Understanding Article 9 Restructuring

Under the Uniform Commercial Code (UCC), debtors have a variety of options to overcome insolvency. For example, an Article 9 reorganization is an out of court restructuring that sells the assets of the debtor company to a third party with the proceeds for the benefit the secured lender. Any residual balance of the secured debt remains with the debtor company. The buyer continues as a new business and does not absorb any of the liabilities of the debtor, including the trade debt. The sale must be at a fair market price, and may be concluded in as little as 60-90 days. With an Article 9 sale, the company avoids bankruptcy and a foreclosure action that would add additional expenses.

No preference law exists in an Article 9 restructuring and creditors may struggle getting payment. Although the creditor doesn't have the risk of a potential preference action in an Article 9, they must look only to the insolvent debtor for payment of their unsecured trade debt. Maintaining open lines of communication and a strong business relationship with a customer, especially if their financial conditions weakens, is the best defense against being taken by surprise by an this or any other insolvency action. The new company is not responsible for the debts of the old company and should be considered a new customer, following the same procedures and due diligence used in onboarding any new company.

In a UCC sale, if any assets left behind benefit the unsecured creditor, take a proactive approach. "Doing a foreclosure under Article 9 is a great way to move assets because there's a buyer that can potentially make a commercially reasonable sale," said Deborah Thorne, U.S. bankruptcy judge, Northern District of Illinois. "From the bank's perspective, it is a way to quickly dispose of assets where the borrower or debtor has been unable to fulfill the terms under their agreements." However, it is less than ideal for creditors

Sales by a secured lender should always be commercially reasonable, and is considered the ultimate test under Article 9. Secured lenders cannot do a foreclosure under Article 9 and sell assets in a manner that gets its debt paid off, but does not maximize value, said Jason Torf, Esq., partner at Tucker Ellis LLP (Chicago, IL). "The problem with Article 9 is there's not nearly enough transparency as there is in a bankruptcy process where everything is publicly available on a court docket," Torf said. Even with both public and private sales, notices can be hard to find because not all notices are sent to every creditor. "Sometimes, Article 9 sales can be done by private transaction where you don't get any notice as an unsecured creditor or might get a notice after its done."

Creditors must stay ahead of what's happening with a debtor. Unsecured trade creditors should be in touch with their debtors and ask questions in order to find if they intend to do a secured party sale, said Justin Kesselman, partner at ArentFox Schiff LLP (Boston, MA). "You have to know what the terms of the sale are because the secured party sale could possibly wipe out all of the collateral," Kesselman said. "The proceeds of that collateral pay the secured debt leaving the debtor with no remaining assets or anything to pay on secured trade creditors. In contrast, with a bankruptcy case, it's a much more open process where all creditors are going to receive notice of any type of disposition of collateral outside the ordinary course of business."

Though bankruptcy can provide more transparency than an Article 9 restructuring, if the assets don't have much worth to them, bankruptcy is not the best decision to make. As a trade creditor, you want to get paid quickly with any assets that are left. And for unsecured creditors, it's not the best scenario because the assets may not be sold in the foreclosure for enough to ever pay the unsecured creditors. "If you're a vendor for someone and know that they're having trouble with their bank, you may want to ask your lawyer to look at whether the bank or another creditor has properly filed their UCC financing statements," said Thorne. "They may or may not have a security interest so you should make sure everything is done. That is where I think an industry group in NACM can be valuable because everyone could have been selling to the same person that's not paying you."

A lender can repossess collateral in either satisfaction of the debt or take collateral and hold a public auction or private sale to satisfy the secured debt. You want to create a unform system to govern the creation and enforcement of security interest, Kesselman said. "Article 9 sale processes should really be used when you have secured debt as an alternative to a restructuring under the bankruptcy code or other state law," Kesselman added. "Your primary debt will be covered as a secured debt and can be an alternative to winding down and liquidating the company through a process run by an independent fiduciary."

In a bankruptcy case, the sale process is going to be run through the bankruptcy court and proceeds of the sale would be used to distribute to secured creditors first. Any remainder to fund distributions to unsecured creditors would be done under a process overseen by a bankruptcy court. Article 9 creates a different notice and time requirement depending on the type of transaction that is run by the secured lender. "An insolvent company can file a bankruptcy but, in many cases, companies are liquidated through Article 9 sales where lenders use collateral," said Bruce Nathan, Esq., partner at Lowenstein Sandler LLP (New York, NY). "A lender can use Article 9 as a remedy for default or collect its AR collateral. UCC Article 9 sales are frequently used as a liquidation device."

-Kendall Payton, editorial associate

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Monday, 27 May 2024

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