How does a secured lender sell defaulted collateral under UCC Article 9?

Secured loans are the norm in the world of big business. These are loans backed by collateral — the debtor pledges something of value as security — and if the loan defaults, the creditor can usually sell the collateral to raise cash that reduces the remaining debt. These sales may be private or public, and Article 9 of the Uniform Commercial Code governs how they work.

Such a sale is a powerful way to reduce or eliminate a debt, but in the U.S. the rules are formal. Written notice of the sale and timing are strict, and violation could subject the seller to liability and damages. The law requires that sales be conducted in good faith and in a commercially reasonable way. The borrower and lender cannot change that rule. Within that rule, lenders have room to work, but private sales are best saved for exceptional situations.

Collateral Value and Availability

Security interests are only as good as the collateral value and availability, so a creditor has an interest in confirming before the sale that it will work out. The creditor should know how to verify that it holds a perfected interest, and the interest has to be worth a sale, with enough value to pay off prior tax liens or senior interests. Senior creditors and tax lienholders may take priority, and purchase money interests could bump it. A debtor does not always give up possession with the debt, and that can affect how the sale works. The lender usually needs possession of the collateral or a non-resisting borrower before an out-of-court sale can take place. Under UCC section 9-609, the creditor can take the collateral without a lawsuit or a hearing as long as there is no breach of peace. A court order probably is necessary to get possession or a sale over the borrower’s or third party’s objection.

Notify Everyone After Possession Is Secure

If the lender is going to do a sale after taking possession of the collateral, the safest course is to notify everyone after possession is secure. That means debtor, senior creditors, junior creditors, guarantors and other secondary obligors. Run a lien search 20 to 30 days before the notice goes out.

If there is a junior federal tax lien in place, the IRS must get the notice at least 25 days before the sale. At the moment, doing a thorough federal tax lien search at the clerk’s office at the United States District Court for Massachusetts in Boston does not work, so the best bet is to send a notice to the IRS at least 25 days before the sale date, to protect the creditor in case a lien is lurking. Both the creditor and the buyer can get hit with liability for the unpaid lien.

Without an IRS lien, send out notice ten days or more before the sale to everyone. Under the UCC, 10 days can be commercially reasonable. The security agreement may require more than 10 days, so look before you leap. The contents of the notice can be important. The law requires that it say who the debtor and secured party are. It should describe the collateral, the sale method, and the debtor’s right to an accounting. If there is a public sale, the time and place should be given. If it’s private, the notice should at least name the date after which the sale may happen.

Private Asset Liquidations

Private sales are a bad idea in most cases. Courts tend to be stricter when they look at private transactions. By contrast, public auctions are presumed to involve fair values. A public sale is much more likely to be recognized by a court as fair and free of fraud or collusion. In Milliken v. Duro Textiles, a corporation sold all its assets to itself under a new name in a private sale. The court found the sale was made in bad faith. In that case, the Massachusetts court ruled in 2008, the new company could be held liable for the old one’s debts. The court also suggested that improper sale and disposal of security could put all parties involved at risk of liability, including the secured lender. Anyone who deals in private asset liquidations would do well to take the case to heart.

Once the goods and assets have been sold at public auction or private sale, the borrower may have nothing left. A judgment against an empty shell may not be worth much, unless the borrower’s owners made personal guaranties. When a sale is private, junior lenders and unsecured creditors — or even shareholders — can raise questions about how fair the price really was. They may argue that they got little or nothing, and never had the chance to bid. A workout through private sales can look appealing to a lender that is anxious to clean its books. But the senior lender should think hard before it agrees. Once the deed is done, those creditors may challenge the sales — then, it’s anybody’s guess what the final cost will be. And a senior creditor may not be able to recover legal fees. If the lender forecloses, sells the assets and then finances the new company that makes the purchase, the lien just shifts from the old company to the new one. To outsiders, that looks even more collusive.

Public auction is the safest way to sell secured goods. Private sales need a good excuse and a lot of care. Using a private foreclosure sale to get out of corporate debt can be a path to disaster.