice Area issues alerts and blogs on an ongoing basis to keep clients, colleagues, and friends up to date on important developments in the insolvency space. If you have any questions regarding the content of this alert, please contact the author, Robert Wonneberger, Thought Leadership Committee chair, at rwonneberger@barclaydamon.com, or Janice Grubin or Jeff Dove, Restructuring, Bankruptcy & Creditors’ Rights Practice Area co-chairs, at jgrubin@barclaydamon.com and jdove@barclaydamon.com.
1These rights are granted by the UCC and do not need to be discussed in the security agreement or other loan documents. However, the exercise of these rights may be subject to limitations or additional requirements set forth in the loan documents.
2Including: a disposition in the usual manner on a recognized market; a disposition at the then-current price in a recognized market; a disposition that conforms to reasonable commercial practices among dealers in that type of property; and a disposition approved in a judicial proceeding, by a creditors committee, or an assignee for the benefit of creditors.
3Official Comment 4 to UCC Section 9-610 provides in part: “Although courts should not be quick to impose a duty of preparation or processing on the secured party, subsection (a) does not grant the secured party the right to dispose of the collateral ‘in its then condition’ under all circumstances. A secured party may not dispose of collateral ‘in its then condition’ when, taking into account the costs and probable benefits of preparation or processing and the fact that the secured party would be advancing the costs at its risk, it would be commercially unreasonable to dispose of the collateral in that condition.”
4It is important to note that this notice before disposition of collateral is separate and distinct from the advertising and notice a secured party may include as part of the collateral sale itself. Whether a disposition is commercially reasonable is collateral- and fact-specific, so it is not possible to set forth a general rule about what advertising or other steps are required.
5The UCC contains specific rules for determining what secured parties are entitled to notice.
6There are special notice requirements for consumer goods transactions.