"Strict Foreclosure" under Article 9 of the UCC
March 18, 2014
Article 9 of Indiana's Uniform Commercial Code provides a secured party with two remedies for enforcing its security interest following a debtor default. The most widely known remedy involves repossessing the collateral and selling it at a public or private sale with the proceeds being applied to the secured debt. There is, however, an alternative remedy known as "strict foreclosure" available under the UCC. Under this less frequently used remedy, a secured party may accept the collateral in full or partial satisfaction of the obligation it secures without the need for a foreclosure sale or court intervention. This article examines the requirements for exercising the "strict foreclosure" remedy with respect to non-consumer goods and when a secured party might utilize "strict foreclosure" instead of an Article 9 foreclosure sale.
a. Requirements for "strict foreclosure."
The requirements for accepting collateral in full or partial satisfaction of the obligation it secures are set forth at I.C. § 26-1-9.1-620. These requirements vary depending upon whether the collateral is being accepted in full or partial satisfaction.
(1) Acceptance in full satisfaction of the secured obligation.
The secured party must send a signed proposal to the debtor setting out the terms under which it is willing to accept the collateral in full satisfaction. The debtor must then consent to the proposal. Consent can occur in one of two ways. The debtor consents to acceptance of collateral in full satisfaction if (i) the debtor agrees to the terms of the proposal in writing after its default or (ii) the secured party sends to the debtor a proposal that is unconditional or subject only to the condition that the collateral be preserved and maintained, notifies the debtor that the proposal is to accept the collateral in full satisfaction and the debtor does not object within 20 days after the proposal is sent.
In addition to the foregoing, the secured party must send a copy of its proposal to accept collateral in full satisfaction to any person that the secured party knows claims an interest in the collateral either because the secured party was provided notice of the claim of an interest or because the other secured party or lienholder holds a security interest or other lien perfected through a UCC financing statement or by virtue of statute, regulation or treaty. If any other secured party or lienholder, including a junior lien creditor, objects within the 20-day period after the proposal is sent, the "strict foreclosure" remedy cannot be utilized.
(2) Acceptance in partial satisfaction of the secured obligation.
The requirements for accepting collateral in partial satisfaction of the debt it secures are the same as those set forth above with the following exceptions. The debtor consents to acceptance of collateral in partial satisfaction only if the debtor agrees to the terms of the secured party's proposal in writing after the debtor's default. Unlike a proposal to accept collateral in full satisfaction, consent is not inferred from the debtor's failure to object to the secured party's proposal within 20 days. Accordingly, acceptance of collateral in partial satisfaction essentially requires an agreement between the secured party and the debtor as to the postdefault value of the collateral.
The secured party proposing to accept collateral in partial satisfaction must send its proposal to any secondary obligor, such as a guarantor, in addition to other secured creditors claiming an interest in the collateral. This requirement ensures that a secondary obligor will have an opportunity to object to the secured party's proposed valuation of the collateral because the proposed valuation impacts the amount of the deficiency following acceptance in partial satisfaction.
(3) Effect of accepting collateral in full or partial satisfaction.
If the secured party complies with the requirements set forth above and no objection to the proposal is received, the following occurs by operation of law: (i) the obligation is discharged to the extent consented to by the debtor; (ii) all of the debtor's rights in the collateral are transferred to the secured party; and (iii) the accepting secured party's security interest and all subordinate liens in the collateral are discharged. The secured party is then free to use, sell, rent or do whatever else it likes with the collateral without the need to follow the foreclosure sale requirements of Article 9 of the UCC.
b. Choosing between an Article 9 foreclosure sale and "strict foreclosure."
In most situations, the secured party is likely to proceed with a foreclosure sale, rather than propose to accept collateral in full or partial satisfaction of the secured obligation. Because "strict foreclosure" does not discharge prior liens, it is unlikely to be utilized unless the secured party holds a first lien in the collateral. Where the value of the collateral is less than the amount of the obligation it secures, acceptance of the collateral in full satisfaction discharges any deficiency. The secured party is therefore unlikely to proceed with "strict foreclosure" in situations where it holds a lien in other collateral securing the obligation, where the obligation is personally guaranteed or where a deficiency can be collected against the debtor.
Conversely, where the value of the collateral exceeds the amount of the debt it secures, the debtor or other secured creditors are likely to object to the secured party's proposal to accept the collateral in full satisfaction. This is because a "strict foreclosure" cuts off the debtor's or a junior secured creditor=s claim to any equity in the collateral. Even when the value of the collateral does not exceed the amount of the secured debt, the "strict foreclosure" remedy can be thwarted by the timely objection of a junior lien creditor. By raising an objection, a junior lien creditor may attempt to leverage a settlement payment from the secured party even when there is no equity in the collateral. The secured party would then be forced to proceed with a foreclosure sale unless it pays for a release of the junior lien.
Accepting collateral in partial satisfaction is often not a practical option for the secured party because the debtor is uncooperative or non-responsive. As set forth above, the secured party cannot accept collateral in partial satisfaction unless the debtor consents in writing after its default.
There are instances, however, in which the secured party should strongly consider pursuing a "strict foreclosure." Take, for example, the situation of a defunct corporation whose only remaining assets consist of equipment. The secured party holds a first lien on the equipment, but does not hold a lien on any other collateral or have any other means to collect the obligation. The secured party could send a proposal to accept the equipment in full satisfaction of the secured obligation because it knows any deficiency would not be collectible. By utilizing this remedy and assuming no objections to the proposal, the secured party can discharge all junior liens and become the owner of the equipment in only 20 days and at minimal cost.
By contrast, if the secured party chose to repossess the equipment of the defunct debtor and conduct an Article 9 foreclosure sale, its transaction costs would be significantly higher and it would take considerably longer. Among other things, the secured party would need to provide notices of the time, place and manner of the sale, ensure the commercial reasonableness standard was satisfied, address any warranties or lack thereof associated with the equipment and provide an accounting to the debtor following the sale if requested. The secured party would also be required to pay any "surplus" to the debtor or another secured creditor in the event the proceeds from the sale of the equipment exceeded the amount of the secured debt. By contrast, under "strict foreclosure," any excess value is retained by the secured party and the transaction is subject to a good faith, rather than commercial reasonableness standard.
The secured party should consider proposing to accept collateral in partial satisfaction when dealing with a cooperative debtor. "Strict foreclosure" provides a mechanism by which the secured party and the debtor can agree upon a value for the collateral, without incurring the high transaction costs of a foreclosure sale. Avoiding these costs benefits the secured party where the collectibility of a deficiency is in question. Because the proceeds of a foreclosure sale are applied to costs of the sale before being applied to secured debt, the debtor also benefits from avoiding these costs. "Strict foreclosure" therefore provides both the secured party and the debtor with an incentive to mutually agree upon a reasonable value of the collateral.
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