“Commercial Reasonableness” of Collateral Sales

Overview

The financial difficulties in agriculture have strained relationships between farmers and their creditors.  Back in vogue are the Uniform Commercial Code (UCC) rules for the dispositions of collateral by a creditor when a debtor defaults.  But, even when a creditor repossesses collateral and takes action to dispose of it, the debtor still has some rights.  One of those rights involves the requirement that the disposition of the collateral be done in a reasonable manner

Commercially reasonable collateral sales – that’s the topic of today post.

Right and Duty to Dispose of Collateral

In General. Upon a debtor's default, a secured party can repossess the collateral and may sell (either by public or private sale), lease or otherwise dispose of the collateral either in its existing condition or following any commercially reasonable preparation or processing. 

Two rules on timing of collateral sales apply:

• If the debtor has paid 60 percent of the cash price of a purchase money security interest (PMSI) in consumer goods, or 60 percent of the loan in the case of another security interest in consumer goods and has not signed, after default, a statement renouncing or modifying the debtor's right, a secured party who has taken possession of the collateral must dispose of the collateral within 90 days after possession or suffer liability to the debtor. A PMSI is involved in situations where the lender provides the financing.

• In all other situations, the secured creditor may, after repossessing the collateral, retain the collateral in full satisfaction of the debt unless the debtor objects within 21 days of receipt of notice of the creditor's intent to retain the collateral. If the creditor does retain the collateral, the security interest is discharged along with any liens that are subordinate to such interest.  If the collateral is not worth the amount that is owed against it, the creditor is not entitled to the deficiency.

Commercial Reasonableness. If the creditor disposes of the collateral, every aspect of the secured party’s disposition of the collateral, including the method, manner, time, place and other terms must be commercially reasonable. If collateral is not disposed of in a commercially reasonably manner, the liability of a debtor or a secondary obligor for a deficiency may be limited.  See, e.g., Ford Motor Credit Co. v. Henson, 34 S.W.3d 448 (Mo. Ct. App. 2001). 

Unless the collateral is perishable or threatens to decline speedily in value or is of a type customarily sold on a recognized market, the creditor must give the debtor reasonable notification of the time and place of any public sale, private sale or other intended disposition of the collateral unless the debtor, after default, has signed a waiver of notification of sale. For example, in In re Krug, 189 B.R. 948 (Bankr. D. Kan. 1995), the creditor repossessed registered shorthorn cattle without giving the debtor notice, and placed them under care of other ranchers while seeking foreclosure.  The court held that repossession was proper because the security agreement allowed lack of notice; the creditor gave the debtor time to cure the default and did not intend to harm the debtor; however, debtor allowed an offset for damage to the cattle and calves against the creditor's claim because the caretakers failed to properly feed the cattle and bred them improperly.

When Article 9 of the UCC was revised, those revisions did not change existing law with respect to the statutory language for the recognized market exception.  See Revised UCC § 9-611(b)-(d). Local livestock auctions cannot qualify for the recognized market exception to the notification requirement because livestock sold at auction are not tangible items and bidders by bidding are individually negotiating the price for the particular livestock in the ring.

If the repossessed collateral fails to bring enough at sale to cover the creditor’s claim, the creditor may bring a legal action against the debtor for the amount of the deficiency.  But, again, to recover the deficiency, the sale of the collateral must have been made in a commercially reasonable manner.  For instance, in Dallas County Implement, Inc. v. Harding, 439 N.W.2d 220 (Iowa 1989), the sale of repossessed collateral was held to not be reasonable where collateral the collateral (farm equipment) was sold at a private sale without notice to the debtor.  As a result, the creditor was not entitled to a deficiency judgment.  However, some courts hold that failure to send notice to the debtor may not invalidate a sale of repossessed property if the collateral is sold at a recognized market or for fair market value.  See, e.g., First National Bank v. Ruttle, 108 N.M. 657, 778 P.2d 434 (1989).  Proof that a greater amount could have been obtained for the collateral by its disposition at a different time or in a different method is not alone sufficient to preclude the secured party from establishing that the disposition was commercially reasonable.  But, a low sales price suggests the court should scrutinize carefully all the aspects of the disposition to insure each aspect was commercially reasonable. 

Ultimately, the issue of whether the disposition of collateral was commercially reasonable is one of fact.  Courts consider a number of factors to evaluate whether collateral was disposed of in a commercially reasonable manner.  These factors include whether the secured party tried to obtain the best price possible, whether the sale was private or public, the condition of the collateral and any efforts made to enhance its condition, the advertising undertaken, the number of bids received and the method used in soliciting bids.

The secured party may buy repossessed collateral at a public sale and may also buy the collateral at a private sale if the goods are of a type customarily sold in a recognized market or of a type which is the subject of widely distributed standard price quotations. 

Revised Article 9

As noted above, a few years ago the UCC was revised.  Under the Revisions to Article 9, in non-consumer deficiency cases, the secured party need not prove compliance with the default provisions unless compliance is placed in issue.  If compliance is placed in issue, the secured party has the burden to show compliance.  If the creditor cannot prove compliance, the rule is that the failure will reduce the secured party’s deficiency to the extent that the failure to comply affected the price received for the goods at the foreclosure sale.  Under the revisions, the value of the collateral is deemed to equal the unpaid debt and the noncomplying creditor is not entitled to a deficiency, unless the creditor seeking a deficiency proves by independent evidence that the price produced at sale was reasonable.  Thus, the creditor must prove what the collateral would have been sold for at a commercially reasonable sale and that this amount is less than the unpaid debt.

While Revised Article 9 does not define “commercially reasonable,” UCC §9-611(c) provides that in a commercial transaction notice must be given to debtors, secondary obligors, any person who has given the foreclosing creditor notice of a claim, and any other secured party that holds a perfected security interest in the collateral.  When consumer goods are involved, notice need only be given to debtors and secondary obligors.

Conclusion

Times of financial distress always strain relationships between debtors and creditors.  That’s a tough situation in agricultural settings because of the typical close relationship that many farmers and ranchers have with their lenders.  But, the law establishes many rules that must be followed in financial transactions – including rules that govern how collateral dispositions are handled.  The rule of “commercial reasonableness” is one of those rules.