Question/Answer Memo for Assignment 5

1. In class, you said that the debtor could redeem the collateral until the moment of sale, but not afterward. I don't understand that conclusion in light of section 9-623(c), which says that "a redemption may occur at any time before a secured party (1) has collected the collateral." Wouldn't that occur before the sale, when the secured party retook possession of the collateral?

No. Don't confuse "collection" and "repossession." The term "collection" refers to a secured party's enforcement of its security interest in intangible collateral like accounts. If the Bank has a security interest in Debtor's accounts, it "collects" those accounts by accepting payment of the accounts from the account debtors.

Section 9-623(c) says that "[a] redemption may occur at any time before a secured party: (1) has collected collateral under Section 9-607; (2) has disposed of collateral or entered into a contract for its disposition under Section 9-610; or (3) has accepted collateral in full or partial satisfaction of the obligation it secures under section 9-622." These three alternatives are mutually exclusive. In other words:

—If the collateral is intangible, then the debtor can redeem the collateral by paying off the debt up until the moment that the secured party actually "collects" that intangible, under § 9-623(c)(1).

—If the collateral is tangible, then the debtor can redeem the collateral by paying off the debt up until the moment that a sale occurs, under § 9-623(c)(2). Alternatively, if the secured party chooses to propose strict foreclosure in lieu of sale, the debtor can redeem the collateral under § 9-623(c)(3) up until the moment that the proposal becomes legally effective to vest title in the secured party by means of strict foreclosure.

2. An "account" under Article 9 includes any "right to payment of a monetary obligation . . . for property that has been or is to be sold, leased, licensed, assigned, or otherwise disposed of" or "for services rendered or to be rendered." Would "rent" for a piece of land be a "right to payment for property that has been leased" within this definition? Does that mean that Article 9 would apply to a security interest in rents? What about payments due under an installment contract for the sale of land?

Yes, "rents" due under a lease, and payments due under an installment contract for the sale of land, qualify as "accounts" given the definition of the term. But if you look at Article 9's "scope" provision, § 9-109, you will see that Article 9 does not apply to a security interest in rents. Under § 9-109(d)(11), Article 9 doesn't apply to "the creation or transfer of an interest in or lien on real property, including a lease or rents thereunder." This means that if a lender made a loan to the owner of an apartment complex and the lender took an assignment of rents as security for the loan, the lender would have to create, perfect, and enforce that interest in rents under real estate law, not Article 9. [This is typically done by requiring the landowner to execute an Assignment of Leases and Rents, recording that Assignment on the land records, and then (following a default by the owner of the land) notifying the tenants to pay their rents directly to the lender.]

Essentially, the Article 9 drafters were afraid that "rents" have traditionally been treated as "real estate" under real estate law, and that if Article 9 took the position that "rents" were personal property, this would have made state legislatures less willing to enact Article 9. [The fear was that those who regularly engaged in real estate transactions would object to having Article 9 encroach upon real estate law and disrupt the way real estate transactions are customarily documented.] Because the drafters are so sensitive to having 50-state adoption of the UCC, the drafters just "carved out" rents from Article 9's scope (even though they would otherwise fit within the definition of "accounts").

This scope exclusion for rents would NOT cover the installment contract payments. Thus, take this example: Fred sells a house to Betty on an installment contract that requires Betty to pay $400 per month for 30 years to complete the purchase. Fred then borrows $50,000 from Bank and grants Bank a security interest in Fred's rights under the installment contract. Fred's right to be paid under the contract is an "account," and thus in collecting the account, Bank would have to comply with Article 9.

3. My question is about Problem 5.1 (where the Bank decided to sell the car at a dealer auction rather than selling it to the Debtor's friend). It seems that if the Bank can do that, it could buy the car at the sale for $7,000, and then turn around and sell it to the Debtor's friend (or someone else) for $8,000, and still recover a $3,000 deficiency from Maxwell. That would mean the Bank would effectively get $11,000, even though the debt was only $10,000. That doesn't seem right.

Your specific example can't happen. Article 9 allows the secured party to purchase the collateral at a public sale, but not at a private sale. § 9-610(c). If Bank sells at a dealer auction, that's a PRIVATE sale. [Look at the comments to § 9-610. Comment 7 says: "Although the term is not defined, as used in this Article, a 'public disposition' is one at which the price is determined after the public has had a meaningful opportunity for competitive bidding. 'Meaningful opportunity' is meant to imply that some form of advertisement or public notice must precede the sale (or other disposition) and that the public must have access to the sale."]

A dealer auction thus can't be a "public sale" because it isn't open to the general public. As a result, the Bank wouldn't be able to buy the car at a dealer auction. To be able to purchase the car at its own sale, the Bank would have to conduct an auction that was open to anyone who wanted to bid (and had the cash to pay). And if the auction is open to the public, then — at least in theory — it makes it difficult for the Bank to buy the car "on the cheap" because third party bidding would drive the price higher toward the car's actual value and thus protect the debtor's equity (or minimize the obligor's liability for a deficiency)..

The casebook authors are clearly skeptical about whether public auctions actually produce that sort of dynamic third party bidding. If they are right, it is possible that a secured party could inequitably profit by buying the collateral "on the cheap" at a public sale, re-sell it at a profit, and collecting a deficiency judgment based on the "cheaper" foreclosure sale price. But in this specific situation — at a dealer's auction — that wouldn't be possible because § 9-610(c) says that the secured party can't buy at its own private sale.

[Also note: § 9-610(c)(2) does allow the secured party to buy at its own private sale "if the collateral is of a kind that is customarily sold on a recognized market or the subject of widely distributed standard price quotations." This language effectively means "if the collateral is stock or commodities." If the collateral is stock or commodities, then a court could determine what the collateral was worth in the market at the exact moment the sale took place — and thus could protect the debtor against the risk of inappropriate behavior by the secured party. For example, if the collateral was Microsoft stock, and at the moment of sale Microsoft stock was trading on the stock exchange at $110/share, but the secured party sold the stock to itself for $60/share, then that's plainly commercially unreasonable — and the secured party would be liable to the debtor for the harm it caused by selling the collateral in a commercially unreasonable manner.]

4. You didn't mention § 9-615(f) in class. [Note: Section 9-615(f) says that "the surplus or deficiency following a disposition is calculated based on the amount of proceeds that would have been realized in a disposition complying with this part to a transferee other than the secured party, a person related to the secured party, or a secondary obligor if: (1) the transferee in the disposition is the secured party, a person related to the secured party, or a secondary obligor; and (2) the amount of proceeds of the disposition is significantly below the range of proceeds that a complying disposition to a person other than the secured party, a person related to the secured party, or a secondary obligor would have brought."] I'm not sure I understand what the statute is saying. Is the statute saying that the deficiency should always be calculated by reference to the fair market value of the collateral rather than the actual sale price when the secured party buys at the sale for a low price? Or does this section apply only if the sale is commercially unreasonable? What does "significantly below the range of proceeds that a complying disposition ... would have brought" mean?

Good questions. The first two I can answer easily. To trigger the application of § 9-615(f), the debtor doesn't have to show that the sale was commercially unreasonable (i.e., that there was some defect with the sale). All the debtor has to do is to show that the sale to the secured party brought a price that was lower than the range that could be expected in a sale to a third party. This prevents the secured party from conducting a public sale, doing everything right (i.e., giving all notices, advertising properly, etc.), and then taking advantage if no one else actually shows up to bid at the sale. [If that happens, the unscrupulous secured party might well bid $10, be the high bidder, and then go after the debtor for an inappropriately high deficiency.] If the secured party buys at a public sale for a true bargain price, section 9-615(f) allows the court to take that into account in establishing the debtor's liability for a deficiency, and the court could reduce the debtor's deficiency by basing it upon "the amount of proceeds that would have been realized" in a commercially reasonable disposition to a third party. The court would typically based the judgment of "the amount of proceeds that would have been realized" in a sale to a third party based on the collateral's fair market value.

The last question is a little trickier. Clearly, if the value of the collateral is $10,000 and the secured party buys it at a public sale for $9,900, that's not such a significant discount that it would trigger § 9-615(f). On the other hand, if the secured party buys the same collateral for $2,000, that would certainly be "significantly below the range of proceeds that a complying disposition ... would have brought." Exactly where the line is located is not clear, and the drafters intentionally made it that way. I think their judgment was that this is an issue that would be better left to be sorted out by courts, as part of the common law process.

5. You said in class that strict foreclosure would have the effect of extinguishing subordinate security interests. What happens to those subordinate lienholders, and how can they protect themselves?

In the problems we discussed in class (Problems 5.5 and 5.6), there weren't any subordinate security interests or subordinate liens mentioned in the problem, so the effect of strict foreclosure upon subordinate security interests didn't explicitly come up. But let's suppose that in Problem 5.5, there had been a perfected subordinate security interest in a piece of cleaning equipment (a vacuum cleaner), and that Bank was the holder of the security interest. In other words, both Bank and Lamp Fair have a security interest in the vacuum cleaner, but we're assuming that Lamp Fair has first priority.

If Lamp Fair wanted to propose either complete or partial strict foreclosure, it would have to make a "proposal" to the debtor Pedro, but it would also have to send the proposal to any parties who hold subordinate security interests and had filed financing statements covering the collateral. See § 9-621(a)(2). It would also have to send the proposal to any other person from whom Lamp Fair had received a notification claiming any interest in the collateral. What this means is that for Lamp Fair to fulfill its obligations, it would have to send its proposal to Bank as well as to Pedro. Bank would also be able to "object" within the 20 day period and, if Bank did object, then Lamp Fair could not obtain strict foreclosure. The only way it could then extinguish Bank's subordinate security interest would be to conduct a foreclosure sale of the vacuum. See § 9-620(a)(2).

This would allow Bank notice and an opportunity to take whatever steps it feels are necessary to protect its subordinate security interest in the collateral before that interest is extinguished. Of course, if Bank's security interest is subordinate, and Lamp Fair's collateral is worth less than the balance of Pedro's debt, then Bank may choose not object to Lamp Fair's strict foreclosure proposal and allow its interest to be extinguished. [In that case, Bank can still enforce the debt against Pedro as an unsecured debt.]

What happens if Lamp Fair proposed strict foreclosure, and Pedro accepted it, but Lamp Fair never sent that proposal to the subordinate secured party (Bank)?

In that case, strict foreclosure still occurs, and Bank's subordinate interest would be extinguished — even though Lamp Fair's failed to comply with the notification requirement! [§ 9-622(a), (b).] But Lamp Fair would be liable to Bank for any actual loss caused by Lamp Fair's noncompliance with Article 9. [§ 9-625(b).] Thus, for example, assume Pedro's debt is $277,000, that all of Lamp Fair's collateral (including the vacuum cleaner) was worth $277,500, and the vacuum was worth $500. If Lamp Fair had complied with its responsibilities, Bank 2 would have objected to strict foreclosure, and a subsequent sale would likely have produced a $500 surplus that would have gone to Bank as a subordinate lienholder. Thus, Lamp Fair would be liable to Bank for $500 in damages.