by Raphaela Taylor
Secured lenders often resort to non-judicial foreclosure
sales of personal property upon a borrower's default. Article 9, Part 6 of the
Uniform Commercial Code requires that every aspect of such a sale must be
commercially reasonable. However, the courts have historically provided little
guidance as to what exactly constitutes a commercially reasonable sale.
Fortunately, the Delaware Chancery Court recently issued a decision, entitled Edgewater
Growth Capital Partners, L.P. v. H.I.G. Capital, Inc., C.A. No. 3601-CS
(Del.Ch. Apr. 18, 2013) [an enhanced version of this opinion is available to lexis.com
subscribers], in which the court analyzed the meaning of this
"commercial reasonableness" requirement and provided helpful guidance to
borrowers and secured creditors alike.
Edgewater Growth Capital Partners, LP
("Edgewater") acquired a company called "Pendum" through a leveraged
buy-out. Additionally, Edgewater was a guarantor of a portion of the
acquisition financing held by Pendum. Following numerous defaults under and
modifications to the senior loans, it became clear that Pendum could not
continue as a going concern, and that an asset sale was the last and best
option. Pendum thereupon negotiated a Foreclosure Sale Agreement with its lead
senior secured creditor, H.I.G. Capital, Inc. ("HIG"), pursuant to which Pendum
was authorized to hire a consultant to identify potential buyers for its
assets. However, this search produced no interested buyers and Pendum's assets
were ultimately purchased by an affiliate of HIG at an auction at which such
affiliate was the only bidder. Edgewater subsequently argued that the asset
sale was not conducted in a commercially reasonable manner.
The court analyzed the commercial reasonableness of the
sale by asking whether it was conducted "in conformity with reasonable
commercial practices among dealers in [that] type of property" as required
under the Uniform Commercial Code as adopted in Illinois. The court focused, in
large part, on HIG's concession to allow Pendum to select and hire the
financial consultant charged with identifying potential buyers. It found that
the consultant performed an involved market test, pursuant to which it
identified and contacted 67 potential buyers, had second round contact with 44
potential buyers, conducted management meetings with and disclosed non-public
information to a smaller set of potential buyers, and additionally placed 2 ads
in the Wall Street Journal. Despite such efforts, none of these potential
buyers elected to bid for Pendum's assets. The court further stressed that
Edgewater failed to identify even a single potential buyer that had not been
contacted by the consultant prior to the sale.
The court also found that there was no evidence to show
that the price paid for the assets was unreasonable, as contended by Edgewater,
clarifying that whether a greater purchase price could have been obtained under
other circumstances is not dispositive in determining the commercial
reasonableness of a given sale. Moreover, the court found it telling that
Edgewater itself declined to bid at the auction, presumably because it
concluded that the assets were not worth more than the final sale price. The
court further explained that, in determining reasonableness, the economic
status of the company itself must be considered, and here Pendum was insolvent,
had been run by poor leadership and was facing major operational issues, all of
which contributed to the reasonableness of a 55-day sale period granted by HIG.
Finally, the court expressed frustration with Edgewater's litigation strategy,
opining that Edgewater filed its lawsuit solely to bully HIG into abandoning
its guaranty claims against Edgewater.
While there will always exist questions of fact as to
whether an Article 9 asset sale is commercially reasonable, Edgewater
provides guidance to both debtors and their creditors as to a strategy found by
one of the nation's leading voices on corporate law to be commercially
reasonable. Thus, secured creditors can take comfort in knowing that following
the program discussed in Edgewater will likely mitigate, if not
eliminate, the risk that a court may later determine the sale was not
commercially reasonable, whereas borrowers can use the case as a shield against
disposition strategies that provide lesser safeguards than those used in Edgewater.
Read other articles at Sheppard Mullin Finance &
Bankruptcy Law Blog
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