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. The first step requires creditors to provide a reasonable notice to parties who have an interest in the collateral being disposed. The second step requires creditors to dispose of the collateral in a “commercially reasonable” manner. This step contains several factors which creditors must consider to properly dispose of collateral under Article 9.
This article discusses two important aspects of a commercially reasonable disposition that creditors must consider to satisfy Article 9: the manner and method of a disposition.
Commercial Reasonableness Overview
After a creditor provides a reasonable notice to the appropriate parties, they may dispose of the collateral. However, a creditor’s disposition must be conducted 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). As a result, a creditor must consider these factors when disposing of collateral to ensure their actions are commercially reasonable under Article 9. The manner and method factors are likely the most important because courts usually place the most consideration on these factors when examining the commercial reasonableness of a creditor’s disposition of collateral. Accordingly, creditors who fail to consider these factors may risk being liable for losses suffered by a debtor or other creditors as a result of the noncompliance.
Method and Manner of Disposition
In general, creditors must consider the method and manner in which they dispose collateral. 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. Both methods allow creditors to choose the time, place, and manner of disposition.
In general, a disposition qualifies as a public sale or auction when: (1) some form of advertisement notifying the public of the upcoming sale; (2) the public has access to the sale; and (3) the public has the opportunity to offer or bid on the collateralized property.
In most cases, a public sale is typically commercially reasonable if a creditor advertises the time, date, and location of the sale in a local newspaper or similar publication at least 10 days before the sale. Also, for a public sale to be commercially reasonable, creditors must allow any purchaser from the public to participate in the bidding and cannot limit a sale to a specific type of buyer. For example, if a creditor holds an auction but limits the bidding to “merchants only,” the auction most likely does not qualify as a “public sale” and may not be commercially reasonable under Article 9.
For a private sale, creditors must take extra precautions to ensure the sale is commercially reasonable. A private sale, for example, is one where the creditor offers the collateral to a select group of buyers or uses a broker to locate a purchaser. Unlike public sales, private sales give creditors more control over the selling price because they are in a position to negotiate with a purchaser. Because of this, third parties with an interest in the same collateral may be more willing to challenge the commercial reasonableness of the creditor’s private sale.
Essentially, whether the creditor’s private sale is commercially reasonable depends on their efforts in marketing the collateral to private purchasers. The creditor must offer the collateral at a price that conforms with the current market and seek various offers to maximize proceeds. For example, suppose a creditor is disposing of collateralize farm equipment through a private sale and knows a few dealers looking to restock their inventory of used farm equipment. The creditor’s private sale is likely commercially reasonable if they negotiate a selling price with each dealer and sell the equipment to the dealer who offers the highest price.
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 several factors that creditors should consider to properly dispose of collateral. Likely the most important factors are the method and manner of a creditor’s disposition. Public and private sales are typically the preferred method of disposition for many creditors. Creditors conducting a public disposition of collateral should advertise the auction and should not limit the auction to a specific group of bidders. For private sales, creditors are generally acting in a commercially reasonable manner if they are actively looking for a buyer who will give them a fair price for the collateral.
The next article in this blog series will explain the other factors creditors must consider to satisfy the Article 9 commercial reasonableness standard.
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.