In In re Estate of Nardoni, an Illinois appellate court upheld a trial court’s grant of summary judgment that a secured creditor had acted in a commercially unreasonable manner by not disposing of collateral pledged to it for a period of two years. The appellate court also upheld the trial court’s decision that the secured party’s ability to pursue a deficiency judgment against the debtor was eliminated as a result of not acting against the collateral in a timely manner. The decision should be of concern to lenders, particularly those doing business in Illinois.
In 2009, Standard Bank extended a $1 million demand line of credit to Cap Estate Corp. Cap granted the bank a security interest in all of its personal property to secure the line. Dennis Nardoni was the president of Cap. Nardoni guarantied Cap’s obligations under the line. Each of Cap and Nardoni granted the bank a security interest in a securities account it maintained at Jackson Boulevard Capital Management. Nardoni died in 2010, and in February 2011, the bank filed a claim against his estate.
In January 2011, Jackson (acting on its own initiative and not in response to instructions from the bank) notified the bank that it was liquidating the securities accounts of Cap and Nardoni. Jackson had stock certificates representing the securities held in the accounts issued in the name of the bank and delivered such certificates to the bank in March 2011. At the time Jackson liquidated the accounts, no default existed on the line of credit.
The executor of Nardoni’s estate requested that the bank deliver the pledged stock certificates to Cap or the estate so that the stock could be sold, and the sale proceeds applied to Cap’s obligations under the line. The bank declined to do this.
Cap continued to make payments on the line until July 2011. A bank officer testified that either Cap or the executor told the bank that Cap “was not going to continue paying on the loan as the collateral had been liquidated and the debt paid in full.” Cap told the bank in September 2011 that it would make no further payments on the line.
In 2013, the trial court, a probate court that was overseeing the administration of the estate, denied the bank’s motions for summary judgment and granted summary judgment to the estate that the bank’s handling of Nardoni's collateral was commercially unreasonable and that, as a result, the estate owed no money to the bank on Nardoni’s guaranty, with the bank being limited to seeking recovery on the pledged stock in its possession. The appellate court affirmed.
Under Section 9-610(a) of the Uniform Commercial Code, a secured party may dispose of its collateral after a default. Under Section 9-620(a), upon default, a secured party may also accept the collateral in full or partial satisfaction of its debt, provided certain conditions are met.
Under Section 9-610(b) of the UCC, “[e]very aspect of a disposition of collateral, including the method, manner, time, place, and other terms, must be commercially reasonable.” Official Comment 3 to UCC§9-610 states that UCC Article 9 “does not specify a period within which a secured party must dispose of collateral.” However, that comment goes on to say that, as part of the analysis of whether a disposition is commercially reasonable, “if a secured party does not proceed under Section 9-620 and holds collateral for a long period of time without disposing of it, and if there is no good reason for not making a prompt disposition, the secured party may be determined not to have acted in a ‘commercially reasonable’ manner.” The comment also refers to the UCC’s general obligation to act in good faith under Section 1-304.
In Nardoni, the appellate court upheld the trial court’s finding that the bank had not acted in a commercially reasonable manner. It noted that the bank had not proceeded under Section 9-620, and that it had held the pledged stock, without disposing of it, for (i) two years after default at the time of the summary judgment motions and (ii) four years after default as of the time the appellate court rendered its decision, which the appellate court found to be “a long period of time without disposing of [the collateral]” within the meaning of Official Comment 3. The appellate court also found that the bank had not provided a “good reason” for not making a prompt disposition of the stock; the decision contains no discussion of why the bank did not act against the pledged collateral, but does say that the bank had attempted to "require Cap to pay the loan in full by some other means."
The appellate court also held that the bank violated its duty to act in good faith: “There is no ‘good faith’ in refusing to cooperate with the estate and Cap in resolving the default on the loan by granting their request that the stock be liquidated and the proceeds used toward the loan.”
The bank pointed out that, by the terms of its collateral documents, it was not obligated to act against the pledged collateral. The appellate court acknowledged that such documents contained provisions to such effect, but stated that “the fact that, by agreement of the parties, Standard Bank did not have to dispose of the collateral or agree to accept the collateral in satisfaction of the loan does not make its refusal to do so, despite repeated requests by the estate and Cap, commercially reasonable.”
The Nardoni decision should serve as a reminder to lenders that an unreasonable delay in acting against their collateral may result in adverse consequences.
From the creditor’s perspective, a troubling aspect of this case is that the borrower’s tactics—whereby it refused to make further payments and told the bank to apply the pledged collateral to satisfy the debt—were ultimately vindicated by the court. Cap initially took the position that the delivery of the stock certificates to the bank constituted payment of the loan obligations, and ceased making payments in cash after the bank took physical possession of the stock. In court, Cap and the estate argued that the loan could not be paid unless the pledged stock were used to do so, and both the trial court and the appellate court took this into consideration in determining whether the bank had acted in a commercially reasonable manner. The trial court accused the bank of creating a “Catch-22” where the bank held collateral that was needed to satisfy the debt, did not act on it, and allowed additional interest and charges to accrue while it did not act. The appellate court stated that it was unreasonable for the bank to continue to hold the stock “when the estate was entitled to pay off the loan, wanted to pay off the loan and was unable to pay off the loan because Standard Bank would not agree to liquidate the stock so that the loan could be satisfied.” In a sense, the borrower and the guarantor in this case were able to dictate to the bank what steps the bank could take. By not doing what they wanted for an extended period, the bank wound up losing its ability to seek a deficiency judgment against the guarantor.
It is unclear from the appellate court's decision whether there was any meaningful recourse to be had from seeking to enforce remedies against the borrower. At the time of the trial court proceedings, two years had passed after default and the bank had still not been paid in full, but had apparently not taken any steps to enforce remedies against the guarantor's collateral. The trial court found this delay to be unreasonable, and the appellate court agreed.
Prior to the adoption of Revised Article 9 of the UCC, there had been a number of cases where debtors asserted that a secured party’s inaction constituted a “constructive” strict foreclosure on collateral; and that, as a result, the secured party was barred from seeking a deficiency judgment. Revised Article 9 eliminated debtors’ ability to assert constructive strict foreclosure by requiring in UCC Section 9-620 that the secured party must either (i) consent to an acceptance of collateral or (ii) send a proposal to accept the collateral under Section 9-621 to the debtor and to certain other creditors and parties with an interest in the collateral. Official Comment 5 to UCC§9-620 states that the inclusion of such requirements “ensure[s] that the debtor cannot unilaterally cause an acceptance of collateral . . . .” Official Comment 5 goes on to say that “[f]or this reason, a mere delay in collection or disposition of collateral does not constitute a ‘constructive’ strict foreclosure. Instead, delay is a factor relating to whether the secured party acted in a commercially reasonable manner for purposes of Section . . . 9-610.” However, even though there was no constructive strict foreclosure here, the loss of a deficiency claim against the guarantor meant that the same practical result obtained.
The Nardoni case illustrates an important practical limitation on the ability of a secured party to choose among potential remedies. Under Article 9 of the UCC, a secured creditor’s election to pursue one remedy will not generally preclude resorting to another remedy at a later time. All things being equal, a secured party might prefer to pursue a borrower to pay the debt out of available cash rather than exercise remedies under UCC Article 9, if only to avoid having to comply with Article 9’s enforcement rules. Nardoni shows that if a secured party elects to pursue one remedy and not another, it should be mindful that its ability to later pursue another remedy (if it does not get a full recovery from the remedy it first selects) may be harmed by its inaction or by the lapse of time while it pursues its first choice.
Whether a disposition of collateral is commercially reasonable is in most instances a question of fact, but the appellate court noted that in Illinois where the facts are undisputed the determination of commercial reasonableness becomes a matter of law. The appellate court found that the facts in Nardoni were undisputed, and that summary judgment was appropriate.
The appellate court in Nardoni did not cite Section 9-626 of the UCC in its analysis. That section sets forth rules that determine how a deficiency or surplus is to be calculated in connection with the disposition of collateral. Section 9-626 provides that where a secured party’s compliance with Article 9 is placed “in issue” by the debtor (such as by an allegation that the secured party failed to dispose of collateral in a commercially reasonable manner), the secured party has the burden of establishing that it complied with Article 9. If the secured party fails to prove that it did so, it will be presumed to have received an amount of proceeds equal to its debt (and thus no deficiency will be presumed to exist). The secured party can rebut this presumption if it can prove that the amount that it would have realized, had it acted, is less than its debt. By way of example, the secured party might be able to make such proof if the collateral were stock of a public corporation for which a historical price quote could be obtained for the time at which a commercially reasonable sale might have been made.
Although the court in Nardoni did not purport to apply Section 9-626, it is clear under that section that a secured party’s right to seek a deficiency can be reduced or eliminated if it does not act in a commercially reasonable manner. The court’s decision contains no mention of the type of stock pledged (for example, whether it was issued by a public company, or whether it was traded on a recognized market), or of its value, but if the bank were able to prove that the amount it would have received, had it disposed of the pledged stock in a commercially reasonable manner, was less than the amount of its debt, it should have been able to rebut the presumption and pursue the deficiency to the extent it made such proof. Instead, the court held that the bank’s right to seek a deficiency was eliminated, which is not consistent with Section 9-626.