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 order to satisfy an unpaid debt, Article 9 allows creditors who repossess collateral to either 1) dispose of the collateral, which was discussed in the previous two articles of this series, or 2) keep the collateral in satisfaction of the debt. Creditors that choose to keep collateral to satisfy the unpaid debt must satisfy certain requirements contained under Article 9. If a creditor fails to comply with these requirements, they may become liable to a debtor or other creditors with an interest in the same collateral.
Under Article 9, creditors have the option to “accept collateral in full or partial satisfaction” of the unpaid debt. U.C.C. § 9-620. This option, known as “strict foreclosure,” permits the creditor to retain collateral after repossessing the property from the debtor rather than selling it to satisfy the debt. However, unlike disposing of collateral, creditors cannot use strict foreclosure to satisfy an unpaid debt on an unwilling debtor.
Generally, creditors choose to use strict foreclosure rather than disposition when the collateral is worth more than the debt owed by the debtor. In other words, strict foreclosure is likely in the creditor’s best interest when they can use or liquidate the collateral to generate revenue that is greater than the debtor’s indebtedness.
Depending on the type of collateral, some creditors may be limited in their ability to use strict foreclosure to satisfy the debtor’s unpaid debt. When the collateral is consumer goods, which are goods used for personal or household use (e.g., refrigerator, television, etc.), the creditor cannot use strict foreclosure if the debtor has repaid 60% of the loan. Also, in situations where the creditor can use strict foreclosure on consumer goods, they must accept the collateral in full satisfaction of the debtor’s debt. In other words, the debtor’s loan debt is completely discharged if the creditor accepts the consumer goods.
In agricultural finance, however, collateral typically consists of non-consumer goods, such as livestock, crops, and agricultural equipment. When collateral consists of these types of property, strict foreclosure is generally available to the creditor no matter the remaining balance of the debtor’s unpaid debt. Also, Article 9 allows the creditor to accept this type of collateral in full or partial satisfaction of the debt.
To begin the strict foreclosure process, the creditor will generally propose to retain the collateral to satisfy the indebtedness. The creditor must send this proposal to the debtor so they can either consent or object to the creditor’s use of strict foreclosure. Additionally, the creditor must send the proposal to certain parties who have an interest in the collateral subject to the strict foreclosure. Essentially, Article 9 requires the creditor to provide these parties with the proposal so they also have the opportunity to object to the strict foreclosure. These parties include anyone who has notified the creditor of their interest and other creditors and lienholders who perfected their security interest in the collateral by filing a financing statement.
To object to the creditor’s strict foreclosure proposal, the debtor or an interested party must provide the creditor with a written objection within 20 days after the creditor sends their proposal. If any of these parties object, the creditor is prohibited from using strict foreclosure. Accordingly, the creditor must dispose of the collateral in accordance with the rules under § 9-610 to satisfy the debtor’s unpaid debt.
As long as there are no objections from any party, the creditor only needs to obtain the debtor’s consent to proceed with a strict foreclosure. In general, the creditor must typically receive an affirmative, written acceptance from the debtor. However, there is a presumption that the debtor consents if three conditions are satisfied:
- The creditor sends a proposal of strict foreclosure to the debtor;
- The creditor’s is retaining the collateral in full satisfaction of the debt (not just partial satisfaction); and
- The debtor does not send a written notice of objection to the creditor within 20 days after the creditor sends the proposal.
If these three conditions are met and the creditor does not receive an objection to any other interested party, they may accept the collateral in satisfaction of the debtor’s unpaid debt.
In general, Article 9 allows creditors to either dispose of collateral or strictly foreclose on the collateral. Essentially, strict foreclosure allows the creditor to keep most agricultural collateral they collect from the debtor in order to fully or partially satisfy the unpaid debt. However, strict foreclosure is not available to the creditor if the debtor or any other interested party objects to the creditor’s proposed use of strict foreclosure. On the other hand, if the creditor does not receive an objection and receives an acceptance from the debtor, they may retain the collateral in satisfaction of the debtor’s indebtedness.
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.