Many business owners do not know what a UCC-1 filing is, never mind understanding what an Article 9 UCC sale is. However, understanding this type of transaction can help both distressed business owners and investors free their business collateral of liens and encumbrances, which is very important when trying to restructure an organization.
First you must understand what a UCC-1 us and what it’s purpose is. UCC stands for Uniform Commercial Code, which covers laws and regulations surrounding business and personal property which is pledged as collateral for a loan or other financial instrument. A UCC-1 is a filing done with the Secretary of State in the state where a business is located. That filing acts much the way a lien does on real property. The creditor who files their UCC-1 first, is in first position on the business assets described in the UCC. Any other creditor who files a UCC after that would have a subordinate position on the same assets. Essentially a UCC filing is a way to lien or encumber any assets that do not have title and cannot be directly liened. For example, a bank may offer a retail store a line of credit in order to purchase and replenish inventory. The bank would want to encumber the inventory in case the borrower went into default, so that they would have the rights to liquidate that collateral to pay down the line of credit. However inventory balances change every day and inventory itself does not have a title that the bank can file a lien on. Therefore the bank would file a UCC-1 filing and list the inventory as collateral.
What this often results in are several creditors filling UCC-1’s on the same group of collateral. If a business owner were to experience reduced revenue and want to liquidate assets to either downsize operations or exit the business all together, he or she would have to get approval from each of the creditors who filed a UCC-1 to release the UCC filing. However, without each creditor being compensated at least to some degree, they will have no incentive to agree to a release. This becomes a problem when there are several UCC-1 holding creditors but the asset base is currently worth less that what is owed to the first position creditor. In that case the first position creditor would want to realize all of the proceeds from any sale and would not want anything going to subordinate creditors unless they were being paid in full. This leaves the business owner, any potential buyer, and the creditors in a stalemate.
However, there is another option – The Article 9 Sale. Article 9 is part of the Uniform Commercial Code, which varies per state but is relatively similar amongst all states, that gives a UCC creditor the ability to conduct a secured party sale which will remove the security of any UCC-1 filing filed after the creditor in question. What happens in an Article 9 sale is the UCC-1 creditor acts on the secured position they have and take possession of the assets from the borrowing entity, very similar to what occurs in foreclosure, and then sells the assets to a pre-arranged buyer. When the secured party takes possession of the assets, any other UCC filing on the borrowing business become no longer relevant and the creditor becomes the seller in a transaction that sells the assets to inquiring buyer. This allows the business owner to cooperate with the first position lender so that a sale can occur without the interference of subordinate creditors.
This type of transaction requires the assistance of an attorney for the first position creditor and often cases for the guarantor and buyer as well. Proper notices are sent to all secured creditors, and a notice period must expire before closing occurs in order for the sale to be considered commercially reasonable. However, if navigated correctly, an Article 9 sale is an excellent way to conduct a sale similar to a friendly foreclosure, that benefits all parties (other than unsecured creditors), but with much less public notice and advertisement, which can negatively affect the reputation of the defaulted guarantor. These types of sales often preserve the business opportunity, save jobs, and greatly reduce the deficiency balance owed by the defaulted borrower.
An SBA workout is like any other debt workout. The goal of the workout is to remove as much of the burden of the debt load and debt service as possible from both the business and the guarantor while preserving the business opportunity (when possible). Workouts take many forms and there is no cookie-cutter way to effectively conduct a workout. Workouts do require a level of risk and there are many things that need to be considered before entering into a workout. Some circumstances worth considering are:
– Liquidated value of business assets: What are the business asset worth and how much of the debt would be covered by liquidating them for the benefit of the SBA creditor?
– Current and projected business performance: How much cash flow can the business afford to service debt with? Can the owner afford any more cuts? Is revenue climbing or falling? Do projections show improvement in the short-term? Is loan modification possible given the financial capability of the business?
– Current industry trends: Is the industry expanding or is the market constricting? Are their external forces affecting business operations?
– Size of the SBA obligation: Is the loan so large and under collateralized that it scares away most potential buyers or investors? Is the loan so small that the debtor will be left personally responsibly for all shortfall liability?
– Personal net worth of guarantors: Does the guarantors show a large amount of equity in their home? Do they have other liquid and unprotected assets?
– Additional collateral for SBA loan: Did the guarantors pledge additional collateral for the loan? Is there a lien on real property? Is there cross-collateralization with another operating business?
Understanding these points of interest will help a defaulted borrower calculate the true costs of a SBA secured debt workout. The results from a successful debt workout are pretty incredible. Guarantors settle their outstanding obligations, businesses survive and are in some cases restructured in order to preserve jobs and opportunity, and the banks satisfy their SBA obligations and receive their SBA guaranty. However, workouts have costs and some businesses are not financially strong enough to support the requirements of a workout. A full assessment and valuation of all relevant business factors should be done before any small business owner enters into a workout with a SBA lending bank.
Because the bank has its SBA guaranty to protect, lenders do not often have the same level of flexibility when it comes to modifying or altering SBA loans. Therefore they follow a strict path of liquidation which is regulated by the SBA Standard Operating Procedures for loans in default. This path traditionally means litigation, foreclosure, and auction of the business followed by a pursuit of the guarantor to collect the deficiency. Workouts offer alternatives to both lenders and debtors that meet all of the SBA requirements but do not require litigation, foreclosure, or bankruptcy. Understanding how to satisfy the SBA requirements is what’s key to success.
Overall a SBA debt workout is a business strategy that is meant to preserve the business opportunity while removing debt from both the business operation and the guarantors. Defaulted SBA borrowers who do not qualify for loan modification are candidates for a workout. However the costs associated with a workout vastly vary based on the circumstances surrounding each loan, each business and each guarantor.
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