This article appeared in the Spring 1991 issue of Southern University Law Review, published by the Southern University Law Center. It may be cited as John Pierre & M. R. Franks, The Consequence of Default to the Debtor Under Part 5, Chapter 9 of the Louisiana Commercial Laws: A Primer on Debtor's Rights, 18 S.U. L. Rev. 21 (Spring 1991).

*John Pierre, assistant professor of law at Southern University, Baton Rouge, Louisiana, holds his Masters in Tax Accounting from Texas Tech University and his Juris Doctor degree from Southern Methodist University.

**M.R. Franks, associate professor of law at Southern University, holds his Bachelor of Science and Juris Doctor degrees from Memphis State University.

Debtors facing financial difficulties often seek an attorney's assistance only after default occurs. The default often occurs in conjunction with the debtor's bankruptcy. The attorney's post-default efforts are critical to the debtor because the debtor may be treated unfairly after default. The debtor at the time of obtaining the loan does not contemplate default and the consequences of incurring a deficiency judgment if default occurs.

In terms of financing movables in Louisiana, the consequences of default upon debtors has changed significantly with the enactment of Chapter 9 of the Louisiana Commercial Laws, which became effective January 1, 1990.¹ Part 5 of Chapter 9 outlines the rights and remedies of the debtor and of the secured party when default occurs.² The purpose of this law review article is to outline the consequences of default from the debtor's perspective.

What is "default"? Nowhere does Chapter 9 define the word that triggers the rights and remedies of both the secured party and debtor.³ The secured party and the debtor generally are free to define default without limitation. Most security agreements contain provisions that stipulate non-payment or late payment as events constituting default. Other events, such as the failure to maintain insurance on the collateral or the bankruptcy of the debtor, may be stipulated as triggering default. Whatever the case, a carefully drafted security agreement should contain default clauses that take into consideration the nature of the transaction and the risks involved in the transaction.

Most security agreements provide the secured party the option to accelerate the debt's maturity and to cause all payments to become due and payable immediately when the debtor has defaulted. Acceleration clauses give the secured party protection and leverage upon the debtor's default and have been upheld uniformly by the courts. One type of acceleration clause expressly authorized under the Louisiana Commercial Laws is an "insecurity clause."⁴ La. R.S. 10:1-208 reads as follows:

Hence, an insecurity clause provides that the secured party may accelerate the debt's maturity whenever he "deems himself insecure."⁵ While it would at first appear that secured parties can act at their whim in accelerating a debt's maturity, that appearance is misleading since La. R.S. 10:1-208 requires that the secured party act in "good faith."⁶ "Good faith" means honesty in fact in the conduct of or transaction concerned, except as provided in La. R.S. 10:1-203.⁷ La. R.S. 10:1-203 provides:

La. R.S. 10:1-203 was amended in 1988 by adding the second sentence.⁸ Prior to that amendment, there was a conflict concerning the standard to be applied in determining "good faith." Courts interpreting Louisiana law had applied both an objective standard (i.e., reasonable prudent man) and a subjective standard in determining "good faith".

In Asian Intern, Ltd. v. Merrill Lynch Pierce, Fenner & Smith, Inc.,⁹ the Louisiana Court of Appeal for the First Circuit made the following observation:

The court in ruling that an objective standard would be used to define "good faith" did so without any analysis. Instead the court simply cited as its authority for its ruling the case of Commercial National Bank in Shreveport v. Calk.¹¹ It is clear from a reading of Louisiana cases decided before enactment of La.R.S.10:1-203 that an objective standard was applied to determine good faith.¹²

In Commercial National Bank in Shreveport v. Calk, the plaintiff bank purchased a promissory note from an implement dealer executed by the defendant and payable to "bearer." The defendant gave the note to the dealer pursuant to his purchase of a trench-digging machine, which later proved to be defective. The defendant argued that the bank was not entitled to recover on the promissory note because the bank would not qualify as a holder in due course, in that the bank knew or had notice of the defective condition of the machine for which the note was given. The court in ruling in favor of the bank made the following observation and conclusion:

In National Safe Corp. v. Benedict and Myrick, Inc.,¹⁴ the Louisiana Supreme Court applied an objective standard in interpreting the "good faith performance" requirement contained in Civil Code article 1901, which is now found in Civil Code article 1983. The court ruled that good-faith performance is implied in all contracts and that the obligation of good-faith performance extends to everything by equity which is incidental or necessary to carry a contract into effect.¹⁵ The court went on to make clear that equity will supply such incidents (i.e., good-faith performance) only as the parties reasonably may be assumed to be knowledgable in the application of such incidents to agreements whereby "good-faith performance" was not expressly stipulated.¹⁶ Stated in another form, "equity" implies an application of the Christian principle "not to do unto others that which we would not wish others should do unto us."¹⁷

Six months prior to the ruling made in Asian Intern, a federal district court applying Louisiana law ruled that a subjective standard would be applied in determining good faith. In Marsh Inv. Corp. v. Langford,¹⁸ the federal district judge commenting on the "slipperiness" of "good faith" made the following conclusion:

The Marsh case illustrates the inherent difficulties in formulating a standard of "good faith." The court in a footnote chronicled the problems of applying a standard of "good faith."²⁰ The court defined the subjective standard of "good faith" as "good faith in fact -- the old white heart and empty head standard."²¹ The court explained that the subjective standard required an intensive, detailed inquiry into the facts surrounding a transaction in order to determine how "white" the heart, how "empty" the head.²²

Because a key limitation placed upon parties in defining default in security agreements is "good faith," it was extremely important that a consistent standard be applied. If the "good faith" limitation was to have a real effect, a precise operational standard of good faith was needed. The amendment of La.R.S.10:1-203 by the Louisiana legislature assured that an objective standard of good faith would be applied in commercial transactions. In amending La.R.S.10:1-203, the legislature adopted the position of Louisiana courts in cases concerning the standard to be applied in determining good faith before the adoption of the Uniform Commercial Code's general definitions.

Having attempted to define default, it is important for us to note that Part 5 of Chapter 9 outlines the key procedures to be followed by a secured party who seeks to excercise on a security interest or otherwise recover on the underlying debt owed by the debtor. When a debtor is in default under a security agreement, a secured party has the option to (1)proceed via ordinary or executory process;²³ (2) sell the property covered by the security interest via a public or private sale;²⁴ (3) retain the property covered by the security interest via strict foreclosure procedures;²⁵ or (4) notify the account debtor or the obligor to make payment to the secured party if the security interest covers accounts or instruments.²⁶ The preceding options will now be discussed in order.

A secured party may reduce his claim to judgment, execute upon or otherwise enforce his security interest by any available judicial procedures upon the debtor's default.²⁷ In Louisiana, this means that the secured party may enforce his security interest via ordinary proceedings or executory process.

In Louisiana, if the secured party chooses to enforce his security interest via ordinary proceedings, he must file a petition for money damages in a trial court and serve the petition on the debtor.²⁸ The debtor at this point in the litigation process may raise any defense challenging the validity of the secured party's suit.²⁹ If the debtor is unsuccessful in defending against the secured party's suit, the judgment obtained by the secured party may be recorded in the mortgage records of the applicable parish, and the judgment may be executed upon the issuance of a writ of fieri facias.³⁰ The secured party at this point is now classified as a "judgment creditor." The debtor must file a suspensive appeal to prevent the judgment creditor from executing on the judgment.³¹ Once a suspensive appeal is filed, the debtor is protected from a premature seizure by the judgment creditor.³² Such seizure renders the judgment creditor liable for damages irrespective of the outcome on appeal.³³ If, however, the debtor files a devolutive appeal, the judgment creditor may execute on the judgment prior to exhaustion of the appeals process.³⁴

As indicated in the above discussion, the execution of a money judgment is accomplished through issuance of a writ of fieri facias directing the sheriff to seize the property by taking actual possession of the movables.³⁵ The judgment creditor, through the seizure, acquires a privilege on the seized property.³⁶ The debtor must be notified in writing on the seizure.³⁷ If the written notice cannot be given the debtor, the trial court must appoint an attorney to receive the notice of seizure.³⁸

The property once seized under a writ of fieri facias can be sold by the sheriff via a judicial sale.³⁹ Notice of the sale must be published, at least once for movable property after three judicial days have passed after service of the notice of seizure upon the debtor.⁴⁰ The debtor has several significant rights that must be protected during a judicial sale. Those rights include the following:

Ordinary process is, of course, very cumbersome for the secured party when compared with executory process. Through an executory proceeding, the secured party can seize and sell the collateral without previous citation and judgment provided the written security agreement granting the security interest covered by Chapter 9 contains a confession of judgment.⁴⁴ An act evidencing a security interest imports a confession of judgment when the obligor acknowledges the obligation secured thereby, whether then existing or to arise thereon, if the obligation is not paid at maturity.⁴⁵

An executory proceeding to enforce a security interest may be brought either in the parish where the property is situated or as provided in Article 42 of the Code of Civil Procedure.⁴⁶ A secured party seeking to enforce a security interest in an executory proceeding must file an ex-parte petition praying for the seizure and sale of the collateral subject to the security interest.⁴⁷ The secured party must submit with his petition the authentic evidence necessary to prove his right to use executory process to enforce the security interest.⁴⁸ Such authentic evidence would include, for Chapter 9 purposes, a written security agreement granting a security interest of a type covered by Chapter 9, signed by a debtor, that contains a confession of judgment.⁴⁹ If the secured party assigns, pledges, or otherwise transfers in whole or in part an obligation or right contained in the security agreement to a third party, the obligation or right therein assigned, pledged, or otherwise transferred as part of the security interest may be proven by any form or private writing signed by the secured party or any person entitled to effect such a transfer.⁵⁰ Such writing evidencing the assignment, pledge or other transfer will be deemed authentic for purposes of executory process.⁵¹

It is important to note that the signatures of all parties whose signatures purport to appear upon any writing evidencing a security interest or obligation secured by a security interest are presumed to be genuine if the verified petition or an affidavit attached thereto alleges or affirms that they are genuine to the best of the plaintiff's or affiant's knowledge or information.⁵² La.R.S. 10:9-508 is a unique section because the provisions of this section do not have a counterpart in Article 9 of the Model Uniform Commercial Code. The section, because of its somewhat unartful drafting, can be difficult to comprehend and interpret.

Judicial action via ordinary proceedings or executory process can clearly become expensive and arduous for the secured party. The secured party can avoid the rigmarole involved in taking judicial action against a debtor in default. To do so, he must resort to extrajudicial procedures allowed by Part 5 of Chapter 9.

Upon default by the debtor, a secured party may sell any goods in his possession or any goods voluntarily surrendered to him for such purposes by the debtor prior to or after default.⁵³ A secured party may in addition sell any instruments, documents, accounts, chattel paper or general intangibles, regardless of whether such instruments, documents, accounts, chattel paper or general intangibles are in the possession of the secured party.⁵⁴ The sale contemplated under Chapter 9 may be either a public or private sale.⁵⁵ The provisions of the Chapter 9 applicable to public or private sales are clearly not applicable to judicial sales following ordinary or executory process. Hence, it is extremely important that practitioners recognize how the rules to be discussed regarding "public" or "private" sales differ from the rules governing judicial sales.

The debtor may decide to surrender the collateral voluntarily in an effort to avoid being charged with the secured party's court costs and attorney fees incurred in exercising judicial process. Once the collateral is in the possession of the secured party, the following rules apply:

(1) The secured party must use reasonable care in the custody and preservation of collateral in his possession;⁵⁶

(2) Reasonable expenses (including the cost of any insurance and payment of taxes or other charges) incurred in the custody, preservation, use or operation of the collateral are chargeable to the debtor and are secured by the collateral;⁵⁷

(3) The risk of accidental loss or damage is on the debtor to the extent of any deficiency in any effective insurance coverage;⁵⁸

(4) The secured party may hold as additional security any increase or profits (except money) received from the collateral;⁵⁹

(5) The secured party must keep the collateral identifiable, but fungible collateral may be commingled;⁶⁰

(6) The secured party may repledge the collateral upon terms which do not impair the debtor's right to redeem the collateral;⁶¹

(7) The secured party may use or operate the collateral for the purpose preserving the collateral or its value;⁶²

(8) The secured party may use of operate the collateral pursuant tot he order of a court of appropriate jurisdiction;⁶³

(9) The secured party, except in the case of consumer goods, may operate the collateral in the manner and to the extent provided in the security agreement.⁶⁴

The obligations listed in (1) through (7) above are applicable to the secured party unless otherwise agreed.⁶⁵ In addition, the secured party is liable for the failure to meet any obligation listed in (1) through (7), but maintains his security interest even if he fails to meet such obligations.⁶⁶

It is interesting to note that the duty to exercise reasonable care may not be disclaimed by agreement.⁶⁷ However, the parties remain free to determine by agreement in any manner not manifestly unreasonable what constitutes "reasonable care" in a particular case.⁶⁸

When collateral has been delivered voluntarily or surrendered by the debtor to the secured party because of a default by the debtor, the secured party may sell, lease or otherwise dispose of the collateral.⁶⁹ The collateral may be sold, leased or otherwise disposed of in its current condition or may be sold, leased or disposed of after commercially reasonable preparation or processing.⁷⁰

Proceeds received from the disposition of such collateral after default must be applied in the following priority:

(1) To reasonable expenses or retaking, holding, preparing for sale or lease, selling, leasing, etc., and reasonable attorney's fees and legal expenses incurred by the secured party to the extent provided for in the security agreement and not prohibited by law;⁷¹

(2) The satisfaction of indebtedness secured by the security interest under which the disposition is made;⁷² and

(3) The satisfaction of indebtedness secured by any subordinate security in the collateral if the subordinated secured party makes a written notification of demand to and the notification of demand is received prior to the complete distribution of the proceeds.⁷³

The secured party must account to the debtor for any surplus, and conversely the debtor is liable for any deficiency unless the parties have otherwise agreed.⁷⁴ Note that if the underlying secured transaction involves the sale of accounts receivable or chattel paper, the debtor is entitled to any surplus or conversely liable for any deficiency only if there is a provision in the security agreement which entitles the debtor to a surplus or imposes liability upon the debtor for any deficiencies.⁷⁵

If the secured party chooses to dispose of the collateral by sale, the sale may be either public or private.⁷⁶ The sale may be made without prior appraisal of the collateral as a unit or in parcels.⁷⁷ The secured party may set the time, place, and terms of the sale, as long as every aspect of such sale including the manner, time, place, and terms of the sale is conducted in good faith and in a commercially reasonable manner.⁷⁸

Reasonable notification of the time and place of any public or private sale or other intended distribution must be sent by the secured party to the debtor.⁷⁹ Where the debtor and the owner of the collateral are not the same person, the owner of the collateral must also be sent reasonable notification, because the term "debtor" includes a person who owns the collateral, whether or not he is the person who owes payment or other performance of the obligation secured.⁸⁰ However, notice is not required to be sent to any surety, guarantor, endorser or other person secondarily liable to the secured party under an accessory contract, because such persons do not fall within the definition of the term "debtor."⁸¹ The debtor after default may, however, renounce or modify his right to notification of sale.⁸² The secured party, except in the case of consumer goods, must also give notice to any other secured parties who have given a written notice of a claim of an interest in the collateral.⁸³ This latter notice must be given before the debtor renounces his rights or before the secured party gives his notification to the debtor.⁸⁴

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