While the world may be in a state of semi-paralysis waiting for a COVID-19 vaccine, the legal environment involving creditors’ rights has changed significantly during the past several months.

In the beginning of the pandemic, we reported that courts viewed Article 9 sales with a more critical eye.  For example, we previously reported that Justice Masley of the New York Supreme Court, New York County Commercial Division, issued a  decision on June 23, 2020 in D2 Mark LLC v. OREI VI Investments, LLC, holding that a UCC Article 9 sale on thirty-six (36) days’ notice, which required the winning bidder to make a non-refundable deposit of 10% of the purchase price, pay the remaining balance within 24 hours, and precluded the borrower from submitting a bid, was commercially unreasonable because of the dire implications of COVID-19. MHH Blog: Lender Stayed From Proceeding With UCC Article 9 Sale

Similarly, on August 3, 2020, Justice Schecter of the New York State Supreme Court, New York County Commercial Division, issued a decision in Shelbourne BRF LLC et al. v. SR 677 Bway LLC, enjoining a lender from conducting a UCC Article 9 sale of collateral because of depressed asset values caused by the pandemic.  In her decision, Justice Schecter held that: “Severe turmoil in the real estate market due to the pandemic makes the notion of a sale resulting in payment of fair market value highly uncertain” and “[b]ids will likely be discounted due to uncertainty about the continued length and severity of the pandemic.”  Justice Schecter specifically referred to Paragraph 7 of the Administrative Order of the Chief Administrative Judge of the Courts dated July 23, 2020 (AO/157/20) which provided that “no auction or sale of property in any residential or commercial foreclosure matter shall be scheduled to occur prior to October 15, 2020” and held that “[t]hough AO/157/20, by its terms, does not apply here, the same logic does. After all, valuation of an equity interest in a company that owns real estate is based on the value of the real estate itself.”

Many of the decisions issued this past Spring, and even into the early Summer, clearly reflected the Courts’ critical review of UCC Article 9 sales and  willingness to provide borrowers  breathing room for relief because of COVID-19.  However, a spate of recent decisions reflects a significant change in the tide.  Most notably, in the very same Shelbourne case, after the court-imposed injunction expired on October 15, 2020, the lender noticed a UCC Article 9 sale for two weeks later.  Although the borrower again moved to enjoin the sale, Justice Schecter changed course and denied the motion (in a decision dated October 27, 2020) with a decidedly different tone:

Forcing defendant to continue funding the costs that plaintiff failed to pay would be commercially unreasonable given the state of the property and the debt to the senior lender. Under current conditions, mezzanine foreclosures are proceeding and the previously-cited administrative order is no longer in effect. Given the circumstances of this case and the current state of the pandemic, further enjoining this sale would be highly inequitable. It may proceed as scheduled on October 30, 2020.[1]

This decision is important because it exhibits a sympathy not for the borrower, but for the plight of a lender, stuck with shouldering the costs of a loan default.  It also acknowledges that while of course COVID-19 is still an extremely serious issue, the current state of the pandemic is no longer one of complete shutdown.  Indeed, in opposing the motion for a preliminary injunction, the lender argued, and the Court agreed, that: (i) there has been an extensive reopening (particularly in Albany, where the subject property is located) since the issuance of the prior injunction; (ii) both sales of commercial real estate and commercial mortgage backed securities have seen a significant uptick; and (iii) at least two other UCC Article 9 sales were scheduled in New York in October 2020, and several others were scheduled for November and December.

Other courts have similarly demonstrated an increased willingness to allow UCC Article 9 sales to proceed.  For example, in 893 4th Avenue Lofts LLC et al v. 5AIF Nutmeg, LLC et al. (New York Supreme Court, Kings County), the lender declared a default based on the borrower’s failure to timely make its monthly interest payments and repay the loan principal due upon maturity.  The lender noticed a UCC Article 9 sale, and the borrower sought an injunction prohibiting the sale from going forward.  In his decision dated August 25, 2020, presiding Justice Ruchelsman denied the motion, finding that the borrower admitted it failed to timely make its interest payment and, therefore, could not demonstrate a likelihood of success on the merits.  Justice Ruchelsman also found that because UCC Article 9 sales are not judicial proceedings, they are not subject to Governor Cuomo’s Executive Order 202.28 precluding residential or commercial foreclosures and UCC Article 9 sales are simply not subject to the foreclosure ban.   It is important to note that while Justice Ruchelsman denied the borrower’s motion, he held that the UCC sale could not proceed for 45 days.  

These recent decisions highlight an important trend in litigation involving UCC sales.  While lenders should obviously continue to properly notice UCC Article 9 sales in an appropriate and conservative manner during COVID-19, it does appear that Courts are more willing to relax the strict scrutiny applied during the height of the pandemic and recognize that UCC Article 9 sales are, in fact, sales of equity interests that are not subject to executive orders prohibiting commercial and residential real estate foreclosures.  Further, courts are increasingly recognizing that the situation since Spring and early Summer has, thankfully, improved.

Key Takeaways:

    • In the midst of COVID-19, expect a number of borrowers to default under their secured financing agreements.
    • Lenders may have increased leverage in restructuring negotiations due to courts’ apparent receptiveness to lender concerns in the current environment.
    • Secured parties seeking to foreclose on collateral and schedule an Article 9 sale need to ensure that the terms of the sale are “commercially reasonable.”
    • While courts are likely to apply a more stringent standard in addressing commercial reasonableness during the COVID-19 pandemic, courts are increasingly allowing UCC Article 9 sales to proceed, are acknowledging that the present environment has improved, and are being more permissive and sympathetic to lenders’ needs and considerations.
    • However, courts are still applying an increased level of scrutiny to UCC Article 9 sales. To maximize likelihood of a successful UCC Article 9 sale, lenders should: (i) notice the sale of collateral at least 45 days before the sale is conducted; (ii) publish the auction notice in a publication where many potential bidders will see it; (iii) provide bidders with either access to the property or, where not feasible, provide bidders with reasonable data on the property and its condition; (iv) ensure that the financial terms of the auction are not onerous; (v) allow the borrower to submit a bid; and (vi) permit bidders to participate virtually.  This last aspect is most crucial in light of COVID-19.

Footnotes:

[1] As the Court noted, the administrative order previously barring auctions or property sales is no longer in effect.  Instead, Administrative Order 232/20 is now in effect, which, subject to COVID-19 protocols and similar protections, permits such auctions to proceed.



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