By Jones Osborn II

The procedure for foreclosing on real property is fairly well known. There is the 90-day notice of the sale, publication, and posting of the property, followed by a public sale at which anyone can appear and bid.

The procedure for foreclosing on personal property is a bit different (and much faster).

Background. One may wonder why a publication that deals with real estate is reviewing the foreclosure procedure for personal property. The reason is because there are a number of situations when it may become necessary to foreclose on personal property in connection with a real estate transaction. For example, an owner of a business located on leased property may have sold his business, subleasing the real estate and selling the personal property. If the buyer defaults he can terminate the lease, but he also needs to have a security interest on the personal property so that he can recover it along with the real estate. For certain kinds of properties - a restaurant or a car wash, for example - it is extremely important to be able to recover both the personal property and the real estate, because the equipment is not only valuable, it is essential to the operation of the property. In such cases, it is important to properly create and perfect a security interest in the personal property at the time of the sale and to follow the proper procedures when foreclosing. Another example where a foreclosure of personal property might be necessary is where real estate has been sold together with a large amount of specialized equipment needed to operate the real estate - for example, a golf course. If a lienholder ever needs to foreclose on this type of property, he will want to be certain he can recover the equipment along with the real estate and that no intervening liens have attached to the equipment.

Creation and Perfection of Security Interest. Whenever a lien on personal property is desired, it first must be created. This is done by an instrument called a security agreement which describes the lien and the lienholder's rights. A security agreement can be included as part of a deed of trust against real property, or it can be a separate document. In addition, the lien must be "perfected." For most kinds of property, this is done by filing a UCC-1 financing statement with the Secretary of State or the County Recorder, depending on the type of property, although for motor vehicles, mobile homes, trailers and the like it is done by filing with the Motor Vehicle Division of the Department of Transportation. In rare cases, perfection is accomplished by other means which are beyond the scope of this memo. Perfection protects the priority of the creditor's lien against intervening liens and purchasers.

Simultaneous Foreclosure with Real Estate. Where a deed of trust on real estate also explicitly creates a security agreement against specified personal property, which is fairly common, foreclosure can be simple. The law allows the foreclosure of the real estate to also operate as a foreclosure of the personal property, and both the real and personal property can be sold as a unit in a single sale. This is not always the most desirable way to proceed, as discussed below, but when it is it is easily accomplished and is essentially no different than foreclosing only on the realty.

Separate Foreclosure. Where there is no deed of trust to be foreclosed, or where it is desirable to foreclose on the personal property separately from the real property, the procedure is as follows:

The first step is to notify the defaulting party of the default and to accelerate the debt so that the entire unpaid balance of the obligation becomes due.

The second step is to give the defaulting party, any guarantors and any other lienholders notice of the time and place of the sale of the collateral. There is no minimum amount of notice required by statute, but it does say that unless the parties have agreed otherwise, ten days is presumed to be adequate (compare that to the 90-day notice required to foreclose on real estate). If the property is perishable, less than ten days may be appropriate. Even though it is not specifically required, it may be prudent to also give notice to the public at large, possibly by publishing or posting, so that the debtor cannot claim there was inadequate notice of the sale; however, no specific type of notice is required - it is only required that the notice be reasonable under the circumstances.

The third step is for a public sale to be held, at which time third parties and the creditor may bid. The sale may be held at any reasonably convenient location. The creditor is allowed to apply the proceeds of sale to his costs and his unpaid obligation. The creditor should disclaim all warranties at the foreclosure sale, or the law will imply warranties of title, possession, and quiet enjoyment, thereby creating potential liability for the creditor. If the property does not sell for enough to satisfy the obligation, the creditor may sue for a deficiency. If there is a surplus, it must be turned over to junior lienholders or the defaulting party.

Additional Issues. There may be situations where a creditor finds it desirable to conduct separate foreclosure sales of personal and real property, even though the deed of trust covers both. For example, it could be advantageous to proceed with a quick foreclosure of the personal property in order to protect its value or to prevent it from disappearing during the 90-day waiting period required under a deed of trust. There also may be situations where real and personal property secure separate obligations, making a single foreclosure impossible. In either case, care should be taken to structure the sale in the way most advantageous to the creditor and to avoid losing the right to a deficiency. It is possible that one foreclosure could prevent the subsequent foreclosure under the anti-deficiency rules, either because of fair market value protections or because of inadvertent violations of the foreclosure procedures. Therefore, it is essential to consult with experienced legal counsel when conducting a foreclosure, particularly where both personal and real property are involved, to insure that the creditor's rights are not prejudiced.

Related Rights and Remedies. As an alternative to foreclosure, the defaulting party and the creditor can agree that the creditor may retain the collateral in full satisfaction of the debt, thereby avoiding the necessity for a sale but also releasing the defaulting party from the risk of a deficiency judgment.

The creditor may demand at any time after a default that the debtor assemble the collateral and make it available to the creditor, or the creditor may by peaceful means use self-help to take possession of the collateral pending the actual sale. If the creditor cannot obtain possession without creating a disturbance, it may be necessary to seek a court order to obtain possession.

Procedure Must Be Commercially Reasonable. Although there are a number of specific procedural requirements, there are many areas where the statutes do not furnish clear guidance. This does not mean, however, that the creditor can do whatever he pleases. The overriding principle when foreclosing on personal property is that the creditor must act in a "commercially reasonable manner" under the circumstances. This term cannot be adequately defined, of course, but if a creditor's actions are deemed by a court to be unreasonable the creditor may be liable for damages, the sale may be set aside, a guarantor may be released, or his right to a deficiency may be lost. For example, a court may find a creditor did not behave in a commercially reasonable manner if he did not give adequate notice of the sale, if he did not prevent perishable collateral of deteriorating, or if he failed to prepare the collateral for sale in a manner reasonably designed to maximize its value.

Conclusion. Care should always be taken in foreclosure actions, whether involving real estate, personal property, or both. There are often strategies available to maximize the creditor's recovery or to enhance his leverage. The procedures are strict, and those who are not familiar with the rules risk losing their security or the right to a deficiency judgment.