The Uniform Commercial Code (UCC) provides a framework to allow a secured party to foreclose its security interest in personal property after a default without judicial proceedings. The secured party may then proceed to take possession of the collateral and render it unusable or dispose of it on the debtor’s premises. The secured party can then dispose of the collateral through a sale, lease, or license, or it may accept the collateral in full or partial satisfaction of the secured debt.
Article 9 sales are important tools for secured parties to consider, as they can be an effective way to liquidate their collateral and for interested parties to acquire assets from insolvent entities. Whether an Article 9 sale is the best option depends on the facts of each case.
The primary advantage of an Article 9 sale is speed. An Article 9 sale may be accomplished in weeks, while a judicial process may take months or even years. An Article 9 sale may be a particularly attractive option if the debtor and other interested parties (i.e., guarantors, other lienholders) are cooperative.1 In such a case, there is little risk of interference in the sale process, and the sale can be completed expeditiously.
Article 9 sales are also cost-effective. If the sale progresses as intended, no court involvement is required, which greatly reduces costs. The secured party’s costs include those for providing UCC required notice, marketing expenses, and the actual costs of the sale. While it is prudent to obtain legal advice to ensure that the debt is properly enforceable and that the mandates of the UCC have been satisfied, legal costs in an Article 9 sale are generally a fraction of those for litigation, a receivership, or a Section 363 sale under the U.S. Bankruptcy Code.
Article 9 provides the option of choosing a private and public sale (auction), which provides the secured party with significant flexibility in designing a strategy that best suits the facts of its situation. Private sales are generally less expensive and often yield higher returns than auctions. A private sale may be the better option if the collateral is specialized or if the secured party seeks to sell all of its collateral to one buyer—as close to a going concern sale as is possible within the confines of Article 9.
Conversely, public sales may be more desirable if the secured party wants to sell “categories” or several pieces of unspecialized collateral. In addition to the notice required to interested parties under the UCC, public sales require public notice. The secured party may purchase the collateral at any public sale by bidding its debt. Unless the collateral is of a type customarily sold on a recognized market, such as publicly traded securities, the secured party cannot purchase collateral in a private sale.
An Article 9 sale transfers to the buyer all of the debtor’s rights in the collateral and discharges the security interest under which the sale is made and any subordinate liens. The secured party is not required to take title to the collateral unless it purchases the collateral itself, and the secured party provides minimal representations and warranties.
As long as the secured party conducts the sale in a commercially reasonable manner, it retains the right to pursue the debtor and any guarantors for a deficiency claim.
As with every legal tool or remedy, there are risks, disadvantages, and limitations to Article 9 sales. They cannot be used until after the debtor defaults, and notice and commercially reasonable marketing efforts are required. While arguably “less public” than a bankruptcy proceeding or litigation, Article 9 sales still require public disclosure of business distress.
A quick sale often requires the cooperation of the debtor, guarantors, and any senior lienholders. While Article 9 sales are often preferred as a means to avoid litigation, the secured party may still find itself in court. Interested parties can commence litigation to obtain an injunction against the sale, which can result in protracted and costly litigation. Even after the sale closes, it still can be challenged in court.
Further, the commercial reasonableness standard is murky at best. If a sale is found not to be commercially reasonable, a court may (i) enjoin the sale, (ii) order the secured party to pay to the debtor or junior lienholders any surplus that would have been obtained had the sale been conducted in a commercially reasonable manner, or (iii) deny the secured party the right to assert a deficiency claim.
Article 9 sales cannot generally be used to effect going concern sales. First, the secured party must also have a lien on all assets to be sold at the sale. Second, the sales are limited to personal property governed by Article 9. For example, mortgaged real property cannot be sold via an Article 9 sale. A cooperative debtor might agree to sell the real estate to the same buyer, but if the debtor is uncooperative, the secured party would be required to foreclose its mortgage lien under other applicable state law.
Unlike a Section 363 sale in bankruptcy, the buyer does not receive an order holding that the sale is free and clear of liens. Good faith buyers receive some protection under the provisions of Article 9 of the UCC, but whether a buyer purchased the collateral in good faith can be disputed, which presents a litigation risk. This risk, coupled with the limited warranties given by a secured party in an Article 9 sale, may depress the sale price.
The most important thing to remember as a secured party charts the details of its Article 9 sale (after ensuring proper notice is given) is that every aspect must be “commercially reasonable.” While that may sound easy, what that term of art actually means is that the secured party must make every effort to secure every possible advantage of time, place, manner, and publicity for the sale based on the type of collateral being sold. Although this is analyzed on a case-by-case basis, some guidelines have been established for how far a secured party must go and what needs to be considered in planning a sale. The overarching standard is that “practices of dealers in the type of property” should be followed.
First, the secured party should determine if there is a recognized market where the collateral may be sold (e.g., a sale of stock on the Nasdaq Stock Market). If so, the collateral should be sold on that market and at the price it establishes. If the collateral is sold in that manner, the sale will be considered commercially reasonable.
The second consideration is whether the sale should be private or public. As noted earlier, either may make sense depending on the type, size, and nature of the collateral, among other considerations. Third, the secured party should examine whether any repairs or cleanup of the collateral is needed. The secured party needs to analyze the cost to repair or clean up the collateral versus the likely resulting increase in sale price. It is safer to err on the side of extra preparation.
Fourth, marketing of the collateral must be considered and whether a wholesale or retail path is better, given the collateral. A fifth consideration is whether the collateral should be sold by unit or in parcels. Typically, there is a standard practice that can be followed (e.g., hot dogs are sold in packs of 10 and buns in packs of eight at retail, but both are sold by the case wholesale).
Sixth, the secured party needs to determine the right time to sell the collateral. While the secured party typically wants to avoid holding collateral for an extended period, delaying a sale of seasonal goods or one planned before a sharp downturn in the relevant market may be prudent. Finally, there is a duty to publicize a public sale to allow other parties a meaningful opportunity to competitively bid.
When the secured party seeks to purchase substantially all of the debtor’s assets, it typically negotiates the price and prepares a purchase agreement that includes the terms. To meet the commercially reasonableness standard, an opportunity is then given to other parties to submit higher bids, and the business is also likely to be marketed by an investment banker.
Just because a different manner or time for the sale could have resulted in a higher price does not make a sale unreasonable. But a low purchase price may subject the transaction to closer scrutiny, particularly in a sale to the secured party. Debtors challenge a sale’s reasonableness typically for one of two reasons: (i) the sale proceeds were low, resulting in a deficiency; or (ii) the sale price was insufficient and deprived the debtor of its equity in the collateral, which is less likely. If a debtor can successfully show the sale was not reasonable, a fact-intensive question with the debtor holding the burden, it can recover damages for the attendant loss.
Although not necessary, the safest route to ensuring a sale is deemed commercially reasonable is to have it blessed by a court or by the debtor’s other creditors or as part of an assignment for the benefit of creditors (ABC). Of course, getting this approval detracts from an Article 9 sale’s primary benefits, as it adds to the complexity, cost, and time needed to complete the sale.
As noted, speed is a key benefit of an Article 9 sale—30-40 days is typically sufficient time to complete such a sale, which is driven by the required notices. This is likely to be much faster than a similar sale in bankruptcy or other sale process requiring court involvement.
As the timing is driven by notice requirements, it is important to understand the notice periods. Whether a private or public sale is selected, “reasonableness” is again the standard for determining how much notice must be given before a sale takes place. A safe harbor, however, provides that 10 days’ notice before a sale of nonconsumer collateral is sufficient. Most secured parties take advantage of this safety.
In addition, the secured party needs to determine the proper notice parties. Another safe harbor provided deems the secured party to have provided proper notice to other secured creditors if it conducts a UCC financing search 20-30 days before sending the notice of sale and then notifies the other secured creditors identified in the search.
The notice requirement is inapplicable to collateral that is perishable or threatens to decline rapidly, or collateral that can be sold on a recognized market. Those dispositions can therefore be done much more quickly, although they still must be accomplished in a commercially reasonable manner.
Several other protections available as part of an Article 9 sale are worth keeping in mind. In addition to the notice and timing safe harbors, Article 9 also provides a form of notice. If the secured party follows the form of notice, it is deemed to have provided sufficient information.
Buyers in Article 9 sales have their own safe harbor. As discussed earlier, a buyer in the ordinary course of business takes the collateral free of security interests. But even more important is that the buyer takes the collateral free and clear even if the sale by the secured party does not strictly comply with Article 9 provisions, as long as the buyer acted in good faith. That means the buyer had no knowledge that the sale violated another party’s rights.
Given that, a buyer likely does not want to overdo its diligence. While neither can it bury its head in the sand, a potential buyer should avoid getting overly involved in the secured party’s running of the sale. The obvious benefit of this rule is that it should provide a more robust market of possible buyers if a purchase is less likely to be unwound due to failures by the secured party.
A secured party’s remedies under Article 9 are intended to provide sufficient flexibility to accommodate all personal property that may be subject to Article 9, such as equipment, farm products, inventory, intellectual property, etc. But as mentioned earlier, Article 9 sales are not appropriate in every circumstance.
Article 9 sales may be particularly attractive options when (i) the secured party has a lien on all UCC assets, (ii) the secured party only wishes to sell discrete categories of assets, (iii) the debtor is cooperative, (iv) the secured party has a senior lien on all property to be sold, and (v) there are no tax liens on the property.
Secured parties have also struggled with whether to use Article 9 sale remedies for pledged intellectual property. It is increasingly common for a secured party to have a security interest only in the debtor’s intellectual property. Whether an Article 9 sale is the right option for pledged intellectual property depends in part on whether the intellectual property is assignable under applicable law. Special consideration must be given to ensuring that the sale can be conducted in a commercially reasonable manner due to the specialized nature of intellectual property.
In many cases, strict foreclosure may be a more desirable option if the debtor and junior lienholders consent. The secured party may then retain the pledged intellectual property without formal marketing or notice, but any remaining debt is extinguished. The secured party must confirm that it can take an assignment of the pledged assets and that there is a market for resale (or that it wishes to retain the assets for use in its own business).