Article Nine of the Uniform Commercial Code ("UCC") provides secured parties with a number of rights that are triggered upon default of the debtor, including the right to sell relevant collateral. Under the UCC, the standard to enforce this right is by conducting a sale in a "commercially reasonable" manner. Courts have held uniformly that a debtor may not waive the defense of commercial reasonableness. However, the UCC drafters refused to define this term, leaving it up to state courts to define.
These courts generally have applied three types of tests to determine the commercial reasonableness of collateral sales, examining: 1) the proceeds, 2) the procedures, and 3) the totality of the circumstances, of such sales.
A minority of courts (including those in California, Connecticut and Ohio) apply the proceeds test, using hindsight to evaluate the ultimate selling price. They look to the difference between the fair market value of the collateral at issue and the ultimate realization from the sale's proceeds. A large disparity between the two could be grounds for finding the sale commercially unreasonable.
Other courts limit their inquiry to the procedures by which the collateral is sold. Irrespective of the price realized, courts applying the procedures test focus on whether creditors met notice requirements and followed proper sale procedures.
Some courts examine the totality of the circumstances surrounding the sale, applying elements of both the proceeds and procedure tests to determine commercial reasonableness.
New York courts tend to apply the procedures test, as exhibited in a recent New York State Appellate case (Marine Midland Bank v. Hakim, 247 A.D.2d 345 (1st Dep't.)). The case arose out of an agreement, whereby the borrower, a wholesaler of jewelry, induced Marine Midland Bank ("Marine") to provide a commercial loan by granting Marine a blanket security interest in its property, including its inventory of diamonds and semi-precious colored stones. The principals of the borrower signed individual guaranties, guaranteeing all debts of the company to Marine. Thereafter, the borrower defaulted.
Marine repossessed the jewelry and sued the guarantors before selling the collateral. The guarantors claimed that Marine [had] failed to dispose of the collateral in a "commercially reasonable" fashion, by failing to sell it immediately, and [also] claimed that the collateral [had] declined in value while in Marine's possession. The guarantors supported this claim in an affidavit from the guarantor which annexed a letter from a competitor in the industry offering to purchase the collateral from Marine, which Marine had rejected.
After Marine's motion for summary judgment was granted, the guarantors appealed. The Appellate Division, First Department unanimously affirmed the lower court ruling in favor of Marine, finding "no evidence suggesting negligence by plaintiffs in the preservation of the collateral or of a decline in value", and that as a legal matter, Marine was not required to "play the market" by selling the collateral.
Thus, the Court concluded that it is commercially reasonable for a secured creditor to hold the collateral while pursuing a claim for the deficiency, and imposed a heavy burden on the debtor to demonstrate that the collateral suffered a significant decline in value because of the secured creditor’s decision to retain the collateral and sell it a later date.