On June 6, 2019, the Appellate Division, First Department issued an important decision in Atlas MF Mezzanine Borrower v. Macquarie Texas Loan Holder LLC, 2019 N.Y. App. LEXIS 4484 (1st Dept. 2019), that will reassure the real estate lending community of the finality of foreclosure sales pursuant to the Uniform Commercial Code (UCC). In Atlas MF, the court addressed the ability of a borrower to unwind a closed foreclosure sale conducted pursuant to the UCC. The First Department reversed the Supreme Court's decision and dismissed Atlas MF's declaratory judgment claiming that a closed UCC foreclosure sale was invalid due to purported collusion between the lender and successful bidder, because that remedy was not provided in the UCC. Atlas MF, 2019 N.Y. App. LEXIS 4484, at *20-21.

This decision reaffirms that a borrower needs to seek injunctive relief prior to the sale of the collateral, and that after closing, the borrower's remedy is limited to damages. In reaffirming those principles, the decision reinforces commercial certainty concerning the repossession of collateral through a UCC sale. However, in ruling that the issue of the commercial reasonableness of a UCC auction is “generally an issue of fact,” the First Department left the door open to borrowers to raise damages claims that will not be dismissed at the pleadings stage, exposing lenders to potentially expensive and protracted litigation as to whether the borrower suffered any damages.

Background

In connection with the acquisition of a portfolio of 11 apartment complexes, Atlas MF obtained a $71 million mezzanine loan in December 2013 from Macquarie, which matured on Jan. 2, 2017. Atlas MF, 2019 N.Y. App. LEXIS 4484, at *2-3. The 11 apartment complexes were each held by a special purpose entity (SPE), and the 11 SPEs were owned by Atlas MF Holdco, LLC, whose equity interests were pledged as security for the mezzanine loan. Id. at *3. After Atlas MF was unable to timely repay the mezzanine loan, Macquarie began pursuing a UCC sale of the equity interests in Atlas MF Holdco, LLC. Id. at *4.

Approximately two weeks before the UCC foreclosure sale was to occur, Atlas MF commenced an action in the U.S. District Court for the Southern District of New York to enjoin the foreclosure sale. Atlas MF Mezzanine Borrower, LLC v. Macquarie Texas Loan Holder LLC, 2017 WL 729128, at *4 (S.D.N.Y. Feb. 23, 2017). The district court denied Atlas MF's request for a preliminary injunction because Atlas MF was unlikely to prevail on its commercial unreasonableness claim and did not show that it would suffer irreparable harm. Id. at *3-5.

After its motion for a preliminary injunction was denied, an affiliate of Atlas MF submitted a bidding certificate for the foreclosure sale, which was rejected. Atlas MF, 2019 N.Y. App. LEXIS 4484, at *6. Atlas MF later submitted a new bidding certificate that was accepted, but claimed Macquarie sought “to impose a new requirement that Atlas must submit evidence of its ability to tender payment for its bid before being permitted to register to bid.” Id.

At the UCC foreclosure sale, the auctioneer rejected Atlas MF's first two bids because Atlas MF had not provided the deposit check that was explicitly required under the bidding procedures provided to all bidders. Id. at *7. Atlas MF objected on the grounds that the terms of sale required a check only at end of the sale. Following the objection, Macquarie allowed Atlas MF to participate in the bidding. Id. Ultimately, Atlas MF bid $77 million for the collateral. The amount bid by Atlas MF was approximately $3.5 million more than the payoff amount. Macquarie selected the second highest bidder—who had bid $250,000 less—based on its ability to close. Id. at *8. After securing the necessary government approvals, the transaction closed on May 3, 2017. Id.

Motion to Dismiss Denied

Approximately a month after the UCC foreclosure sale closed, Atlas MF brought an action against Macquarie and the successful foreclosure bidder, seeking, among other things, a declaratory judgment that the foreclosure sale should be unwound and damages awarded to it because, Atlas MF alleged, the foreclosure sale was not conducted in a commercially reasonable manner. See id. at*9-13. The Supreme Court denied the motions to dismiss by Macquarie and the winning bidder. The Supreme Court repeatedly stated that there was “nothing in the UCC that prohibits” Atlas MF from unwinding the consummated sale. Atlas MF Mezzanine Borrower, LLC v. Macquarie Texas Loan Holder LLC, Index. No. 651657/2017, Doc. No. 220 (April 11, 2018) at 9-10, 14. Moreover, the Supreme Court found that because Atlas MF alleged that Macquarie conspired with the winning bidder, there was a factual dispute regarding the reasonableness of the auction and whether the winning bidder was a good-faith purchaser. Id. at 15-18.

First Dept. Rejects Unwinding

The First Department reversed the Supreme Court and found Atlas's declaratory judgment claim to unwind the consummated foreclosure sale was not a remedy contemplated by the UCC. Atlas MF, 2019 N.Y. App. LEXIS 4484, at *20. Atlas MF claimed that the alleged collusion between Macquarie and the successful bidder, along with general principles of equity, permitted a declaratory judgment to unwind a completed UCC foreclosure sale. Id. at *13-14. The First Department, however, concluded that Atlas MF's argument lacked “support in the plain reading of the UCC [and] in existing case law.” Id. at *2.

Atlas's principal argument was that the phrase “subject to the debtor's rights in the collateral” in UCC §9-617 meant that “a transferee who did not act in good faith does not take clear title.” Id. at *15. The First Department noted, however, that the UCC provision “does not touch on the remedies available to the debtor in the case of a 'bad faith' transferee.” Id. at *18. Thus, the First Department concluded that “it would be a stretch to interpret the language as providing a court with the authority to unwind a concluded UCC sale.” Id. at *18-19. Rather, the First Department found that “[a]t most, the language of UCC 9-617 that Atlas focuses on can be read to mean that the debtor, in the case of a commercially unreasonable sale that also involved a transferee that falls into the category of 'other transferee,' may still exercise some rights in the collateral, such as the redemption right.” Id. at *18.

The First Department noted that its interpretation of UCC §9-617 was supported by UCC §9-625, which addresses, among other things, the availability of injunctive relief. The First Department noted that courts had repeatedly found that “the sale must not have taken place in order for injunctive relief to be awarded.” Id. at *19. The court also noted that under the UCC a borrower can pursue injunctive relief prior to the sale, but after a sale, a borrower can only pursue claims for damages. Id. at *20.

Moreover, the First Department found that none of the cases cited by Atlas MF supported unwinding a UCC foreclosure sale. The main case that Atlas MF relied on, O'Brien v. Chase Home Finance, LLC, 42 A.D.3d 344 (1st Dept. 2007), was not applicable because the sale in that case had not yet closed when plaintiff sought to vacate the auction and prevent defendants from closing. Atlas MF, 2019 N.Y. App. LEXIS 4484, at *15. Moreover, the O'Brien decision did not cite any provision of the UCC that would allow a sale to be unwound. Id. at *16.

Despite rejecting Atlas MF's claim to unwind the foreclosure sale, the First Department permitted Atlas MF to pursue its claims for damages based on the foreclosure sale being allegedly conducted in a commercially unreasonable manner. Id. at *25. Atlas MF alleged the foreclosure sale was not commercially reasonable because two weeks was insufficient time to diligence the 11 properties at issue, that it was subjected to “ever-changing” requirements to participate in the sale, that Macquarie rejected the highest offer, that multiple drafts of the transactional documents were distributed close to the sale date, and that Macquarie and the winning bidder colluded. Id. *22-23.

The First Department rejected Macquarie's motion to dismiss this claim because a court is required “to afford the complaint the presumption of truth” and “whether a term or requirement is commercially reasonable is generally an issue of fact that cannot be decided at this stage.” Id. at *24.

The court also permitted Atlas MF's claim to recover the surplus of $836,891.45 to proceed. Macquarie had not provided the surplus to Atlas MF because it had incurred approximately $1.3 million in attorney fees. While the UCC recognizes that payment of reasonable attorney fees and legal expenses will reduce the surplus owed to the debtor, the First Department found the “question of reasonableness…cannot be answered at this pleading stage.” Id. at *25-26.

The court dismissed Atlas MF's claim against Macquarie for breach of contract and breach of duty of good faith and fair dealing because Atlas MF failed to identify any provision of the loan documents that was breached, and because Atlas MF itself failed to perform its obligations under the loan documents. The First Department also dismissed the civil conspiracy and tortious interference claims against the winning bidder because it had dismissed the claim for breach of the loan agreement. Id. at *26.

Conclusion

The First Department's decision rejecting a borrower's attempt to unwind a completed UCC foreclosure sale is an important decision reaffirming the finality of UCC foreclosure sales in New York. Allowing borrowers to seek to unwind completed UCC foreclosures would, as the First Department recognized, “only serve to muddy the waters surrounding nonjudicial sales conducted pursuant to Article 9 of the UCC, and to deter potential buyers from bidding in nonjudicial sales, which would, in turn, harm the debtor and the secured party…” Id. at *2. While borrowers may not seek to unwind completed a UCC foreclosure sale, even if there is a “bad-faith transferee,” borrowers still have the ability to seek injunctive relief prior to the consummation of the UCC foreclosure sale and can seek damages arising from a sale that is not conducted in a commercially reasonable manner.

The First Department's decision to allow a monetary claim for commercial unreasonableness to proceed highlights the need to establish clear and consistent rules for UCC foreclosure sales to prevent a creative borrower from being able to allege facts that allow it to survive a motion to dismiss under New York's pleading standard. In order to avoid the potential for protracted litigation over the reasonableness of a UCC foreclosure sale, the pledge agreement and other loan documents should be explicit in establishing procedures that the borrower acknowledges are commercially reasonable.

Janice Mac Avoy and Matthew D. Parrott are partners and co-heads of the real estate litigation practice and Justin J. Santolli is a special counsel in the litigation department at Fried Frank Harris Shriver & Jacobson.