“Default” Hypothetical
Durango State Bank (the “Bank”) has extended a line of credit to How Now Brown Cow, LLC,
a Colorado limited liability company (“How Now”). How Now owns and operates a large cattle
ranch in southwestern Colorado. How Now sells its cattle to The Bum Steer, a meat
processor in Albuquerque. How Now is owned by Roy Rodeo and his spouse, Roxy Rodeo.
They met as teenagers at a roping competition in Monticello, Utah. As Roy puts it, “There
was this cute filly with a smile as wide as the Rio Grande and with a fire in her eyes who
done know her way around with a lasso and before I knows what was happenin’ she done had
the rope around me and she has not let go since.” Roy and Roxy built How Now, side-byside, with spit and baling wire and have been in business for 30 years. The line of credit is
secured by a properly perfected security interest in all of How Now’s equipment, inventory,
farm products and accounts, whether now owned or hereafter acquired. The loan
documents include a promissory note for the amount of the line of credit, a loan agreement,
and a security agreement describing the collateral. The amount that can be borrowed under
the line of credit is determined by the value of the livestock and the accounts. How Now
provides to the Bank a weekly report with those totals. The loan agreement states the
following regarding default:
Each of the following events shall be an Event of Default under this Loan
Agreement:
1. Borrower fails to make any scheduled payment of principal or interest on the
Promissory Note within ten days after the payment is due;
2. Borrower fails to comply with any other covenant or obligation under this Loan
Agreement, the Promissory Note, or the Security Agreement, and such
noncompliance is not cured within thirty (30) days after notice has been given by
Bank to Borrower;
3. Borrower files for relief under the Bankruptcy Code; or
4. Bank deems itself insecure.
The Loan Agreement then provides that “upon an Event of Default, without any additional
notice, Bank may (1) stop making any additional advances to Borrower, (2) accelerate the
outstanding amounts under the loan and declare them all immediately due and payable, and
(3) exercise all rights and remedies under the Colorado Uniform Commercial Code.”
Consider each of the following scenarios and answer this question: “Can Bank exercise its
remedies under the Loan Agreement without delay and without taking any other steps??”
1. How Now fails to make a monthly payment required by the Promissory Note. Bank
sends a letter stating that the payment must be made by a certain date that is ten days
away and no payment is received during that ten day period.
2. How Now fails to make a monthly payment required by the Promissory Note and
ten days pass after the due date without the payment being received. By the way, there is
enough money in How Now’s checking account to make the missed payment.
3. How Now stops sending in the weekly report of livestock and accounts. This
continues for three weeks. Bank gives written notice to How Now that all outstanding
reports must be received within thirty days. At the end of the thirty days, no reports have
been provided to Bank.
4. How Now is meeting all of the payment and other obligations under the Loan
Agreement, the Promissory Note and the Security Agreement. Bank’s president, Milburn
Drysdale, reads an article about how cattle and beef prices in the West and Southwest are
dropping like cheap socks. Mr. Drysdale says to himself, “I think our bank is suddenly
feeling insecure about the How Now loan.”
5. How Now is meeting all of the payment and other obligations under the Loan
Agreement, the Promissory Note and the Security Agreement. Mr. Drysdale is a member of
the Bank’s board of directors, and at a board meeting there is considerable discussion about
the large portfolio of agriculture loans that the Bank has outstanding and the fact that the
FDIC, the insurer of bank deposits, has criticized the Bank in that regard. Mr. Drysdale is
told by the board, “Do something about it.” Mr. Drysdale tells Jayne Hathaway, the loan
officer handing the How Now loan, “Jayne, the minute How Now is late with anything we will
need to default them.” A few weeks later, How Now fails to make a scheduled monthly
payment, and ten days pass without the payment being made.
6. How Now is meeting all of the payment and other obligations under the Loan
Agreement, the Promissory Note and the Security Agreement. Jayne Hathaway will
periodically visit the How Now ranch with others from the Bank and they will do an audit of
the livestock and the books to verify the information that is being provided on the weekly
report to the Bank. As the day passes, Jayne and her colleagues determine that the total
number of livestock at the ranch is far less (more than 50% less), than what is listed on the
latest report. When Jayne asks Roy and Roxy about the discrepancy, Roy just says, while
looking down at the dirt, “Oh, thems must be the cows that died the other day.” To which
Roxy replies, “Yep, was nothin’ but a darn shame.” Jayne returns to the Bank and tells Mr.
Drysdale, “I am very nervous about the How Now loan; I think they are dummying up the
weekly report to support the amounts they are borrowing.”
7. How Now’s business is seasonal. There are times of high expenses and low income
and there are times of high income and low expenses. Although the Promissory Note
requires monthly payments, Bank will routinely permit How Now to miss a series of payments
during the high expense, low income periods with the common practice of How Now catching
up on all late payments during the good periods of the year. The regulators tell Bank to
stop that practice immediately. Coincidentally, that demand from the regulators is during a
lean part of the year and How Now is late on two monthly payments.
8. How Now is meeting all of the payment and other obligations under the Loan
Agreement, the Promissory Note and the Security Agreement. However, fuel prices are
high and beef prices are low. The Bank line of credit will be maturing soon and How Now is
asking the bank for a renewal of the line of credit for another two years. At the maturity
date, the line of credit will have had a six year history. The relationship between the
Rodeos and Mr. Drysdale has become strained. Roxy Rodeo ran against Mr. Drysdale in the
school board elections and Roxy beat Mr. Drysdale easily. A Durango paper, which had
supported Roxy, printed a headline the next morning that read, “So long Dies-Dale”. As part
of the loan renewal request, How Now provides a pro forma financial statement in which
How Now gives projections to as to how the ranch will do in the next two years. The
projections are generally optimistic. When Mr. Drysdale gets a copy of the pro forma
financial statements from Jayne Hathaway, he writes on his copy, “This stuff is worse than
the stuff those old coots shovel out of their barn stalls” (and he used a more graphic word
than “stuff”), and he puts the copy in the loan file. Just a week before the maturity date of
the line of credit, Jayne leaves a voice mail message for Roy and Roxy saying, “Sorry, we will
not be renewing the line of credit; we expect the outstanding loan balance to be paid off
next week.” Next week comes and no payment is received from How Now.
Remedy Hypothetical
South Provo Bank has an outstanding line of credit to Umbrella Corporation, a Utah
corporation. As part of the loan, Umbrella Corporation signed a security agreement
granting to South Provo Bank a security interest in all of Umbrella Corporation’s equipment,
inventory, accounts, chattel paper, instruments, deposit accounts and general intangibles,
whether now owned or hereafter acquired together with all proceeds. South Provo Bank
perfected its security interest by doing the following: (1) filing a proper UCC financing
statement with the Utah Department of Commerce, (2) taking possession of a promissory
note that is payable to Umbrella Corporation by Salt Lake Pool and Patio (“SLPP”), and a
security agreement that secures that promissory note with SLPP’s inventory and accounts1,
and (3) entering into a control agreement with Alpine Bank.2 Jacqueline Jones, the owner of
Umbrella Corporation, has signed a guaranty agreement in favor of the Bank, by which she
unconditionally guarantees the obligation of Umbrella Corporation to South Provo Bank.
After the South Provo Bank loan and after South Provo Bank filed its financing statement,
Umbrella Corporation financed some new equipment with Equipment Supply Company in which
1
SLPP was unable to pay a large account to Umbrella Corporation and so Umbrella Corporation agreed
to take a promissory note from SLPP which evidenced an agreement to pay the obligation over time.
SLPP signed a security agreement as collateral for the promissory note covering SLPP’s inventory and
accounts. Umbrella Corporation filed a proper financing statement against SLPP’s inventory and
accounts. The promissory note from SLPP calls for monthly payments, which SLPP has been making to
Umbrella Corporation.
2
Umbrella Corporation deposits funds from its operations into an account at Alpine Bank. The control
agreement includes a section in which Alpine Bank subordinates its right of setoff and any security
agreement in the account in favor of South Provo Bank.
Equipment Supply Company took a security interest in the equipment it sold to Umbrella
Corporation. The sale closed on November 1, 2005. Umbrella Corporation took possession
of the new equipment on November 2, 2005. Equipment Supply Company filed its financing
statement on November 30, 2005.
The loan from South Provo Bank has matured, and Umbrella Corporation cannot repay the
loan, despite efforts of the Bank to give time to Umbrella Corporation to do so. Unlike most
defaulted situations, South Provo Bank and Umbrella Corporation are unable to work things
out through negotiation and settlement. Therefore, South Provo Bank has posed to you the
following questions:
1. Can South Provo Bank just sue Umbrella Corporation for the unpaid loan??
2. How can South Provo Bank repossess the collateral under Section 9-609??
3. Once South Provo Bank gets possession and wants to conduct a sale under Section 9-610,
what are some steps that it should take to make sure that the sale is commercially
reasonable??
4. Who should get notice of any sale under Section 9-611??
5. How much time should the notice give before any sale under Section 9-612??
6. What about the accounts?? How does South Provo Bank foreclose on the accounts??
What if some of the account debtors have defenses to payment on the accounts (e.g., the
umbrellas they bought were defective and could not be sold)??
7. What about the SLPP promissory note?? How does South Provo Bank foreclose its
security interest in that promissory note?? Can South Provo Bank foreclose against SLPP’s
inventory and accounts that secure the SLPP’s promissory note??
8. What about the Alpine Bank deposit account?? How does South Provo Bank foreclose its
security interest in that deposit account??
9. Equipment Supply Company repossessed some of the equipment in which it had a security
interest and it has just given notice to South Provo Bank of its intent to sell the equipment
in 10 days to a competitor of Umbrella Corporation?? What can South Provo Bank do??
10. Does Equipment Supply Company have any argument that could help its position??
More Remedy Hypotheticals
Hypothetical No. 1: Pleasant Grove State Bank has an outstanding loan to Timpanogos
Typewriter Repair Corporation, owned by Lucy (“Inky”) Nelson. It appears that the
typewriter will not be making a comeback as Inky had hoped (Inky was heard to say, “I
guess those doggone computers are here to stay!”). The Bank has repossessed tools and
equipment in which the Bank had a security interest and has made arrangements (after a
reasonable marketing effort), to sell portions of the collateral to different buyers. The
credit agreement requires that any notice to the borrower is deemed effective if sent to
123 E. Main Street, Pleasant Grove, Utah 84123. The Bank officer handling the loan
collection effort knows that the business site is now empty and knows the address of Inky’s
home. How does the Bank meet its obligation under Section 9-611(b)??
Hypothetical No. 2: [Hypothetical No. 1 continued.] On October 15, 2006, the Bank mails
a notice to the borrower to both the business address listed in the credit agreement and to
Inky’s home. It is sent certified mail, return receipt requested. The notice states that the
collateral will be sold at private sales, the first of which will occur after October 25, 2006.
The post office is unable to deliver either notice – the business site is vacant and Inky is on
a trip to Denver to explore the possibility of becoming a VHS tape player repair person.
Inky will not be back until October 26, 2006. Can the Bank complete the sales after
October 25, 2006??
Hypothetical No. 3: [Hypothetical Nos. 1 and 2 continued.] October 26, 2006 arrives.
The Bank is nervous about the fact that Inky never received the notice. That afternoon,
the Bank officer calls Inky. Inky tells the Bank officer that she is back in town, that she
just saw the notice and that she doesn’t have a problem with the sales going forward as
planned. The Bank officer asks Inky to send an email to that effect, which Inky does (the
email states “all notices of sale are waived”). The Bank then makes contact with its
potential buyers and the buyers now all have cold feet, and the Bank does not have an
enforceable commitment from any of them. Weeks go by as the Bank officer tries to work
with these buyers. Eventually, the sales agreements are reached, and the sales are to close
on December 15, 2006. Does the Bank have an obligation to send a new notice of disposition
under Section 9-611(b)??
Hypothetical No. 4: In September of 2006, Springville Community Bank conducts an
Article 9 non-judicial foreclosure sale of some equipment and inventory collateral that the
Bank repossessed. The borrower was trying to make a go of it in the video world by trying
to manufacture and market a new “pong” game, but unlike the 1975 version, this 2006
version had audio crowd noises like, “ooohhh” and “aaahhh”. The sale was a private sale to a
Las Vegas company that had a niche in selling and repairing vintage video games as a novelty.
The Bank gave no notice of the sale to the borrower. Did the lack of notice affect the sale
to the Las Vegas company??
Hypothetical No. 5: Mapleton Bank conducts a non-judicial foreclosure sale under Article
9 of a security interest granted by Turn Table Incorporated. The borrower was convinced
that the old LP albums and turn table record players would make a big comeback. The bank
sold all of the borrower’s equipment at a private sale. The loan balance was $50,000.00.
The expenses incurred by the bank totaled $8,000. The sale proceeds were $65,000. The
bank received no demand from any other secured party. How would the proceeds be applied
under Section 9-615(a) and (d)??
Hypothetical No. 6: [Hypothetical No. 5 continued.] If the sale proceeds were $40,000,
how would the proceeds be applied under Section 9-615(a) and (d)??
Hypothetical No. 7: [Hypothetical No. 6 continued.] The Bank files a lawsuit against the
borrower to collect the $18,000 deficiency. In the Answer filed by the borrower, the
borrower asserts that the Bank did not give reasonable notice of the sale under Section 9611(b), and that the method by which the Bank solicited potential buyers was commercially
unreasonable. The borrower claimed in its court pleadings that the industry commonly seeks
buyers of such equipment through a trade journal called “Turn Table Nostalgia”, and the
bank did not advertise in that publication. The borrower presented evidence that showed
that if the Secured Party had undertaken that usual course of advertising in that
publication, the sale proceeds would have been $65,000. The Bank did not present any
conflicting evidence. Under Section 9-626, what effect does the borrower’s Answer have
on the lawsuit to collect the deficiency??
Hypothetical No. 8: [Hypothetical No. 7 continued.] What if the only defense raised in
the borrower’s Answer is that there was never a “default” under the terms of loan
agreement??
Hypothetical No. 9: Umbrella Corporation has granted a security interest to South Provo
Bank in all of Umbrella Corporation’s accounts. The account debtors include R. C. Willey
Home Furnishings. The loan is in default and the Bank is interested in foreclosing its
security interest in the accounts:
1. How does the Bank foreclose its security interest in the accounts??
2. What if R. C. Willey has a defense to payment (the umbrellas that it bought were
defective)??
3. What if the loan to the Bank is not in default and yet R. C. Willey pays the Bank
the amount of the outstanding accounts??
4. What if R. C. Willey is nervous about whether to pay the Bank?? Is there
anything that R. C. Willey can do to get comfortable??
Section 615(f) Hypothetical
Salina State Bank in central Utah has made a loan that has gone into default. The loan is
secured by a perfected security interest in livestock. That bank obtained possession of the
livestock through a writ of replevin. Because the livestock was in a locked yard, the Bank
decided that it would not be able to conduct a self-help repossession without breaching the
peace. The standard accepted method for selling livestock in that area is at the weekly
cattle auction in Salina. The bank makes the arrangements to have the livestock sold at one
of the Salina auctions. The Bank gives the proper 10-day notice of the auction sale to the
borrower. At the auction, there is not much interest and the bids are low. Seeing the lack
of interest and the low bids, the Bank decides to bid for the livestock by using the debt it
is owed as a credit against the bid price. In other words, the Bank bids the debt that will
otherwise be paid with the auction proceeds. This is called a “credit bid.” The Bank is the
successful bidder at the auction by bidding a low amount. In preparing for the Salina
auction, the Bank learned that much higher prices are currently being paid in and around
Grand Junction, Colorado. The Bank sues the borrower for the large deficiency on the loan
that is left unpaid after the Salina auction sale. And later, the Bank makes a profit on the
livestock that it resells in Grand Junction. Additional information: the outstanding loan
balance is $50,000. The Bank credit bid was $5,000 for the livestock at the auction, and
the Bank sued the borrower for the $45,000 deficiency. The Borrower has collected
evidence (including livestock quotes from Grand Junction and elsewhere), that shows the
livestock had a market value of $25,000. How does Section 9-615(f) apply??
© Kevin Glade 2006. These materials are intended for classroom use only. None of these materials may be copied,
reproduced or distributed without the author’s prior written consent.
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