Contributed by Debra A. Dandeneau.
Looking at the Big Picture: CBGB shows that strict foreclosure may be a useful enforcement tool, but a more effective bankruptcy strategy might have hindered the lender’s efforts.
Outside the real estate context, the term “foreclosure” is often used loosely to refer to any attempt by a secured party to enforce its payment rights against the collateral that secures such rights. Judge Bernstein’s recent decision in CBGB, though, not only reminds us that “foreclosure” has a particular meaning under Article 9 of the UCC, but also provides a thorough explanation of the process a secured party must follow to “foreclose” on its Article 9 collateral. Perhaps, however, the facts of the decision make the process appear almost too easy. Under other circumstances, a borrower might have been able to use chapter 11 more effectively to delay, if not challenge altogether, the strict foreclosure.
“Strict foreclosure” under UCC Article 9 is the process by which a secured party elects to retain the collateral securing its debt in full or partial satisfaction of the debt. When a lender properly complies with the requirements of “strict foreclosure,” it becomes the owner of the collateral and need not subject the collateral to a commercially reasonable public or private sale. As a result, the lender also does not need to account to the borrower for any excess value the collateral may have.
To protect the borrower or other parties with an interest in the collateral (such as junior lienholders) against the secured party obtaining a windfall when it forecloses on its collateral, UCC sections 9-620 and 9-621 require the foreclosing lender to give at least 20 days’ notice of the proposed strict foreclosure to such parties. If the borrower or such other party has not consented to the foreclosure and timely objects, then the lender must dispose of the collateral in a commercially reasonable manner. Moreover, the borrower cannot agree in advance to permit a lender to exercise its strict foreclosure rights; it can only consent (or be deemed to consent) after the default occurs. In CBGB, following a default, the lender and the borrower (CBGB) entered into a forbearance agreement that permitted the lender to retain the collateral in full satisfaction of the debt if the borrower did not cure the default by repaying the loan during the forbearance period. After the expiration of such period, the lender took steps to transfer the collateral to its name. One month later, CBGB commenced its chapter 11 case and unsuccessfully argued that its failure to cure the default was a new default requiring a new 20-day notice period before the lender could take title.
CBGB leaves open a number of questions and possible strategic alternatives the debtor may have pursued. For example, in CBGB, the debtor commenced its chapter 11 case after the expiration of the time the lender had given it to cure the default. If CBGB had commenced the case before the expiration of the forbearance period, what would have been the result? At a minimum, CBGB may have been able to take advantage of the section 108(b) of the Bankruptcy Code, which affords the debtor at least 60 days after the petition date to cure a default under an agreement. In cases involving a debtor’s right of redemption under real property statutes, courts generally have applied section 108(b) to extend the debtor’s right to redeem real property. See, e.g., Canney v. Merchants Bank (In re Frazer), 284 F.3d 362 (2d Cir. 2002); In re Tynan, 773 F.2d 177, (7th Cir. 1985); In re Little, 201 B.R. 98 (Bankr. D.N.J. 1996), aff’d, 159 F.3d 1352 (3d Cir. 1998). Even more advantageous to CBGB’s estate would have been if the debtor could somehow have treated the agreement as an executory contract that it was free to assume any point in its case by curing the default, even after the expiration of the extended deadline under section 108(b). Moreover, if the lender had given the 20 days’ notice without first obtaining the borrower’s consent to strict foreclosure, the borrower or any junior secured party could have blocked the strict foreclosure by objecting. If the borrower then commenced a chapter 11 case before the lender could take control and dispose of its collateral, the lender simply would be a secured creditor in the debtor’s chapter 11 case, with no particular time pressure on the debtor to cure the default.
Moreover, even if a borrower consents to a strict foreclosure by a lender, as Judge Bernstein concluded was the case in CBGB, such consent does not protect the lender from a later challenge on behalf of the debtor’s estate that the lender received property worth more than its debt, and, therefore, the strict foreclosure constituted a fraudulent transfer to the extent of such excess value. Judge Bernstein noted in CBGB that a strict foreclosure should not result in a preference because the secured creditor should not receive more than it would receive in a chapter 7 liquidation in satisfaction of its debt. That reasoning, however, does not protect against a fraudulent transfer allegation. Judge Bernstein expressly noted, though, the debtor did not allege that the collateral was worth more than the secured obligations. By pursuing strict foreclosure of the collateral instead of the alternative of taking control of collateral, disposing of the collateral in a commercially reasonable manner, and accounting to the debtor (and junior secured parties) for any excess proceeds, the lender might subject itself to a challenge in a later bankruptcy case that the lender’s foreclosure of the collateral constituted an avoidable fraudulent transfer. Whether or not such challenge ultimately would prove successful, it could threaten to tie up the assets transfered to the lender until the conclusion of such action.
Strict foreclosure in full satisfaction of debt also may not be an attractive remedy where the lender has other collateral or is holding guarantees from other parties. For example, if the debt is secured by a mortgage as well as the parent’s pledge of its equity in the borrower, the lender could attempt to strictly foreclose on the pledged equity and take control of the borrower. Such procedure, however, would be in full satisfaction of the debt, and the lender would thereby lose the ability to take priority over the borrower’s other creditors by foreclosing on the real estate collateral.
In CBGB, the lender’s efforts to strictly foreclose on its collateral proved successful, and about four months after the debtor commenced its chapter 11 case, Judge Bernstein concluded that the lender was the rightful owner of the collateral. In evaluating its remedies after a default, though, a lender must still consider the risks of pursuing a strategy of strict foreclosure and how strict foreclosure falls within its objectives. CBGB might make strict foreclosure look easy. It is not clear that another situation would yield the same result if the debtor made different strategic moves.