Navigating the Unmarked Hazards for Marine Lenders in Non-Judicial Foreclosure of Preferred Ship Mortgages
Feb 22, 2021
“The pessimist complains about the wind; the optimist expects it to change; the realist adjusts the sails.”
William Arthur Ward
Ward’s descriptions of the pessimist, the optimist and the realist apply handily to those parties involved in the foreclosure of a ship mortgage. It was, after all, the optimism of the borrower that led him to take out the loan and set sail. And it must have seemed pessimistic of the loan officer when she directed the borrower to make his mark on the signature line of the ship mortgage. But sometimes, if the winds of fortune die down too soon, both parties would be wise to become realists and adjust their sails if they wish to avoid an uncertain and expensive fight.
The conditions for the fight are often set by these same perspectives. Our borrower, having failed to pay his debt and seen his vessel repossessed, has not abandoned his optimistic valuation of his former vessel. He remembers the price he paid in the purchase agreement and expects the lender will receive something close to it at disposition. But market forces, depreciation and forced-sale conditions may exact heavy tolls on the value of the vessel in ways the optimistic borrower may not accept. For this reason it is not an uncommon occurrence for a marine lender, having repossessed and sold the vessel, to be left with a deficiency balance as well as a litigious borrower who is certain that the vessel should have sold for more.
Enter Uniform Commercial Code (“UCC”) sections 9-207 and 9-610. These provisions were drafted with the laudable goal of ensuring that a secured lender uses commercially reasonable practices in the disposition of the vessel. After all, the foreclosed borrower is at the mercy of the lender. He has lost title to the vessel and associated rights—such as in the time and manner of sale—and his right of redemption has been contractually foreclosed.
Thus the authors of the model code provisions were concerned that an unscrupulous lender might fail to take measures, often expensive, to ensure that the vessel is maintained and that the best price for the vessel was obtained at the sale. These concerns are most persuasive when the market value of a vessel far exceeds the remaining loan balance because a lender will be more assured that a below-market sale price will nonetheless satisfy the loan obligation, even if it does leave less to the defaulted borrower.
But when the sale proceeds (minus expenses) are not expected to exceed the outstanding loan obligation, the threat of a deficiency balance should reduce concerns that a lender would not follow commercially reasonable practices in the preservation and sale of a vessel. Any lender worth its salt knows that deficiency judgments may be difficult to collect against defaulted borrowers. If a deficiency is anticipated, therefore, lenders have a strong incentive to obtain the greatest value in the sale of the vessel to recoup as much of their loss on the loan as possible, when possible.
Nonetheless, perhaps because of the difficulty in crafting a statutory exception for lenders in these circumstances, the proponents of the “commercial reasonableness” provisions have determined it too dangerous to rely on the self-interest of the lender in the catch-as-catch-can strategy of maximizing value in the disposition of the collateral vessel. They have determined, under §9-207, the lender must “use reasonable care in the custody and preservation” of the vessel while in possession of it. Furthermore, in the words of §9-610, “every aspect of a disposition of collateral, including the method, manner, time, place and other terms, must be commercially reasonable.” For more on what courts have considered “reasonable care” in the preservation of a repossessed vessel, see our companion article 1 on the subject.
The authors put teeth into these commercial reasonableness provisions by providing certain remedies for the lender’s failure to be commercially reasonable in the preservation or sale of a vessel 2. These potential damages include the borrower’s direct losses as a result of the failing, in addition to an amount “not less than the credit service charge plus 10 percent of the principal amount of the obligation….” The “credit service charge” here is left to the interpretation of the courts in the various jurisdictions. But many have found that it equals the amount of the finance charge in the Truth In Lending Disclosure Statement. It is easy to see how, in the right circumstances, these penalties could add up to an amount much greater than the deficiency a lender is pursuing, or perhaps even more than the loan obligation itself.
Perhaps the pessimism of our loan officer above was justified. What, exactly, does it mean that “every aspect” of the sale of a repossessed vessel must be “commercially reasonable”? Different vessel types and sizes have very different needs and often require expensive maintenance and storage. It is not always clear what should be replaced and repaired on a vessel. They may need to be marketed for months or years by a professional broker to obtain market value. And surveys of the same vessel by different surveyors, even if performed days apart, may present different expected market values. Location is likewise a confounding factor. What may be standard treatment for the broker of a flybridge motor yacht in the harbors of Florida may seem inappropriate to a broker of the same vessel in the lakes of Washington. The range of potential issues in the “commercially reasonable” disposition of repossessed vessels is outside the scope of this article. But I address many of them in another companion article 3 along with examples of how courts have drawn the lines of commercial reasonableness in these circumstances.
To make matters worse for the lender, the borrower need only file a complaint and assert with minimal facts that the lender’s sale was not up to the standards of the industry 4. Once this is “placed in issue” the lender must then carry the burden at trial of proving that “every aspect” of the sale was commercially reasonable. But the lender faces another confounding variable in this respect. Lenders are not in the business of brokering vessels. They generally, therefore, must rely on the expertise of one or more third party vendors to handle the repossession, storage, maintenance, and sale of the vessel. A lender must therefore carefully consider the qualifications and record keeping capabilities of these third-party vendors well in advance of the repossession, especially if it wishes to ensure a successful legal claim against a defaulted borrower in a deficiency action.
All told, the model code provisions present the conditions for a perfect storm of legal challenges against a foreclosing marine lender. A borrower who is overly optimistic about the value of the vessel may scoff at the price obtained at the sale. He is not likely to understand the difficulties presented when selling a repossessed vessel and may be eager to hire counsel to challenge the lender’s efforts to collect on the loan deficiency. And the borrower’s counsel will have plenty to work with in states that have adopted the UCC provisions mentioned herein, as most states have. There are many incentives to file a claim in court, given that the burden at trial is placed on the lender to demonstrate “every aspect” of the sale was commercially reasonable. It is worth restating that the damages available to a borrower who is successful asserting these provisions could exceed the damages the lender was seeking for the deficiency in the first place.
A marine lender considering repossession and sale of a vessel must therefore adopt the perspective of the realist, trimming its sails, watching the horizon, and preparing for the storm ahead. In the subsequent articles in this series, we offer some strategies that will assist lenders when navigating these hazards.
1. “What Duties Does A Marine Lender Owe In The Care of A Repossessed Vessel Under UCC §9-207?”
2. UCC §9-625
3. “What Duties Does A Marine Lender Owe In The Sale Of A Repossessed Vessel Under UCC §9-610?”
4. UCC §9-626