Problem.Foreclosure on mixed collateral
An abundance of competition has forced Kyoto International, a corporation, to close its San Francisco sports bar and restaurant and to default on a substantial note payable to Bank of Japan. The Bank of Japan financed Kyoto's acquisition of the restaurant property from a prior owner. The note is secured by a deed of trust on the real property, owned by Kyoto, at which the sports bar and restaurant was located and is also secured by a security interest in the equipment, fixtures and inventory of the sports bar and restaurant. The equipment and fixtures consist primarily of tables and chairs, stoves and ovens, cooking and eating implements, and cash registers. The equipment also includes both a valuable antique piano and a valuable collection of framed baseball cards of famous American and Japanese baseball players. There is no remaining inventory to speak of because Kyoto discarded spoiling food almost immediately upon closing the sports bar and restaurant.
As in-house counsel to Bank of Japan, you need to advise it of its options. To assist you, a new lawyer on the staff has prepared the following sketchy summary of the nature and purpose of the subsections of California Commercial Code 9-604. You view the summary with the same caution you view all analyses prepared by other lawyers, especially new ones, because you are the one charged with the responsibility of coming up with the correct answers. Because U.C.C. 9-604 is lengthy, you will probably find it helpful to print a hard copy of the section rather than scrolling through it.
Memorandum
To: Responsible lawyer
Re: Summary of Cal. Comm. Code 9604
From: New lawyer on the staffAfter studying Cal. Comm. Code 9-604 (formerly Cal. Comm. Code 9-501(4), effective beginning in 1986) and various commentaries upon it, I have prepared the following summary of its provisions:
Subsection (a)(1): Provides maximum flexibility to secured party in choosing among foreclosure options. Option 1 allows separate foreclosure sales of real and personal property, either contemporaneously or sequentially in any order. Option 2 allows a unified sale of real and personal property in accordance with procedures for foreclosure on real property. Option 3 allows a combination of separate sales of some personal property and a unified sale of other personal property with real property.
Subsection (a)(2): Absent a unified sale, and absent an applicable exception in subsection (a)(3), real property rules do not interfere with the secured party's rights under Article 9.
Subsection (a)(3): Notwithstanding subsection (a)(2), specified real property rules do apply in listed situations.
Subsection (a)(4): Proceeds from Article 9 sales do not cure defaults.
Subsection (a)(5): I need to do some more reading before I figure out the purpose of this subsection.
Subsection (a)(6): Definition of "monetary judgment on the debt."
Subsection (a)(7): The effects of defective unified sales on purchasers for value.
Subsection (a)(8): Real property fair value limits apply to unified sales such that the value of personal property sold is included in the determination of the amount of any deficiency.
A. Assuming that Kyoto is unable to reinstate or redeem, and assuming that it will not be filing a bankruptcy proceeding, what will be the most productive way for the Bank to proceed? Does the commercial reasonableness language of U.C.C. 9-610(b), or the general obligation under U.C.C. 1-203 to act in good faith in connection with any contract (including Article 9 security agreements) to which the U.C.C. applies, require a particular method of proceeding? In considering this second question, what help, if any, if offered by: (i) that portion of the Aspen case which discusses a unified sale; or, (2) by the following excerpt from a letter sent by the Vice-Chair of the State Bar Committee that drafted the report on amendments to U.C.C. 9-604 (formerly 9501(4)) to the legislative consultant to the legislative committee considering the amendment?
In response to concerns that have been raised by interested parties, we have agreed to delete the two references to commercial reasonableness in Commercial Code section 9501(4)(a) . . . The intended effect of these deletions is to leave existing law with respect to these issues unchanged, without indicating any view as to what existing law is.
B. Assume that prior to commencing any foreclosure proceedings, vandals with a love of music and sports destroy all equipment and fixtures of the sports bar and restaurant other than the piano and baseball cards. If Bank of Japan non-judicially forecloses on the deed of trust, may it thereafter foreclose, either judicially or non-judicially, upon the piano and baseball cards? May it thereafter recover a deficiency to the extent the proceeds from the separate foreclosure sales leave an amount owing on the note? Would it have been in a better position to recover a deficiency if the obligation had been represented by two notes, each in the amount of the total obligation (e.g. each note in the amount of $100,000 and the total obligation owed by the debtor is $100,000), one of which was secured by the real property and the other of which was secured by the equipment and fixtures? See Freedland v. Greco. What if the obligation had been represented by two notes totalling the amount of the obligation (e.g each note in the amount of $50,000 and the total obligation owed by the debtor is $100,000), one of which was secured by the real property and the other of which was secured by the equipment and fixtures? What if the obligation had been represented by two notes each of which is for less than the amount of the total obligation but the sum of which is for more than the amount of the total obligation (e.g. one note for $75,000 and the other note for $50,000 and the total obligation owed by the debtor is $100,000), one of which was secured by the real property and the other of which was secured by equipment and fixtures?
C. Continue to assume that equipment and fixtures other than the piano and baseball cards have been destroyed. If Bank of Japan were to file an action in which it requested judicial foreclosure of the real property and a deficiency, could Kyoto successfully raise an affirmative defense forcing Bank of Japan to include the piano or the baseball cards in the judicial foreclosure action prior to recovery of any deficiency?
D. Continue to assume that equipment and fixtures other than the piano and baseball cards have been destroyed. If Bank of Japan forecloses on the piano or baseball cards without judicial action, may it then proceed to non-judicially foreclose the deed of trust? Would your answer be different if it had foreclosed judicially on the piano or baseball cards in a lawsuit in which it also sought a deficiency judgment? See Walker v. Community Bank. Did Cal. Comm'l Code 9-604 overturn or conform to the result in Walker? In Walker the California Supreme Court quieted title to and enjoined the non-judicial foreclosure sale of property which, together with personal property, had stood as security for a debt. The Court did not interfere with the lower court's grant of a $93,570,83 deficiency following sale of the personal property security. Had the debtor not sold the property to Walker and had the debtor asserted the sanction, could the lender have enforced its $93,570.83 judgment by executing on the real property which, prior to assertion of the sanction, had been security for the debt? If so, to what additional risks has the lender exposed itself by not having included the real property in the original judicial foreclosure action?
E. Suppose Kyoto's acquisition of the sports bar and restaurant had been financed through a seller carry-back taken by the original owner rather than through a loan from Bank of Japan. Continue to assume that equipment and fixtures other than the piano and baseball cards have been destroyed following a default. Suppose the seller foreclosed judicially on the piano and baseball cards in a lawsuit in which it also sought a deficiency judgment. Might Kyoto successfully assert any defense other than an affirmative defense under 726? On this question, it appears as if Cal. Comm'l Code 9-604(a)(3)(A) is redundant to the second paragraph of Cal. Code Civ. Proc. 580b, a paragraph that was added to 580b in 1949. If so, and if the seller amended its complaint to drop its prayer for a deficiency and obtained a judgment only for possession of the piano and the baseball cards, could seller thereafter non-judicially foreclose on the real property?
F. Whether the secured party is Bank of Japan or the prior owner, will a court, on Kyoto's complaint, enjoin a foreclosure on the piano or baseball cards, either judicial or non-judicial, pending expiration of the reinstatement period provided in Cal. Civ. Code 2924c? If Kyoto timely tenders the amount required by Cal. Civ. Code 2924c to reinstate the note, will a court, on Kyoto's complaint, enjoin a foreclosure on the piano or baseball cards? On the real property? If proceeds from the foreclosure sale of the piano or baseball cards equal or are greater than the amount required under Cal. Civ. Code 2924c to reinstate the note, and if those proceeds are received by the secured party prior to the expiration of the reinstatement period, will a court, upon Kyoto's complaint, enjoin foreclosure on the real property?
G. Had enough? If not, there are plenty more examples in Bernhardt, The Mixed Multiple Collateral Muddle, 9 Real Prop. L. Rep. 101 (1986).