Fair value limitations

     Execution sales are distress sales, often at poorly attended auctions, and property is sold without warranties of quality or title.  Article 9 sales are also distress sales.  The property is sold without warranties of quality but may be sold with warranties of title.  See U.C.C. 9-610(d)-(f).   Because both execution and Article 9 sales are distress sales, buyers at these sales, including a judgment creditor bidding in part or all its debt at an execution sale or a secured party bidding in part or all of its debt at a foreclosure sale, typically pay less for the property being sold, whether real or personal property, than would be paid for a sale of the same property in a different context. As a consequence, buyers at these sales get very good deals, and, if they so desire, may well be able to resell the property at a profit.

     Should that profit be at the debtor's expense? Consider the following examples (each of which, for simplicity, ignores costs of sale and accrual of interest). Suppose an unsecured creditor has obtained a judgment against the debtor for $200,000. At an execution sale of a non-exempt asset of the debtor, a third party buyer, the high bidder at the sale, acquires the asset for $100,000. Almost immediately thereafter, and not as a consequence of a change in the market price of the asset, the buyer is able to resell the asset for $175,000. Nonetheless, the amount of the unsatisfied judgment will be $100,000. Under the law governing execution sales, the same will be true if the buyer at the execution sale is the judgment creditor itself, bidding in $100,000 of the judgment as the purchase price; the amount of the unsatisfied judgment will be $100,000, for satisfaction of which the judgment creditor may execute on other assets of the debtor, even if the judgment creditor immediately resells for $175,000 the property it purchased at the execution sale. Another way to express this result is that we credit against the judgment the net proceeds of the execution sale rather than the value, often referred to as "fair value," that the property would fetch if sold in another context. 

     We will see the same result (i.e. a deficiency of $100,000) in the context of an Article 9 sale, unless the transferee of the disposition is the secured party, a person related to the secured party, or a secondary obligor.  (Note that a secured party may purchase at a public disposition of collateral but not at most private dispositions of collateral.  U.C.C. 9-610(c).)    For a disposition to a secured party, person related to a secured party, or secondary obligor, the deficiency will be limited if the amount of proceeds from the disposition is significantly below the range of proceeds that would have been received in a complying disposition to someone other than the secured party, a person related to the secured party, or a secondary obligor.  See U.C.C. 9-615(f).  For example, suppose the secured creditor acquired the collateral at a foreclosure sale with a credit bid of $100,000 but the debtor or obligor (carrying the burden of proof on this issue, U.C.C. 9-626(a)(5)) can prove that $100,000 is significantly below the range of proceeds that would have been received in a complying disposition to someone other than the secured party, a person related to the secured party, or a secondary obligor.  In such a case, the debtor's deficiency would be limited to the difference between $200,000 and the amount that the secured party would have obtained from a complying disposition (e.g. $125,000) to someone other than the secured party, a person related to the secured party, or a secondary obligor.  However, the protection of the obligor in such a case is not as extensive as a "fair value" rule.  Even if the secured party immediately resells the property for $175,000 (suggesting that $175,000 is reflective of the fair value of the property), the debtor remains liable for a $75,000 deficiency.    

     During the Article 9 revision process, consumer advocates and others vigorously, but unsuccessfully, sought an Article 9 fair value rule that would apply to all Article 9 dispositions, not just dispositions in consumer transactions.   They argued that even commercially reasonable dispositions (i.e. dispositions that complied with the procedural requirements of Article 9) frequently generate an unreasonably low price and therefore expose the debtor to an unreasonably high deficiency.   Advocates for secured parties argued that a procedurally adequate sale is sufficient to generate the greatest possible amount of proceeds or that alternatives would be costly or impractical.  The debate is developed, the fair value position advocated, and its consideration in the Article 9 revision process detailed in Rapson, Deficient Treatment of Deficiency Claims: Gilmore Would Have Repented, 75 Wash. U.L.Q. 491 (Spring 1997). 

     Despite the absence of a fair value rule in Article 9, the lawyer might urge a court to exercise its equitable powers to apply such a rule in circumstances where the proceeds of a disposition are unusually low.  Courts have done so in other contexts where the governing statute is silent on the issue.  See e.g., Citibank v. Errico, 597 A.2d 1091, 1097 (N.J. Super. Ct. App. Div. 1991)(real property), Vito's Towing Inc. v. Kemp, 652 A.2d 1259 (N.J. Super. Ct. App. Div. 1995)(statutory lien sale of auto for towing and storage charges).  But a court may be unpersuaded to do so in the Article 9 context given the express consideration and rejection of a fair value rule in the Article 9 revision process.  Alternatively, the lawyer may argue that a low disposition price requires the court to exercise additional scrutiny in determining whether a disposition was commercially reasonable.  See Official Comment 2 to U.C.C. 9-627.  A finding of commercially unreasonable disposition will not trigger a fair value rule but will trigger the rebuttable presumption rule of U.C.C. 9-626(a) or, in consumner transactions, another deficiency limiting rule developed by the courts under the authority of U.C.C. 9-626(b).  I do not think that U.C.C. 9-626(b) authorizes the courts to develop a "pure" fair value rule in consumer transactions.  That section authorizes courts to develop deficiency limiting rules where a disposition is commercially unreasonable but does not seem to authorize the development of such a rule in low price but commercially reasonble dispositions.  See Official Comment 4 to U.C.C. 9-626. 

     Real property security law in many jurisdictions, including in California, does impose fair value limitations.  To illustrate, consider the numbers from our previous examples in the context of a real property secured transaction. Suppose that a creditor who is owed $200,000 holds a first deed of trust on real property. In a judicial foreclosure sale the creditor, as high bidder, obtains title to the property by bidding in $100,000 of its debt. The creditor then requests a deficiency of $100,000. Cal. Code Civ. Pro. 726(b) requires the court to determine the fair value of the property acquired at the foreclosure sale. It must ask, in effect, what the property would likely fetch at a sale under "normal market conditions." If the court determines that the property would fetch $175,000 (that is, the property's fair value is $175,000), the creditor's deficiency will be limited to $25,000. Thus, unlike execution sales or Article 9 foreclosure sales, the creditor will not be entitled to the windfall that would otherwise result from holding (and perhaps reselling) property worth $175,000 and getting a deficiency judgment for $100,000 on account of a $200,000 debt.

     The fair value provisions applicable to foreclosures of real property also apply if a third party buyer rather than the foreclosing creditor is the high bidder at the sale. At first glance this might seem strange, because the foreclosing creditor has not gained title to the property and thus cannot reap any windfall from its resale. The third party buyer, not the foreclosing creditor, reaps the benefit of the difference between the fair market value of the property and its distress price at the foreclosure sale. However, the foreclosing creditor had within its power at the foreclosure sale the ability to prevent unnecessary loss to the debtor by outbidding the third party purchaser, at least up to the amount of the debt or the "fair value" of the property, whichever is less. To illustrate, suppose, using the same numbers, that a third party made a high bid of $100,000 at the foreclosure sale. If we hypothesize that the property may be worth as much as $175,000, the foreclosing creditor, after having received $100,000 from the foreclosure sale, will be limited to a $25,000 deficiency on its $200,000 debt because it could have bid as much as $175,000 at the foreclosure sale without harm because (again ignoring costs) it could receive $175,000 upon resale of the property and a $25,000 deficiency. In this situation, the fair value limitations in effect provide that the debtor should not suffer excessive loss from the foreclosing creditor's failure to make the highest reasonable bid that it could have made.

    Fair value limitations do not operate to protect unsecured creditors of the debtor against the loss of value attributable to the difference between the distress sale price and the fair market value of property sold at a foreclosure sale. If, to modify our previous example, property purchased at a foreclosure sale for a high bid of $100,000 can be immediately resold for $225,000 (i.e. $25,000 more than the amount owed to the foreclosing creditor), unsecured creditors of the debtor can understandably feel unfairly deprived of part of the value of an asset that could, but for the sale, have been applied to payment of unsecured debt. In the state remedies system, unsecured creditors generally are entitled to attack conveyances of a debtor's non-exempt property for less than reasonably equivalent value if the conveyance was made while the debtor was insolvent or if the conveyance rendered the debtor insolvent. See, e.g., section 5(a) of the Uniform Fraudulent Transfer Act. The theory is that debtors should not give away, or have taken from them, property the value of which could be applied to the satisfaction of claims of unsecured creditors if the debtor is insolvent (i.e. otherwise has insufficient assets to pay debts), unless, because of the receipt of reasonably equivalent value for the conveyance, the debtor's balance sheet looks no worse after the conveyance than before the conveyance. Application of this theory to foreclosure sales would, however, chill bidding, because a bidder will not be anxious to bid high enough to avoid a fraudulent conveyance attack (because of the absence of title or quality warranties) and will fear bidding so low that it would be purchasing a fraudulent conveyance attack. Accordingly, the Uniform Fraudulent Conveyance Act exempts from attack "regularly conducted, non-collusive foreclosure sale[s]". See section 3(a) of the Act. The United States Supreme Court has reached the same conclusion in the bankruptcy context with respect to non-judicial foreclosure. See BFP v. Resolution Trust Corporation.