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The Business Lawyer

Fall 2023 | Volume 78, Issue 4

Personal Property Secured Transactions

Stephen L Sepinuck

Personal Property Secured Transactions

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The article reviews the most important judicial developments involving UCC Article 9 and secured transactions in 2022, including:

  • Several rulings by the U.S. District Court for the Southern District of New York that a provider of merchant cash advances might have RICO liability for engaging in transactions that were, in substance, usurious loans.
  • A ruling by the Florida Supreme Court that the state’s filing office does not have standard search logic, with the result that any error in the debtor’s name in a filed financing statement renders the financing statement ineffective to perfect.
  • A ruling by a Bankruptcy Court in Pennsylvania that a debtor’s post-default consent to the secured party’s planned disposition of collateral was ineffective because the requirement of commercial reasonableness cannot be waived or varied in advance and, while a debtor and secured party can agree on the standards to measure commercial reasonableness, the consent did not actually set any standards.

I. The Scope of Article 9

Article 9 applies to any transaction, regardless of the transaction’s form, in which personal property secures an obligation. However, subject to a few exceptions, Article 9 does not apply to consensual liens on real property, including rents. This rather basic distinction came up in two cases last year.

In HBKY, LLC v. Kingdom Energy Resources, LLC, a mortgagee claimed a security interest in the debtor’s rights to rents and royalties under a coal lease. The lessees moved to dismiss and argued, among other things, that the mortgagee’s interest was unperfected because the mortgagee had not filed a UCC financing statement. The court rejected the lessees’ argument, concluding that the mortgagee’s interest in rents and royalties was an interest in real property under Kentucky law, and thus filing a financing statement was not necessary.

The facts of In re Caribbean Motel Corp. were substantially different. The debtor operated a motel that charged by the hour. A mortgagee claimed a security interest in the rents and “fruits” of the property, and in the debtor’s bankruptcy sought to prohibit the debtor from using post-petition receipts on the ground that the receipts were cash collateral. The court rejected the mortgagee’s argument. While acknowledging that the Bankruptcy Code treats payments for the use or occupancy of hotel and motel rooms the same as rents, the court concluded that under Puerto Rican law the mortgage’s reference to rents did not encumber room proceeds, and that to perfect any security interest in room proceeds, the mortgagee would have needed to file a UCC financing statement.

Article 9 applies to some transactions that are not loans, either in structure or economic substance. These include sales of accounts and chattel paper. Because Article 9 applies both to loans secured by accounts and to sales of accounts, whether a transaction involving accounts is a secured loan or a sale has no impact on the applicability of Article 9. However, the distinction between a secured loan and a sale can matter for other purposes. Perhaps chief among these is whether the transaction is subject to restrictions on usury.

Last year’s survey reported on several cases from 2021 that dealt with a relatively new type of financing arrangement: a purported sale of an interest in future receivables. Typically, these transactions involve a payment of a “purchase price” in return for a specified percentage of the seller’s future accounts receivable until the putative buyer receives a specified total return. The agreements also typically provide for the putative seller to pay the buyer—by automatic debit to its deposit account—a specified amount each day or each workday. The agreements might also contain a “reconciliation provision,” pursuant to which the amount of the daily payment can be adjusted more closely to match the amount equal to the specified percentage times the amount of receivables actually collected. In many of these transactions, the putative buyer’s rate of return is so high that the transaction would be usurious if it were deemed to be a loan, rather than a sale. Consequently, courts are frequently called upon to decide whether the transaction is a loan or a sale.

Although the putative sellers have had limited success claiming that the transactions are usurious loans, a trio of cases decided last year by the United States District Court for the Southern District of New York—by three different judges—might signal a shift in the legal landscape.

In Fleetwood Services, LLC v. RAM Capital Funding, LLC, Judge Liman ruled that a transaction structured as a sale of future receivables for a price of $100,000 until $149,000 was repaid, and that provided for a daily ACH transfer of $1,399, was a loan. He concluded that the agreement had none of the characteristics of a true sale of receivables in terms of the transfer of risks and rewards: the putative buyer had no risk of loss arising from any account debtor’s failure to pay, and received no reward if account debtors performed better than expected. The agreement also imposed liability on the putative seller and the guarantors in almost every imaginable circumstance. Although the agreement contained a reconciliation provision for adjusting the amount of the daily payment, that provision was largely illusory because adjustment was within the sole discretion of the putative buyer. Because the transaction was usurious regardless of whether New York or Texas law applied, the lender and its principals were liable under RICO for receiving income through collection of an unlawful debt.

Three weeks later, in Haymount Urgent Care PC v. GoFund Advance, LLC, Judge Radkoff ruled, in a class action, that merchants that purportedly sold their future receivables stated a claim for violation of RICO against the putative buyer by alleging that the transactions were disguised usurious loans with an effective annual interest rate in excess of 50 percent, and that the putative buyer committed wire fraud by using misleading names to evade the blocks that the merchants had put on their deposit accounts. Although the agreements contained a reconciliation provision for adjusting the amount of the daily payment, that provision could be used only during the last five days of a calendar month, by which time the putative seller might already have defaulted and the putative buyer would have no duty to change the daily amount. If only one automatic debt were rejected, the putative buyer could declare a default, accelerate the entire amount due, and proceed to collect from the guarantor. Collectively, these terms suggest that the putative buyer did not assume the risk that merchants would have less-than-expected or no revenues.

Less than a month later, in Lateral Recovery, LLC v. Queen Funding, LLC, Judge Schofield refused to dismiss a RICO claim brought by merchants that had purportedly sold their future receivables but alleged that the transactions were disguised usurious loans with an effective annual interest rate ranging from 100 percent to 300 percent. The merchants claimed that the putative buyer committed wire fraud by falsely stating that: (i) the transactions were not loans, (ii) the required daily payment was a good-faith estimate of the merchant’s receivables, (iii) the daily payment was for the merchant’s convenience, and (iv) the automated ACH program is labor intensive, requiring the buyer to charge an exorbitant fee. Although the agreements contained a reconciliation provision for adjusting the amount of the daily payment, that provision appeared to be a sham because adjustment was within the sole discretion of the putative buyer. Moreover, other terms shielded the buyer from the risk that the purchased receivables might be uncollectible, and without such risk the transactions were, in economic substance, loans.

II. Attachment of a Security Interest

In general, there are three requirements for a security interest to attach to collateral: (i) the debtor must authenticate a security agreement that describes the collateral; (ii) value must be given; and (iii) the debtor must have rights in the collateral or the power to transfer rights in the collateral. There were noteworthy cases on the first and third of these requirements last year.

A. An Authenticated Security Agreement that Describes the Collateral

The requirement of an authenticated security agreement is fairly easy to satisfy. No specific language is needed for the grant of the security interest, and the collateral description need not be specific or list every individual item; it need merely “reasonably identif[y]” the collateral. In other words, the security agreement must merely “make [it] possible” to identify the collateral. Although the standard is rather easy to satisfy, one creditor last year failed to do so.

In In re Flint, an individual owned 220 shares of stock in a closely held corporation. The shares were represented by Stock Certificate No. 5 but the certificate was not signed by officers of the corporation, as the corporation’s bylaws required. The individual then sold 120 shares on credit to a buyer while retaining possession of the certificate. The buyer signed a promissory note that purported to grant a security interest in stock in the corporation “represented by Certificate No. 3.” Before fully paying the note, the buyer filed for bankruptcy. The seller filed a secured claim and moved for relief from the automatic stay to pursue his remedies in state court. The bankruptcy trustee objected, claiming that the seller did not have a security interest in the shares sold to the debtor.

The court agreed with the trustee. It ruled that the grant of the security interest was ineffective because the described collateral—shares represented by Certificate No. 3—did not exist. While a security interest in a certificated security can attach without an authenticated security agreement if a certificate has been delivered to the secured party pursuant to an oral security agreement, or the secured party has control pursuant to section 9-106, neither of those rules saved the seller because Certificate No. 5 was not properly issued, had never been indorsed to the buyer, and could not represent both the seller’s and the buyer’s shares.

For most types of property, a description by a type of collateral defined in the U.C.C. is sufficient. However, a description only by a defined type of collateral is an insufficient description of a commercial tort claim. Hence if the parties desire to encumber a commercial tort claim, their security agreement must describe the claim with greater specificity than simply by type. One creditor ran into problems with this rule last year.

In In re Main Street Business Funding, LLC, a creditor who had a security agreement covering “all tangible and intangible personal property,” including existing and after-acquired accounts and general intangibles, sought an order requiring the bankruptcy trustee to turn over the proceeds of a post-petition settlement of the debtor’s pre-petition claims against a consultant. The court first noted that, of the debtor’s claims against the consultant for fraudulent misrepresentation, conversion, civil conspiracy, unjust enrichment, breach of fiduciary duty, aiding and abetting breach of fiduciary duty, and legal malpractice, only the unjust enrichment claim sounded in contract; all the others sounded in tort. The court then ruled that, pursuant to the “gist of the action” doctrine, the entire claim was a commercial tort claim. Because the creditor’s security agreement did not adequately describe the commercial tort claims—indeed, it did not mention “commercial tort claims” at all—the agreement did not grant a security interest in the claims. The court then ruled that the security interest did not attach to the bankruptcy trustee’s post-petition settlement of the claim because a clause in the security agreement encumbering after-acquired general intangibles does not reach proceeds of a commercial tort claim.

B. Rights in the Collateral

A debtor cannot grant a security interest in property in which the debtor does not have rights or at least the power to convey rights. Because of that, prospective secured parties should generally take steps to confirm that the prospective debtor does indeed have property rights in the desired collateral. And, if an individual is to authenticate a security agreement on behalf of a business entity, it is incumbent on the secured party to make sure that the individual has the authority to do so. Two creditors encountered a problem with these basic requirements last year, with varying results.

In The Peoples Bank of Marion v. Nutrien AG Solutions, Inc., an appellate court affirmed a trial court ruling that a bank that had loaned money to a partnership, which had authenticated a security agreement purporting to grant the bank a security interest in the partnership’s farm equipment, did not in fact acquire a security interest in the equipment. The partnership had been formed by two brothers and it was the brothers who initially acquired the equipment. Although the bank provided the court with affidavits by the brothers in which they claimed to have transferred—at varying times—the equipment to the partnership, and a pre-loan balance sheet submitted by the partnership listing the farm equipment as partnership property, there was no documentation of such a transfer of the equipment to the partnership. Moreover, for other agreements that the brothers had entered into, the bank listed the farm equipment as their individual property.

In In re Rudick, the court ruled that an individual who owned a limited liability company and signed, on behalf of the company, a security agreement purporting to grant a security interest in property owned by the individual, did grant the security interest. The court concluded that individual had consented to the company’s action.

A debtor cannot grant a security interest in contraband because it is not possible to have property rights, or even the power to transfer property rights, in contraband. But, to the good fortune of one creditor last year, a court concluded that it is possible to obtain a security interest in property requiring a license, even if the debtor does not have such a license.

In McGrath v. Addy & McGrath Fireworks, Inc., a lender had a security interest in the inventory of a fireworks company even though the company lacked the state and federal licenses needed to lawfully purchase, possess, and sell fireworks, and had purchased fireworks using the license number of another entity. The court concluded that the company had possession of and ownership rights in the fireworks because they were purchased with the company’s funds, stored in a facility leased by the company, and stamped with the company’s assumed business name. Moreover, the security interest was not invalidated because of the company’s wrongdoing because the security interest did not require either the lender or the company to engage in illegal activity. Indeed, the company had represented in the security agreement that the company had obtained and would maintain all licenses necessary to conduct its business, the lender had no knowledge or reason to know that the company would illegally acquire fireworks without a valid license, and, the court concluded, the lender had no duty to investigate whether the debtor actually had all necessary licenses prior to making the loan.

C. Other Attachment Issues

When a debtor’s rights to transfer property are restricted by contract or law, the debtor might nevertheless be permitted to grant a security interest in that property. That is because Article 9 contains several rules that override many contractual and legal restrictions on assignment. However, these rules do not apply to shares of stock in a corporation or an interest in a partnership or limited liability company. Consequently, if a debtor is restricted from encumbering membership interest in a limited liability company, no security interest can attach to the debtor’s membership interest.

Such was the conclusion of one court last year. In Jefferson Financial Federal Credit Union v. New Orleans Libations & Distilling Co., a lender to a limited liability company acquired no security interest in a guarantor’s membership interest in the company because the company’s operating agreement prohibited any transfer of an interest, including the grant of a security interest, without the prior written consent of all the members, and no such consent was obtained.

III. Perfection of a Security Interest

A. Method of Perfection

In general, perfection of a security interest is a necessary condition for the secured party to have priority over the rights of lien creditors, other secured parties, or later buyers, lessees, and licensees of the collateral. The method by which a secured party may perfect a security interest depends on several things, in particular the type of property involved. In this respect, timing, as they say, is everything. As collateral shifts from one type to another, the method of perfection can change. One creditor was tripped up by this last year.

In In re Brainard, a divorce lawyer claimed to have a security interest in a client’s interest in a pension plan. An interest in a pension plan is a general intangible under Article 9, and a security interest in a general intangible can be perfected only by filing a financing statement. However, by the time that the lawyer filed a financing statement, the client had already received and deposited a check from the company that managed the pension fund. By that time, the claimed collateral was no longer an interest in a pension plan, it was a deposit account. As a result, even if the lawyer had a security interest in the deposit account, the only way that security interest could be perfected was by control. Because the lawyer did not have control, the court concluded that any security interest the lawyer did have in the deposit account was unperfected.

B. Adequacy of a Financing Statement

When a secured party does file a financing statement to perfect a security interest, the financing statement must provide the name of the debtor, provide the name of the secured party or a representative of the secured party, and indicate the collateral. Of these three requirements, using the correct name of the debtor is the most important. That is because financing statements are indexed by—and searches are conducted using—the debtor’s name. A filed financing statement that lists an incorrect name for the debtor is not effective to perfect unless the financing statement would be disclosed in response to a search under the debtor’s correct name, using the filing office’s standard search logic. One very notable case from last year explored what it means to have search logic.

1944 Beach Boulevard, LLC v. Live Oak Banking Co. involved a Chapter 11 debtor’s effort to avoid a security interest. The secured party had filed a financing statement misidentifying the debtor as “1944 Beach Blvd., LLC” by using the common abbreviation for “Boulevard.” All parties agreed that this was not the debtor’s correct name, so the issue was whether the error made the financing statement seriously misleading.

The bankruptcy court ruled for the secured party and the district court affirmed. The Court of Appeals for the Eleventh Circuit certified the question to the Florida Supreme Court. The issue was difficult because Florida’s search system, which is outsourced to and operated by a private company, does not sift through filed financing statements and select those that are most relevant. Instead, the response to every search is—quite literally—the entire index of filed financing statements, arranged alphabetically by debtor name. The searcher is simply placed, initially, at a particular location in that index, but then permitted to scroll forwards and backwards through the entire index, page by page. The financing statement in this case would have been revealed if the searcher scrolled backwards to the preceding page.

The parties and the court assumed that there was a search logic and agreed that not everything in the index should be deemed to be responsive to a search request. Instead, they argued about how far forwards or backwards a searcher should be expected to review the results. The debtor argued that only the twenty entries on the initial page should be deemed disclosed. The secured party argued that the filings listed on the initial page, the preceding page, and the subsequent page—a total of sixty—should be deemed disclosed.

The Florida Supreme Court rejected both arguments and instead adopted the analysis presented by amicus curiae that, because the search response did not return a finite list of hits but instead provided the entire index, there was no search logic at all. Hence any error in the debtor’s name in a filed financing statement renders the financing statement ineffective to perfect. So, for secured parties the lesson is clear: make sure that you obtain and input the debtor’s correct name in any financing statement you file in Florida; there is no grace for any error.

IV. Priority of a Security Interest

A. Competing Security Interests

When there are two security interests in the same collateral, and only one of them is perfected, the perfected security interest has priority over the unperfected security interest. There are no exceptions to this rule and equitable principles should rarely, if ever, intervene to change that result.

In Arch Insurance Co. v. FVCbank, a bank had a security interest in a subcontractor’s deposit accounts at the bank. The bank’s security interest was perfected by control. A surety company, that had issued a performance bond covering the subcontractor’s performance on a project, had a security interest in the subcontractor’s right to payment on the project. That security interest attached to the amounts paid to the subcontractor on the project and deposited into the deposit account, but was not perfected because the surety had never filed a financing statement covering the right to payment or obtained control of the deposit account. The surety argued that it should nevertheless have priority because it had the right to be equitably subrogated to the subcontractor’s rights. The court rejected this argument because a subrogee’s rights are no better than the subrogor’s rights, and the bank had rights to the deposit account superior to the subcontractor’s rights.

In general, when there are two perfected security interests in the same collateral, priority is determined under the first-to-file-or-perfect rule. The first security interest perfected or subject to an effective financing statement has priority, provided there was no period thereafter when there was neither filing nor perfection. There are, however, numerous exceptions to this rule. One exception is in section 9-330(b), which subordinates a perfected security interest in chattel paper to a purchaser that gives new value and takes possession or obtains control of the chattel paper in good faith, in the ordinary course of the purchaser’s business, and without knowledge that the purchase violates the rights of the secured party. For the purposes of this rule, the term “purchaser” includes another secured party.

In In re Silver, a pawn shop purchased pawn loans originated by another pawn broker and in which a lender had a perfected security interest. The court ruled that the purchaser did not have priority under section 9-330(b) because the pawn shop was in the business of making secured, nonrecourse loans, not in the business of buying such loans from another pawn broker. As a result, the purchaser committed conversion by collecting and retaining the proceeds of the purchased loans.

B. Buyers of Goods

A buyer of goods takes free of an unperfected security interest in the goods if the buyer gives value and receives delivery without knowledge of the security interest. In contrast, a buyer of goods encumbered by a perfected security interest normally takes subject to that security interest. One notable exception to that rule is in section 9-320(a), which provides that a buyer in ordinary course of business takes free of a perfected security interest created by the seller. This rule does not apply to a buyer of farm products from a person engaged in farming operations, but the federal Food Security Act provides that a buyer in ordinary course of business of farm products takes free of a perfected security interest created by the seller.

To be a buyer in ordinary course of business, the buyer must, among other things, buy goods: (i) in good faith; (ii) without knowledge that the transaction violates a third person’s rights in the goods; and (iii) in the ordinary course of business from a person engaged in the business of selling goods of that kind. A person that acquired goods through a transfer in bulk is not a buyer in ordinary course of business. There were two noteworthy cases last year about buyers in ordinary course of business.

In In re East Shore Auto, Inc., a vehicle dealer, which had granted a perfected security interest in its inventory to a floor plan financer, regularly leased vehicles to customers and then sold the leases and residual interest in the vehicles to Auto Trakk, apparently with the understanding that the dealer would use the funds paid to it by Auto Trakk to pay off any outstanding lien on that vehicle. Shortly before the dealer filed for bankruptcy, Auto Trakk bought five vehicles from the dealer but the dealer failed to pay off the floor plan financer, and the financier refused to release the certificates of title to those vehicles. Auto Trakk sued, seeking a declaratory judgment that it had purchased the vehicles free and clear of the financer’s perfected security interest.

The financer claimed that Auto Trakk had not acted in good faith, and thus could not be a buyer in ordinary course of business, because Auto Trakk had failed to perform due diligence that would have alerted it to the financer’s interest. The court rejected this argument, noting that the issue was not whether Auto Trakk knew or should have known of the financer’s interest, but whether Auto Trakk knew that its purchase violated the financer’s rights. Since the only violation of those rights occurred when the dealer failed to use the sale proceeds to pay the financer, and there was no evidence that Auto Trakk was even aware of that fact let alone complicit in or responsible for it, Auto Trakk was a buyer in ordinary course of business.

In In re Waggoner Cattle, LLC, the debtors were several related entities, all owned by Quint Waggoner, that operated cattle feeding operations. Lone Star Bank had a perfected security interest in the debtors’ livestock. Beginning in 2014, one of the debtors began selling calves to Waggoner’s sons. However, the sales were not documented, the sons never paid for the calves, the calves remained on the debtor’s ranch and were raised, sold, and slaughtered with the debtor’s other cattle, and the father had complete control over the number of calves sold, the price to be paid, and how the proceeds of the cattle were used. Most important according to the court, even though it is ordinary for buyers to act in their own interest, millions of dollars of proceeds from the calves went back to the debtors. For these reasons, the court concluded that the sons were not buyers in ordinary course of business and did not take free of the bank’s security interest.

V. Enforcement of a Security Interest

A. Default

Article 9 gives secured parties various rights upon default, including the rights to repossess, collect, and dispose of the collateral. However, Article 9 does not define default. Instead, it leaves that to the parties’ agreement and other law. Consequently, unless some other law provides otherwise, parties are free to define default very broadly. In two notable cases from last year, the debtor felt the sting of this wide latitude.

In Seifert v. U.S. Bank, the court ruled that the debtors had not stated a cause of action for breach of contract or conversion against a secured party that repossessed and sold their recreational vehicle. The court reasoned that even if, as the debtors claimed, they were current in making payment on the secured obligation, the security agreement obligated the debtors to keep the vehicle in their possession and not attempt to sell it without the secured party’s written permission, and the debtors had transferred possession of the vehicle to a broker for sale. Similarly, in Blackshear v. South Fork CDJR, the court ruled that a debtor who failed to insure her car, as required by the terms of a security agreement, was in default and had no conversion claim against the company that repossessed the car.

In two other cases, however, the debtor had more success challenging the existence of default. In Mitchell v. Auto Mart, LLC, the court held that a debtor was entitled to summary judgment on its claim that a repossession company violated the Fair Debt Collection Practices Act by repossessing her car before she was in default. The sales agreement for the car provided that the debtor would be in default if she failed to make payment within thirty days after its due date, but the company repossessed the car before the thirty-day period expired. Although the agreement also prohibited the debtor from “permanently” taking the car out of Nevada without the secured party’s written consent, and the debtor had taken the car to Florida, the agreement did not indicate that doing so constitutes a default, nor had the repossession company made any such argument.

In Marine Electric Systems, Inc. v. MES Finance, LLC, the owner of a corporation that granted a security interest in his shares of stock to secure a loan to the corporation obtained a preliminary injunction prohibiting the secured party from conducting a sale of the stock. The owner had demonstrated a likelihood of success on the merits by alleging, among other things, that the secured party had waived its right to rely on the alleged defaults based on its course of conduct and bad faith and had accepted what the debtor believed and intended was full payment, only to later claim additional amounts were due.

B. Repossession

Article 9 permits a secured party to repossess collateral without judicial process, provided it can do so without causing a breach of the peace. This duty not to breach the peace is non-waivable. The duty is also non-delegable; a secured party violates the rule even if an independent contractor causes a breach of the peace. Moreover, a breach of the peace can occur even if there is no violence. Consequently, a secured party and its agents must normally withdraw from a confrontation with the debtor or with third parties. In two notable cases last year, secured parties and their agents found themselves liable or potentially liable for the manner in which collateral was repossessed.

In Davis v. Complete Auto Recovery Services, Inc., the court ruled that a debtor stated a cause of action for breach of the peace against a secured party based on the debtor’s allegations that an independent contractor assaulted her while conducting a repossession of the debtor’s car on the secured party’s behalf. The debtor also stated causes of action for conversion, trespass to chattels, and trespass claims against the repossession company and the individual contractor who repossessed the car because the Maryland Collection Agency Licensing Act prohibits the collection of debts, which includes repossession of collateral, without a collection agency license, and neither the company nor the contractor had a license. However, the debtor did not state a claim for battery against the repossession company because, even if there was evidence of a battery by the contractor, and even if the contractor was the company’s employee, the debtor was unable to establish that the battery was within the scope of the contractor’s employment.

In Smith v. Kershentsef, a secured party was liable for breaching the peace during the first repossession of the debtor’s vehicle because a physical altercation occurred between the debtor and the repossession agent. A second repossession, which took place after the debtor paid the arrearage, retrieved the vehicle, and then failed again to make required payments, did not breach the peace because the debtor contended only that he felt threatened due to the presence of two repossession agents; he did not allege that they actually threatened him.

However, in a third case, Labadie v. Nu Era Towing & Services, Inc., the debtor was unable to establish that a breach of the peace occurred. In Labadie, a repossession agent initially used a vehicle to block plaintiff ’s access to her car in a shopping area parking lot. When the plaintiff objected, the agent called for a tow truck that arrived twenty minutes later. When the plaintiff again objected and explained that she needed to take her son to receive medical treatment at a residential facility, the agent agreed to allow the plaintiff to drive there, but admonished her if she attempted to drive anywhere else, he would call the police. The agent followed the plaintiff to the facility and, once there, proceeded to repossess the car over the plaintiff ’s objection. In so doing, the agent requested the keys to the car and advised the plaintiff that if she did not comply, she would be charged $400 for a replacement key.

The debtor asked the court to apply a five-factor test identified by the Eighth Circuit, which looks at (1) where the repossession took place, (2) the debtor’s express or constructive consent, (3) the reactions of third parties, (4) the type of premises entered, and (5) the creditor’s use of deception. The court concluded that even under this test, the debtor failed to state a claim for breach of the peace. In so doing, the court noted that no case law supported the proposition that blocking access to the collateral is a breach of the peace. It then concluded that, under this test, expressing an objection to repossession, however strenuously, does not make the agent’s conduct a breach of the peace in the absence of other circumstances indicating that the activities of the repossession agent are of a kind likely to cause violence, or public distress. Finally, the court concluded that advising the debtor that the police would be called if she fled and that her failure to provide the keys to the car would result in a $400 charge were neither threats nor deceptive practices.

C. Notification of Disposition

After default, a secured party may dispose of the collateral. Before most dispositions, the secured party must send reasonable notification of the disposition to the debtor and any secondary obligor. Such notification must describe the debtor, the secured party, and the collateral subject to the disposition; it must also state the method of the intended disposition, that the debtor is entitled to an account of the unpaid indebtedness and the charge therefor, and the time and place of a public disposition or the time after which a private disposition will be conducted. If the secured transaction is not a consumer transaction, the failure to include any of this information is not necessarily fatal; whether such a notification is sufficient is a question of fact. In a consumer transaction, however, all of this information, and a bit more, is required. Last year, courts dealt with several challenges to a notification of disposition, with mixed results.

In The Central Trust Bank v. Branch, a bank sent a notification of disposition that described the intended disposition as a private sale. The disposition was a dealers-only auction. The trial court ruled that the notification was insufficient. On appeal, the Missouri Supreme Court reversed. After noting that Article 9 does not statutorily define what constitutes a “public disposition,” the court looked to the official comments, which describe a public disposition as one in which “the public has had a meaningful opportunity for competitive bidding,” which implies that the “public must have access to the sale.” Based on this, the court held that an auction open only to dealers is not a public disposition.

In Caterpillar Financial Services Corp. v. Get ‘Er Done Drilling, Inc., the court ruled that a notification of a public internet sale, sent on October 2, which stated that the auction would begin and end on November 2, was reasonable even though the auction began on October 12 and concluded on October 26. The court concluded that the incorrect information did not prejudice the debtor because he had a reasonable period of time in which to exercise his option to participate in the sale or redeem the collateral, he did not read the notification, he had no funds with which to bid, and he had previously unsuccessfully attempted to find a buyer for the collateral.

In Wilson v. Capital Partners Financial Grp. USA, Inc., a secured party sent, as a notification of disposition of medical equipment, an email message stating that: (i) the secured party intended to repossess the equipment in nineteen to twenty days; (ii) the items will then be offered for sale and the secured party had already received a few bids; and (iii) the landlord would not permit repossession of the generator or HVAC system, and this would affect the final shortfall. The trial court granted summary judgment for the secured party and the court of appeals reversed.

In reviewing and applying each of the requirements for a notification of disposition, the court first ruled that because the e-mail message provided the debtor’s and the secured party’s names and gives information from which their roles in the secured transaction could be readily deduced, the message reasonably described the parties. The court then held that the message reasonably described only a portion of the collateral. Statements that the secured party planned to liquidate “what is at the facility” and “the items” were, according to the court, too general to reasonably describe the collateral. However, by stating that the secured party would sell “all the permissible equipment from the FLER clinic” and had already received bids “for the CT and radiology equipment,” the message did suffice to describe the items that fell in those categories. The court then noted that the message referred to bids already received, thereby hinting that the disposition would be by private sale rather than at a public auction conducted live. But the court nevertheless concluded this “one clue concerning the sale’s format” was insufficient to state whether the sale would be public or private. Finally, the court ruled that, by stating when the repossession would occur, the message did not satisfy the requirement of stating when a public sale would be held or the date after which a private sale would be conducted.

D. Conducting a Commercially Reasonable Disposition

A secured party may dispose of collateral by a sale, lease, license, or other disposition. The disposition may be public—that is, typically an auction open to the public—or private. However, every aspect of a disposition must be “commercially reasonable.” If a secured party’s compliance with this standard is challenged, the secured party has the burden of proof. There were five notable cases last year dealing with the commercial reasonableness of a secured party’s disposition of collateral.

In BMO Harris Bank v. Hassanally, a bank brought a deficiency action after it disposed of 124 new Mitsubishi vehicles through a major vehicle auction company. The defendants challenged the reasonableness of sale, arguing that the bank should have waited until the debtor’s franchise was terminated, at which point the manufacturer would have been statutorily required to repurchase the vehicles for far higher amounts. Both the trial court and appellate court rejected this argument. Although the bank had been able to sell other new vehicles back to their manufacturers, Mitsubishi had refused to negotiate, taking the position it had no repurchase obligation until the debtor’s franchise was actually terminated, a process that was dragging on. Moreover, the debtor’s lease had been terminated, requiring that the vehicles be relocated.

Two other secured parties did not fare so well. In In re PA Co-Man, Inc., the assignee of the debtor’s bankruptcy estate brought a claim against a secured party for conducting a commercially unreasonable disposition, alleging that the secured party had orchestrated a private sale of all of the debtor’s assets for $35.7 million, in secret and without bidding, when potential buyers had expressed interest in purchasing the equity in the debtor for $47–51 million. The creditor sought to have the claim dismissed because the debtor, through its president, executed after default a consent acknowledging that the planned foreclosure sale was commercially reasonable, waiving all existing claims against the secured party, and releasing the security party from any liability in connection with the transaction. The court rejected that argument, concluding that the consent was not effective to waive the claim because it was executed before the foreclosure, and under section 9-602 the requirement of a commercially reasonable disposition cannot be waived or varied in advance. Although parties may, by agreement, set the standards for measuring commercial reasonableness, provided those standards are not manifestly unreasonable, the court ruled that consent did not actually set any standards; it provided merely for the collateral to be surrendered for sale to an identified buyer in satisfaction of the secured obligation and prohibited the debtor from challenging the commercial reasonableness of the sale.

In CCO Condo Portfolio (AZ) Junior Mezzanine, LLC v. Feldman, the secured party brought an action against two guarantors to collect a deficiency after the secured party conducted a disposition sale of limited liability companies that owned New York condominiums. The guarantors challenged the commercial reasonableness of the sale. Some facts were undisputed. The sale was conducted on January 7, 2021. It was advertised for seven consecutive days in the New York Times and one day each in the New York Post and New York Daily News. Bidders were required to provide an opening deposit of $500,000 as well as a second deposit of 5 percent of the bid, if selected as the winner. The secured party was the prevailing bidder with a bid of $65 million. The guarantors argued that the sale was commercially reasonable due to the timing and advertising of the sale during the winter holiday season and ongoing pandemic, the high amounts required as deposits, and the perceived below-market final sale price. The court ruled that summary judgment was inappropriate.

Section 9‑627(c) provides that a sort of statutory safe harbor: a disposition of collateral is commercially reasonable if it has been approved in a judicial proceeding. In Elemental Processing, LLC v. Amerra Cap. Mgmt., LLC, the court followed this rule and held that a disposition of collateral conducted by a receiver pursuant to court-approved procedures and confirmed by the court was commercially reasonable. In contrast, three days later, in Anders v. CrossFirst Bank, the court ruled that a disposition of collateral by a court-appointed receiver, which the court expected to confirm but never did, was not included in the statutory safe harbor for commercial reasonableness.

E. Other Enforcement Issues

It is not uncommon for a debtor and secured party to agree, after default, to a privately structured transaction in which the collateral is transferred to the secured party or a newly formed entity owned and controlled by the secured party. Such a consensual transaction need not be structured as a disposition of the collateral under Article 9, in which case it is not subject to the requirement of commercial reasonableness. Moreover, given the post-default and consensual nature of the transaction, Article 9 effectively places no limits or restrictions on such a transaction. But other law might. That is one important lesson from the Delaware Supreme Court’s decision last year in Stream TV Networks, Inc. v. SeeCubic, Inc.

In that case, a Delaware corporation’s charter required approval of the Class B shareholders for any “sale, lease or other disposition of all or substantially all of the assets.” The court ruled that a transfer of substantially all of the corporation’s personal property to a newly formed entity controlled by the creditors with a security interest in the assets was a “disposition” within the meaning of this provision, and thus the Class B shareholders’ approval was required.

VI. Liability Issues

To ensure the free flow of funds in commerce and the finality of payments, section 9‑332(b) provides that a transferee of funds from a deposit account takes free of a security interest in the deposit account unless the transferee acts in collusion with the debtor to violate the secured party’s rights. Two notable cases applied that rule las year.

In Newtek Small Business Finance, LLC v. Texas First Capital, Inc., a secured party that had a security interest in the debtor’s deposit account as proceeds of accounts brought an action for conversion against a buyer of the debtor’s future receivables that received payments through automatic debits to the debtors deposit accounts. The court ruled that there could be no conversion because, in the absence of collusion with the debtor to violate the secured party’s rights, the buyer took free of the security interest under section 9-332(b), and no facts were pled to support a claim of collusion.

Similarly, in First Financial Bank v. Fox Capital Group, Inc., the court ruled that a secured party with a perfected security interest in the debtor’s deposit accounts had no claim for conversion against a factor that purchased the debtor’s accounts and received payment from the debtor’s deposit account, because the factor took free under section 9-332(b) unless it acted in collusion with the debtor to violate the secured party’s rights, and there was no allegation of collusion.

Collectively, these cases provide the backdrop for several important pieces of advice to secured parties that loan against or buy a merchant’s receivables. First, for secured parties who are first in time, it is important to either establish a lockbox for all collections on receivables or to obtain control of the debtor’s deposit accounts and to monitor what happens with those deposit accounts. For secured parties who are second in time (to an earlier perfected security interest), and who want the benefit of section 9‑332(b)’s take-free rule, it is vital to allow the debtor to collect the receivables and then remit payment, whether through an automated ACH transfer or otherwise. If the second secured party instead collects the receivables directly from the account debtors, section 9-331(b) will not apply. In such a case, the second secured party will take the funds free of the earlier secured party’s security interest only if the second secured party qualifies for priority as a purchaser or holder in due course of an instrument (the account debtor’s check). If the account debtors pay the second secured party directly by funds transfer, rather than by check, there is no rule that allows the second secured party to take free of the first secured party’s perfected security interest.