Strict foreclosure is a little known process where a lender can take back assets in satisfaction of the debt. It eliminates the costly legal and accounting requirements associated with a receivership. This article will explain the process in the context of a hypothetical business borrower in default.
World of Widgets (“WOW”) operates in a strip mall and enjoys a solid mix of commercial and walk up clients for its eclectic line of decorative widgets. The company has few hard assets as the widgets are manufactured elsewhere and purchased by WOW at a competitive price. Unanticipated personal problems in WOW’s management have created growing cash-flow problems causing this once profitable business to operate in the red. Senior Bank holds a blanket UCC filing on all WOW assets. Junior Bank holds a 2nd position of certain assets as well. The loan to Senior Bank has now fallen in default and bank management is considering its options.
The best case scenario is to quickly recover the WOW assets and sell the business as a going concern. However, the principal of WOW no longer has the ability to manage day to day operations, especially with the growing debt due to his personal financial situation. A bankruptcy liquidation seems logical within the next 6-12 months.
Although WOW is profitable, the costs associated with a receivership break the model. The loan officer calls outside counsel to inquire into alternatives.
The attorney advises that Colorado UCC law allows for something called a strict foreclosure. Here’s how it works:
Revisions to the UCC allow Senior Bank to use strict foreclosure on all types of personal property, both tangible and intangible. This important change allows foreclosure on the non-real estate assets of an entire business, including intangibles like accounts, goodwill and intellectual property, thereby encouraging resale of the business on a going-concern basis. This practice is becoming more and more common. In fact, this “user friendly” approach was a guiding force in the recent change to the UCC .
To make the strict foreclosure work, the secured creditor must be in the senior position and have a blanket security interest in the business assets of the borrower. The secured creditor wants to strictly foreclose on all the business assets to maintain the going- concern value of the business.
Accordingly, step one in the process is a complete review of the bank’s security agreement and its UCC filings. As with many things in life, what you think you have might be entirely different from what you got.
This is important because Article 9 makes it clear that “supergeneric” descriptions in a security agreement, such as “the debtor’s assets” or “all the debtor’s personal property” just don’t cut the legal mustard. We’d be happy to devote a future blog-post to security agreements or provide on-site training. Just call!