If your business is behind on a secured loan, chances are the lender holds a blanket lien. A lien on all of your company’s assets means that the bank has an interest in every single asset the business owns. So when you’re running out of time in the forbearance, the extensions have piled up, and there’s little prospect of a refinance or turnaround, what other options are there? Bankruptcy is usually what comes to mind. But there is another route, and a sale under the Article 9 Uniform Commercial Code is something you might not be familiar with.
An Article 9 sale is a sale of the collateral by the secured creditor (the lender) under Article 9 of the Uniform Commercial Code, the part of state law that governs security interests. Let’s assume that the borrower has pledged its assets as collateral to secure a bank loan. So the bank has a lien on those assets. To execute an Article 9 sale, the bank sells those assets. If the business is still operating, the bank can sell it as a going concern, which is often how the most value gets out of the collateral.
Why not just sell the company yourself and pay off the bank at closing? Often you can’t. Finding any buyer is a challenge, but finding a buyer who can navigate the complicated web of liens, defaults, and legal issues can be a daunting task. The price may not be enough to clear the junior liens, or even the senior one. If the junior lienholders refuse to release their liens, how can the business owner close on the sale? If the suppliers are not paid, they may claim that the sale of the business was a fraudulent transfer and seek to have the sale reversed. The buyer will also fear that, as a result of the sale, it may be responsible for your company’s debts on a theory known as successor liability. Put those risks together and you can see why lenders and buyers tend to rely on bankruptcy. Many buyers prefer a Section 363 sale under Chapter 11 of the Bankruptcy Code, or a receivership or an assignment for the benefit of creditors, because a court order approving the sale will protect them from most of those claims.
That protection is expensive. In Chapter 11 the legal costs accumulate, and during the sale process the lender has to continue to advance funds to keep the debtor running and to cover professional fees and other costs of the case. This is called debtor-in-possession financing or a cash collateral deal. If there are creditors’ committees, the bank gets an even bigger bill. The creditors’ committee will look at the validity of the bank’s liens and the sale may not go through. A receivership or assignment will be cheaper but it is a less defined process and the outcome is less certain.
A Lower-cost Way to Achieve the Same Result
By contrast, an Article 9 sale is streamlined and straightforward. With an Article 9 sale, it’s unlikely you would have to seek the court’s approval to sell, and you wouldn’t have the huge costs associated with a Chapter 11 case. And it can avoid the hassle of an unsecured-creditor committee. A sale under Article 9 is a lower-cost way to achieve the same result. The one big limit: Article 9 deals with securing loans with personal property, not real estate. If your collateral is personal property, it can be sold outside a court case through a so-called Article 9 sale. Real estate needs a separate foreclosure or deed in lieu.
Here is how it works. The lender sends the notices Article 9 requires to the borrower, the guarantors and any other lienholders. A sale must be effected in a commercially reasonable manner. In one recent case, the lender sold a portfolio company that was a food business with about 100 employees and annual sales of about $60-$70 million. The notice of sale went out and the sale closed about two weeks later. The private equity owner was out of the money and refused to sign a purchase agreement with the buyer, so the lender sold the company as a secured party to the buyer with minimal representations and warranties. The buyer was left to deal with the trade creditors post-closing. The major costs of a bankruptcy were avoided. In bankruptcy, the sale will be subject to approval by the bankruptcy court in a public hearing, all of which the company’s competitors can learn about. An Article 9 sale can stay out of public view. In short, when an Article 9 sale is feasible, it’s a shortcut that can lead to better outcomes for the lender and the buyer. But if the buyer will insist on a 363 sale, or a receivership or assignment, an Article 9 sale is off the table.
The Owner’s Cooperation
Your cooperation matters more than you might think. The lender can hold the sale without you. What it cannot do without a court order is make the borrower turn over its assets. In a going-concern sale, it’s essential to keep the business operating, and everyone wants the transition to be as smooth as possible, so the owner’s cooperation is very important. So you’ve got a lot of leverage, and a lot to lose. And to help it go smoothly, there is a lot of effort you can put in as the borrower to move things along.
Cooperating usually means signing a disposition agreement with the lender. In this agreement, the borrower (and its owners) recognize that the sale is commercially reasonable and agree to deliver the collateral to the purchaser on an “as-is” basis, in the current location. It should be reviewed by both parties separately by a lawyer before any documents are signed. Owners may cooperate in order to preserve the relationship with the lender or their reputation; otherwise I’d want incentives like relief of the guarantees. Either way, the point is to reach an understanding with your lender, so everyone can get out of it as quickly and as cheaply as possible, without the need for a court to impose a solution.
Risks and Uncertainties
There are risks. Take unpaid creditors. They could say the sale was a “constructive fraudulent transfer” so nobody needs to prove anybody intended to harm them. Depending on the jurisdiction, they can bring a claim within 4 to 6 years of the sale, or a bankruptcy trustee can pursue it if the company subsequently declares bankruptcy. To win, they have to prove that the price is too low and you were broke when the sale happened. Insolvency can be measured several ways, including balance sheet and cash flow, and you may be in trouble under both of them. If you defaulted on the bank and left creditors unpaid, that part is pretty easy to prove. The value question is harder. The bank’s going to argue that it got the best price it could have. If the purchaser was an unrelated party who paid an arms length price following a bona fide marketing process, establishing that the price was too low can be very challenging, and the cost of litigation is significant.
Junior lienholders who get nothing from the sale have their own tool. Specifically, the Article 9 foreclosure can be challenged if the sale was not “commercially reasonable.” A professional marketing and sale process goes a long way toward defeating that argument. That risk is less if the loan has an intercreditor agreement, since such an agreement may bar subordinated lenders from contesting a sale the senior lender supports.
None of this is meant to suggest that a sale under Article 9 is without risks and uncertainties. But it is something to consider when you are in a bind that may be getting worse. An Article 9 sale is no slam dunk, but it is worth thinking about. If the bank is looking to exit your loan and might be open to hearing about an alternative to bankruptcy, you will have more to offer it if you know that an Article 9 sale is one of those alternatives.
