Many agricultural producers borrow money to successfully run their operations. Typically, the lender requires the borrower to give a security interest in property such as land, equipment or commodities before supplying the funds. This type of transaction is considered a secured transaction, which is primarily governed by Article 9 of the Uniform Commercial Code (“UCC”). In general, a secured transaction is one that creates a security interest for the creditor. Thus, the producer who borrows money from the creditor will provide a security interest in their agricultural property to the creditor. Previous articles in this series discuss the rules governing these types of transactions.
Creditors take security interests in a debtor’s property to provide themselves with the ability to enforce their interest in the collateralized property. In most cases, debtors repay their debts by the maturity date. However, if a debtor defaults on their loan, a creditor can enforce their interest to satisfy the debt owed to them.
When a creditor must enforce their interest, Article 9 provides certain rights to those creditors. In general, Article 9 provides creditors two options as to how they may enforce their interest in order to satisfy a debtor’s unpaid debt: (1) dispose of the collateral, or (2) keep collateral in satisfaction of the debt.
Many creditors choose to dispose of collateral by selling the property at an auction or to a private buyer. When doing so, lenders much satisfy two steps required under Article 9: (1) provide reasonable notice to parties who have an interest in the collateral being disposed, and (2) dispose of collateral in a “commercially reasonable” manner.
Unfortunately, there is no exact definition of “commercially reasonable” because the term is not defined under the UCC. Rather, Article 9 specifies that every aspect of a creditor’s disposition, “including the method, manner, time, place and other terms, must be commercially reasonable.” U.C.C. § 9-610(b). Accordingly, creditors must consider these factors when disposing of collateral to ensure their actions are commercially reasonable.
Under Article 9, creditors may “sell, lease, license or otherwise dispose of” the collateral. U.C.C. § 9-610(a). In many instances, creditors choose to dispose of collateral in either a public or private sale. Under either method, creditors must consider the time and condition of the collateral to ensure their disposition is commercially reasonable under Article 9. Additionally, for private dispositions (non-public auctions), creditors must also consider the selling price of collateral to satisfy the commercial reasonableness standard.
Time of Disposition
Article 9 does not specify a time period which creditors must dispose of collateral. Rather, it directs creditors to dispose of collateral at an appropriate time. For the most part, the time of disposition depends on the type of collateral subject to disposal. Consequently, if a creditor does not dispose of collateral at an appropriate time, their actions may not be commercially reasonable.
After repossessing collateral from a debtor, it is generally in the creditor’s interest to quickly sell the collateral. Creditors that hold onto collateral for a lengthy period of time—without a good reason to do so—may be acting unreasonably. For example, it is not commercially reasonable to let farm products, such as dairy or flowers, spoil before disposing of collateral.
Nevertheless, there are some instances when it is commercially reasonable for the creditor to hold onto collateral for an extended period of time. For instance, the current market conditions of the collateral may prevent a prompt disposition. Essentially, creditors must ensure the economic conditions are reasonable so that it will provide a fair price for the collateral at the time of the sale. If the market for the collateral is down, it may be commercially reasonable to hold onto the collateral until the market recovers before selling the property.
Another situation where it may be commercially reasonable for the creditor to hold onto collateral is when it can be sold in divisible units or parcels over a period of time. For example, if the collateral subject to disposal is a farmer’s rice crop, the creditor may choose to store the rice and sell it in increments as market prices increase. In this situation, the creditor is likely acting in a commercially reasonable manner by selling the collateral under separate contracts to obtain more proceeds to satisfy the farmer’s unpaid debt.
Condition of Collateral
Under Article 9, creditors may dispose of collateral “in its present condition or following any commercially reasonable preparation.” U.C.C. § 9-610(a). In other words, creditors have the option to either sell the collateral “as is” or restore the collateral before disposition. Although Article 9 does not require creditors to restore or repair collateral, there are some situations where it is not commercially reasonable to sell collateral “as is”.
For example, if the benefits of repairing the collateral outweigh the costs, it is likely not commercially reasonable to dispose of the collateral “as is”. In these instances, creditors should consider making repairs before selling the collateral to ensure they comply with Article 9.
Although an important factor, the selling price of the collateral is not conclusive of whether a creditor’s disposition is commercially reasonable. In many cases, a creditor is unable to receive the full value of the collateral at a sale. This is especially true for creditors disposing of collateral through a public sale because the selling price of the collateral is determined by individuals bidding on the property, which means the creditor has very limited control on the sales price. Thus, creditors using this method of disposal generally do not have to consider this factor for their actions to be commercially reasonable.
On the other hand, creditors selling collateral through a private sale must generally take the selling price of the collateral into consideration because selling collateral at a very low price may indicate a creditor is not attempting to maximize the proceeds for collateral. When creditors do not attempt to maximize proceeds for collateral, it is more likely their actions are not commercially reasonable under Article 9.
In general, Article 9 requires creditors to dispose of collateral in a “commercially reasonable” manner. Although the UCC does not define that term, Article 9 specifies that the manner, method, time, price, and condition are some things to consider to determine whether a creditor’s disposition of collateral is commercially reasonable. Essentially, creditors who use reasonable efforts to maximize the proceeds from a collateral sale are generally acting within a commercially reasonable manner. Consequently, a creditor who fails to satisfy the requirements under Article 9 may be unable to recover any remaining debt balance owed by a debtor after the disposition.
The next article in this blog series will explain what creditors must do with the proceeds they receive from a sale of collateral.
To read the other articles of this series, click here.
For more National Agricultural Law Center resources on finance and credit, click here.
For more National Agricultural Law Center resources on secured transactions, click here.