Various business formations and financial transactions utilize alternative entity forms, such as limited liability companies (“LLC”), limited partnerships, master limited partnerships, limited liability partnerships, limited liability limited partnerships—you get the idea. In turn, commercial borrowers may offer—and lenders may request—interests in such entities as collateral. This blog post focuses on LLC membership interests (“LLC Interests”) as collateral.
Before accepting LLC Interests as collateral, lenders should consider what their options will be in the event of default. This blog post outlines, at a high level, options secured lenders may have pursuant to Article 9 of the Uniform Commercial Code (“UCC”). For purposes of this blog post, a perfected security interest is assumed. A discussion of issues in perfecting a security interest in LLC Interests can be found here.
A secured lender generally has two options under Article 9: strict foreclosure and a commercially reasonable sale.
Upon default, a secured lender may accept collateral—here, LLC Interests—as full or partial satisfaction of the debtor’s obligations secured by the collateral. See UCC 9-620. Partial satisfaction allows the secured lender to accept the collateral and retain the right to seek a deficiency for remaining unpaid indebtedness. If a secured lender accepts collateral in full satisfaction, then the obligations securing the collateral are extinguished and the secured lender does not have a right to a deficiency.
Accepting collateral in full or partial satisfaction requires the secured lender obtain some form of consent from the borrower and any other party with an interest in the collateral. It is important to note the secured lender must receive this consent after default. Meaning, consent in a security agreement, pledge agreement, or other document is ineffective if the consent is given before default.
Here are the various forms of consent:
- For partial satisfaction, the debtor must expressly agree in writing to the terms of the acceptance. See UCC 9-620(c)(1).
- For full satisfaction, the debtor either must agree in writing to the terms of acceptance, or fail to timely object to the proposed acceptance. See UCC 9-620(c)(2).
- In either case, other parties with an interest in the collateral are deemed to consent if they do not timely object to the secured lender’s proposed acceptance.
Depending on the circumstances, consent may be difficult to secure. In the absence of consent, a commercially reasonable sale may be a viable option.
Commercially Reasonable Sale
Upon default, a secured party may sell, lease, license, or otherwise dispose of collateral, provided every aspect of the disposition occurs in a commercially reasonable manner. See UCC 9-610(a) and (b). Aspects of a commercially reasonable sale include the method, manner, time, place, and other terms.
Generally, a commercially reasonable sale may occur at either a public or private disposition. If the secured party wishes to purchase the collateral at the sale, the sale can be either public or private, although, if private, the collateral must be “of a kind that is customarily sold on a recognized market or the subject of widely distributed standard price quotations.” See UCC 9-610(c). Whether LLC Interests qualify as collateral customarily sold on a recognized market or the subject of widely distributed standard price quotations is unclear.
Lenders’ options on default merely comprise one piece of the puzzle. Lenders should consider a variety of other factors, including the enforceability of anti-assignment clauses in operating agreements, perfection issues, and the idiosyncrasies of state entity and UCC laws, all of which are beyond the scope of this blog post.