Disposition of UCC Collateral: “Everybody Does It”

Morgantown Excavators, Inc. v The Huntington Nat’l Bank (In re Morgantown Excavators, Inc.), 557 B.R. 469 (Bankr. N.D. W.Va. 2016)

Chapter 7 debtors sued a lender alleging violations of the Uniform Commercial Code (UCC) and other state law based on the lender’s sale of equipment that was part of its collateral. The debtors sought summary judgment on the issue of the lender’s liability for failing to sell the collateral in a commercially reasonable manner as required by the UCC. Specifically the debtors claimed that notice of disposition of the equipment was not commercially reasonable.

The debtor executed multiple promissory notes. Collateral for the debt included its equipment. After the debtor failed to make required payments and entered into forbearance agreements multiple times, the lender decided to sell the equipment. The sequence of events was as follows:

  • February 27: The lender and an auctioneer entered into an asset purchase agreement providing for the sale of the debtor’s equipment for $535,000. Under the agreement the auctioneer made a 25% deposit upon execution of the agreement, with the balance of the purchase price to be paid upon the auctioneer’s removal of the equipment and the lender providing title.
  • March 5: The auctioneer took possession of the equipment. (Under the agreement it was required to take possession no later than March 15.)
  • March 22: The lender sent the debtors a notice of private disposition of the collateral “sometime after April 9.”
  • March 23: The auctioneer paid the full purchase price to the lender.
  • Before April 6: The auctioneer began advertising an equipment auction to be held on April 20.
  • April 18: The lender delivered a bill of sale and executed titles for the equipment in favor of the auctioneer.
  • April 20: The auctioneer sold the equipment at a public auction.

The debtors argued that the auctioneer acquired equitable title no later than March 23, and this transfer constituted a disposition of collateral under the UCC. If so, the debtors received only one day’s notice of the disposition, which was not commercially reasonable notice. The lender contended that (1) the agreement provided for transfer of title in a commercially reasonable manner, (2) it did not pass equitable title to the auctioneer, and (3) in any event transfer of equitable title is not a disposition.

Section 401 of UCC article 2 (regarding the sale of goods) provides that in the absence of an explicit agreement title passes to the buyer upon delivery, but in any event a seller’s attempt to retain title to delivered goods after delivery to the buyer is characterized as a reservation of a security interest.

This led the court to reason: “As a party that retains legal title maintains only a security interest in the property subject to the sale, a transfer of an interest in property other than legal title must occur because a party cannot take a security interest in its own property.” The court then noted that property interests include both legal and equitable interests. Equitable title involves the beneficial ownership and right to the use and income of property. A person has equitable title if “the holders thereof have in a court of equity an equitable chose in action to compel the holders of the legal title to convey.”

Turning to the asset purchase agreement, (1) the buyer was obligated to take possession no later than March 15, and (2) the buyer was required to pay the balance of the purchase price at a later time, at which time the seller was required to convey title to the equipment. Thus, (a) the agreement modified the default UCC provision providing for transfer of title upon delivery, and (b) the failure to deliver legal title upon payment resulted in the seller retaining a security interest with a transfer of equitable title to the buyer occurring at the time of payment.

This UCC analysis was consistent with state common law: The auctioneer acquired equitable title prior to the transfer of legal title on April 20. It had paid the full purchase price and began marketing the equipment several weeks before acquiring legal title. Since the sole purpose of purchasing the equipment was to resell it at a public auction, marketing of the property by the auctioneer well before it received legal title indicates that it had a property interest sufficient to permit it to use and enjoy the benefits of ownership. In addition the auctioneer had fully performed under the purchase agreement and was entitled to enforce the lender’s obligation to transfer legal title in a court of equity.

The lender argued that the parties did not intend to transfer equitable title. However, equitable title passed by operation of law based on performance under the agreement, and there was no indication that the parties intended to avoid the legal effect of the agreement. The lender also argued that the agreement required the parties to comply with the UCC, and thus they did not intend to pass title before giving adequate notice. However, the agreement did not prevent liability if in fact the parties’ performance did violate the UCC.

Under the UCC “every aspect of a disposition of collateral … must be commercially reasonable,” and a secured party is required to send a reasonable notification of disposition of collateral to the debtor. Whether timing is reasonable is a question of fact. The purpose of the notice is to allow the debtor a chance to redeem or bring a better offer to the table. A notice sent too close to the disposition would not allow the debtor to act and would be unreasonable.

However, in order to trigger the notification requirement there must be a “disposition” of collateral. The UCC does not define “disposition.” A “sale” is defined to mean the passing of title, but courts have determined that a disposition is a broader form of transfer than a sale.

In this case the court determined that a transfer of equitable title constituted a disposition such that the lender disposed of the equipment no later than March 23. Accordingly the lender gave notice only one day prior to the disposition – which was not reasonable. In addition, the notice stated that the equipment would be sold no earlier than April 9. Since the disposition occurred on or before March 23, the notice was inadequate. Finally, because all aspects of a disposition must be reasonable and the notice was not reasonable in violation of UCC 9-611, the lender was also liable for a failure to comply with UCC 9-610.

The terms of the agreement between the lender and the auctioneer (including timing) is fairly typical. An attempt to raise concerns about whether transactions of this type comply with the UCC is often met with the response that “everybody does it.” While that may be true, as illustrated by this case, it does not follow that the concerns are invalid. Although the court opinion does not address the consequences of noncompliance, it should be kept in mind that among other things under UCC 9-625 the secured creditor is generally liable for any loss caused by its noncompliance (including the increased costs of alternative financing).

Vicki R Harding, Esq.

About BankruptcyRealEstateInsights

Vicki R. Harding was a partner in the Detroit office of Pepper Hamilton LLP who moved to Arizona seeking warmer weather. Ms. Harding continues to handle commercial transactions with an emphasis on real estate and bankruptcy issues (but no longer owns a snow shovel).
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