February 2, 2022
Secured term loan and revolver lenders in retail bankruptcy cases often leave money on the table because they do not understand how their security interests in a debtor’s “accounts” under the Uniform Commercial Code (UCC) extend to the proceeds of sale of a debtor’s real property interests, including leases, lease designation rights, and real property (collectively, real property interests).
The typical collateral package granted by retail company borrowers to revolver lenders and term loan lenders includes accounts, inventory, equipment, and other personal property. Those lenders perfect their security interest in that collateral by filing UCC-1 financing statements. The retailer’s real property interests fall outside the usual collateral package in part because of the additional hurdles to perfect security interests in real property collateral: (a) a security interest in personal property covered by a UCC-1 financing statement does not cover the underlying real property interests and therefore would require local real estate recordings at each encumbered real estate site, and (b) landlords strongly resist a tenant’s revolver and term loan lenders placing leasehold mortgages on any leaseholds. Therefore, in large retail cases, a debtor may have hundreds of unencumbered leases and other real property interests.
When a retail borrower files for bankruptcy and sells its assets, the unsecured creditors’ committee typically asserts the right to the value of those unencumbered real property interests for the benefit of general unsecured creditors, and secured lenders often do not contest that assertion. As a result, secured revolver and term loan lenders often get a recovery of less than par while unsecured creditors— although subordinated to the recoveries of the secured lenders to the extent of the lenders’ collateral package—get at least a pro rata recovery from proceeds of sales of the debtor’s real property interests.
However, in these instances, secured lenders may be unnecessarily and inadvertently letting value leak from their recovery to unsecured creditors. As set forth in this article, a careful reading and application of the UCC’s definition of “accounts” should give those lenders a senior claim to the proceeds of any unencumbered real property interests.
Los Angeles partner Robert A. Klyman prepared this article for the Journal of Corporate Renewal (JCR, Jan/Feb 2022), the official publication of the Turnaround Management Association (TMA). View the article on your desktop or download the JCR app to your Apple or Android device to view the entire issue.
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