BEFORE YOU MAKE THAT LOAN THINK THROUGH YOUR LIQUIDATION STRATEGY
In some banking organizations, the folks making loans and doing the underwriting are frequently removed from the day to day realities of having to collect them if they go bad. I want to make the case for asking each commercial lender and credit analyst to begin to think through the actual logistics of liquidation as part of the credit decision process. Much more is involved in a successful recovery effort than is revealed simply by the appraised value of the assets.
A good place to start in this analysis is to separately identify each item of collateral and determine how it would be classified as a matter of law. Generally, collateral breaks down into real property and personal property and within personal property, between tangible and intangible assets.
If the collateral consists of real estate, you should have some general understanding of the expense and timeline of foreclosure law in your market area. Here in the Tri-State, the foreclosure proceedings of Indiana, Kentucky, and Illinois are significantly different even though they all require a lawsuit. They also involve different expense structures and the debtors have different rights in each state. Time and expense are the lender’s enemy. If your real estate is located in a jurisdiction with which you are not familiar, it would be a good idea to speak to someone knowledgeable about foreclosure practice in that area to take these factors into account.
In the case of personal property, procedures available in each state are somewhat different but are more alike than with real estate foreclosures. (This, of course, assumes that what you think is personal property has not actually turned into a fixture by attaching it to real estate thus bringing it under foreclosure law.) In the case of tangible personal property, you have to get possession of it before you can sell it. In Indiana, this is done through a replevin action or by self-help repossession. The rules regarding self-help repossession also vary from state to state. In Indiana you can generally repossess personal property collateral after default if it can be done without breaching the peace. But what does or does not breach the peace is not particularly well defined. Generally speaking, if the debtor resists the repossession at all, the self-help effort need to stop and judicial intervention should be sought.
Getting a court order to seize personal property through a replevin action generally involves the posting of a bond by the lender and the lender making logistical arrangements to do the physical work of repossession under the supervision of law enforcement. General speaking, if you get a court order for the sheriff to pick up a tractor trailer, the sheriff will supervise it, but will not be arranging for the tow truck and will not be responsible for seeing that it is towed off in a safe and responsible manner. Arranging for the towing company to meet the sheriff at the location of the collateral and making sure there is a safe and secure place to take it falls on the lender. These efforts take time, money, and a fair amount of perseverance to get all the necessary parties together. This is particularly difficult in the case of mobile collateral that may be shifting around.
After repossession, it is still incumbent upon the lender to go through the normal UCC sale process, including giving the appropriate notices, and the obligation to act in a commercial reasonable manner in liquidating the property.
If the personal property is intangible, such as a payment stream from a contract, distributions from an LLC or non-publically traded stock, you can almost count on needing to craft a special judicial mechanism to turn these assets into money. And, of course, not the least of your problems is finding someone to actually buy these intangibles. Sometimes the expense of a receiver may be necessary simply to have them collect revenue stream over time from intangible assets.
Back on the issue of real estate, if you are wanting to collect rent from real estate, this generally also requires the appointment of a receiver and court supervision. However, the receiver will not have the authority to actually to sell the property. That will still have to be done through a judicial foreclosure.
If you have a mortgage on less than the whole interest in property, such as having a mortgage signed only by one of two tenants in common, it may also be necessary to partition the ground as part of the foreclosure proceeding. It is fairly complicated, expensive, and time consuming to blend the two actions.
Finally, if your collateral is in more than one state, you must be extremely careful to make sure taking an action in one state does not inadvertently waive your rights to take action in the other. It would take a very long article to list all the ways this could happen. But, recognize that if your collateral is in multiple jurisdictions, counsel, and perhaps counsel in multiple states, will have to be utilized to successfully push through a liquidation effort. Coordination of these efforts is a critical function to avoid unintended yet avoidable consequences for the lender.
Spotting and analyzing these issues at the underwriting stage can help more appropriately handicap the values that might be obtained upon liquidation, the expense that might be involved, and the timeframe necessary for it to be accomplished. All of this will help the lender make a more intelligent decision on whether or not to make the loan requested.