If your company has defaulted on a secured loan, you may soon hear the phrase “Article 9 sale” from your lender’s lawyers. It’s not actually a specific type of sale, but rather a shorthand for a forced sale or disposition of a secured lender’s collateral after the borrower defaults on the loan. When you take out a loan that’s secured by assets (like inventory or equipment), Article 9 of the Uniform Commercial Code (UCC) dictates the rules for how the lender can enforce its security interest if you default. So an “Article 9 sale” is simply a foreclosure of business assets by a secured lender. It’s a remedy available to the lender after default. And it can be used to sell your business as a going concern. As a business still in operation. This is more difficult.
Sometimes a troubled borrower can’t just sell its assets directly to a buyer who then pays off the debt owed to the lender at closing. Maybe because the price won’t cover all the junior liens (maybe not even the senior liens) or maybe because the junior lienholders won’t release their liens unless they are paid in full. Plus buyers are typically concerned about unpaid trade/unsecured creditors claiming the seller didn’t get “fair consideration” or “reasonably equivalent value” for the sale and therefore the sale is a fraudulent transfer. Buyers are also concerned about “successor liability” for the seller’s debts. So buyers typically want the sale conducted in an insolvency proceeding: a bankruptcy court “section 363 sale” or a state or federal receivership or an assignment for the benefit of creditors (“ABC”). This court-supervised sale protects the buyer from most, if not all of these claims.
The Article 9 Sale Minimizes the Lender’s Cost
So why would your lender skip the courthouse? From the lender’s side, bankruptcy is painful and costly. Even a quick Section 363 sale that the lender supports still means the lender will spend a lot of money on its own legal fees. The lender will probably have to finance the borrower’s working capital, legal fees and other administrative expenses pending the sale, as debtor-in-possession (DIP) financing or a cash collateral agreement. The unsecured creditors’ committee will probably look into whether the lender’s liens are valid, and whether the estate has any claims against the lender. Then there is the risk that the sale will not occur as expected. The buyer could pull out and another bidder could swoop in. A receivership or ABC may not cost the lender as much, but the process is less predictable, and the outcome is less certain. And, of course, bankruptcy is a public proceeding. An Article 9 sale need not be. Done out of court, the Article 9 sale minimizes the lender’s cost, and delivers the sale quickly.
Here is how one of these sales played out. The borrower was a food business owned by a private equity firm, with about 100 employees and $60-70 million in annual sales. Like many companies, it had cash flow issues, declining revenues, and had borrowed too much money. It had a senior lender that had lent about $14 million on a secured basis, including a revolver and term loan, and it had the usual blanket lien on all its assets (there was no real estate to pledge). The company also had about $7 million of subordinated secured mezzanine debt, and unpaid trade debt. The company had defaulted on financial covenants, and had signed a forbearance agreement and extensions thereto. But the sponsor (the private equity firm) did not want to inject any additional equity, and a restructuring was not feasible. The company hired an investment banker to sell the business. The sponsor, being out of the money, would not sign a purchase agreement with the buyer. Ultimately, a buyer agreed to purchase the assets of the company from the lender, as the secured party under Article 9. The lender gave notices to other lienholders and the borrower and guarantors. The deal was closed about two weeks later. The business owners signed a disposition agreement to the effect that the sale was commercially reasonable, and that they would deliver the assets to the buyer “as-is, where-is, with all faults.” Once the sale closed the buyer dealt directly with trade creditors.
So who owned the company’s assets at the end? The buyer ended up owning the business assets. The lender is just a middleman in that case - the ultimate owner becomes the purchaser. That’s right: the buyer purchases your assets from a lender that took a security interest in them, not from you or your business. The owners of the business are not a party to the asset purchase agreement. The lender makes minimal representations and warranties, merely enough to reassure the buyer that the lender has complied with Article 9. The business turns over the assets to the buyer in “as-is, where-is, with all faults” condition. The lender receives the proceeds of the sale. All junior liens and unsecured claims (like trade creditors) are left to chance. Article 9 is not a mechanism for transferring real estate. So if the business has real property that it is using as collateral, the lender has to conduct a separate real estate foreclosure or a deed-in-lieu of foreclosure.
Can Challenge the Sale
Can anyone undo the sale once it closes? Your vendors and other unsecured creditors who were left unpaid are the most likely to try. They can seek a remedy under state law by arguing the Article 9 sale was a “constructive” fraudulent transfer. The “constructive” part of the claim means the unsecured creditors don’t have to prove an intent to defraud. A bankruptcy trustee can challenge the sale if a bankruptcy filing follows. The challenge can be brought up to 4 to 6 years after the sale, depending on the state. The creditors must show that (1) the borrower was insolvent (balance sheet) or in similar financial trouble (cash flow or capitalization) and (2) the sale was made for less than “fair consideration” (state law) or “reasonably equivalent value” (Bankruptcy Code). Insolvency is usually not difficult to show. The borrower was in default and the creditors were not paid. But if the sale was made arm’s-length, to a third party (i.e. not an insider) after a full marketing effort, it can be very difficult to show that too little was received. The value issue, coupled with the cost of the litigation, may deter unsecured creditors. But the risk has to be assessed on a case by case basis. A bankruptcy or other insolvency sale can greatly minimize or even eliminate the risk, but at higher cost, with longer time, and with execution risks.
Unsecured creditors are not the only ones who might object. If there is a second lender behind your bank, that lender also might be unhappy about how your business is being sold. A junior lienholder that isn’t paid from the proceeds can challenge the sale if it was not “commercially reasonable,” although a professional marketing and sale process makes that challenge much harder to win. In the food company case, the senior lender and the subordinated lenders had entered into a standard intercreditor agreement. On the borrower’s default, the agreement largely precluded the subordinated lenders from challenging any collateral sale supported by the senior lender.
Negotiating Power
But that’s not the end of the story. In fact, your secured lender’s plan to sell your company might depend on you. And that means that you could have more power in the situation than you realized. A sale under Article 9 of the Uniform Commercial Code can be completed without your cooperation, but not without a court ordering you to deliver up your assets. If it is a going concern sale, the borrower’s cooperation is of great value: continuity of operations is critical and everyone wants as seamless a transition as possible. The equity owners, especially a private equity sponsor, may cooperate to some extent to maintain a relationship with the lender or their reputation generally. If that is not enough, financial incentives, such as waiver of guaranty obligations (if any) or other value, may be necessary to complete the transaction. The lender has an incentive to negotiate, and you should be prepared to use that negotiating power.
To sum up: If you are in default on a secured loan, your lender may be able to sell your whole business through an Article 9 sale, quickly and privately, with you out of the deal. The buyer ends up owning the assets. The lender gets paid from the proceeds. Junior lenders and unsecured creditors may be left unpaid. But a going concern sale works best with the owner’s cooperation, and that gives you something to bargain with, such as relief on personal guaranties. Get advice early, before the notices go out.
