Few closely held LLCs will qualify under UCC § 9-610(c)(2), meaning that the only way a lender whose loan is secured by membership interests in a closely held LLC can purchase the collateral at the foreclosure sale is if the foreclosure sale is a “public disposition.”
The rub is that membership interests in LLCs may be viewed as securities under state and federal law, and their sale may be subject to registration of such securities, or compliance with an applicable exemption from registration.
The commentary to the UCC acknowledges this issue:
8. Investment Property. Dispositions of investment property may be regulated by the federal securities laws. Although a “public” disposition of securities under this Article may implicate the registration requirements of the Securities Act of 1933, it need not do so. A disposition that qualifies for a “private placement” exemption under the Securities Act of 1933 nevertheless may constitute a “public” disposition within the meaning of this section. Moreover, the “commercially reasonable” requirements of subsection (b) need not prevent a secured party from conducting a foreclosure sale without the issuer’s compliance with federal registration requirements.
Unfortunately, the UCC commentary is not law and certainly does not override federal securities laws, rules, or regulations. Further, there is no specific federal exemption from securities registration for the conduct of a creditor sale under the UCC.
Nevertheless, precedent exists for conducting a sale that qualifies as a “public disposition” under the UCC while steering clear of federal registration requirements. The Securities Exchange Commission has issued no-action letters that permit UCC sales without registration. The factors that typically have existed or been cited by the SEC in providing no-action letters include:
- the pledged securities will be sold only as a block to a single purchaser, and will not be split up or broken down;
- the purchaser must represent that the securities will be purchased with investment intent for the purchaser’s own account, and not with a view toward sale or distribution of such securities;
- the securities will be subject to transfer restrictions prohibiting sale or transfer without registration or a valid exemption;
- the seller will provide on request to any prospective purchaser the information that seller has regarding the issuer of the securities;
- the public auction of the securities would be conducted in accordance with the UCC;
- the lender believed that the loan would be repaid in accordance with the loan documents, and there would be no need to foreclose on the collateral (including the securities);
- the lender is not an affiliate of the pledgor or issuer of the securities, but was merely an arms-length lender;
- notice of the sale would be given to every person required by law and would be published in one or more newspapers, and where applicable trade journals;
- the lender is likely to be the purchaser of the pledged securities at the foreclosure sale; and
- no public market exists for the securities.
Other factors should be considered to maximize the prospect that the sale is found to be commercially reasonable under the UCC and to minimize the prospect that the sale is challenged as a violation of securities laws:
- limiting the sale to purchasers who would qualify for an exemption in connection with the private sale of securities (commonly referred to as “accredited investors”);
- demanding from the borrower/pledgor and the LLC all relevant information and documentation regarding the LLC, its assets, liabilities, and operations;
- preparing a data room containing all relevant information and documentation that is available to the lender;
- engaging a qualified auctioneer (depending on the scope of the auctioneer’s role, the lender should consider engaging an auctioneer who is registered as a securities broker/dealer);
- engaging a qualified broker to market the assets;
- Establishing a marketing plan that appropriately balances the exigencies of the LLC’s business and the time needed to maximize the sale price;
- Advertising the sale in a manner that maximizes the prospect of a meaningful sale; and
- preparing and disseminating to all qualified buyers an information packet (akin to a private placement memorandum) regarding the LLC, its assets, liabilities, and operations.
In sum, a lender can foreclose on LLC membership interests, but the lender should understand that care is required to avoid pitfalls, and that a foreclosure on such interests can be more costly and time-consuming than a foreclosure on other, more conventional forms of collateral. Subsequent installments will address other issues arising in connection with security interests in LLC membership interests.