When lenders take on debt, there is always the chance of defaulting on repayment. If the loan is secured by personal property, not including real estate, the lender can sometimes foreclose more efficiently on the collateral under Article 9 of the Uniform Commercial Code (UCC). However, within this provision, the creditor is required to sell the collateral in a “commercially reasonable” manner (Section 610). What is commercially reasonable? Read on to learn more about properly handling a UCC Article 9 sale.
THE UCC ARTICLE 9 SALES PROCESS
Specifically within Article 9, Section 610 states that “every aspect of a disposition of collateral, including the method, manner, time, place, and other terms, must be commercially reasonable. If commercially reasonable, a secured party may dispose of collateral by public or private proceedings, by one or more contracts, as a unit or in parcels, and at any time and place and on any terms.”
Before we jump more deeply into how case law defines reasonable, let’s first outline the steps the creditor must take in a UCC Article 9 sale:
- Repossess the collateral – as per the lending agreement, the creditor must properly lay claim to the collateral.
- Provide notice of intent to sell – as detailed in UCC ARTICLE 9, SECTION 611, provide authenticated notice to the debtor and any other lienholders or obligors, at least 10 days prior to the sale. The notice must be reasonable with respect to timing, manner and content.
- Seek to maximize the sale – whether through public or private sale, the creditor is obligated to pursue the best option and highest return for the sale of the collateral; should the debtor sue the creditor at a later period for unreasonable collection, the court will more heavily scrutinize a private sale.
- Apply sale proceeds to the unpaid debt – after covering the legal and administrative fees of the sale, the creditor shall USE THE PROCEEDS towards satisfaction of the debt and distribute the proceeds to junior creditors and even return any excess proceeds to the debtor.
COMMERCIAL REASONABLENESS UNDER UCC ARTICLE 9
Whereas property to be sold under U.S. bankruptcy law (often referred to as a 363 sale) requires a judicial process, Article 9 sales do not. Instead, an aggrieved party could bring a challenge after the sale of the collateral under Article 9.
The secured lender has the option of selling the collateral at either a private or a public sale. A public sale must be advertised in a commercially reasonable manner and accessible to the public to create an opportunity for competitive bidding. If the secured lender wants to own the collateral, it can purchase it at a public sale, or at a private sale if the collateral is “of a kind customarily sold on a recognized market” or “the subject of widely distributed standard price quotations.” By contrast, a private sale can be handled quickly.
Federal district courts in Pennsylvania have helped develop guidance as to what counts as “commercially reasonable” disposition:
- “Sale of collateral in accordance with provisions of Uniform Commercial Code is commercially reasonable if the seller acts in good faith, avoids loss, and makes an effective realization.” (AUER VS. EQUIBANK)
- “Collateral is sold in ‘commercially reasonable manner,’ within meaning of Pennsylvania Uniform Commercial Code (UCC), if secured party either sells collateral in usual manner in any recognized market thereof, or if he sells it at price current in such market at time of sale, or if he has otherwise sold it in conformity with reasonable commercial practices among dealers in that type of property… factors that the court may consider in deciding whether sale of collateral was conducted in ‘commercially reasonable manner,’ within meaning of Pennsylvania Uniform Commercial Code (UCC) are: the setting of a valuation figure with or without an independent appraisal; any disparity between price received and estimated value of collateral, parties’ good faith; avoidance of loss; and effective realization of seller/secured party.” (CHRYSLER CREDIT CORP. V. BJM, JR., INC., 834 F. SUPP. 813)
Looking at case law, here are a few examples of actions and best practices on behalf of lenders to help ensure their sales were commercially reasonable throughout the process:
- Holding a bulk sale of items when there is limited interest in items that exist within a niche market;
- Conducting a cost-efficient sale of large industrial items in a space where electricity was turned off, during the day and in ideal weather conditions, avoiding the higher cost of turning the electricity back on;
- Advertising unique collateral well and for a possible extended amount of time in order to find the right buyer and obtain the highest sale; and
- Utilizing experienced auctioneers to help find buyers.
Conversely, case law provides some examples of situations that would not constitute commercially reasonable conduct, including:
- Not connecting with industry-specific publications or contacts in an attempt to appeal to probable buyers for niche collateral; and
- Accepting significantly below-market value for items ($125 auction sale for items valued at approximately $45,000).
In short, a creditor proceeding under Article 9 has a duty to get the maximum possible value from the collateral. An arm’s length process helps meet that expectation. If a secured lender fails to comply with the statutory requirements of Article 9, it may lose the value of its deficiency claim.
BEYOND A COMMERCIALLY REASONABLE UCC ARTICLE 9 SALE
If the sale process works, a creditor should avoid any successor liability for the buyer, any claim from the debtor and guarantors that the deficiency balance (if any) is wiped out, and resolve the matter completely. In an optimal scenario, the borrower agrees to this process – if a willing buyer is identified, it can potentially be fast and easy. In a more likely scenario, while UCC Article 9 sales do not require a judicial process, the creditor may have to utilize the court system to obtain the collateral and foreclose on it. Naturally, that would entail more time and expense.
If you are a lender considering a UCC Article 9 sale, please connect with a member of our Bankruptcy & Creditors’ Rights team.
