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In times of financial distress, it may be impossible for a farmer to comply with all the terms of all the security agreements to which he or she is a party. As a result, he or she may default under some of them. He or she may likewise be unable to perform under his or her unsecured obligations. The unsecured creditor (as discussed in another fact sheet in this series, Rights of Unsecured Creditors) must first obtain a judgment against the debtor to collect his or her debt. The secured creditor has a built-in advantage in collecting debt by virtue of having a lien against certain assets of the debtor. This fact sheet explores options available to creditors with a security interest in personal property and reviews the procedures required under Minnesota law to foreclose a security interest in personal property.

What Constitutes Default?
The first issue that arises in a lender's decision to exercise rights under a security agreement is whether the debtor has, in fact, defaulted. The Uniform Commercial Code (UCC) contains no definition of default, but allows it to be defined by the parties to the transaction in their documents. As a result, virtually every security agreement contains a broad definition of events that constitute a default. Such events include the failure to make an installment payment when due, the sale of collateral without the creditor's prior written consent, the failure to keep the collateral adequately insured, or the occurrence of any other event that causes the creditor to deem itself insecure. In addition, the promissory note and the security agreement generally contain an acceleration clause that allows the creditor to demand payment of the loan in full upon the occurrence of default.

Secured Party Options After Default
Once default has occurred, several options are available to the secured party. Not all options involve the enforcement of the security interest under the UCC. For example, in the case of a farming operation, if the primary collateral consists of growing crops, the secured creditor will likely forebear from exercising its right to foreclose upon the crops until the debtor has harvested them. Once the crops are harvested, the secured creditor will be in a better position than if enforcing rights immediately upon default. As a result, even though a default may exist, the secured creditor may make additional advances to allow the farmer to continue to operate long enough to harvest the crops.

A second option is allowing the debtor to sell the collateral independently. The secured creditor may think that a better price can be obtained for the collateral if the sale is held directly by the borrower.

A third option, especially in the case of farming operations, is the workout. The typical workout arrangement involves creditors besides the secured creditor. In such cases, the workout arrangement includes an extension of time and a payment by the debtor of less than the full amount owing outside the formal structure of the bankruptcy court. The purpose of a workout is to restructure the debt to enhance the chances of continuing the business and ultimately repaying all creditors. In some cases, the secured creditor may conclude that its position will be enhanced by encouraging continuation of the business versus what it would receive from liquidation of the collateral.

One final option is action against the debtor on the underlying debt. In such a case, the creditor is subject to the rights and duties set forth in another fact sheet in this series, Rights of Unsecured Creditors. This option may be taken when the secured party suspects that the collateral is insufficient to satisfy the unpaid balance of the debt. It is attractive to the secured party, however, only if the debtor has unencumbered nonexempt assets that can be reached to satisfy the underlying obligation.

Repossession
If the secured creditor prefers to repossess and sell the personal property collateral, it must comply with state law. The UCC, however, is clearly drawn with the protection of the secured party in mind. Once default, as defined by the creditor in the security agreement, occurs, the creditor can: repossess the collateral by self-help or with the aid of a court order, dispose of the collateral by public or private foreclosure sale, retain the collateral in satisfaction of the debt, terminate the debtor's right of redemption, add the costs of repossession and foreclosure to the unpaid balance of the debt, and pursue the debtor for any remaining unpaid balance or deficiency.

The first step in this process, however, is the repossession of the property. There are three methods by which the secured lender can obtain possession of the property. The first method, and the one that most lenders initially explore, is negotiating an agreement with the debtor to cooperate voluntarily in a turnover of the secured property to the lender. In fact, in many cases, the sale of the secured property may even be conducted on the debtor's premises. Doing so may be advantageous to the debtor. Since all reasonable expenses of foreclosure (including storage, sales preparation, labor, trucking, repairs, advertising, auctioning, clerking and legal expenses) are added to the secured debt, the debtor may only be increasing his or her liability to the lender by not cooperating with the sale.

If the debtor is unwilling to voluntarily turn over secured property to the creditor, the creditor will need to take action to obtain the property. When the collateral is property used in the farming operation, including equipment, crops, and livestock, or when it is serving as collateral on a loan used for farm operations, it is deemed agricultural property. Minnesota's farmer-lender mediation statute generally requires the creditor to offer mediation of the debt to the debtor prior to initiating an action to repossess such property. The farmer-lender mediation statute began requiring mediation in 1986. Generally, the statute requires, among other things, that a creditor seeking to repossess agricultural property first send notice to the debtor and offer the debtor the opportunity to mediate a resolution to the debt prior to beginning such action. If the debtor elects to mediate the debt, the creditor's repossession of the property can be suspended for a period of up to 90 days pending completion of the mediation. When the debt involved has been scheduled by the debtor in a bankruptcy or involved in a previous farmer-lender mediation, the debt is not subject to the farmer-lender mediation statute and the creditor can seek repossession of the property without first offering mediation.

The secured creditor may repossess the collateral by self-help and without first obtaining a court order so long as no breach of the peace occurs. The UCC contains no definition of breach of the peace, and many courts have struggled with defining it. In general, a secured party may not break any locks, use any physical force, issue any threats, or proceed in the face of any commands from the debtor or his family or other representatives to stay away or otherwise refrain from removing the collateral.

Should self-help be unavailable, the secured party must initiate a court action to obtain possession of the property. In Minnesota, this action is known as a replevin action or action for claim and delivery. Such a lawsuit is an action to obtain the immediate possession of personal property. In most cases, a secured party may obtain possession of personal property over the objections of the debtor only after the debtor has received notice and a hearing. If, at the hearing, the secured party demonstrates that it will successfully establish its claim to the property at a formal trial, the court will order the sheriff to seize the property on behalf of the secured party prior to conclusion of a trial on the matter.

If, however, the court finds that the debtor has a defense to the secured party's claim, that the debtor's interests cannot be adequately protected by a bond filed by the secured party, and that the harm suffered by the debtor would be greater than the harm suffered by the creditor if the property were not delivered to the creditor prior to a final decision, the court may allow the debtor to retain possession of the property until conclusion of the trial. If the court finds that the debtor is entitled to retain possession, it may require the debtor to make a partial payment of the debt, post a bond, or make the property available for inspection. The court can make any other provision it deems fair. If the court determines the creditor is entitled to possession of the property, the creditor must post a bond with the court that is one-and-a-half times the fair market value of the property.

In some cases, it may be possible for a creditor to obtain a court order to obtain possession of the property without notice and a hearing. To do so, however, the creditor must demonstrate to the court that it has made a good faith effort to inform the debtor of the hearing or that informing the debtor of the hearing would endanger the ability of the creditor to recover the property; that it is entitled to possession of the property; that the debtor is about to remove the property in question from the state or to conceal, damage, or dispose of the property; or that due to other circumstances the creditor will suffer irreparable harm if it does not obtain possession of the property prior to a hearing. Even in such cases, a hearing must be held at the earliest practicable time.

Once the secured party has obtained a court order, it has the right to repossess and remove the collateral from the debtor's premises. Once the creditor takes possession of the property, it must store and take good care of the collateral pending sale. It also must provide all labor and trucking.

Foreclosure Sales
As soon as the secured lender has possession of the property or knows that it can deliver possession to buyers, it will arrange to liquidate the collateral. The UCC requires that any sale by a creditor be held in a commercially reasonable manner. The UCC does not define the term, so it varies with the circumstances of each case. It does not require sale at the highest possible price, but at whatever price is obtained after going about the sale in a way that is commercially reasonable under the circumstances. Considerations such as the kind of collateral; its condition; the number, location, and identity of likely buyers; seasonable markets; and all other factors that would be considered by a reasonable commercial seller selling such items without regard to any foreclosure would be considered by a court in determining whether a sale was held in a commercially reasonable manner.

The law allows either a public or private sale. Based on the facts of each case, the lender must determine which is more reasonable commercially. Certain items of collateral—such as grain, which has a recognized market price—may be more appropriate for a private sale. Similarly, if the collateral consisted of livestock that couldn't be sold on the debtor's premises, but were so numerous that they couldn't be kept elsewhere pending a public sale, a private sale would be the likely choice. In most situations, however, a well advertised public auction is the preferred method of sale.

Regardless of the type of sale intended by the lender, it must provide reasonable notification to the debtor before any sale, which in accordance with applicable case law and a proposed law which would be effective in the year 2001, is 10 days' notice. The notice generally tells the debtor what will be sold; whether the sale will be public or private; the date, time, and place if it is a public sale, or the date after which such sale will take place if it is a private sale; the amount of the secured indebtedness; a statement that the debtor may redeem the collateral by paying the indebtedness and expenses in full before the date of the sale; and how the sales proceeds will be applied.

Once the sale has been held, the law sets forth the order in which the sales proceeds will be applied to the various claims. This order is:

1. Reasonable expenses involved in the repossesion and foreclosure.
2. Satisfaction of the foreclosing creditor's debt.
3. Satisfaction of indebtedness held by subordinate secured parties.

If there is money left over, the surplus must be turned over to the debtor. If, however, there is still a balance owed to the foreclosing creditor, the creditor can pursue the debtor for the remaining balance due. This remaining balance is called a deficiency. The secured creditor's right to pursue a deficiency may be restricted by a court if the creditor has not followed the procedures of the UCC in foreclosing its security interest. If a deficiency judgment is sought, the secured creditor must follow the procedures set forth in the fact sheet, Rights of Unsecured Creditors.

If desired, in certain cases, the secured creditor may simply retain the collateral in satisfaction of the underlying debt. Provided the debtor has not paid 60 percent or more of the debt, or signed a statement waiving his right to require a sale of the property, nothing in the law prohibits this and nothing in the law requires a secured creditor to sell the collateral. To retain the collateral, the secured creditor must send a written notice of his proposal to the debtor and any other secured party which has given the creditor written notice of an interest in the collateral. Upon receipt, the debtor and such other secured parties have 21 days to object to the retention of the property by the secured party. Upon objection, the secured party must dispose of the collateral according to the rules set forth above. If no objection is made, the creditor takes title to the collateral and cuts off the debtor's right to redeem the collateral. In such case, the creditor cannot claim deficiency against the debtor. Under the proposed revisions to the UCC, it will be possible for a creditor to retain collateral in partial satisfaction of its debt.

Creditor Misbehavior
If a creditor does not comply with the rules of the UCC, the debtor may seek appropriate sanctions in court. Such creditor misbehavior may consist of repossession prior to default, repossession with breach of the peace, failure to conduct a sale in a commercially reasonable manner, failure to notify the debtor in advance of the sale, holding an improper strict foreclosure, or obtaining a price that is too low. One sanction that can be obtained in some cases is an injunction against the foreclosure. A debtor must move quickly, however, and must realize that obtaining an injunction may be difficult. A second sanction, available when disposition has already occurred, is recovery of damages in an amount equal to any loss caused by failure to comply with the rules of the UCC.

Conclusion
Foreclosure of a security interest in personal property under the UCC involves many steps. The events triggering default, the nature of the collateral, and the relationship of the parties all contribute to how a foreclosure occurs. The law, however, is designed to aid and assist the secured creditor in exercising its collection rights.

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• Agricultural Production Contracts (WW-7302).
• Bankruptcy: Chapter 7 Liquidations (WW-7295).
• Bankruptcy: Chapter 11 Reorganizations (WW-7296).
• Bankruptcy: Chapter 12 Reorganizations (WW-7301).
• Bankruptcy: The Last Resort (WW-2598).
• Contracts, Notes and Guaranties (WW-2590).
• Farm Leases (WW-2593).
• Financing the Farm Operation (WW-2589).
• Mortgages and Contracts for Deed (WW-7293).
• Mortgage Foreclosures (WW-7297).
• Rights of Unsecured Creditors (WW-7299).
• Tax Considerations in Liquidations and Reorganizations (WW-7300).
• Termination of Contracts for Deed (WW-7294).
• Termination of Security Interests in Personal Property (WW-7298).

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