A Kansas Supreme Court decision issued this summer illustrates some of the issues a secured lender must consider when contemplating strict foreclosure of its security interest. Generally, under UCC §9-620 a secured lender can accept collateral in full or partial satisfaction of the secured debt if the debtor consents to the acceptance and certain other parties required to receive notice do not object. If collateral is being accepted in partial satisfaction, the debtor must agree to the terms of the arrangement in an authenticated record after default. If in full satisfaction, either the debtor must agree in an authenticated record after default, or the debtor must fail to object within 20 days after the secured party sends an authenticated proposal. The decision in Born v. Born, 374 P.3d 624 (2016), discussed several of these components. (Some of the underlying facts and arguments discussed below were obtained from the Court of Appeals and District Court opinions.)
The Proposal. The Born case involved two secured loans and two borrowers. Borrower One was obligated under and provided collateral for only one of the loans (Loan One). Borrower Two was obligated under both loans and provided collateral for both. After default, the secured party sent two notices to Borrower Two, and one to Borrower One. The notices did not specify that the lender was willing to accept the collateral, but instead indicated that the secured party had accepted the collateral, treating it as a fait accompli. Additionally, the notices did not state that the acceptance of collateral would fully (or partially) satisfy the debt, notify the secured party of its right to object, or specify the amount of the secured obligation to be satisfied or a method to calculate that amount. Notwithstanding these potential shortcomings, all of which were raised by Borrower Two, the court ruled that the notices were effective.
A lender sending notice under §9-620 should be reluctant to rely on the conclusions in Born regarding the contents of the notice. The definition of “proposal” in §9-102(66) and Official Comment 4 to §9-620 seem to require that the notice convey a willingness or proposal to accept the collateral and explicitly reference that the acceptance would be in full (or partial) satisfaction of the debt. The decision in Born may be limited to the facts of the case since the Court relied on a reference in the notices to the underlying loan documents and some unusual language in those documents. At a minimum, the secured party’s proposal should make it clear that the notice constitutes a proposal and explicitly state that the collateral will be accepted in full, or partial, satisfaction of the debt. In order to help avoid later disputes with the borrower, the notice should inform the debtor of its right to object. Finally, since it is included in Official Comment 4, the notice should include the amount of the secured obligation to be satisfied or a method to calculate that amount. Even the Court of Appeals in Born, while holding that it is not required, seems to tacitly acknowledge that this would be a “good business practice.”
There is another side to the court’s ruling on this point that a secured party must consider. The holding that a notice that does not, on its face, seem to satisfy §9-620 and §9-102(66) is sufficient raises the possibility that correspondence not intended as a proposal to accept collateral might be construed as one. For example, in a situation in which there are guarantors and the collateral is worth significantly less than the amount of the debt, the obligated parties may try to treat correspondence from the lender as a proposal under §9-620 in order to eliminate the deficiency and the guarantors’ liability. A lender must be careful in its communications to avoid language that would provide that opportunity.
The Objection. One of the major issues in Born is whether Borrower Two objected to the lender’s proposal. The trial court had determined that, since there was no formal written objection, Borrower Two had accepted the lender’s proposal. Within the 20-day objection period, Borrower Two emailed and mailed a letter to the lender to arrange for payment in full of the loans and commenced the lawsuit against the lender. The court in Born seems to conclude that this constitutes a sufficient objection. Given this guidance, a secured lender should review all communications and actions of the debtor to determine if they could be construed as an objection to the lender’s proposal.
The appellate court also determined that, based on the loan documents, the lender’s sole remedy was to accept the collateral and, based on that conclusion, ruled that, in addition to objecting to the proposal, Borrower Two also had to redeem the collateral by repaying the loans in full. However, the Kansas Supreme Court disagreed that acceptance of the collateral was the only remedy. More importantly, it ruled that even if acceptance was the only remedy, Borrower Two retained the right to object to the proposal and was not obligated to redeem the collateral in order to do so. The court confirmed that under §9-602, the rights of the debtor to object to the acceptance of collateral could not be waived or varied by any provision of the loan documents.
The Effect. Since Borrower Two objected to the lender’s proposal, title to the collateral did not pass to the lender and Borrower Two had the right to cure the default by repaying the accelerated loans in full. Also, since Borrower One accepted the lender’s proposal with respect to Loan One, Borrower Two was entitled to a credit against that loan for the value of the collateral provided by Borrower One and accepted by the lender.
Although not addressed by the court, presumably because it was not raised by Borrower Two, this last point could have resulted in an even worse result for the lender. Since the Court determined that the notice from the lender constituted a proper proposal to accept collateral in full satisfaction of the debt and Borrower One accepted the proposal, Borrower Two could have argued that Loan One was paid in full. Under §9-622, a proposal to accept collateral in full satisfaction of the debt that is consented to by the debtor discharges the obligation — not just the consenting debtor’s liability for that obligation. There is no indication in the decisions that the notices from the lender made any provision to separate the liability of the two borrowers or address the situation that actually occurred where one borrower consented and the other objected. Depending on the exact wording of the notices, Borrower Two would have had a strong argument that Loan One was fully satisfied and it only remained liable for the other loan.
Lessons. Strict foreclosure under Article 9 can be a useful and efficient tool to resolve a defaulted loan. However, when using this tool, a careful lender should:
- Phrase the notice to the debtor as a proposal, explicitly state that the collateral will be accepted in full, or partial, satisfaction of the debt, inform the debtor of its right to object, and include the amount of the obligation to be satisfied or a method to calculate that amount;
- Avoid language in communications with the borrower that could be misconstrued as a proposal to accept collateral;
- Not rely on pre-default waivers of the borrower’s right to object;
- Carefully consider communications from and actions by the borrower to determine if they may be construed as an objection to the proposal, even in the absence of a formal explicit written objection; and
- When providing a proposal to multiple borrowers, make sure that acceptance by one does not discharge the liability of all obligated parties.