- Foreign Law
While far from perfectly protecting the consumer, the laws of other countries appear to have considered more fully the need to protect borrowers from banks who sell their houses for far less than they are worth.
- The Criteria of Commercial Reasonableness[1]
The Uniform Commercial Code (UCC) of the United States
Section 9 – 627 of the UCC in entitled “determination of whether conduct was commercially reasonable”. This criteria is used for deciding whether a creditors sale of a house (or other property) is legally justified. If the court decides in the negative then, inter alia, a creditor cannot then collect any shortfall in the difference between the price sold for and the amount owed.
The obligation to be commercially reasonable cannot be waived.[2]
To be fair sub section (a)[3] provides that “the fact that a greater amount could have been obtained by a ..disposition…at a different time or ..method is not of itself [4] sufficient to” make it commercially unreasonable. In other words, the whole picture needs to be looked at: the degree of the ‘greater amount’, the inconvenience of the “different method” etc.
According to the Official Comments, however,
“[w]hile not itself sufficient to establish a violation of [Part 6], a low price suggests that a court should scrutinize carefully all aspects of a disposition to ensure that each aspect was commercially reasonable.” Rev. U.C.C. § 9-627, cmt. 2.[5]
- At the Price Current
The key criteria, for our purposes, is sub section b (2) [6]. That the disposition is made “at the price current in any recognized market at the time”.
In other words, in our context at the price that an estate agent could get in the normal market.
In is perhaps true in the US that an auction could be used since the nature of a large, rich market like the US is that auctions yield much closer to the price that an real estate agent gets. However, South African auctions sometimes yield 10 -50% of the price that a property would yield when marketed by an estate agent for 3-6 months. This kind of price would surely fail the test of subsection b (2) and be thus not be considered “commercially reasonable”.
This provision may be why it is normal practice to engage an estate agent to sell a house that has been repossessed in the US whereas in South Africa an (illiquid) auction is chosen instead. This latter procedure being, in practice, far more prejudicial to the debtor.
The whole text of subsection (b) reads as follows:
(b) [Dispositions that are commercially reasonable.]
A disposition of collateral is made in a commercially reasonable manner if the disposition is made:
(1) in the usual manner on any recognized market;
(2) at the price current in any recognized market at the time of the disposition; or
(3) otherwise in conformity with reasonable commercial practices among dealers in the type of property that was the subject of the disposition.
- Judicial Supervision
Subsection (c) provides that ..dispositions… are commercially reasonable.. when they are inter alia approved in a judicial proceedings or by creditors. Thus in the South Africa context , if a bank was required to approach a court if it wanted to sell a property for less than its market price, the resulting judgment would be a proof of commercially reasonability in a US context.
The subsection reads as follows:
(c) [Approval by court or on behalf of creditors.]
A collection, enforcement, disposition, or acceptance is commercially reasonable if it has been approved:
(1) in a judicial proceeding;
(2) by a bona fide creditors’ committee;
(3) by a representative of creditors; or
(4) by an assignee for the benefit of creditors.
Section (d) reads as follows:
(d) [Approval under subsection (c) not necessary; absence of approval has no effect.]
Approval under subsection (c) need not be obtained, and lack of approval does not mean that the collection, enforcement, disposition, or acceptance is not commercially reasonable.
In other words, no judicial supervision is required in the US for the sale to be legal, as long as its done in a “commercially reasonable manner”.
- If the sale is not commercially reasonable, you can raise this as a defence if the lender tries to collect a “deficiency” balance from you. A ‘deficiency’ balance is what the debtor owed minus what a house is sold for.[7]
- Good Faith
Further, although creditors have some leeway in how it sells your property, it must do so in good faith as well as in a commercially reasonable manner. In the words of one US legal adviser “ if the creditor sells the car at a price that is significantly lower than what the car is worth, it may raise a red flag.” [8]
Under Article 1 of the Uniform Commercial Code, “good faith,” defined as “honesty in
fact in the conduct or transaction concerned,” is a purely subjective standard.[9] The obligation cannot be waived.[10]
- Price vs Process
Often what is looked at is not the price per se but whether the process used is one likely to yield a good price. What is looked at then is “manner, time, place, and terms of the sale.”
The question in the US is usually whether a private sale is commercial reasonable as opposed to their public auctions which are much more liquid than hours are usually achieve prices close to the price achieved by real estate agents. But the criteria used to assess private sales in the US can be used to assess our South African auctions:
“There are times, however, when a private or “dealer only” sale may not be commercially reasonable, such as in the following instances:
- the creditor has the ability to sell the car on the retail market
- the buyer is a friend, relative, associate or employee of the creditor
- car resales in your area are conducted by public auction, not “dealer only” or other private sales
- the creditor made little or no effort to attract buyers
- the creditor sold the car as junk without obtaining an appraisal, or
- the creditor buys back the vehicle then resells it at a significantly higher price.”
Number one is of interest. If it is possible to sell a house (or in this case a car) on the retail market then that should be preferred to other options. In other words, using an estate agent is better than an auction which is better than a private sale.
Number two would also invalidate a sale in South Africa under the Sheriff’s Act[11]. However, the problem is that while everyone knows such a market exists, it is difficult to prove by the debtor in individual cases.
Number six, is a currently widespread practice in South Africa. This is known as PIP which stands for properties in possession. In this situation the bank buys the property from its erstwhile client at a price sometimes far lower than the price it would fetch if properly marketed by an estate agent. It then sells it to a buyer at a price greatly in excess of this. The excess then accrues to the bank and not to the client.
Under this US practice, that would mean the property had not been sold in a commercially reasonable manner.
It is interesting that [although] Revised Article 9 does not impose upon a secured party a duty to prepare or process the collateral, a secured party “may not dispose of collateral ‘in its then condition’” when to do so would be “commercially unreasonable.” [12]
- R & J of Tennessee
In R & J of Tennessee v. Blankenship-Melton Real Estate, Inc we see the criteria discussed above laid out:
“The second issue was whether R & J conducted the sale in a commercially
reasonable manner. Under Tennessee Article 9, a secured party[13] may sell, lease,
license, or otherwise dispose of any or all of the collateral in its present condition or
following any commercially reasonable preparation or processing. In carrying out
the sale, the obligations of good faith and commercial reasonableness bind secured
creditors and govern every aspect of the disposition. Also, the disposition should be
in accordance with prevailing trade practices among reputable and responsible
commercial enterprises. Consequently, the court determines compliance on a case
by case basis.” [14]
3.1. “Commercially Reasonable Efforts” and “Best Efforts”
The phrase “commercially reasonable efforts” is frequently used in contract drafting, with several dozen reported decisions considering contracts containing this phrase since 1999. This entire phrase, however, has had little judicial consideration. Given the jurisprudence surrounding “best efforts” and “reasonable efforts”, the question to be considered is whether “commercially reasonable” implies a lower or higher standard from “reasonable efforts”. That is, are “commercially reasonable efforts” restricted only to steps that might be commercially acceptable, thus making a less onerous standard, or does “commercially” raise the bar such that the standard is closer to “best efforts” but only in a commercial context? This is an open question.
- Commercially Reasonable in Security Agreements
In the context of a security agreement, the standard for a “commercially reasonable” transaction was outlined as follows in R and J[15]:
“Generally there are two tests that may be applied to the conduct of a sale as referred to by the Court of Appeal in Wood v. Bank of Nova Scotia[16] . One is the less stringent test which is that the creditor who sells must act in good faith. The plaintiff has clearly complied with that test. The other test is the more stringent one, that the creditor must take reasonable care that the proper value is obtained. While it is not a trustee for the debtor it cannot act negligently in the sale. I adopt the principle as stated in Debor Contracting Ltd. … (a Mechanics’ Lien action) that the creditor must “act a role somewhat akin to that of an agent or fiduciary for the purpose of a sale”. This is a higher standard than that referred to in Kimco Steel Sales Ltd. … where the test was that the sale be in good faith and not be in a recklessly improvident manner calculated to result in a sacrifice of the equipment.11
Based on this decision, “commercially reasonable” incorporates “proper value” as a central consideration of what will be reasonable. In the security agreement context, the “commercially reasonable” standard must be considered objectively from a commercial standpoint, as opposed to subjectively, as might be expected in most good faith agency relationships.12
Based on the Alberta Court of Appeal decision in Atcor Ltd. v. Continental Energy Marketing Ltd.13, the concept of being “commercially reasonable” plays a major role in the interpretation of force majeure clauses. In the Atcor case, the appellate court found that, as a general proposition, a party claiming the protection of force majeure has a duty to mitigate the effect of a force majeure event using a standard of “commercial reasonableness”. At paragraph 11, the Court of Appeal stated:
A supplier need not show that the event [of alleged force majeure] made it impossible to carry out the contract, but it must show that the event created, in commercial terms, a real and substantial problem, one that makes performance commercially unfeasible.
The Court of Appeal sent the matter back to trial, but the parties ended up settling out-of-court. As a consequence, no judicial consideration of the standard “commercial reasonableness” beyond the phrase “commercially unfeasible” emerged from Atcor. It remains undecided as to whether profit is a factor to be considered. It is difficult to predict just what the reference to “commercially unfeasible” means and leads to uncertainty in interpreting the standard of being “commercially reasonable”.
“Commercially reasonable efforts” may be tied to efforts required to secure a particular value for a commodity, with the market acting as an objective measure of what a “proper” value might be. If this is the case, the standard is less onerous than “best efforts” in that stones may be left unturned (so to speak) so long as a market can provide a fair valuation. The standard may be less onerous than “reasonable efforts” in that the true measure of the efforts required are those required to satisfy a market based on an independent commercial evaluation, and not “all reasonable and measured steps” required to achieve an objective. However, it is not difficult for one to imagine a situation where a market valuation of a commodity is so high (or low) that acquiring (or disposing) of the commodity in question might itself be commercially unreasonable. Surely obtaining a commodity at a market value that would otherwise bankrupt an enterprise cannot be considered to be “commercially reasonable.” Without further judicial consideration, “commercially reasonable efforts” is ambiguous and should either be used with caution or specifically defined within the contract to which it applies.
“Upon determining that Blankenship did not receive adequate notice and that
R & J failed to act in a commercially reasonable manner, the Court remanded the
case to determine whether R & J was entitled to a deficiency judgment. R & J could
recover the deficiency by virtue of the “rebuttable presumption rule,” which applies
when a secured creditor fails to conduct a commercially reasonable sale. Under this
rule, a presumption arises against the creditor, who must prove what amount should
have been realized from a commercially reasonable sale. Failure to rebut the
presumption results in denial of the secured creditor’s deficiency judgment and
possible liability to the debtor. If the creditor sustains the presumption, however,
then the rule offsets the deficiency”[17]
While, in the US it must be done in a “commercially reasonable manner”, in the UK there is an obligation to get the best price. CBT
Articles
Rapson “Default and Enforcement of Security Interests under Revised Article.” Chicago-Kent Law Review Volume 74 Issue 3 Symposium on Revised UCC Article 9
Cases
R & J of Tennessee v. Blankenship-Melton Real Estate, Inc., 166 S.W.3d 195
(Tenn. Ct. App. 2004
Legislatiion and Rules
Uniform Commercial Code Article 9
[1] Rapson “Default and Enforcement of Security Interests under Revised Article” p1 says this article has been the most litigated in the whole code.
[2] U.C.C. § 9-501(3)(b); Rev. U.C.C. § 9-602(7) cited in McCahey, John P “Commentary on the Enforcement of Security Interests Under UCC Revised Article 9” 18
[3] Uniform Commercial Code (UCC) of the United States Section 9 – 627 a
[4] My italics
[5] McCahey, John P “Commentary on the Enforcement of Security Interests Under UCC Revised Article 9”
[6] Uniform Commercial Code (UCC) of the United States Section 9 – 627 b
[7] This would clearly only apply if the resulting amount was positive.
[8] Though this is not enough in itself. See also http://law.justia.com/codes/ohio/2006/orc/jd_1309627-5845.html this the Ohio implementation of the UCC. Note most states versions are 90% similar to the UCC.
[9] Uniform Commercial Code of the United States Article 1
[10] It should be noted that the Uniform Commercial Code prohibits a waiver of the
obligation of “good faith.” U.C.C. § 1-102(3).
[11] Sherriffs Act SA
[12] Rev. U.C.C. § 9-610, cmt. 4
[13] The term ‘secured party’ in terms of Article 9 is equivalent to “creditor” in South Africa.
[14] R & J of Tennessee v. Blankenship-Melton Real Estate, Inc., 166 S.W.3d 195
Tenn. Ct. App. 2004
[15] [15] R & J of Tennessee v. Blankenship-Melton Real Estate, Inc., 166 S.W.3d 195
Tenn. Ct. App. 2004
[16] This is a Canadian case based on the similar but not identical equivalent to the UCC, the Canadian Personal Property Security Registration System (PPSR). The UCC is emulated in many countries. In Canada the first PPSR province was Ontario which passed that legislation in 1967.
[17] R & J of Tennessee v. Blankenship-Melton Real Estate, Inc., 166 S.W.3d 195
(Tenn. Ct. App. 2004