What Duties Does A Marine Lender Owe In The Care of A Repossessed Vessel Under UCC §9-207?
Feb 24, 2021
This article is the second of our three-part series on Uniform Commercial Code (“UCC”) sections 9-207 and 9-610. Those model code provisions govern the duties associated with the preservation and disposition of secured collateral. In the following article we address the duty of reasonable care and preservation as it applies to lenders who have repossessed vessels.
In states that have adopted UCC §9-207, marine lenders who resort to repossession following a default have a duty to preserve the collateral. In the words of the model code, the lender must “use reasonable care in the custody and preservation” of the vessel while it is “in the secured party’s possession”. But what exactly is meant by “reasonable care” in these circumstances? The answer is by no means clear.
A few recent court decisions have, however, offered some guidance. We begin with the federal case our law firm recently handled in the Western District of Washington, where we successfully defended against all of the borrowers’ counterclaims, including a claim under §9-207 and its state statute counterpart, RCW §62A.9A.207.
In SunTrust Banks, Inc. v. Be Yachts LLC 1 , the lender pursued a claim for breach of contract after the borrowers failed to satisfy the deficiency balance following the repossession and sale of a 63-foot motor yacht. The defendant borrowers asserted several counterclaims against the lender, alleging, inter alia, that the lender had failed to properly safeguard the collateral and had stored the vessel in conditions that deteriorated the value of the collateral.
The borrowers presented expert witness testimony concluding that the vessel did not receive the cleaning, maintenance, or repairs necessary to maintain it in a reasonable condition for a vessel of its type and value. The borrowers alleged that although the evidence indicated the vessel had been cleaned once a month, the luxury yacht should have received more frequent cleanings and detailing to maintain its exterior and interior surfaces. The borrowers also alleged that the lender was obligated to run the vessel’s engines and generator set every two weeks, rather than once a month as the evidence suggested had been done. In support of his conclusion that the vessel was not sufficiently maintained, the borrowers’ expert testified that there were no records of maintenance for any of the vessel’s electrical, mechanical, hydraulic, plumbing and electronic systems during the approximate one-year period the vessel was in the lender’s possession. The expert even surmised that the expiration of the onboard fire extinguishers placed the vessel in peril.
Central to the borrowers’ challenge to the preservation of the vessel was the allegation that the vessel had not been sufficiently climate controlled. The borrower presented eye-witness testimony suggesting the vessel had been removed from shore power for an extended period and was accumulating moisture in the windows, which damaged interior surfaces, caused a musty odor and degraded the value of the vessel. The borrower also alleged that because the vessel survey had indicated a heating deficiency in the forward and port staterooms, the air was not properly circulated resulting in further moisture damage.
We, however, presented testimony on the lender’s behalf that the vessel had only been briefly disconnected from power during various moves within the storage facility, that the surveys conducted shortly after repossession and approximately one year later upon sale of the vessel did not show a change in the vessel’s “above average” condition, that there was no evidence of moisture damage in photos taken of the vessel, that witnesses who boarded the vessel while it was being marketed did not notice moisture issues and that the HVAC system functioned sufficiently to maintain temperature and humidity throughout the vessel.
After reviewing the evidence, the court granted the lender’s motion for summary judgment, finding that the borrower had not demonstrated the lender’s alleged lack of care diminished the vessel’s value. The court noted the fact that the two surveys, conducted nearly a year apart and spanning the entire time the vessel was in the lender’s care, did not suggest a severe diminishment in value from degradation of the vessel. The court dismissed the borrower’s claim for violation of §9-207 and RCW §62A.9A.207 2.
In 2014 a federal court in Maryland addressed a challenge to the forced liquidation sale of a 58-foot yacht in Md. Nat’l Bank v. Traenkle 3. The defendants borrowed $850,000 for the purchase of their vessel and defaulted on the payments. The lender repossessed the vessel and sold it at auction less than two years later for $550,000. The borrowers likewise alleged that the lender did not exercise reasonable care while in possession of the yacht, relying on conclusions in two surveys. One survey, performed by the lender shortly after taking possession, contained recommendations for repairs. Another survey, presumably ordered by the borrowers, documented certain areas of concern with the vessel’s condition.
The Traenkle court rejected the borrowers’ counterclaims, determining that the lender exercised reasonable care while in possession of the vessel 4. The court noted that the lender’s agents made numerous investigative visits to the vessel and kept detailed notes, cleaned and maintained the yacht, and corrected problems with the bilge pump and air conditioner while the yacht was in its possession 5. The court rejected the borrowers’ claims that unreasonable maintenance caused deterioration in the boats value, even though the lender’s agent did not act on every recommendation made in the survey. And although the lender’s agent operated the vessel without permission, the court suggested this act was merely inappropriate and did not result in a diminishment of value 6. The Traenkle court also found that the low selling price obtained for the vessel was not sufficient to demonstrate a lack of reasonable care. The court noted that the vessel had been used extensively prior to repossession, had displayed design defects, and that market conditions at the time of sale could have affected the price obtained.
There are several lessons to be gleaned from these cases when it comes to a lender’s statutory duty to use reasonable care in the custody and preservation of a vessel. Foremost is the fact that a borrower can find creative ways to argue that the lender violated its statutory duty. The summaries presented above are not exhaustive of the allegations the borrowers levied against the lenders in the hope of eliminating their respective deficiency balances. A wise lender will therefore ensure that it carefully selects the third-party vendors that will store and maintain their repossessed vessels. These vendors’ records, as well as the lender’s own records, will be essential if the borrower should later raise a claim for violation of the duty of reasonable care. Immediately following repossession, vendors should not just conduct an inventory and prepare a report on the vessel condition, but should take sufficient high-resolution photos that will allow for comparison to additional photos taken around the time of the sale of the vessel.
The cases also suggest that courts consider regular maintenance and replacement of essential components as important factors supporting reasonable care. Lenders are advised to ensure that essential systems are regularly operated. Systems and components should be maintained according to manufacturers’ recommendations, if available. And for expensive motor yachts, engines and generator sets should be run until operating temperature is reached on a minimum monthly basis.
While courts have held that the duty of care of collateral does not place a burden on the secured party to perform repairs to the collateral in order to obtain the best price possible, a lender should take measures that one would reasonably expect to preserve the collateral in its status quo and prevent deterioration which could affect a subsequent sales price. For items other than vessels, some courts have held that the collateral need not be preserved entirely, provided proper efforts were made to ensure preservation 7. But lenders with repossessed vessels are advised to at least make modest repairs to any essential components that fail while the vessel is in the lender’s possession. Depending on the type and size of the vessel, essential components may include bilge and pump systems; steering control or hydraulic systems; covers, hatches, doors, and other weather seals; HVAC systems and electronic systems. A lender is advised to ensure that vessels that require power to maintain cabin temperatures and humidity levels are consistently connected to shore power and that records of power are maintained.
Surveys can also provide a valuable tool for demonstrating a lender’s reasonable care in preservation. For higher value vessels, a minimum of two surveys should be performed. Marine lenders will typically order a valuation survey immediately following repossession to assess initial listing values and minimum bid prices. And, if offered on the private market, purchase agreements may require a pre-purchase survey before a sale is closed. If not, lenders should ensure that a second survey is performed at or near the time the vessel is sold, whether arranged by the buyer or performed at the lender’s expense. If arranged by the buyer, the lender should obtain a copy for its records. Comparison of the initial and final surveys can provide strong evidentiary support for the lender’s reasonable care.
A marine lender is also advised to use the same surveyor for each of the surveys, which should reduce potential inconsistencies between surveys. If different types of surveys are performed, the initial survey should be the most thorough. Issues that appear for the first time in a subsequent survey because they were overlooked in a prior survey may suggest the lender’s lack of care of the vessel. Ideally, the initial survey would be a full condition survey with a sea trial. Operating the vessel on the water is likely to reveal more issues than merely powering up and down equipment at the dock or out of the water.
The scope of a marine lender’s duty of reasonable care in the preservation of a vessel is not clearly defined. And as the cases above indicate, borrowers will not hesitate to challenge a lender’s performance of this statutory duty if the price obtained at the sale of the vessel does not meet their expectations, which are often high. But lenders can increase their odds of defeating any such claims by taking some precautionary measures and, importantly, ensuring that adequate records are maintained for a minimum of two years following the sale of collateral.
1. SunTrust Banks, Inc. v. Be Yachts, LLC, No. C18-840 MJP, 2020 WL 3545500 (W.D. Wash. June 30, 2020)
3. Md. Nat’l Bank v. Traenkle, U.S. District Court for the District of Maryland Civil Case No. CCB-90-2731, 2000 U.S. Dist. LEXIS 21019, at *20 (D. Md. Apr. 18, 2000)
4. Id. at *21
5. Id. at *9
6. Id. at *10
7. For an extreme example, see Morin v. General Motors Acceptance Corp., 602 S.W.2d 596 (Tex. Civ. App.)(finding secured party used reasonable care in preservation of 1973 Chevrolet Nova despite fact that engine went missing during time in its possession).