Agricultural Business Management

FARM LEGAL SERIES June 2015 Foreclosure of Security Interests in Personal Property Phillip L. Kunkel, Jeffrey A. Peterson, Jason Thibodeaux Attorneys, Gray Plant Mooty virtually every security agreement contains a INTRODUCTION broad definition of events that constitute a default. Such events include the failure to Lenders typically require borrowers to pledge make an installment payment when due, the property (or collateral) to secure the loan. sale of collateral without the creditor's prior Collateral is real or personal property owned written consent, the failure to keep the by the borrower that is pledged to the lender collateral adequately insured or the as security for the repayment of the debt occurrence of any other event that causes the obligation. For further discussion, see creditor to deem itself insecure. Financing the Farm Operation; Contracts, Notes and Guaranties; Mortgages and Acceleration Clause Contracts for Deed; and Security Interest in Both the promissory note and the security Personal Property. In the event of default, the agreement will generally contain an lender may look to the collateral to satisfy acceleration clause. This clause allows the the debt. creditor to demand payment of the loan in The process of foreclosing a mortgage in real full upon the occurrence of any event of property and foreclosing a security interest default. in personal property are very different. In this fact sheet, we will discuss the options SECURED PARTY OPTIONS AFTER DEFAULT available to creditors with a security interest Once a default has occurred, there are a in personal property and review the number of options available to the secured procedures under Minnesota law that are party. Not all of these options involve the required to foreclose a security interest in enforcement of the security interest under personal property. For further detail on the UCC. mortgage foreclosures, see Mortgage Foreclosures. Continued Operation of the Farm In the case of a farming operation, if the DEFAULT primary collateral consists of growing crops, Acts of Default the secured creditor will likely refrain from exercising the right to foreclose upon the In order for a lender to exercise its rights crops until the debtor has harvested them. By under a security agreement, the debtor must waiting until after the harvest, the secured have, in fact, defaulted on his obligations. creditor generally will be in a much better The Uniform Commercial Code (UCC) position than if it enforced its rights contains no definition of default, but allows immediately upon default. As a result, even default to be defined by the parties to the though a default may exist, the secured transaction in their documents. As a result,

creditor may actually make additional judgment the lender may be precluded from advances to allow the farmer to continue to foreclosing its security interest in any operate long enough to harvest the crops. personal property.

Allow for Voluntary Sale of Collateral Foreclosure of Security Interests in Personal A second option is to allow the debtor to sell Property the collateral on his own. The secured The final option is the substance of this fact creditor may think that a better price can be sheet. The lender may look to the personal obtained for the collateral if the sale is held property for repayment of the debt. directly by the borrower. REPOSSESSION Workout Agreement If the secured creditor determines that it A third option, especially in the case of prefers to repossess and sell the personal farming operations, is the workout. The property collateral, it must comply with state typical workout arrangement usually involves law. The UCC, however, is clearly drawn with other creditors besides the secured creditor. the protection of the secured party in mind. The workout arrangement includes both an Once default—as defined by the creditor in extension of time and a payment by the the security agreement—occurs, the creditor debtor of less than the full amount owed, but can repossess the collateral. After occurs outside the formal structure of the repossession, the creditors can dispose of the bankruptcy court. The purpose of a workout collateral by public or private foreclosure is to restructure the debt to enhance the sale, retain the collateral in satisfaction of chances of continuing the business and the debt, terminate the debtor's right of ultimately repaying all creditors. In some redemption, add the costs of repossession cases, the secured creditor may conclude that and foreclosure to the unpaid balance of the its position will be enhanced by encouraging debt and pursue the debtor for any the continuation of the business as a growing remaining unpaid balance or deficiency. concern when compared with what it would receive from the liquidation of the collateral. The first step in this process, however, is the repossession of the property. Repossession Seek Money Judgment can either be voluntary (by agreement) or A fourth option available to the creditor is an involuntary (by self-help or by court action). action against the debtor on the underlying Voluntary Agreement debt. In such a case, the creditor is subject to the rights and duties as set forth in another The first method, and the method initially fact sheet in this series, Rights of Unsecured explored by most lenders, is to negotiate an Creditors. This option may be followed when agreement with the debtor to cooperate the secured party suspects that the collateral voluntarily in a turnover of the secured is insufficient to satisfy the unpaid balance property to the lender. In fact, in many cases, of the debt. It is attractive to the secured the sale of the secured property may even be party, however, only if the debtor has conducted on the debtor's premises. Doing unencumbered nonexempt assets that can be so may be advantageous to the debtor. Since reached to satisfy the underlying obligation. all reasonable expenses of foreclosure A lender is often hesitant to only seek a (including storage, sale preparation, labor, money judgment against the farmer, since by trucking, repairs, advertising, auctioning, making the election to only seek a money clerking and legal expenses) are added to the

secured debt, the debtor may only be general, a secured party may not break any increasing his liability to the lender by not locks, use any physical force, issue any cooperating with the sale. threats or proceed in the face of any commands from the debtor, his family or Involuntary Foreclosure other representatives to stay away or If the debtor is unwilling to voluntarily turn otherwise refrain from removing the over secured property to the creditor, the collateral. creditor will need to take action to obtain the Court Action property. Where the collateral is property If self-help is unavailable, the secured party used in the farming operation, including must initiate a court action to obtain equipment, crops and livestock, or where it is possession of the property. In Minnesota, this serving as collateral on a loan used for farm action is known as a replevin action or action operations, it is deemed agricultural for claim and delivery. Such a lawsuit is an property. Minnesota’s farmer-lender action to obtain the immediate possession of mediation statute generally requires the personal property. In most cases, a secured creditor to offer mediation of the debt to the party may obtain possession of personal debtor prior to initiating an action to property over the objections of the debtor repossess such property. The farmer-lender only after the debtor has received notice and mediation statute began requiring mediation a hearing. If, at the hearing, the secured party in 1986, with the statute’s expiration date demonstrates that it will succeed at a formal being extended in the years following original trial in establishing its claim to the property, passage. Generally, the statute requires, the court will order the sheriff to seize the among other things, that a creditor seeking property on behalf of the secured party prior to repossess agricultural property first send to conclusion of a trial on the matter. notice to the debtor and offer the debtor the opportunity to mediate a resolution to the If, however, the court finds that (1) the debt prior to beginning such action. If the debtor has a defense to the secured party's debtor elects to mediate the debt, the claim, (2) the debtors interests cannot be ade- creditor’s repossession of the property can quately protected by a bond filed by the be suspended for a period of up to 90 days secured party and (3) the harm suffered by pending completion of the mediation. Where the debtor would be greater than the harm the debt involved has been scheduled by the suffered by the creditor if the property were debtor in a bankruptcy or involved in a not delivered to the creditor prior to a final previous farmer-lender mediation, the debt is decision, the court may allow the debtor to not subject to the farmer-lender mediation retain possession of the property until statute and the creditor can enforce seek conclusion of the trial. If the court finds that repossession of the property without first the debtor is entitled to retain possession, it offering mediation. may require the debtor to make a partial payment of the debt, post a bond or make Self-Help Repossession the property available for inspection. The The secured creditor may repossess the court can make any other provision that it collateral by self-help and without first deems fair. If the court determines that the obtaining a court order so long as no breach creditor is entitled to possession of the of the peace occurs. The UCC contains no property, the creditor must post a bond with definition of breach of the peace, and many the court that is one and a half times the fair courts have struggled with defining it. In market value of the property.

In some cases, it may be possible for a “commercially reasonable,” so it varies with creditor to obtain a court order allowing it to the circumstances of each case. It does not obtain possession of the property without require a sale at the highest possible price, notice and a hearing. To do so, however, the but rather that the price is obtained after creditor must: (1) demonstrate to the court conducting the sale in a way that is that it has made a good faith effort to inform “commercially reasonable under the the debtor of the hearing or that informing circumstances.” Considerations such as the the debtor of the hearing would endanger the kind of collateral; its condition; the number, ability of the creditor to recover the property; location and identity of likely buyers; (2) that it has shown that it is entitled to seasonable markets; and all other factors possession of the property; (3) that the that would be considered by a reasonable debtor is about to remove the property in commercial seller selling such items without question from the state or to conceal, regard to any foreclosure would be damage or dispose of the property; or that considered by a court in determining whether due to other circumstances the creditor will a sale was held in a commercially reasonable suffer irreparable harm if it does not obtain manner. possession of the property prior to a hearing. Even in such cases, a hearing must be held at Type of Sale the earliest practicable time. The law allows either a public or private sale. Based on the facts of each case, the lender AFTER REPOSSESSION must determine which is commercially more reasonable. Certain items of collateral—such Once the creditor has obtained a court order, as grain, which has a recognized market it has the right to repossess and remove the price—may be more appropriate for a private collateral from the debtor's premises. This is sale. Similarly, if the collateral consisted of usually done by an order for the sheriff to livestock that couldn't be sold on the seize the property and return it to the debtor's premises, but were so numerous creditor. Once the creditor takes possession that they couldn't be kept elsewhere pending of the property, it may either sell the a public sale, a private sale would be the property and apply the proceeds to the debt, likely choice. In most situations, however, a or keep the property to satisfy all or part the well-advertised public auction generally is debt. The creditor is responsible for storing the preferred method of sale. and taking good care of the collateral pending sale. It also must provide all labor Notice and trucking. Regardless of the type of sale, the lender must provide reasonable notification to the FORECLOSURE SALES debtor and any other secured creditor before As soon as the secured lender has possession any sale. Ten days is considered reasonable of the property or knows that it can deliver notification. The notice generally tells the possession to buyers, it will usually arrange debtor what will be sold; whether the sale to liquidate the collateral. will be public or private; the date, time and place if it is a public sale or the date after Commercially Reasonable which such sale will take place if it is a The UCC requires that any sale held by a private sale; the amount of the secured creditor be held in a commercially reasonable indebtedness; a statement that the debtor manner. The UCC does not define may redeem the collateral by paying the

indebtedness and expenses in full before the To retain the collateral, the secured creditor date of the sale; and how the sales proceeds must send a written notice of his proposal to will be applied. the debtor and any other secured party which has given the creditor written notice of an Application of the Proceeds interest in the collateral. Upon receipt, the Once the sale has been held, the law sets debtor and such other secured parties have forth the order in which the sales proceeds 20 calendar days to object to the retention of will be applied to the various claims. This the property by the secured party. Upon order is as follows: objection, the secured party must dispose of the collateral according to the rules set forth 1. Reasonable expenses involved in the above. If no objection is made, the creditor repossession and foreclosure, takes title to the collateral and cuts off the including reasonable attorneys’ fees debtor's right to redeem the collateral. The and legal expenses if provided for in creditor can also claim a deficiency against the security agreement; the debtor if the debtor receives from the 2. Satisfaction of the foreclosing creditor, and consents to, a written proposal creditor's debt or agricultural liens. that the creditor will accept the collateral in 3. Satisfaction of indebtedness held by partial satisfaction of the debt. All other subordinate secured parties. secured parties must also consent to the proposal. If there is money left over, the surplus must be turned over to the debtor. If, however, RIGHTS OF REDEMPTION there is still a balance owed to the foreclosing creditor, the creditor can pursue A debtor or any other secured party has the the debtor for the remaining balance due. right to redeem, or get back, the collateral. In This remaining balance is called a order to redeem, the debtor or other secured “deficiency.” The secured creditor's right to party must pay the creditor the amount owed pursue a deficiency may be restricted by a on the debt and pay the expenses incurred court if the creditor has not followed the for taking, holding, and preparing for procedures of the UCC in foreclosing its disposition and, if included in the security security interest. If a deficiency judgment is agreement attorneys’ fees. The debtor or sought, the secured creditor must follow the other secured party must exercise this right procedures set forth in the fact sheet, Rights before the creditor has disposed of the of Unsecured Creditors. property, contracted to dispose the property, or accepted property in full or partial KEEPING THE PROPERTY satisfaction of the debt. The secured creditor may, in some CREDITOR MISBEHAVIOR circumstances, retain the collateral in partial or full satisfaction of the underlying debt If a creditor does not comply with the rules rather than sell the property. Provided the of the UCC, the debtor may seek appropriate debtor has not paid 60 percent or more of sanctions from a court. Such creditor the debt, or has signed a statement waiving misbehavior may consist of repossession his right to require a sale of the property, prior to default, repossession with breach of nothing in the law prohibits this and nothing the peace, failure to conduct a sale in a in the law requires a secured creditor to sell commercially reasonable manner, failure to the collateral. notify the debtor in advance of the sale,

holding an improper strict foreclosure or CONCLUSION obtaining a price that is too low. One The foreclosure of a security interest in sanction that can be obtained in some cases personal property under the UCC involves is an injunction against the foreclosure. A many steps. The events triggering default, debtor must move quickly, however, and the nature of the collateral and the must realize that obtaining an injunction relationship of the parties all contribute to may be difficult. A second sanction, available how a foreclosure occurs. The law, however, when the disposition already has occurred, is is designed to aid and assist the secured the recovery of damages in an amount equal creditor in exercising its collection rights. to any loss caused by failure to comply with

the rules of the UCC. For more information: extension.umn.edu/agriculture/business

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