You are behind on a secured bank loan, and the lender’s counsel brings up an Article 9 sale. You hope this is just a restructuring where the bank will forgive the shortfall, but the truth is tougher. In most cases, an Article 9 sale won’t save your company for you, even if it keeps the business alive.
Article 9 of the Uniform Commercial Code was not written to help business owners reorganize their companies after a default. It was written to give lenders a remedy. Its provisions allow a secured lender to sell its collateral without going to court after the borrower defaults, and it will let the lender sell not just the assets but the entire business as a going concern. It can save the business and the jobs, but it was never built to protect the owner’s stake.
You might think that selling a business would let you use the proceeds to pay your bank at closing. Often, though, that’s not realistic. The sale price might not be enough to cover junior liens, or even your senior debts. Junior lenders may refuse to release their security interests unless paid in full. Unpaid trade creditors could sue to undo the sale as a fraudulent transfer for less than fair value. The buyer may worry about being left on the hook for the seller’s debts. As a result, the buyer may insist on taking the business through an insolvency proceeding.
That proceeding can take a few forms. One alternative is a Chapter 11 Section 363 sale, where a court orders the sale and insulates the buyer from creditor claims. But a Chapter 11 can be prohibitively expensive for the lender. The lender has to pay attorneys’ fees, it has to fund the company’s operations and professionals’ fees through a DIP financing or cash collateral arrangements, and a creditors’ committee will scrutinize the validity of its liens. The sale can fall apart. An alternative is a state or federal court receivership, or an assignment for the benefit of creditors (ABC). These are cheaper and less predictable than a Chapter 11, and the process isn’t as tidy or uniform. Bankruptcy is public, an Article 9 sale is private.
Sell a Continuing Business Through an Article 9 Sale
It’s more complicated to sell a continuing business through an Article 9 sale than it is to liquidate the assets of a business that’s already shut down. But in the right circumstances it can work out very well for the lender and the buyer. Here is one case where it did. The company in this case was a food business with around one hundred employees and roughly 60-70 million dollars in sales. Unfortunately sales were going down, and the company was struggling with cash flow and debt. The senior lender held a $14 million revolver and term loan with a blanket lien on all company assets. There was no real estate to use as collateral. In addition, the company had $7 million in subordinated secured mezzanine debt. It also owed money to trade creditors and had breached its financial covenants. The company was in a forbearance agreement which had been extended several times.
The private equity sponsor of the company did not want to put in additional equity, and debt restructuring was not an option. So the company engaged an investment banker to sell the company. The sponsor was out of the money and did not want to incur any additional liability, so the sponsor refused to execute an asset purchase agreement with the buyer. The top buyer agreed to purchase from the lender under Article 9, and the lender selected Article 9 over a Chapter 11 proceeding. That choice made sense partly because the debt structure of the company wasn’t complicated enough to require a Chapter 11 bankruptcy case. Article 9 cannot sell real estate, but the company had no real estate.
The lender sent notices to all other lienholders and to the borrower and guarantors as Article 9 requires. About two weeks later, the sale closed. The lender gave the buyer almost no representations and warranties at all. The borrower and sponsor signed a disposition agreement with the lender that recited the sale was commercially reasonable, and that they would surrender the assets to the buyer as-is, where-is and with all faults. Once the sale closed, the buyer negotiated directly with the trade creditors on their claims, with no involvement from the lender.
Knowing What Your Cooperation Is Worth
The lesson for the business owner is that the forbearance period is time to make your plans. Part of that planning is knowing what your cooperation is worth. When the lender wants to go ahead with the Article 9 sale without the owner’s cooperation, it will still need to go to court and get an order to make the owner turn over the assets. A going concern sale isn’t just a transaction; it’s an operation. You need the business to keep running and the process to be seamless. Owners will sometimes help because they want to stay on the lender’s good side or because their reputation is on the line. A lender might sweeten the deal by offering relief on any guaranties, and that is the owner’s leverage.
Challenge the Sale
Even a sale handled this way carries risk. Unpaid unsecured creditors can sue under their state’s fraudulent transfer laws, alleging a constructive fraudulent transfer. They don’t need to prove you intended to cheat them. If the company later files bankruptcy, the trustee can bring the claim too. Depending on the state, the statute of limitations can be four to six years after the sale. In order to win, the challenger has to prove that the company was insolvent and that the sale price was less than fair consideration or reasonably equivalent value. While a default makes insolvency easy to prove, an arm’s-length sale to an outsider after a full marketing process can make it hard to prove the price was too low; and the cost of such a claim deters many creditors.
If a sale doesn’t net enough money and the junior lienholders didn’t get paid out of the sale proceeds, they can challenge the sale on the grounds that it was not commercially reasonable under Article 9. To minimize the chances of a court finding a sale to have been not commercially reasonable, there should be a professional marketing and sale process. In this case, the mezzanine lenders were largely barred under the terms of an intercreditor agreement from contesting a sale approved by the senior lender after a default.
Here’s the bottom line for you, the owner. A sale under Article 9 can save the business, the people it employs, and its customers. It usually won’t save your ownership. An Article 9 sale is a lender’s remedy. The lender will use it after a default. The buyer must be willing to buy outside of a bankruptcy or other insolvency proceeding. The borrower’s true leverage in an Article 9 sale is cooperation. For the owner, the best preparation is to know your guaranties and your unsecured creditors before the lender’s notice lands.
