 |
 |
|
|
Personal property foreclosure
Having obtained possession of tangible personal property, the secured party must realize its value and apply that value to reduction or satisfaction of the amount of the secured obligation. Article 9 affords the secured party two mechanisms for doing so: (1) disposition of the collateral by sale or other means (U.C.C. 9-610, 9-611, 9-612, 9-613, 9-614); (2) retention of the collateral in full or partial satisfaction of the obligation (often referred to as "strict foreclosure") (U.C.C. 9-620, 9-621, 9-622). Once the secured party has completed either, the debtor may no longer redeem the collateral, i.e. its right to redeem has been foreclosed. U.C.C. 9-623(c). Hence, the term "foreclosure" is commonly used to describe the secured party's use of either of these two mechanisms. Foreclosure by disposition (usually sale) is probably more common than strict foreclosure, but strict foreclosure is the ancestor and I therefore discuss it first.
The right to redeem evolved from the intervention of equity to prevent forfeiture of a debtor's interest in property upon default. Early lenders secured debt by real property through the form of an absolute conveyance of title subject to defeasance. For example, the debtor might convey title to the debtor's real property: "to [lender], but if I, [debtor], repay the sum of $ ____ by October 1, 1645, title shall revert to me." Thus, the lender retained title only upon the debtor's default. Of course this device could work great hardship; even trivial default (a day late or a dollar short) resulted in the debtor's forfeiture of all of its equity in the property conveyed. Faced with forfeiture, debtors obtained relief from courts of equity in the form of an extension of time to pay. This relief came to be known as the "equity of redemption," i.e. a right to redeem the property from the lender upon cure of default. Lest the period of redemption extend indefinitely, lenders in turn obtained relief to terminate the debtor's equity of redemption after a reasonable period of time. The phrase strict foreclosure developed to describe termination of the debtor's equity of redemption.
While mechanisms for securing debt have evolved from a much earlier form (conveyance of real property subject to defeasance) to our modern forms (the real property mortgage or deed of trust and the personal property security agreement), the phrase "strict foreclosure" retains its basic historical meaning: the secured party ends up holding the debtor's interests in the collateral in full or partial satisfaction of the obligation secured. In the context of personal property secured credit, we see this in U.C.C. 9-622(a). We explore the statutory procedure for strict foreclosure in Problem.Strict Foreclosure.
If collateral is worth more than the debt it secures, strict foreclosure will sacrifice the debtor's interest (or the interest of a subordinate lienholder) in the collateral. Often the debtor or a subordinate lienholder will not be able to prevent this sacrifice through redemption because redemption requires payment in full of all obligations secured by the collateral. U.C.C. 9-623(b). Consider this extreme example. A debtor has purchased a Mercedes on secured credit. Two months short of paying off the remaining $750 debt, the debtor defaults because of a temporary interruption in income. The secured lender repossesses the Mercedes, still worth $25,000, and proposes to retain the Mercedes in satisfaction of the remaining obligation. To prevent this sacrifice, Article 9 gives the debtor or subordinated secured parties the right to insist that the secured party dispose of the collateral (thus hopefully generating a surplus to be paid the debtor or the subordinated secured party, as the case may be) rather than retain the collateral in partial or full satisfaction of the obligation. U.C.C. 9-620. In some cases involving consumer goods U.C.C. 9-620(e) prohibits strict foreclosure altogether.
The alternative to strict foreclosure is foreclosure by disposition. U.C.C. 9-610 and sections following detail foreclosure by disposition. The fundamental requirements are timely advance notice of disposition (U.C.C. 9-611 et. seq.) and a commercially reasonable disposition. U.C.C. 9-610(b). We explore these requirements in Problem.Foreclosure by disposition and Westgate State Bank v. Clark. For typical types of collateral (e.g. automobiles), most institutional lenders will rely on agents or independent contractors with established routines for repossession, storage, advertising, preparation for sale, and auction of collateral. Such secured lenders generally have no desire or facility to retain collateral in satisfaction of an obligation indefinitely (what would a bank do with farm equipment?). However, in some cases any secured creditor might wish to avoid complying with the requirements of foreclosure by disposition, either to avoid fronting the initial expense of advertising and other preparations for sale or to avoid uncertainty about whether the method of disposition will be commercially reasonable. To do so, the secured party may choose strict foreclosure, thereby become the owner of the collateral, and thereafter dispose of the collateral at any time and in any manner it chooses without consequence.
If the secured party forecloses by disposition and thereafter seeks to recover a deficiency, the debtor may contest either the adequacy of notice or the commercial reasonableness of the disposition, or both. In such contests, two questions are paramount: (1) Who has the burden of proof on the issues of adequacy of notice and the commercial reasonableness of the disposition? (2) How should inadequate notice or commercially unreasonable disposition affect the amount of the deficiency to which the secured party is entitled? In addition, even if notice is adequate and disposition is commercially reasonable, should a deficiency be reduced if the amount of proceeds of a disposition is unusually low in comparison to the amount of proceeds one might expect to obtain from a disposition in another context? We explore these issues in Problem.Deficiency and in Commentary.Fair value limitations.