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, such as the right to collect or repossess collateral. Another right granted to creditors after a default is the right to use the collateral in order to satisfy a debtor’s unpaid debt. In general, creditors who repossessed collateral have two options as to how the collateral may be used to satisfy the indebtedness: (1) dispose of the collateral, or (2) keep collateral in satisfaction of the debt.
This article discusses the first option of satisfying a debtor’s indebtedness mentioned above. Specifically, this article explains the notice requirements that creditors must fulfill in order to properly dispose of collateral under Article 9. If a creditor fails to comply with the notice requirements, they may become liable to a debtor or other creditors with an interest in the same collateral. Thus, it’s important that creditors understand the laws governing the disposal of collateral in order to protect themselves financially.
Disposition of Collateral
Under Article 9, creditors may “sell, lease, license, or otherwise dispose of any or all of the collateral in its present condition or following any commercially reasonable preparation” after a debtor defaults. U.C.C. § 9-610(a). This provision provides creditors broad discretion on the method of disposal (“sell, lease, license, or otherwise…”); however, creditors must complete two important steps to properly dispose of collateral under Article 9.
Essentially, creditors must 1) provide a “reasonable” notice to parties who have an interest in the collateral being disposed, and 2) dispose of the collateral in a “commercially reasonable” manner. Each step contains its own requirements which creditors must satisfy in order to properly complete that step. Consequently, creditors who fail to comply with these requirements may risk being liable for losses suffered by a debtor or other creditors as a result of the noncompliance.
Typically, before the creditor disposes collateral, they must send a “reasonable authenticated notification of disposition” to the debtor and other parties who have an interest in the collateral subject to disposition. U.C.C. § 9-611(b). Article 9 requires the creditor to provide this written notice to interested parties so they have the opportunity to monitor the disposition of the collateral, purchase the collateral, minimize possible proceed deficiencies, demand to receive any remaining proceeds recovered after disposition, and also give the debtor the opportunity to repay the debt in order to reclaim the property before it is disposed.
Before disposing of the collateral, the creditor must provide notice to the debtor and any secondary obligors. Secondary obligors (sometimes called “guarantors”) are parties that guarantee the repayment of the debtor’s loan, and are generally treated as a debtor under the loan. Thus, this makes them liable to the creditor when the primary debtor defaults. As a result, Article 9 requires the creditor to send notice to secondary obligors so that they have the opportunity to minimize any harm they may suffer from the creditor’s disposition of the collateral.
If the collateral being disposed is not a consumer good, Article 9 requires creditors to provide additional notice to parties who have an interest in the collateral. The UCC defines “consumer goods” as “goods that are used or bought for use primarily for personal, family, or household purposes.” U.C.C. § 9-102(a)(23). In agricultural finance, creditors generally take security interest in a debtor’s agricultural products and equipment, which are not consumer goods. Thus, these creditors must typically provide notice to other interested parties.
Under Article 9, there are three different types of parties who may have an interest in the collateral. First, any party who sends the creditor a written notice—before the notification date—claiming they have an interest in the collateral are entitled to notice. The “notification date” is the earlier date of which 1) the creditor sends notice to the debtor, or 2) the debtor waives their right to receive a notice (waive only valid post-default). U.C.C. § 9-611(a). Therefore, if a party notifies the creditor of their interest after the notification date, the creditor is not obligated to provide them with notice.
Second, the creditor must provide notice to any other secured creditor or lienholder that held a perfected security interest in the collateral 10 days before the notification date. However, the creditor is only required to send notice to these parties if they perfected their interest by filing a proper financing statement. The creditor complies with this requirement if they conduct a UCC financing statement search for filings that are against the debtor in the same collateral between 20 and 30 days before the notification date. U.C.C. § 9-611(e). If this search reveals other secured parties and lienholders that hold an interest in the same collateral, they must provide them with notice.
Third, the creditor must notify any other creditor who holds a perfected security interest in the same collateral under § 9-311 of the UCC. Section 9-311 exempts creditors from having to file a financing statement in order to perfect their interest in compliance with a federal or state statute, regulation, or treaty. For example, some states have enacted statutes that require creditors to perfect their interest in certain farm equipment by indicating their interest on a certificate of title. Because perfection requires creditors to indicate their interest on a certificate of title, rather than filing a financing statement, they satisfy § 9-311 and hold a perfected security interest under the statute.
Creditors must provide notice to each interested party in order to comply with Article 9 and to protect themselves financially. For example, suppose Jake obtains a loan from Farm Credit Bank (“FCB”), which is secured by all of Jake’s farm equipment and cattle. Because of his poor credit record, Jake’s sister Carla cosigns on the loan so Jake can borrow from FCB. Later, Jake obtains a loan from his friend Kate, which is secured by all of Jake’s cattle. Afterwards, Jake grants Ag State Bank (“ASB”) a security interest in all of his farm equipment to obtain a loan from the bank. ASB promptly perfects this interest by filing a financing statement. Four months later, Jake defaults on his loan with FCB, and FCB chooses to dispose of the collateral at a public sale to satisfy the unpaid debt. Afterward Jake’s default, FCB conducts a UCC financing statement search and discovers that ASB holds a perfected security interest in all of Jake’s farm equipment. The next day, FCB receives an email from Kate informing it of her interest in Jake’s cattle.
In order for FCB to comply with Article 9, it must provide notice of its plans to dispose of Jake’s farm equipment and cattle to Jake because he is the debtor, as well as Carla because she cosigned on the loan, which makes her a secondary obligor. Further, because farm equipment and cattle are not consumer goods, FCB must provide notice to ASB and Kate. ASB is entitled to a written notice because it perfected its notice by filing a financing statement, and it held this interest months before the notification date. Also, Kate is entitled to notice from FCB because she sent a written notice by email that informs FCB of her interest in Jake’s cattle before FCB sent notice to Jake. Therefore, if FCB provides written notice to each of these parties, it will most likely comply with Article 9. However, if FCB fails to provide notice to a party, they may risk having to pay damages to that party for the harm they suffered due to FCB’s failure to provide them with notice.
Although there are many different parties that are entitled to notice, there are some situations where the creditor is not required to provide notice. Article 9 does not require the creditor to send notice if the collateral is perishable. U.C.C. § 9-611(d). In agricultural finance, some creditors take a security interest in perishable farm products, such as vegetables or dairy products. In these situations, the creditor may dispose of the perishable farm products without notifying the debtor or any interested party.
Also, creditors are exempt from providing notice to the debtor when they waive their right to receive notice. However, this exception only applies if the debtor waives their right post-default. In other words, the debtor cannot agree to waive their right to notice in the parties’ security agreement or anytime before defaulting on their loan. In situations where the collateral is not consumer goods and the debtor waives their notice rights, creditors must still provide notice to the other known parties who have an interest in the collateral.
Article 9 requires creditors to send “reasonable” notice. Whether the creditor’s notice is reasonable depends on the timing of the notice, the manner in which it is sent, and the information contained within the notice.
Typically, the creditor’s notice is timely when it gives the receiving party an opportunity to act on the notification before collateral is disposed. In agricultural finance, the creditor’s notice is generally timely if it is sent after default and at least 10 days before the collateral is disposed. Also, the manner in which the creditor sends notice is reasonable when their notice is in writing. Because the creditor’s notice must be “authenticated,” an oral notice is most likely unreasonable under Article 9.
Article 9 contains a safe harbor provision that provides creditors with the necessary information needed to have a reasonable notice. Section 9-613 sets forth the required information the creditor should include if the collateral subject to disposition is non-consumer goods. In order to satisfy this provision, the creditor’s notice must include:
- Description of the debtor and creditor;
- Description of the collateral subject to disposition;
- Method of intended disposition;
- Statement informing the debtor that they are entitled to an accounting of the unpaid debt and states the charge for an accounting; and
- States the date, time, and place of a public disposition or the date and time if the disposition is private.
The creditor’s notice containing the information under § 9-613 will most likely be considered a reasonable notice. Nevertheless, the creditor’s notice can still be reasonable even if it lacks some information listed under the safe harbor provision or contains minor errors. However, whether the creditor’s notice is reasonable is a question of fact. In other words, a jury decides the reasonableness of the creditor’s notice in situations where a notice is challenged in a lawsuit.
In general, Article 9 allows creditors to dispose of collateral in order to satisfy the debtor’s indebtedness. Although creditors have discretion on the method of disposition, they must satisfy two steps in order to properly dispose of the collateral. The first step, unless there’s an exception, requires creditors to provide a reasonable notice to the debtor, any secondary obligor, and other parties who hold an interest in the collateral subject to disposition. Weather the creditor’s notice is “reasonable” is determined on the time, manner, and information contained within a notice. Generally, the creditor’s notice is reasonable when they provide a written notice that includes all the information listed under § 9-613 at least 10 days before disposing collateral. Overall, creditors must comply with these requirements under Article 9 to reduce the risk of becoming liable to another party for damages caused by the creditor’s failure to provide sufficient written notice. The next article in this blog series will cover the “commercially reasonableness” requirements creditors must satisfy when disposing 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.