What can a secured lender do when a business borrower defaults under UCC Article 9?

In a bad economy more small businesses miss loan payments. For those of you who have already borrowed, and secured the debt with business assets, it pays to know the lender’s Article 9 rights.

Every state uses the same basic rules for handling secured business debt — to an extent. Article 9 is part of the Uniform Commercial Code, and all states adopted it. But each state gets to make changes, and the section numbering can differ by state. For example, some states adopted more recent versions of the rules than others. So please check the law in your state before any Article 9 sale. The references below are to New York’s version of Article 9.

The Lender Has Several Choices

Once you default on the terms of the loan, the lender has several choices. These are the more common options:

• Repossession: When the lender takes possession of business assets after default, on its own, without resorting to a court for permission or help.
• Foreclosure: When the lender takes business assets after a judge says it can, with the help of the sheriff.

The process usually begins with a notice of default. This gives you notice that you’re behind on payments, and often includes a warning that repossession or foreclosure will happen within 10 days or so unless you bring the account current. Every loan is different so you have to look at your loan documents to find the exact terms. If you can’t or don’t bring the account current, the lender can turn to its Article 9 remedies.

Section 9-607 in New York law says your lender can collect receivables it has a perfected lien on. It can try to use you to help, but it doesn’t have to get your help if you’re not being cooperative. If it knows who the customer is, it can write to the customer directly. After that, the customer must pay the lender, and if the customer pays you instead, it still owes the lender.

The lender also has a right to apply money from your deposit accounts covered by a perfected lien to the debt. Under Section 9-609, it can ask you to assemble the collateral. It can only take possession that way if you cooperate.

Collateral Sale Process

Once the lender has possession of the collateral it can sell it according to section 9-610. Every aspect of the sale must be commercially reasonable. Section 9-612 says that 10 days after default is a reasonable amount of notice to give for a commercial transaction. A sale at public auction or a private sale is permissible. With a private sale, the lender must be able to prove it was commercially reasonable. The way it usually does this is by producing a valuation by a third party. If the private sale price comes close to the appraiser’s figure, that is a defense. If nobody knows what the collateral is worth, a well-marketed public auction may make more sense.

If you cooperate with your lender, and your lender is on the ball, the whole collateral sale process can go forward relatively quickly. You can figure on it taking about 100 days. Lenders usually give you 10 days to cure, or whatever the loan documents allow. After that, the lender will likely begin marketing collateral (perhaps for an auction) almost immediately, and that can take about 60 days. Then, it can take another 30 days to close the sale and haul the collateral away. If you cooperate, and have a ready buyer, a private sale can go faster.

Asking a Judge to Order You to Turn over the Collateral

The UCC doesn’t stop a lender from asking a judge to order you to turn over the collateral. If you won’t do so voluntarily, a court may let the sheriff take it away. Then the lender doesn’t need to worry about a breach of the peace or about conversion. One disadvantage to this approach is that it tends to be slow, and it’s usually expensive. Another problem is that judicial foreclosure isn’t governed by the UCC and differs from state to state.