If your business has fallen behind on a secured loan, you may be weighing a Chapter 11 filing against letting the lender run an Article 9 sale. To compare the two, you first need to know how the Article 9 route works. Article 9 of the Uniform Commercial Code allows your secured creditor, if you default, to sell the collateral and apply the proceeds toward the debt. It can have a public sale or a private one. The lender has to follow certain rules about timing and notification and all that, or it can get sued for damages. The UCC lets the lender decide how to dispose of the collateral, as long as the method is “commercially reasonable” and “in good faith”, and the lender and debtor cannot waive away that requirement.
A Perfected Security Interest in the Collateral
Before your lender sells off the collateral, it needs to make sure it has a perfected security interest in the collateral and that the collateral is worth enough money after paying off tax liens and other senior (perfected) security interests, including purchase money security interests, to justify the sale. Your secured lender should confirm that it has possession of the collateral or that you don’t object to its taking possession. If you do object, it may need to sue. Under UCC 9-609 it can get possession through a lawsuit, or without a lawsuit only if it proceeds “without breach of the peace.”
Notice of Intended Disposition
As soon as your secured lender has actual possession of the collateral and has identified interested parties, it will send notice of intended disposition to you, to the senior and junior lienholders, and to the secondary obligors (if any), such as guarantors. The lien search should be conducted or updated 20 to 30 days before the notification date.
If there is a junior federal tax lien on the property, the lender must notify the IRS of the disposition at least 25 days before it occurs. If it doesn’t notice the tax lien, both the buyer and the secured lender can be on the hook for the tax lien. In Massachusetts, the “federal tax lien search function” at the federal courthouse in Boston is broken at the moment, so the smart lender would assume you have a federal tax lien, notify the IRS about the sale, and wait 25 days rather than the usual 10 days.
Unless the IRS also has a claim against the collateral, your secured lender must give at least 10 days notice of any sale to all people who are entitled to it. That’s what the UCC says is “commercially reasonable,” but your security agreement may be more generous and call for more notice than that. The notice that’s sent out has to say
- (1) who the debtor and the secured party are,
- (2) what collateral is being sold,
- (3) how it will be sold,
- (4) that you have a right to get an accounting for the debt, and
- (5) the time and place of a public sale, or the date after which a private sale will take place.
Private sales have potential pitfalls. Courts look more closely at private sales than they do at public sales. This is because public sales are generally assumed to fetch the best possible price, and the risk of a private sale’s being unfairly tilted is greater. In Milliken & Co. v. Duro Textiles, LLC (Mass. 2008), a company sold its assets in an Article 9 private sale to a new version of itself; the court said the sale was not made in good faith and held the new company liable for the debts of the old company. The case also implied that the secured lender might be liable to third parties for the apparently collusive sale.
If a company’s in deep trouble because it’s over-leveraged, and all its business assets have a lien against them, counsel for borrower (or a “white knight” buyer) will sometimes try to get a “friendly” private secured party sale to a related buyer, who then runs the business free of the old trade debt and junior liens. If none of those other creditors asked for personal guarantees, the borrower (now with no assets) is essentially judgment-proof. That kind of sale looks like a nice way to put the whole mess behind you and get back to business, but a secured lender should be reluctant to agree.
The trouble is, your secured lender’s private sale can be challenged by your junior secured creditors, your unsecured creditors and your shareholders. That’s because they get no money, and if there had been a public sale they would have had the opportunity to participate and bid. A challenged lender can get dragged into endless litigation, with no way to recover its legal fees, and possible exposure for a bad faith or collusive sale. The suspicion is stronger where the foreclosing lender finances the new company’s purchase of the assets, effectively shifting its lien from the old company to the new one and causing its other creditors to wonder if the sale is fair.
That means that selling off the collateral has to be done carefully. Your lender should really think hard before they opt for a private sale over a public one, especially when the buyer that’s picking up the collateral is connected to you or any of your people. Keep these rules in mind as you weigh an Article 9 sale against Chapter 11.
About Delancey Street
Delancey Street is a premier, and award winning, business debt settlement company that helps business owners nationwide. Our goal is simple: help you escape debt in a safe and legal manner. Based out of New York, we can help in 49 of 50 states. We tell you how it is; because your business and future is on the line.
