Business Law 1

Foreclosure Under Revised Division 9 of the Uniform Commercial Code
by Ellen Friedman and Hill Blackett III

Ellen Friedman and Hill Blackett III, Murphy Sheneman Julian & Rogers, San Francisco. Ms. Friedman is author of Secured Transactions in California Commercial Law Practice, 2001, and contributing author to Trade Secrets Practice in California, 1997, both published by CEB.

Revised Division 9 of the Uniform Commercial Code has been in effect in California and most other states since July 1, 2001. Because of the decline in California’s economy since the effective date, many practitioners are finding it necessary to apply the provisions in Chapter Six of Revised Division 9 entitled “Default.” These provisions create detailed rules for the enforcement of security interests, including rules for the collection of intangible assets such as accounts and general intangibles, public and private foreclosure sales to third parties, and so-called “strict” foreclosures in which the secured party takes or retains collateral in partial or complete satisfaction of the secured obligation. Although the basic elements of enforcement remain largely the same as under former Division 9, Revised Division 9 adds much greater detail in its description of the various enforcement mechanisms and, in the process, changes several of the rules and limitations that applied under former Division 9. This article focuses only on the enforcement rules applicable to commercial transactions and does not address consumer transactions for which several different rules apply.

Default

Like its predecessor, Revised Division 9 requires a “default” before the secured party may exercise any remedies against the collateral. Com C §9601(a). Default is not defined, but is left to the security agreement or other contract executed by the debtor and secured party. Generally, and particularly if the security agreement so provides, the secured party should deliver a written notice to the debtor of the defaults that exist. We recommend that the notice of default be delivered as soon as the secured party learns of the defaults, rather than waiting until the secured party elects to exercise its remedies. It is not necessary for the secured party to accelerate or demand full payment of the secured obligations in the notice of default or in the notice of sale described later in this article. However, it is helpful for the secured creditor to demand full payment as part of the notice to eliminate the debtor’s argument that it can cure the default and stop the sale by tendering payment of the past-due amount or providing other partial performance.

Collection of Accounts and General Intangibles

In many instances, the first remedy a secured party pursues is to collect on accounts and general intangibles against third parties. The proceeds are then applied to the secured obligations. After default—and earlier if provided in the security agreement—the secured party may notify account debtors to pay the secured party directly and may enforce the debtor’s claims against those parties. See Com C §9607(a). “Account debtor” is broadly defined to include all obligors on accounts and other contracts, as well as defendants in litigation (including commercial tort and intellectual property litigation). Com C §§9102(a)(3) and (42). The secured party may also apply proceeds in the debtor’s deposit account if the secured party has “control” of the account. Com C §§9607(a)(4) and 9104(a).

Foreclosure Sales

After default, a secured party may “sell, lease, license, or otherwise dispose” of collateral, either “as is” or after preparation or processing, in bulk or in lots, at any time or place, via public or private disposition. Com C §9610(a) and (b). The secured party may purchase at any public sale, or at a private sale if the collateral “is customarily sold on a recognized market or the subject of widely distributed standard price quotations” (i.e., publicly traded securities or commodities). Com C §9610(c).

Notice of Disposition
Generally, the secured party must provide notice of the proposed foreclosure sale to the debtor, any guarantor, any person who has delivered notice of an interest in the collateral to be sold, and any person with a properly filed financing statement or other perfected lien as of ten days before the notification date. Com C §9611(c). The only exceptions to the notice of sale requirement are for sales of collateral that is perishable, collateral that “threatens to decline speedily in value” (such as New Year’s decorations in December), or collateral that is customarily sold on a recognized market (such as publicly traded securities). Com C §9611(d). The notice must be sent within a reasonable time prior to the sale, but notice sent after default and ten days or more before the disposition is deemed reasonable. Com C §912(b).

To satisfy the notice requirements, the secured party must obtain an official search from the proper office in which to file against the collateral as of ten days before the notice date (i.e., the proper filing jurisdiction under revised Division 9). This notice requirement should promote coordination (or at least reduce confusion) among secured parties.

The notice is “sufficient” if it: (i) includes a description of the debtor and secured party; (ii) describes the collateral to be sold; (iii) states the intended method of disposition; (iv) states that the debtor is entitled to an accounting of the unpaid obligations; and (v) states either the time and place of the sale if it is to be a “public” disposition, or the time after which the disposition will take place if it is to be a private disposition. Com C §9613. No particular phrasing or format for the notice is required, but Section 9613 includes a “safe-harbor” form that prudent secured parties will use. Minor, non-misleading errors and additional information do not render a notice insufficient, but the sufficiency of any notice will be based on the particular facts. Com C §9613.

Effect of Disposition
Good faith purchasers at foreclosure sales receive all of the debtor’s rights in the collateral free of the security interest foreclosed upon and all junior interests even if the foreclosure sale does not comply with Chapter 6. Com C §9617. Proceeds from sale are applied in the same manner as proceeds from collections—first to the secured party’s costs, second to the secured obligations, third to junior secured obligations to the extent of any surplus, and fourth to the debtor. Com C §§9615(a) and (d). The obligor remains liable for any deficiency. Com C §9615(d).

Generally, the calculation of any surplus or deficiency is based on the amount received by the secured party. However, in a disposition to a secondary obligor, the secured party, or any person related to the secured party, if the amount received is “significantly below” the range of proceeds that would have been received in a sale to an unrelated third party, the deficiency is determined based on what would have been received in that unrelated-party transaction. Com C §9615(f). This special rule is new and is intended to remedy the effects of collusive foreclosures and subsequent inflated deficiency claims.

Strict Foreclosures

Revised Division 9 clarifies and expands the right of a secured party, with the consent of the debtor, to accept collateral in satisfaction of the secured obligations. This process is unofficially known as “strict foreclosure.” The secured party may accept any collateral (e.g., inventory, equipment, accounts, intellectual property, or commercial tort claims) in full or partial satisfaction of the secured obligation, if the debtor consents and any other secured parties entitled to notice do not object. Com C §9620. The debtor may consent in an authenticated record any time after default, or may be deemed to consent if the debtor does not object in writing within twenty days after the secured party delivers notice of its proposed acceptance. The secured party must deliver notice to: (i) the debtor; (ii) any person claiming an interest in the collateral; and (iii) any secured party with a financing statement properly filed against the collateral ten days before debtor consents to the proposed acceptance. Com C §9621. For acceptance in partial satisfaction, secondary obligors must also receive notice. There can be no “constructive” strict foreclosure by the secured party; the secured party must either consent or deliver a proposal to retain the collateral. Com C §9620(c).

Transfer Statements

Revised Division 9 enables secured parties to create a formal transfer document—a “transfer statement”—that can be delivered to filing or recording offices to evidence the transfer of title created by the foreclosure sale or strict foreclosure. Com C §9619. The statement must recite that the debtor has defaulted, the secured party has exercised its post-default remedies, and the transferee has acquired title as a result of the exercise of those remedies. The statement is intended for use in offices such as the California Department of Motor Vehicles or the United States Copyright or Patent and Trademark Offices.

Commercial Reasonableness

Revised Division 9 continues the prescription under former Division 9 that all aspects of any collection or enforcement against collateral, and any disposition of collateral must be commercially reasonable, including the method, manner, time, place, and other terms. Com C §§9607 and 9610. Commercial reasonableness is not defined. In general, it is a standard of conduct based on a balancing of the secured party’s interest in receiving full, prompt payment against the debtor’s interest in preserving the full realizable value of the collateral. Secured parties may find some guidance by asking what they would do to liquidate the collateral if they owned it.

Disposition at a price or collection of an amount that does not represent full value is not determinative, although it may be indicative of inadequate procedures undertaken by the secured party. Com C §9627. Dispositions in conformity with reasonable commercial practices of dealers in relevant markets are presumed to be commercially reasonable. Sales approved by creditors committees, bankruptcy courts, or assignees for the benefit of creditors are also presumed reasonable. Com C §9627. Existing case law continues to be relevant. Depending on the circumstances, commercial reasonableness can require cleaning or fixing equipment, completing inventory, identifying and noticing potential purchasers, publishing advertisements in trade journals, using brokers or auctioneers, selling at retail rather than wholesale, or even requesting marketing information from the debtor.

Effect of Noncompliance

Generally, a court may order or restrain collection, enforcement or disposition as appropriate as a consequence for the secured party’s noncompliance with any provision of Division 9, and may assess consequential damages. Com C §9625. Plaintiffs with standing to enforce these remedies for noncompliance are limited to debtors, obligors (including secondary obligors), and other secured parties. If the secured party fails to comply, the debtor or secondary obligor’s obligation to satisfy any deficiency claim is limited to the amount by which the secured obligation exceeds the greater of the actual amount received by the secured party or the amount that would have been received in a complying transaction.

Mixed Collateral

Revised Division 9 continues to include a non-uniform, unique provision for foreclosure of “mixed collateral” (real and personal property). The language in Section 9604 is virtually identical to Section 9501(4) under former Division 9. These provisions specifically address the interplay and conflicts that would otherwise exist between Chapter 6 and California real property foreclosure laws. They provide that a secured party with both real and personal property collateral may: (i) utilize separate judicial or non-judicial procedures to enforce its security interests in each; (ii) include personal property in its judicial or non-judicial foreclosure against the real property; and (iii) divide its personal property collateral into separate or combined foreclosure procedures.

For a detailed discussion of California’s non-uniform foreclosure and other provisions, see UCC Committee Report: Revised Division 9 of the California Commercial Code and California’s Non-Uniform Provisions, in Business Law News (The State Bar of California, Business Law Section, Vol. XXI, Issue 1, 2001). In addition, for a more detailed explanation of the default provisions under revised Article 9, see Friedman, Ellen, Secured Transactions in California Commercial Law Practice (CEB 2001), and Zinnecker, Timothy R., The Default Provisions of Revised Article 9 (ABA Bus Law Section 2001).

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