Default and Foreclosure Under Revised Article 9

Journal Issue

May 2000

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The default, repossession and foreclosure rules of revised Article 9 carry forward many of the principles
of current law. Although the revision incorporates numerous minor changes, the repossession rules are
virtually identical to current law and the foreclosure rules still rely primarily on the "commercial
reasonableness" standard. There are, however, several significant changes in the law. Possibly the most
important such change is the revision of the "strict foreclosure" rules to permit secured parties to retain
collateral in partial, rather than full, satisfaction of the indebtedness. Another major change is the adoption
of the "rebuttable presumption" rule for dealing with non-complying foreclosure sales in non-consumer
transactions. This will be a major change for practitioners in those states that bar the collection of
deficiencies in cases where the secured party violates the Article 9 rules.

Practitioners will need to become familiar with these rules before the Act's July 1, 2001, effective
date. Under the Act's transition rules, the new default rules will become effective immediately on that
date and will apply even to transactions that were entered into under current law. See §9-702(a). (The
revision will not apply to an action, case or proceeding commenced before the Act's effective date. See
§9-702(c)).

<h3>Consumer Transactions</h3>

Although many of the new rules do apply to consumer transactions, some of the most important
changes only affect non-consumer transactions. For example, the new partial strict foreclosure rules only
apply to non-consumer transactions. See §9-620(g). The drafters of the revision were unable to reach a
consensus on many other difficult consumer issues posed by the revision. Thus, a last-minute compromise
left some of these issues for later court resolution. For example, although the revision adopts the "rebuttable
presumption" rule for determining the deficiency in non-complying non-consumer foreclosure sales, it gives
no guidance as to the proper rule for consumer cases. This effect is incorporated in the following truly
unusual bit of statutory language:

<blockquote>
The limitation of the rules in subsection (a) to transactions other than consumer transactions is
intended to leave to the court the determination of the proper rules in consumer transactions. The
court may not infer from that limitation the nature of the proper rule in consumer transactions and
may continue to apply established approaches. §9-626(b). Note, however, that this is one area
where states are likely to adopt non-uniform amendments that may resolve some of these questions.
</blockquote>

<h3>Default and Repossession</h3>

There is almost no change in the rules governing default, repossession and redemption. Although most of
the enforcement rights depend on a "default" before they are triggered, the revision continues the current
practice of not defining "default." Thus, the parties must take care to define the elements of default in the
security agreement.

After default, a secured party may take possession of the collateral, and without removal may render
"equipment" unusable and dispose of collateral on the debtor's premises. See §9-609(a). Like current law,
the secured party may either proceed through the judicial process or use self-help remedies like
repossession. However, non-judicial enforcement is available only if the secured party proceeds "without
breach of the peace." See §9-609(b)(2). Also like current law, the revision makes no attempt to define or
explain what conduct might constitute a breach of the peace. See §9-609, cmt. 3. The revision continues
the right of the debtor, a secondary obligor or a lienholder to redeem the collateral prior to disposition. See

§9-623.

<h3>Collection and Enforcement Rights</h3>

Under current law, upon default a secured creditor may exercise collection rights against an account
debtor or the obligor on an instrument. See current §9-502(1). These rights are expanded under the
revised Act to include other types of collateral and the enforcement of non-monetary obligations. See
§9-607. The definition of "account debtor" is expanded to include the person obligated on an account,
chattel paper or a general intangible. See §9-102(3). Thus, monetary payment obligations under licenses
and other contract rights are now subject to the secured party's collection rights.

In addition, the secured party is given new enforcement rights with respect to non-monetary obligations.
For example, if the debtor is a franchisee and has pledged its rights under the franchise agreement to the
secured party, the revised Act gives the secured party enforcement rights against the franchisor. In addition,
the secured party has collection and enforcement rights against other persons obligated on the collateral or
persons liable on a supporting obligation. For example, the secured party would have enforcement rights
against the bank on a pledged deposit account.

Although §9-607 gives broad enforcement rights to the secured party, the revised Act does not impose
a correlative duty on the obligor to render performance to the secured party. See §9-607(e). The revised Act
does not alter any otherwise applicable law that may excuse the franchisor, licensor or other obligated
person from rendering performance to the secured party. As a result, the secured party will need to carefully
consider the value of assets such as collateral, and may wish to obtain an agreement from the obligated third
party that it will render performance to the secured party or its assignee in the event of default.

<h3>Notice of Sale</h3>

The revision makes a number of changes to the Article 9 notice requirements for collateral dispositions.
First, the list of required contents of a pre-sale notice is longer than under current law. The Act continues
the current requirement that the notice state the time and place of a public sale or the time after which any
other disposition is to be made. Compare current §9-504(3) with §9-613(1)(E). However, for both
consumer and non-consumer transactions, the notice of sale also must describe the debtor, the secured party
and the collateral; state the method of disposition; and state that the debtor is entitled to an accounting of
the unpaid indebtedness and list the charge, if any, for the accounting. See §9-613(1). In consumer
transactions, the notice must include a description of any liability for a deficiency, a phone number for
obtaining a redemption payoff balance, and a phone number or mailing address for obtaining additional
information concerning the disposition or the debt. See §9-614(1). However, the risk of error is reduced
because the revision contains sample "safeharbor" notice forms and a defense for certain minor or
non-misleading errors. See §§9-613(3) and (5) and §9-614(3) and (5). In addition to the pre-sale notice, a
post-sale notice may be required in consumer transactions. If the debtor is entitled to a surplus or liable for
a deficiency in a consumer goods transaction, the secured party may be required to provide a detailed
explanation of the surplus or deficiency calculation. See §9-616.

Absent an appropriate post-default waiver, the notice of disposition must be sent to the debtor and any
secondary obligors. See §9-611. In addition, in non-consumer transactions, notice must be sent to certain
other parties claiming an interest in the collateral. The revision retains the current rule requiring that notice
be sent to any person from whom the secured party has received a notice of a claim of interest in the
collateral. See §9-611(c)(3)(A). However, it also imposes on the foreclosing secured party a duty to search
the UCC records and send notice to any party who has properly perfected its security interest in the
collateral by filing a financing statement. See §9-611(c)(3)(B). Although this should insure that holders of
both junior and senior perfected security interests receive notice, the foreclosing secured party has no duty
to send such notice if the filing office fails to respond in a timely fashion or if the search result does not list
a particular secured creditor. Thus, the safe practice would be for secured creditors to continue sending
notices of their interests to competing secured parties.

<h3>Sale Process</h3>

The revised Act carries forward the current law's policy of flexible collateral disposition rules. The
revision expressly adds licensing as an appropriate method of disposition. However, while the secured party
is authorized to sell, lease, license or otherwise dispose of the collateral, every aspect of the disposition must
be commercially reasonable. See §9-610(a) and (b). In a significant change from current law, the contract
for sale, lease, license or other disposition carries with it all warranties which by operation of law would
accompany a voluntary disposition of similar property. See §9-610(d). Thus, for example, warranties of
title, possession and quiet enjoyment might arise. Further, if the secured creditor was a dealer in goods of
the kind involved, an implied warranty of merchantability might arise. See <a href="http://www.westlaw.com/find/default.asp?rs=CLWP2.1&vr=1.0&cite=… §2-314</a>. While the secured
party may disclaim or modify these warranties, the ability to do so is limited by the commercial
reasonableness standard. See §9-610(b & e).

<h3>Related Party Sales</h3>

The revised Act addresses the problem of low-price dispositions by applying a special rule where the
transferee is the secured party, a person related to the secured party or a secondary obligor. If the sale price
is "significantly below" the price that would have resulted from a hypothetical sale to a third party, then the
deficiency or surplus is calculated based on the amount that would have been realized in such a third-party
sale. This rule applies even though every aspect of the sale was conducted in a commercially reasonable
manner.

<h3>Strict Foreclosure</h3>

As a practical matter, the changes in the strict foreclosure rules may prove to be the most important
revisions of the Article 9 enforcement rules. Under the current rules, the secured party can propose to keep
tangible collateral that is in its possession in full satisfaction of the indebtedness. See current §9-505(2). The
revision expands this option in several ways. First, the possession requirement is eliminated in
non-consumer transactions. See §9-620(a). Thus, strict foreclosure is now available as an option for
intangible collateral and for tangible collateral that has not been repossessed.

The debtor can agree to the secured party's acceptance of the collateral in full satisfaction of the debt
either by affirmatively consenting after default or by failing to object within 20 days after the secured party
sends its proposal to the debtor. In addition, the secured party must send notice of its proposal to those
parties who would be entitled to notice of the disposition (discussed above). See §9-621. In general, those
parties can block the strict foreclosure by objecting within the 20-day period.

The more important expansion of the strict foreclosure right is the secured party's option in
non-consumer cases to propose to keep the collateral in partial satisfaction of the indebtedness. See
§9-620(a). Here, the debtor must affirmatively agree to the terms after default. See §9-620(c)(1). Failure
to object will not constitute consent. Partial strict foreclosure gives the secured party the option to both keep
the collateral and pursue the debtor for a deficiency. This may become the preferred method of disposition
since it is cheap and quick and since there is no advantage to forcing a sale if the secured party offers a fair
credit for the collateral value.

<h3>Effect of Violation</h3>

Under current law, the courts are split on the question of the effect of a secured party's failure to comply
with the Article 9 enforcement rules. Some courts bar the collection of a deficiency, while others apply a
rebuttable presumption that the sale would have satisfied the indebtedness had it been conducted properly.
For non-consumer transactions, the revised Act adopts the rebuttable presumption approach. See
§9-626(a)(3). Thus, for example, if the secured party fails to give proper notice of sale, it can still collect
a deficiency from the debtor. However, the deficiency will be based on the amount of proceeds that would
have been realized in a hypothetical complying sale, rather than the actual proceeds of the non-complying
sale. For consumer transactions, the Act is silent, leaving it to the courts to fashion an appropriate rule. See
§9-626(b).

Non-compliance with the Article 9 requirements, including the enforcement rules, can also result in
liability for statutory damages. Like current law, the secured party is liable for any loss caused by its failure
to comply with Article 9. Compare current §9-507(1) with §9-625(b). The revision also carries forward the
minimum damage provision for consumer transactions. In such cases, the debtor or secondary obligor is
entitled to a minimum recovery of not less than the credit service charge plus 10 percent of the principal
amount of the obligation, or the time-price differential plus 10 percent of the cash price. See §9-625(c)(2).

<h3>Enactment Update</h3>

Since last month's column, there has been a lot of legislative activity involving the revision of Article
9. Five new states have enacted the revision: Indiana, South Dakota, Utah, Washington and West Virginia.
In addition, the act is awaiting the governor's signature in two other states—Kentucky and Virginia. Finally,
three new states have introduced legislation to adopt revised Article 9. Thus, a total of 14 states have passed
revision bills and 22 additional states have pending bills.

For a complete analysis of the new default rules, see Rapson, Donald J., "Default and Enforcement of
Security Interests under <a href="http://www.westlaw.com/find/default.asp?rs=CLWP2.1&vr=1.0&cite=… Article 9," 74 Chi.-Kent L. Rev. 893 (1999)</a>, and <a href="http://www.westlaw.com/find/default.asp?rs=CLWP2.1&vr=1.0&cite=…, Timothy R.,
"The Default Provisions of Revised Article 9 of the Uniform Commercial Code (Pts. 1 & 2)," 54 Bus. Law.
1113 & 1737 (1999)</a>. All citations are to the revised 1999 version of Article 9 of the Uniform Commercial
Code, unless otherwise indicated. Citations to the currently applicable 1972 version of Article 9 are
indicated by the term "current." Like current law, notice is not required if the collateral is perishable,
threatens to decline speedily in value, or is of a type customarily sold on a recognized market. See

§9-611(d). This provision applies to both consumer and non-consumer debtors. However, strict foreclosure
is not available for a consumer-goods security interest if the debtor has paid 60 percent of the cash price
in a purchase-money transaction, or 60 percent of the principal amount in a non-purchase-money
transaction. See §9-620(e).

Journal Authors

G. Ray Warner

Journal Date

Monday, May 1, 2000 - 12:00