Volume 5, Issue 4 (Fall 2009)
Introduction
Welcome to the Fall 2009 Newsletter of First American’s UCC Division. Again, we hope this Newsletter is a useful source of information for your lending or legal pursuits. As always, we solicit your advice on topics you would like us to explore. As in most of our Newsletters, after this introduction, we will review recent cases, on topics other than Personal Property Secured Transactions that were covered in our last Newsletter. If you missed that issue, you can retrieve Volume 5, Issue 3 here. We want to thank again our good friend Steven O. Weise of Proskauer Rose LLP, Los Angeles office, and his co-authors, Teresa Wilton Harmon of Sidley Austin LLP, Chicago, and Lynn A. Soukup of Pillsbury Winthrop Shaw Pittman LLP, Washington D.C., for supplying the case summaries. The case summaries were part of their presentation to the Spring Meeting of the Business Law Section of the American Bar Association titled 2008 Commercial Law Developments.
We also include for your review a copy of the Report of the UCC Committee of the State Bar of California Re: Possible Amendments to Uniform Commercial Code Article 9 Individual Name Provisions. This Report has been approved by the Executive Committee of the Business Law Section of The State Bar of California and was delivered to the Uniform Law Commission to aid in their deliberations concerning possible revisions to Article 9. As many of you may know, there has been extensive debate over the solving of a perceived problem concerning the appropriate methodology of dealing with individual debtor names in UCC Financing Statement filings. At one “extreme” are those who would prefer to do nothing under the theory of “do no harm.” There are those at the other extreme who prefer to established a drastically different priority system for the “correctness” of individual names. Among the “priority” type suggestions is the “Only If” approach that says that it the individual debtor has a valid driver’s license, the name on the driver’s license alone is sufficient as the debtor name.
The problem with priority oriented approaches is that they favor the filer to the extreme detriment of the searcher, overturning Article 9’s well crafted balancing act between two innocent parties. Further, the priority oriented approaches require extraordinary revisions to Article 9 and bring into play the concern of “unintended consequences.”
The UCC Committee of The State Bar of California, in an extraordinary effort, unanimously rejected the “Only If” and other “Priority” approaches as solving a minimal problem with great disruption to the structure of the Uniform Commercial Code. The UCC Committee then by majority favored the “Safe Harbor” approach which allows for perfection under the standard UCC rules, but not forced priority, through the use of designated naming documents, such as a valid driver’s license. In lieu of “Safe Harbor,” the UCC Committee recommends doing nothing; the perceived illness involving problems over the “correct” individual name is not worth any of the other proposed cures.
The UCC Committee deserves all of our thanks for the thought and effort put into this Report. A job very well done.
Finally, Jennifer Liptan, V.P. Operations Manager of our Search and Filing Division, offers her thoughts on UCC search and filing issues. By having our own internal search and filing Division, we can provide more responsive search and filing services. We also offer tax lien, judgment, pending civil litigation and bankruptcy searches as well as all corporate document retrieval. You can look to ONE source for all your external UCC requirements.
Beyond the efficiency of dealing with one source, this internal capability is merely one aspect of what we offer that is unique in the UCC insurance market place – internal legal competence. Our employees are active members on all levels of UCC related national and local professional organizations, from the ABA to IACA, from TMA to the current AALI/ULC Review Committee on changes to Article 9. We are also fortunate enough to have a General Counsel who teaches Secured Transactions and Bankruptcy Law at Pepperdine Law School. We are an insurance company with the knowledge needed to be an effective sounding board to discuss your UCC requirements, to assist in discerning the various legal alternatives to a given financing transaction, and the most cost effective provider of UCC insurance products in the industry.
One issue that is of greater concern today than two years ago is the issue of what constitutes a “commercially reasonable” sale. The first point we want to make is, absent a collusive sale or other facts that would deny the purchaser at a foreclosure sale the benefit of status of a “good faith transferee under section 9-617(b), the buyer at a foreclosure sale is generally not concerned whether the foreclosure sale was “commercially reasonable,” including the form of foreclosure notice and other matters. The foreclosing creditor, on the other hand, is correct to be concerned because if the sale is not commercially reasonable, the debtor could have a cause of action against the secured creditor in damages or to reduce any resulting deficiency. In an effort to assist the foreclosing creditor, First American created a Foreclosure Notice Policy insuring the notice, timing and required recipients of the notice of foreclosure sale. This policy runs to the benefit of the foreclosing creditor. It was not necessary to build this type of coverage into our Buyer’s Policy because the purchaser at a foreclosure sale doesn’t need the coverage.
Further, we have called our policy a Buyer’s Policy rather than an “Owner’s Policy” because ownership is not a term recognized in the UCC. We specifically insure that the buyer, in the mezzanine foreclosure context, has “all Rights” in the collateral, which is a term recognized under the UCC. We are not sure “ownership” means anything standing alone under real property law. More is needed, such as what kind of ownership are you talking about, fee simple or a lease for two days. This issue stresses the point that UCC policies, unlike land title policies, are not uniform and you should read the jackets carefully. For example, our policy will insure foreclosing on uncertificated securities, while our competitor’s policy, on its face, is limited to certificated securities under Article 8 of the UCC and, further limited to limited liability company and partnership interests under Article 9. One more reason to carefully review your UCC insurance policy.
For the foreclosing creditor, however, what constitutes “commercial reasonableness” is collateral and transaction specific, and the UCC provides very little guidance. Section 9-610(b) merely states that every aspect of a disposition of collateral, including the method, manner, time, place, and other terms, must be commercially reasonable (emphasis added). Section 9-627(b) (3) goes on to say that the foreclosure sale must be in conformity with reasonable commercial practices among dealers in the type of property that was the subject of the disposition (emphasis added). This is why each foreclosure transaction is, to some extent, unique. As justice paraphrase of Potter Stewart in Jacobellis v. Ohio (1964) would say, commercial reasonableness is like pornography, hard to define, but you know it when you see it.
The case law on what constitutes a commercially reasonable sale is slim, but there are two cases that practitioners need to keep in mind. The first case is out of the Court of Chancery of Delaware, New Castle County, titled Vornado PS, L.L.C. v. Primestone Inv. Partners, L.P., 821 A.2d 296, 49 UCC Rep.Serv.2d 1348 (2002). In this case, the lender who was engaged in commercial real estate development brought action against borrower who also was involved in commercial real estate development, seeking declaration that it was entitled to enforce its loans, that its foreclosure auction on limited partnership units securing such loans was conducted in a commercially reasonable manner, and that it was the winner of the auction. Borrower counterclaimed on a variety of theories including breach of contract, fraud, tortious interference, and breach of fiduciary duties. The Court of Chancery held, in part, that lender's sale of limited partnership units securing loans was conducted in a reasonable manner. Specifically, the Court held: (1) for purposes of determining under New York law whether a sale of collateral was made in a commercially reasonable manner and whether lender could seek a deficiency judgment, there is no requirement that actual market value for assets sold in foreclosure must be obtained; (the price paid for the stock being foreclosed upon was equivalent to the closing of trust's shares on the relevant stock exchange on the day of the foreclosure sale) (2) though the lender was privy to some inside information that it did not provide to potential purchasers, non-disclosure of the inside information did not preclude commercial reasonableness because the lender had no sense of how reliable the inside information was and had no way of obtaining additional inside information; and (3) the investment banking firm that was hired by the foreclosing lender to do the marketing of the collateral, and efforts undertaken by investment banking firm were consistent in all material respects with actions it had taken in the past in connection with other marketing processes relating to real estate-related companies and equity interests therein.
In Vornado, Primestone's first objection to Vornado's foreclosure auction was Vornado's belief that the units needed to be sold at a public auction in order for it to make a bid for the units. Primestone argued that Vornado should have sought a private sale anyway because the New York U.C.C. generally “encourages private dispositions on the assumption that they frequently will result in higher realization on collateral for the benefit of all concerned” (NY U.C.C. § 9- 610 Official Comment 2.) The Court decided that such a generalized policy under the U.C.C. must give way in this circumstance, however, because there can be little doubt that Vornado was one of the most interested and able potential purchasers of the units. By conducting a private sale, and thus eliminating Vornado as a potential purchaser, the price for the Units had the potential to be much lower than the ultimate selling price.
Primestone also argued that the price attained for the units was unreasonably low. At the auction, the Units sold at a price equivalent to the closing price of shares into which the unites could be converted on the New York Stock Exchange on the date of the foreclosure sale. Primestone admitted that the units were the economic equivalent of the convertible shares. The Court, therefore, held that the values were equivalent. More importantly, however, the Court stated that there is no requirement that actual market value for assets sold in foreclosure must be obtained. New York Courts have “held that bids ranging from as low as 30% ... of market value are not commercially unreasonable.” Finally, although the lender made the only bid at the auction and purchased the units, this sole bid was made only after a significant marketing process by the lender's financial advisor. The Court noted that Goldman Sachs was hired to do the marketing, and the efforts undertaken by Goldman Sachs were consistent in all material respects with actions it has taken in the past in connection with other marketing processes relating to real estaterelated companies and equity interests therein. The only major flaw in the auction was the fact that only Vornado was privy to certain inside information as mentioned above. However, the Court noted that Primestone could certainly have chosen to provide such inside information to potential purchasers, yet it refused to do so. Further, although Vornado did possess some inside information, it had no sense of how reliable it actually was. It also had no way to obtain any additional inside information. Finally, the Court held that Primestone was properly disqualified from bidding at the foreclosure sale because it could not produce a valid financing commitment.
In conclusion, Vornado stands for certain indicia of commercial reasonableness:
- The foreclosing creditor should seriously conduct the sale as if it really wanted to obtain the highest price for the collateral, including the hiring of respected and knowledgeable investment bankers, real estate brokers and the like.
- Inside information need not always be disclosed if there is sufficient reason for confidentiality or the failure to disclose.
- An external market will be dispositive of reasonable price but the highest price is not required for reasonableness.
- A public sale is warranted notwithstanding Official Comments especially if the foreclosing creditor is a likely sole bidder for the collateral, which is often the case in the foreclosure of real estate mezzanine loan collateral.
The noticed rules for the conduct of the sale can be followed.
The second case of interest is Voutiritsas v. Intercounty Title Co. of Illinois, 279 Ill.App.3d 170, 664 N.E.2d 170, 215 Ill.Dec. 773, 31 UCC Rep.Serv.2d 950 (1996). In this case, certain vendors of real property brought declaratory judgment action against a title insurer (not us), seeking declaratory judgment as to their rights following insurer's sale of purchaser's note which had been assigned to insurer as collateral. The Appellate Court held that the U.C.C. applied to assignment of note but that the sale had not been conducted in a commercially reasonable manner. Specifically, the Court held that the secured party is required to exercise due diligence to sell the collateral for the best price obtainable and to have a reasonable regard for the debtor's interest. “Where by failing to advertise in a manner that will engender competitive bidding the secured party insures an opportunity for self-dealing, a court must scrutinize the sale closely. Where no one attends the public auction except the secured creditor, improper notice of the public auction may be inferred” (emphasis added).
In Voutiritsas, the record revealed that the notice published in the Chicago Tribune failed to identify or refer to either the real estate located at 205 West Randolph Street in Chicago, or to the trust deed that secured the note. The notice in the Chicago Tribune read as follows:
“NOTICE OF PUBLIC SALE
NOTICE IS HEREBY GIVEN that on the 20th Day of May 1987 at the offices of Intercounty Title Company of Illinois, 120 West Madison Street, Chicago, Illinois, Suite 400, Intercounty Title Company of Illinois will offer the right, title and interest of Harry Giotis and George N. Voutiritsas in and to a certain note dated December 13, 1985, in the amount of $3,000,000 as secured by American National Bank and Trust Company of Chicago as Trustee under Trust Agreement dated November 21, 1985 and known as Trust Number 66061.
Furthermore, the notice discouraged competitive bidding by only offering to sell a “claimed” 60% legal or equitable interest of plaintiffs in the note, and stating the secured party's denial that it was a secured party and that it was the “absolute 100% legal owner” of the note. Further, the secured party was the only bidding party to attend the auction, thus implying improper notice.
Further, while price alone does not establish commercial reasonableness, price is the key component in assessing commercial reasonableness. The trial court had found that the secured party’s bid was without substance and lacking in foundation. The bid of $350,000 was not based on any appraisal, but rather was “pulled out of thin air,” based on a number the secured party’s had in his mind. The trial court also found that although neither party had presented any credible evidence to establish the fair market value of the note and trust deed at the time of sale, the record established that both parties considered the value to be significantly greater than $350,000. The $350,000 bid was significantly lower than the $3,000,000 face value of the note, as well as lower than 60% of the $700,000 debt, or $420,000.
Based on these facts, the Court found the trial court's determination that the sale was commercially unreasonable to be consistent with the manifest weight of the evidence.
We can learn the following from Voutiritsas:
- If you are foreclosing on equity collateral pledged to secure a mezzanine real property loan, it is very prudent to describe the underlying realty that is involved because that is where the value lies. No one bidding at the foreclosure sale wants to acquire the membership certificate just to frame it. Notwithstanding what is being foreclosed, what actually is being sold?
- Again, as in Vornado, the foreclosing creditor should seriously conduct the sale as if it really wanted to obtain the highest price for the collateral.
- If the secured party is the only bidder at the foreclosure sale, it will have a significant burden showing that the sale was conducted in a commercially reasonable manner. Keep notes to answer the question as to why the secured party was the only bidder, e.g., the property was so far under water that the pledged equity in the owner of the real property had no value and the secured party held the sale for other legitimate reasons, such as to set a deficiency.
- If the collateral being foreclosed has value, be sure the bid of the foreclosing creditor has something to do with that value.
Maybe not all the guidance one would want on what constitutes a “commercially reasonable” sale, but a good beginning point. We have been involved in a number of foreclosures insuring the buyer as to the lien status of the acquired collateral and the buyer’s status as a “protected purchaser” under Article 8 in the appropriate circumstance. Further, our UCC coverage has been useful in setting the stage for an analysis of the authority of the new member through foreclosure to exercise management and control over the real property owning entity, such as in the subsequent disposition of the real property. This is key to providing clean owner’s or lender’s land title coverage for this subsequent disposition. We have also been involved in Article 3 issues’ involved in the sale of pools of notes and similar matters. Again, internal competence is key in helping to analyze transactions and finding the appropriate cost-effective UCC insurance to effectively manage the legal risk of the transaction.
As always, we appreciate your feedback and actively solicit your advice on topics you would like us to explore. We at the UCC Division of First American Title Insurance Company look forward to being of service. Enjoy the Newsletter!
