assignment under ucc

14.1 Assignment of Contract Rights

Learning objectives.

• Understand what an assignment is and how it is made.
• Recognize the effect of the assignment.
• Know when assignments are not allowed.
• Understand the concept of assignor’s warranties.

The Concept of a Contract Assignment

Contracts create rights and duties. By an assignment The passing or delivering by one person to another of the right to a contract benefit. , an obligee One to whom an obligation is owed. (one who has the right to receive a contract benefit) transfers a right to receive a contract benefit owed by the obligor One who owes an obligation. (the one who has a duty to perform) to a third person ( assignee One to whom the right to receive benefit of a contract is passed or delivered. ); the obligee then becomes an assignor One who agrees to allow another to receive the benefit of a contract. (one who makes an assignment).

The Restatement (Second) of Contracts defines an assignment of a right as “a manifestation of the assignor’s intention to transfer it by virtue of which the assignor’s right to performance by the obligor is extinguished in whole or in part and the assignee acquires the right to such performance.” Restatement (Second) of Contracts, Section 317(1). The one who makes the assignment is both an obligee and a transferor. The assignee acquires the right to receive the contractual obligations of the promisor, who is referred to as the obligor (see Figure 14.1 "Assignment of Rights" ). The assignor may assign any right unless (1) doing so would materially change the obligation of the obligor, materially burden him, increase his risk, or otherwise diminish the value to him of the original contract; (2) statute or public policy forbids the assignment; or (3) the contract itself precludes assignment. The common law of contracts and Articles 2 and 9 of the Uniform Commercial Code (UCC) govern assignments. Assignments are an important part of business financing, such as factoring. A factor A person who pays money to receive another’s executory contractual benefits. is one who purchases the right to receive income from another.

Figure 14.1 Assignment of Rights

Method of Assignment

Manifesting assent.

To effect an assignment, the assignor must make known his intention to transfer the rights to the third person. The assignor’s intention must be that the assignment is effective without need of any further action or any further manifestation of intention to make the assignment. In other words, the assignor must intend and understand himself to be making the assignment then and there; he is not promising to make the assignment sometime in the future.

Under the UCC, any assignments of rights in excess of $5,000 must be in writing, but otherwise, assignments can be oral and consideration is not required: the assignor could assign the right to the assignee for nothing (not likely in commercial transactions, of course). Mrs. Franklin has the right to receive $750 a month from the sale of a house she formerly owned; she assigns the right to receive the money to her son Jason, as a gift. The assignment is good, though such a gratuitous assignment is usually revocable, which is not the case where consideration has been paid for an assignment.

Acceptance and Revocation

For the assignment to become effective, the assignee must manifest his acceptance under most circumstances. This is done automatically when, as is usually the case, the assignee has given consideration for the assignment (i.e., there is a contract between the assignor and the assignee in which the assignment is the assignor’s consideration), and then the assignment is not revocable without the assignee’s consent. Problems of acceptance normally arise only when the assignor intends the assignment as a gift. Then, for the assignment to be irrevocable, either the assignee must manifest his acceptance or the assignor must notify the assignee in writing of the assignment.

Notice to the obligor is not required, but an obligor who renders performance to the assignor without notice of the assignment (that performance of the contract is to be rendered now to the assignee) is discharged. Obviously, the assignor cannot then keep the consideration he has received; he owes it to the assignee. But if notice is given to the obligor and she performs to the assignor anyway, the assignee can recover from either the obligor or the assignee, so the obligor could have to perform twice, as in Exercise 2 at the chapter’s end, Aldana v. Colonial Palms Plaza . Of course, an obligor who receives notice of the assignment from the assignee will want to be sure the assignment has really occurred. After all, anybody could waltz up to the obligor and say, “I’m the assignee of your contract with the bank. From now on, pay me the $500 a month, not the bank.” The obligor is entitled to verification of the assignment.

Effect of Assignment

General rule.

An assignment of rights effectively makes the assignee stand in the shoes of An assignee takes no greater rights than his assignor had. the assignor. He gains all the rights against the obligor that the assignor had, but no more. An obligor who could avoid the assignor’s attempt to enforce the rights could avoid a similar attempt by the assignee. Likewise, under UCC Section 9-318(1), the assignee of an account is subject to all terms of the contract between the debtor and the creditor-assignor. Suppose Dealer sells a car to Buyer on a contract where Buyer is to pay $300 per month and the car is warranted for 50,000 miles. If the car goes on the fritz before then and Dealer won’t fix it, Buyer could fix it for, say, $250 and deduct that $250 from the amount owed Dealer on the next installment (called a setoff). Now, if Dealer assigns the contract to Assignee, Assignee stands in Dealer’s shoes, and Buyer could likewise deduct the $250 from payment to Assignee.

The “shoe rule” does not apply to two types of assignments. First, it is inapplicable to the sale of a negotiable instrument to a holder in due course (covered in detail Chapter 23 "Negotiation of Commercial Paper" ). Second, the rule may be waived: under the UCC and at common law, the obligor may agree in the original contract not to raise defenses against the assignee that could have been raised against the assignor. Uniform Commercial Code, Section 9-206. While a waiver of defenses Surrender by a party of legal rights otherwise available to him or her. makes the assignment more marketable from the assignee’s point of view, it is a situation fraught with peril to an obligor, who may sign a contract without understanding the full import of the waiver. Under the waiver rule, for example, a farmer who buys a tractor on credit and discovers later that it does not work would still be required to pay a credit company that purchased the contract; his defense that the merchandise was shoddy would be unavailing (he would, as used to be said, be “having to pay on a dead horse”).

For that reason, there are various rules that limit both the holder in due course and the waiver rule. Certain defenses, the so-called real defenses (infancy, duress, and fraud in the execution, among others), may always be asserted. Also, the waiver clause in the contract must have been presented in good faith, and if the assignee has actual notice of a defense that the buyer or lessee could raise, then the waiver is ineffective. Moreover, in consumer transactions, the UCC’s rule is subject to state laws that protect consumers (people buying things used primarily for personal, family, or household purposes), and many states, by statute or court decision, have made waivers of defenses ineffective in such consumer transactions A contract for household or domestic purposes, not commercial purposes. . Federal Trade Commission regulations also affect the ability of many sellers to pass on rights to assignees free of defenses that buyers could raise against them. Because of these various limitations on the holder in due course and on waivers, the “shoe rule” will not govern in consumer transactions and, if there are real defenses or the assignee does not act in good faith, in business transactions as well.

When Assignments Are Not Allowed

The general rule—as previously noted—is that most contract rights are assignable. But there are exceptions. Five of them are noted here.

Material Change in Duties of the Obligor

When an assignment has the effect of materially changing the duties that the obligor must perform, it is ineffective. Changing the party to whom the obligor must make a payment is not a material change of duty that will defeat an assignment, since that, of course, is the purpose behind most assignments. Nor will a minor change in the duties the obligor must perform defeat the assignment.

Several residents in the town of Centerville sign up on an annual basis with the Centerville Times to receive their morning paper. A customer who is moving out of town may assign his right to receive the paper to someone else within the delivery route. As long as the assignee pays for the paper, the assignment is effective; the only relationship the obligor has to the assignee is a routine delivery in exchange for payment. Obligors can consent in the original contract, however, to a subsequent assignment of duties. Here is a clause from the World Team Tennis League contract: “It is mutually agreed that the Club shall have the right to sell, assign, trade and transfer this contract to another Club in the League, and the Player agrees to accept and be bound by such sale, exchange, assignment or transfer and to faithfully perform and carry out his or her obligations under this contract as if it had been entered into by the Player and such other Club.” Consent is not necessary when the contract does not involve a personal relationship.

Assignment of Personal Rights

When it matters to the obligor who receives the benefit of his duty to perform under the contract, then the receipt of the benefit is a personal right The right or duty of a particular person to perform or receive contract duties or benefits; cannot be assigned. that cannot be assigned. For example, a student seeking to earn pocket money during the school year signs up to do research work for a professor she admires and with whom she is friendly. The professor assigns the contract to one of his colleagues with whom the student does not get along. The assignment is ineffective because it matters to the student (the obligor) who the person of the assignee is. An insurance company provides auto insurance covering Mohammed Kareem, a sixty-five-year-old man who drives very carefully. Kareem cannot assign the contract to his seventeen-year-old grandson because it matters to the insurance company who the person of its insured is. Tenants usually cannot assign (sublet) their tenancies without the landlord’s permission because it matters to the landlord who the person of their tenant is. Section 14.4.1 "Nonassignable Rights" , Nassau Hotel Co. v. Barnett & Barse Corp. , is an example of the nonassignability of a personal right.

Assignment Forbidden by Statute or Public Policy

Various federal and state laws prohibit or regulate some contract assignment. The assignment of future wages is regulated by state and federal law to protect people from improvidently denying themselves future income because of immediate present financial difficulties. And even in the absence of statute, public policy might prohibit some assignments.

Contracts That Prohibit Assignment

Assignability of contract rights is useful, and prohibitions against it are not generally favored. Many contracts contain general language that prohibits assignment of rights or of “the contract.” Both the Restatement and UCC Section 2-210(3) declare that in the absence of any contrary circumstances, a provision in the agreement that prohibits assigning “the contract” bars “only the delegation to the assignee of the assignor’s performance.” Restatement (Second) of Contracts, Section 322. In other words, unless the contract specifically prohibits assignment of any of its terms, a party is free to assign anything except his or her own duties.

Even if a contractual provision explicitly prohibits it, a right to damages for breach of the whole contract is assignable under UCC Section 2-210(2) in contracts for goods. Likewise, UCC Section 9-318(4) invalidates any contract provision that prohibits assigning sums already due or to become due. Indeed, in some states, at common law, a clause specifically prohibiting assignment will fail. For example, the buyer and the seller agree to the sale of land and to a provision barring assignment of the rights under the contract. The buyer pays the full price, but the seller refuses to convey. The buyer then assigns to her friend the right to obtain title to the land from the seller. The latter’s objection that the contract precludes such an assignment will fall on deaf ears in some states; the assignment is effective, and the friend may sue for the title.

Future Contracts

The law distinguishes between assigning future rights under an existing contract and assigning rights that will arise from a future contract. Rights contingent on a future event can be assigned in exactly the same manner as existing rights, as long as the contingent rights are already incorporated in a contract. Ben has a long-standing deal with his neighbor, Mrs. Robinson, to keep the latter’s walk clear of snow at twenty dollars a snowfall. Ben is saving his money for a new printer, but when he is eighty dollars shy of the purchase price, he becomes impatient and cajoles a friend into loaning him the balance. In return, Ben assigns his friend the earnings from the next four snowfalls. The assignment is effective. However, a right that will arise from a future contract cannot be the subject of a present assignment.

Partial Assignments

An assignor may assign part of a contractual right, but only if the obligor can perform that part of his contractual obligation separately from the remainder of his obligation. Assignment of part of a payment due is always enforceable. However, if the obligor objects, neither the assignor nor the assignee may sue him unless both are party to the suit. Mrs. Robinson owes Ben one hundred dollars. Ben assigns fifty dollars of that sum to his friend. Mrs. Robinson is perplexed by this assignment and refuses to pay until the situation is explained to her satisfaction. The friend brings suit against Mrs. Robinson. The court cannot hear the case unless Ben is also a party to the suit. This ensures all parties to the dispute are present at once and avoids multiple lawsuits.

Successive Assignments

It may happen that an assignor assigns the same interest twice (see Figure 14.2 "Successive Assignments" ). With certain exceptions, the first assignee takes precedence over any subsequent assignee. One obvious exception is when the first assignment is ineffective or revocable. A subsequent assignment has the effect of revoking a prior assignment that is ineffective or revocable. Another exception: if in good faith the subsequent assignee gives consideration for the assignment and has no knowledge of the prior assignment, he takes precedence whenever he obtains payment from, performance from, or a judgment against the obligor, or whenever he receives some tangible evidence from the assignor that the right has been assigned (e.g., a bank deposit book or an insurance policy).

Some states follow the different English rule: the first assignee to give notice to the obligor has priority, regardless of the order in which the assignments were made. Furthermore, if the assignment falls within the filing requirements of UCC Article 9 (see Chapter 28 "Secured Transactions and Suretyship" ), the first assignee to file will prevail.

Figure 14.2 Successive Assignments

Assignor’s Warranties

An assignor has legal responsibilities in making assignments. He cannot blithely assign the same interests pell-mell and escape liability. Unless the contract explicitly states to the contrary, a person who assigns a right for value makes certain assignor’s warranties Promises, express or implied, made by an assignor to the assignee about the merits of the assignment. to the assignee: that he will not upset the assignment, that he has the right to make it, and that there are no defenses that will defeat it. However, the assignor does not guarantee payment; assignment does not by itself amount to a warranty that the obligor is solvent or will perform as agreed in the original contract. Mrs. Robinson owes Ben fifty dollars. Ben assigns this sum to his friend. Before the friend collects, Ben releases Mrs. Robinson from her obligation. The friend may sue Ben for the fifty dollars. Or again, if Ben represents to his friend that Mrs. Robinson owes him (Ben) fifty dollars and assigns his friend that amount, but in fact Mrs. Robinson does not owe Ben that much, then Ben has breached his assignor’s warranty. The assignor’s warranties may be express or implied.

Key Takeaway

Generally, it is OK for an obligee to assign the right to receive contractual performance from the obligor to a third party. The effect of the assignment is to make the assignee stand in the shoes of the assignor, taking all the latter’s rights and all the defenses against nonperformance that the obligor might raise against the assignor. But the obligor may agree in advance to waive defenses against the assignee, unless such waiver is prohibited by law.

There are some exceptions to the rule that contract rights are assignable. Some, such as personal rights, are not circumstances where the obligor’s duties would materially change, cases where assignability is forbidden by statute or public policy, or, with some limits, cases where the contract itself prohibits assignment. Partial assignments and successive assignments can happen, and rules govern the resolution of problems arising from them.

When the assignor makes the assignment, that person makes certain warranties, express or implied, to the assignee, basically to the effect that the assignment is good and the assignor knows of no reason why the assignee will not get performance from the obligor.

• If Able makes a valid assignment to Baker of his contract to receive monthly rental payments from Tenant, how is Baker’s right different from what Able’s was?
• Able made a valid assignment to Baker of his contract to receive monthly purchase payments from Carr, who bought an automobile from Able. The car had a 180-day warranty, but the car malfunctioned within that time. Able had quit the auto business entirely. May Carr withhold payments from Baker to offset the cost of needed repairs?
• Assume in the case in Exercise 2 that Baker knew Able was selling defective cars just before his (Able’s) withdrawal from the auto business. How, if at all, does that change Baker’s rights?
• Why are leases generally not assignable? Why are insurance contracts not assignable?

N.Y. Uniform Commercial Code Law Section 2-210 Delegation of Performance

• Assignment of Rights

Source: Section 2-210 — Delegation of Performance; Assignment of Rights , https://www.­nysenate.­gov/legislation/laws/UCC/2-210 (updated Sep. 22, 2014; accessed Aug. 24, 2024).

Accessed: Aug. 24, 2024

Last modified: Sep. 22, 2014

§ 2-210’s source at nysenate​.gov

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ULC Statement on Ownership of Investment Property under Uniform Commercial Code Article 8

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The ucc today, article 1, general provisions.

Uniform Commercial Code Article 1 contains definitions and general provisions applicable as default rules to transactions covered under other articles of the UCC. Article 1 was last revised in 2001, with a few minor amendments since then to harmonize with recent revisions of other UCC articles. View Article 1, General Provisions

Article 2, Sales

Uniform Commercial Code Article 2 governs the sale of goods. It was part of the original Uniform Commercial Code approved in 1951. Article 2 represented a revision and modernization of the Uniform Sales Act, which was originally approved by the National Conference of Commissioners on Uniform State Laws in 1906. The Uniform Law Commission and American Law Institute approved a revised Article 2 in 2003 that was not adopted in any state, and was subsequently withdrawn by both organizations in 2011. Thus the 1951 version of Article 2 is the most recent official version. View Article 2, Sales

Article 2A, Leases

Uniform Commercial Code Article 2A governs leases of personal property. It was first added to the Uniform Commercial Code in 1987 and amended in 1990. A revision was approved by the Uniform Law Commission and the American Law Institute in 2003, but was not adopted in any jurisdiction and subsequently withdrawn by both organizations in 2011. Thus, the 1987 version of Article 2A, as amended in 1990, remains the official text. View Article 2A, Leases

Article 3, Negotiable Instruments

Uniform Commercial Code Article 3 governs negotiable instruments: drafts (including checks) and notes representing a promise to pay a sum of money, and that have independent value because they are negotiable. An instrument is negotiable if it can be transferred to another person and remain enforceable against the person who originally made the promise to pay. The substance of Article 3 has its roots in the Negotiable Instrument Law first approved by the National Conference of Commissioners on Uniform State Laws in 1896. That early uniform law was revised and incorporated into the original version of the UCC in 1951, and a further revision was approved in 1990. Finally, a set of amendments to UCC Articles 3 and 4 was approved in 2002. View Article 3, Negotiable Instruments

Article 4, Bank Deposits and Collections

Uniform Commercial Code Article 4 governs bank deposits and collections, providing rules for check processing and automated inter-bank collections. Article 4 was completely revised in 1990 and amended in 2002. View Article 4, Bank Deposits and Collections

2002 Amendments to Article 3, Negotiable Instruments and Article 4, Bank Deposits

These 2002 amendments to Uniform Commercial Code Articles 3 and 4 update provisions dealing with payment by checks and other paper instruments to provide essential rules for new technologies and practices in payment systems. View Article 3, Negotiable Instruments and Article 4, Bank Deposits, Amendments to

Article 4A, Funds Transfers

Uniform Commercial Code Article 4A provides a comprehensive body of law on the rights and obligations connected with fund transfers. It was added to the UCC in 1989. View Article 4A, Funds Transfers

2012 Amendments to Article 4A, Funds Transfers

These 2012 Amendments to Section 108 of Uniform Commercial Code Article 4A provide that Article 4A applies to a remittance transfer that is not an electronic funds transfer under the Federal Electronic Funds Transfer Act (EFTA). The amendment was necessary to conform the UCC with the federal law and associated regulations. View Article 4A, Amendments to

Article 5, Letters of Credit

Uniform Commercial Code Article 5 governs letters of credit, which are typically issued by a bank or other financial institution to its business customers in order to facilitate trade. Article 5 was updated in 1995 to address advances in technology and modern business practices. View Article 5, Letters of Credit

Article 6, Bulk Sales

Uniform Commercial Code Article 6 covers bulk sales - a topic many states have determined is obsolete. The original version of Article 6 was withdrawn by the Uniform Law Commission and the American Law Institute in 1989 and replaced with two options for every state to consider: replace Article 6 with a revised version 6, or repeal Article 6 entirely. The ULC recommends repeal, and nearly every state has followed that recommendation. View Article 6, Bulk Sales

Article 7, Documents of Title

Uniform Commercial Code Article 7 covers documents of title for personal property, including warehouse receipts, bills of lading, and other documents typically used for commercial trade. Revised Article 7, approved in 2003, updates the original version to provide a framework for the further development of electronic documents of title, and to update the article in light of state, federal and international legal developments. View Article 7, Documents of Title

Article 8, Investment Securities

Uniform Commercial Code Article 8 provides a modern legal structure for the system of holding securities through intermediaries. The 1994 revision sets forth rules concerning the system through which securities are held, specifying the mechanisms by which ownership and other interests in securities are recorded and changed, and setting out some of the rights and duties of the parties who participate in the securities holding system. View Article 8, Investment Securities

Article 9, Secured Transactions

Uniform Commercial Code Article 9 provides a statutory framework that governs secured transactions--transactions that involve the granting of credit secured by personal property. Each state maintains an office for filing finance statements to publicly disclose security interests in encumbered property. A substantial revision to Article 9 was completed in 1998 and adopted in all states. The article was further amended in 1999, 2000, 2001, and 2010. View Article 9, Secured Transactions

2010 Amendments to Article 9, Secured Transactions

Uniform Commercial Code (UCC) Article 9 governs secured transactions in personal property. The 2010 Amendments to Article 9 modify the existing statute to respond to filing issues and address other matters that have arisen in practice following a decade of experience with the 1998 version. Most significantly, the 2010 Amendments provide greater guidance as to the form of the name of an individual debtor to be provided on a financing statement. View Article 9, Secured Transactions, Amendments to

2018 Amendments to 9-406 and 9-408 of UCC Article 9, Secured Transactions

Amendments to UCC Article 9 Sections 9-406 and 9-408 modify the anti-assignment override provisions, thereby excluding security interests in ownership interests of general partnerships, limited partnerships, and limited liability companies from the override provisions. View UCC Article 9, Secured Transactions, Amendments to 9-406 and 9-408

Article 12 and the 2022 Amendments

The 2022 amendments to the Uniform Commercial Code address emerging technologies, providing updated rules for commercial transactions involving virtual currencies, distributed ledger technologies (including blockchain), artificial intelligence, and other technological developments. The amendments span almost every article of the UCC and add a new Article 12 addressing certain types of digital assets defined as “Controllable Electronic Records” (CERs). The amendments provide new default rules to govern transactions involving these new technologies and clarify the UCC’s applicability to mixed transactions involving both goods and services. The amendments also contain some miscellaneous revisions unrelated to technological developments but providing needed clarification. View UCC, 2022 Amendments to

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When Your Vendor’s Lender Demands You Pay It Instead of Your Vendor

Apr 22, 2020

Categories:

Blockchain and Banking Blog Blogs Coronavirus Response Team

Vincent E. Mauer

A commercial lender’s favorite collateral is often a borrower’s accounts receivable. This collateral is the building block of countless revolving lines of credit that provide borrowers with working capital and flexibility. Lenders prefer accounts receivable as collateral because it is similar to cash, unlike collateral that must be fed and liquidated (assets that must be insured, stored, marketed and sold). Additionally, the Uniform Commercial Code (“UCC”) permits lenders to collect accounts receivable directly from the borrower’s customers without using judicial process, thus saving time and money. [1]

After a loan agreement “goes bad” and the lender declares a default, the lender’s options for collection of accounts receivable collateral include giving notice to persons whose accounts owed to a borrower were pledged by that borrower to the lender (the borrower’s customer is a “payor”), [2] that is, accounts receivable in which the lender has a UCC Article 9 Security interest. [3] The primary operative provision is UCC 9-406, which states in part:

• Subject to subsections (b) through (i), an account debtor on an account , chattel paper , or a payment intangible may discharge its obligation by paying the assignor [borrower] until, but not after, the account debtor receives a notification, authenticated by the assignor or the assignee that the amount due or to become due has been assigned and that payment is to be made to the assignee. After receipt of the notification, the account debtor [ payor] may discharge its obligation by paying the assignee [Lender] and may not discharge the obligation by paying the assignor [Borrower] .
• Subject to subsection (h), notification is ineffective under subsection (a): (1) if it does not reasonably identify the rights assigned; (2) . . . [a limitation applicable to payment intangibles that are not accounts   receivable, for example insurance settlements]; or (3) at the option of an account debtor, if the notification notifies the account debtor to make less than the full amount of any installment or other periodic payment to the assignee, even if: (A) only a portion of the account , chattel paper , or payment intangible has been assigned to that assignee; (B) a portion has been assigned to another assignee; or (C) the account debtor knows that the assignment to that assignee is limited. [4]
• Subject to subsection (h), if requested by the account debtor [ payor], an assignee [lender] shall seasonably furnish reasonable proof that the assignment has been made . Unless the assignee complies, the account debtor may discharge its obligation by paying the assignor, even if the account debtor has received a notification under subsection (a).

(Emphases added.) Ordinarily, the above-quoted statute means that, after a borrower defaults, the lender can give a “notification” to its borrower’s customers ( payors) [5] and demand that amounts owed to the borrower instead be paid to the lender if the lender has a perfected security interest in its borrower’s receivables.

There are a few common concerns faced by our payor clients who receive notifications from their secured vendor’s secured lenders.

The first thing a  payor must understand is that neither (a) the borrower’s granting of a security interest in its accounts receivable, nor (b) a lender’s notification under UCC 9-406, will change the amount owed, the terms of the account debt, or the payor’s rights such as a discount for returned merchandise or prompt payment. A  payor who receives a lender’s notification should, therefore, take a deep breath and determine exactly what is owed to the vendor that granted the security interest to the lender.

In my experience,  payors who receive a lender’s notification nearly always choose to alert their vendor (the lender’s borrower) of the notification. The statute neither permits nor prohibits such action. Typically, the payor’s communication is, in part, an effort by the payor to (i) alert its vendor that a payment may not be coming, (ii) assess the vendor’s stability so the payor can determine if it needs to find a new source for the goods and services supplied by the vendor, and (iii) to seek information on whether the lender’s notification is real and appropriate.

Contacting the vendor is understandable. It is natural for a  payor to seek information from the party with whom it regularly does business rather than a probable stranger, the lender. Vendor-provided information, however, comes with a caveat: If the vendor asserts that the lender’s notice to the payor is in error and should be ignored, the payor accepts that advice at its own risk. The UCC provision quoted above clearly states that a  payor who has received an appropriate lender’s notification cannot discharge its debt to the vendor by paying the vendor instead of the lender.

Rather, or in addition to, contacting the vendor, a  payor can choose to contact the lender and request evidence that payment to the lender is appropriate. In this event, the UCC requires the lender to provide “reasonable proof that the assignment was made.” This usually means evidence that the vendor granted a security interest to the lender and that the accounts receivable created by the payor’s debt to the vendor is covered by that security interest. A  payor should take advantage of this opportunity to communicate with the lender and request “proof,” if either (a) the vendor asserts that the lender’s notice to payor is wrongful, or (b) the lender’s “notification” seems inadequate. This is a proper response to payor’s concerns. [6]

In my experience, lenders often ignore a  payor’s request for “proof” following a lender’s “notification.” There are many possible reasons for this inaction by the lender. [7] Whatever the rationale, however, the result is the same. According to UCC 9-406 comment 4:

[e]ven if the proof is not forthcoming, the notification of assignment would remain effective, so that, in the absence of reasonable proof of the assignment, the account debtor could discharge the obligation by paying either the assignee or the assignor. Of course, if the assignee [lender] did not in fact receive an assignment, the account debtor [ payor] cannot discharge its obligation by paying a putative assignee who is a stranger [a fraudster] .

(Emphasis added). Given the last sentence in this comment, the only safe action by payor is payment to the vendor, not the lender, if the lender failed to respond to payor’s request for “proof.”

As noted above, the lender’s notification to payor does not alter the terms of the payor’s obligations to the vendor. For example, if a  payor has received a notification from a lender and has requested reasonable proof of the assignment, payor may discharge its obligation by paying the assignor at the time when payment is due, even if the account debtor has not yet received a response to its request for proof. This is a warning for lenders to think about their borrower’s collection cycle when sending notifications to payors.

If a  payor deals with a large vendor or one with diverse operations, the vendor may have more than one secured lender. Vendors can have two or more secured creditors each with a security interest in the vendor’s accounts payable. [8] Sophisticated payors will often discover this fact when they do an online search with the appropriate Secretary of State’s office. Unfortunately, the UCC’s official commentary is silent on the payor’s duties in this situation. See, however, comment 7 to UCC 9-406:

For example, an assignor [vendor] might assign the same receivable to multiple assignees [. . . .] Or, the assignor could assign the receivable to assignee-1, which then might re-assign it to assignee-2, and so forth. The rights and duties of an account debtor in the face of multiple assignments and in other circumstances not resolved in the statutory text are left to the common-law rules. See, e.g., Restatement (2d), Contracts Sections 338(3), 339.

When faced with this problem, counsel must determine which state’s common law applies and find the non-UCC answer from applicable law.

Finally, clients often ask whether a particular lender notification is an appropriate and effective “authenticated” notification. The answer depends on the circumstances of the notification. Fortunately, there are plenty of court decisions that can provide guidance on this question. One example is Swift Energy Operating, LLC v. Plemco-South Inc. , 157 So.3d 1154 (La. Ct. App. 2015), where a borrower did business with an account receivable factor, the secured party. The borrower and factor sent an email to the payor which was the alleged lender notification under Louisiana’s version of UCC 9-406. In response to that email, the payor’s employee directed the lender to contact the payor’s appropriate office. The payor’s employee, however, did not sign and return the acknowledgment that payor received the lender’s notification. The lender subsequently failed to contact the payor’s accounts payable office as directed and the payor paid its obligation to the vendor rather than the lender/account receivable factor. Litigation was initiated in an effort to determine if payor was nonetheless liable to the lender for failure to follow the lender’s notification.

The Louisiana Court of Appeals held that the email was not an “authenticated” notification in compliance with the statute. The court reasonably held that the required notice must be directed to the appropriate payor department or employee when the lender has notice of that department. The court ruled:

[W]e find that the notice required by La.R.S. 10:9-406(a) was not effected prior to Swift Energy’s payment to Plemco–South. Given the size of its operation, we find that Swift Energy maintained reasonable routines for communicating significant information through its departmentalization policy, and both Factor King and Plemco–South were timely made aware of the proper department for delivery of the required notice. Had either Ms. Gleberman or Mr. Stigall followed Ms. Keo’s instruction, notice would have been effected to the appropriate department well before the payment to Plemco–South at issue.

Id. at 1164.

The UCC’s provision for nonjudicial collection of accounts receivable collateral is important and valuable to lenders. Unfortunately, it regularly raises questions and concerns for recipients of lender notifications. Experienced counsel can help their payor clients resolve concerns, determine who to pay, and possibly smooth any tensions between the payor and its vendor by demonstrating that the payor exercised every opportunity to protect the vendor before paying the lender.

For more information, please contact Vince Mauer or any attorney in Frost Brown Todd’s Financial Services industry team.

[1]  This post does not address a lender’s efforts to control accounts receivable collateral while the lending relationship is intact, such as use of a lockbox to receive payments and control over the borrower’s bank accounts into which the accounts receivable payments are deposited by the borrower (whether by check or wire transfer).

[2]  For purposes of this blog post, I will use the term “Payor” for the borrower’s customer who owes money to the borrower and whose debt to borrower is subject to a security interest in favor of the lender. This blog post is written from a Payor’s perspective.

[3]  A warning for lenders: According to the Ohio Supreme Court, this remedy is not fully available against the collateral of a borrower whose customer, the Payor, is a government entity. See MP Star Financial Inc. v. Cleveland State Univ. , 837 N.E.2d 758 (Ohio 2005) ( “provision of UCC making an account debtor liable to an assignee of accounts receivable, for payments made to assignor after receiving notice of assignment, does not apply to payments made by an account debtor that is a governmental unit.”).

[4]  Under subsection (b)(3), an account debtor that is notified to pay an assignee less than the full amount of any installment or other periodic payment has the option to treat the notification as ineffective, ignore the notice, and discharge the assigned obligation by paying the assignor [vendor]. This is a convenience for Payors and a warning to lenders.

[5]  For the typical recipient of this notice (a Payor), the borrower whose account was assigned is a vendor, a business that sells goods or services to you and grants its lender a security interest in the account receivable generated by that sale.

[6] Comment 3 to UCC 9-406 states: “[i]f an account debtor [Payor] has doubt as to the adequacy of a notification, it may not be safe [for the Payor] in disregarding the notification unless it [Payor] notifies the assignee [lender] with reasonable promptness as to the respects in which the account debtor considers the notification defective.” So, a Payor with concerns may be better off to seek information from the lender rather than making its own decision concerning the adequacy of the notification.

[7]  I have occasionally counseled lender clients to ignore a Payor’s request for “proof.” The reasons for this advice are beyond the scope of this blog post.

[8]  Hopefully, there is an Intercreditor Agreement addressing lien priorities and which lender(s) can send a lender notification.

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Secured Party Has Same Rights as Assignee Under UCC § 9-406

On November 22, 2022, the Court of Appeals issued a decision in Worthy Lending LLC v. New Style Contrs., Inc. , 2022 NY Slip Op. 06631 , holding that a secured party has the same rights as an assignee under UCC § 9-406, explaining:

Section 9-607 (a) (3), entitled “Collection and Enforcement by Secured Party,” provides as follows: If so agreed, and in any event after default, a secured party may enforce the obligations of an account debtor or other person obligated on collateral and exercise the rights of the debtor with respect to the obligation of the account debtor or other person obligated on collateral to make payment or otherwise render performance to the debtor, and with respect to any property that secures the obligations of the account debtor or other person obligated on the collateral. An account debtor who receives a secured creditor’s notice asserting its right to receive payment directly can pay the secured creditor and receive a complete discharge (UCC 9-406 [a]) or, if in doubt, can seek proof from the secured creditor that it possesses a valid assignment and withhold payment in the interim (UCC 9-406 [c]). Here, Worthy is the “secured party,” with the authority to enforce the rights of its debtor (Checkmate) to collect on the obligations of the account debtor (New Style). The lower courts held that subsection 9-607 (e) bars Worthy from using the mechanism provided for in section 9-607, by providing that this section does not determine whether an account debtor, bank, or other person obligated on collateral owes a duty to a secured party. However, the plain language of subsection (e) merely states that UCC 9-607 does not itself determine whether an account debtor owes a duty to a secured party. The agreement between Worthy and Checkmate grants Worthy the right to direct Checkmate’s debtors to pay Worthy directly, and bars Checkmate from interfering with any such direction if given. Subsection (e) of 9-607 does not even imply, much less state, that parties cannot contractually assume duties concerning the right of a secured party to enforce the rights of a debtor as against account debtors. Indeed, section 9-607 (a) (3) expressly provides that “in any event after default,” a secured party may obtain collateral directly from an account debtor, and the secured party and debtor may agree that the secured party may do so by agreement, without regard to default—which they did here. Consistent with the statute’s text, the official comments of the UCC Permanent Editorial Board (PEB)[FN1] issued in 2020 explain that UCC 9-607 “establishes only the baseline rights of the secured party vis-a-vis the debtor” and permits “the secured party to enforce and collect [from an account debtor] after default or earlier if so agreed” (UCC 9-607, Comment 6; see also PEB Commentary No. 21 at 4 n 21). New Style contends that UCC 9-406 allows only assignors—not holders of security interests—to rely on the payment-redirection provisions contained in that section. UCC Section 9-406 (a) states: An account debtor on an account, chattel paper, or a payment intangible may discharge its obligation by paying the assignor until, but not after, the account debtor receives a notification, authenticated by the assignor or the assignee, that the amount due or to become due has been assigned and that payment is to be made to the assignee. After receipt of the notification, the account debtor may discharge its obligation by paying the assignee and may not discharge the obligation by paying the assignor. The definition of “security interest” in the UCC itself does not distinguish between a security interest and an assignment and the definition section contains no separate definition of “assignment,” “assignor” or “assignee.” The commentary makes clear that a security interest is treated as an assignment. As the commentary explains, treating assignments and security interests identically promotes efficient dealings between the parties—they do not have to try to determine whether the interest is an assignment or a security interest by parsing contractual language. New York case law, state and federal, is consistent. The PEB recently amended the official UCC comments to clarify what has long been the case: the term assignment, as used in UCC article 9, refers to both an outright transfer of ownership and a transfer of an interest to secure an obligation. (Internal quotations and citations omitted).

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The Critical Need to Give Proper Notice of Assignment

A recent decision out of the Maryland federal courts is a good reminder of how critical it is to properly notify account debtors of an assignment of secured loans (and leases) so as to make the account debtor legally obligated to pay you, and to assure that they pay the assignor at their peril.  The case, Forest Capital LLC v. BlackRock, Inc. , 2015 U.S. Dist. LEXIS 23773 (D. Md. Feb. 26, 2015), involved a lawsuit filed by Forest Capital LLC against BlackRock, Inc. for conversion and violations of the Uniform Commercial Code (UCC). The facts of the case are quite different from a standard equipment lease/loan because it involved a factoring relationship. The lessons to be learned, however, are nonetheless applicable to what is a routine occurrence in our industry – the assignment of loans and leases. The case involved a factor who alleged that a depository institution improperly made two payments totaling $1.05 million to the borrower’s creditors despite receiving notice that the borrower’s rights in the monies held by the depository institution had been assigned to the factor. The Court granted the depository institution’s motion to dismiss the lawsuit, finding, amongst other reasons, that the factor never gave the depository institution proper notice under the UCC. The Court found that the alleged notice (a December 2013 letter sent by the borrower) was legally insufficient because it was “vague” and did not “reasonably identify the rights assigned.” Moreover, the factor never countersigned, or was copied on, the letter. While again the case involved unique facts, the notice was defective under the same UCC provisions governing the notice routinely given in the equipment leasing and finance industry when loans and leases are assigned (as is often the case when a broker or lessor is involved). Thus, the decision is nonetheless an important reminder to ensure that proper notice of assignment is given to the account debtor. Proper notice of assignment achieves two important objectives for an assignee under two separate sections of Article 9 of the UCC. First, under UCC 9-406(a), it puts the account debtor “on the hook” for ensuring that payments are actually made to, and received by, the assignee. Second, under UCC 9-404(a), it cuts off the account debtor’s right to assert against the assignee claims and defenses – such as offset – arising after the notice is issued and related to the underlying loan transaction, as well as those claims and defenses arising after the notice is issued and related to other transactions between the account debtor and the assignor. Absent effective notice of assignment, the account debtor may continue to pay the assignor and may raise against the assignee defenses and claims which accrued even after the assignment took place (1.) .  This begs the question – what constitutes proper notification?  First, the content of the notice must be sufficient. Under UCC 9-404(a) – the code section which cuts off defenses – the notice must be authenticated, convey the essential fact of the assignment, and identify the assignee. However, UCC 9-406 – the code section which obligates the account debtor to pay you and not the assignor – is somewhat more stringent. The notice must not only be authenticated (2.) , but also must include a demand that future payments be made directly to the assignee (3.) , and must “reasonably identify the rights assigned. (4.) ”  Authentication can normally be satisfied by sending the notice on the assignee’s letterhead or on a form upon which the assignee’s name appears (5.) . As far as what constitutes “reasonable identification”, while there is no “black letter rule” defining it, an appropriate level of common sense should be employed. It should go without saying that an assignee should not rely on simply issuing new invoices listing the assignee’s address, or notifying the account debtor in conversation (as a factor unfortunately did in another case where the Court found the notice ineffective (6.) ). The notice should be a separate written communication and care should be taken to identify the collateral, the loan documents, the parties to the loan documents, and indicate an account/loan number, if applicable. The more detail, the better. Also, keep in mind that if an account debtor is notified to pay anything less than the full amount of an installment to the assignee, he can ignore the notice because it’s ineffective (7.) .   Second, the account debtor must actually receive the notification. Notice which is merely sent to the address listed in the loan documents which is no longer a valid address, is unlikely to pass muster. While we’re cognizant of the economic realities underlying deal flow in the equipment leasing and finance industry – especially on smaller ticket deals – it behooves an assignee to avoid treating the notice as a merely ministerial matter. Care should be taken to identify the proper address (e.g., an Internet search, post office inquiry, credit report, or skip trace). Also, as is the case in most commercial transactions, if the account debtor is a company, the appropriate agents to receive notice should be identified (e.g., CEO, office manager, etc.). Notice is probably best sent via ordinary U.S. Mail as well as via certified or registered mail, return receipt requested, as well as via email.  Moreover, while again in many states an assignee’s ownership of the loan/lease is not predicated upon obtaining a written assignment, it’s important to remember that an account debtor has the right to request “reasonable proof” of the assignment from the assignee. Until such proof is received, any payments made to the assignor will count towards discharge of the obligation assigned (8.) . Therefore, best practices dictate that the assignee obtain a written assignment and retain it in the file.  Finally, these are all general guidelines and counsel on a state-by-state basis, and if possible, on a transaction-by-transaction basis, should review assignee notices. In addition, consumer transactions may be subject to other laws establishing special rules for consumer account debtors and thus care should be taken to address those rules as well.

1. Notably, however, defenses and counterclaims are not available to the account debtor if he contractually waived those defenses in the loan/lease documents (i.e., the industry standard “Waiver of Defenses” provision) and certain conditions are met, such as the assignee has no knowledge of any defenses (UCC 9-403). It is also important to remember that notice of assignment is not required to validate the assignment itself. In fact, in many states, not only is notice irrelevant, but a written assignment itself is not even required. 2. UCC 9-406(a) 3. UCC 9-406(a) 4. UCC 9-406(b)(1) 5. UCC 9-406, Official Comment 2 6. In re Haley, 81 UCC rep. 2d 990 (Bankr. N.D. Ala. 2013). 7. UCC 9-406(b)(3) 8. UCC 9-406(c)

§ 5-114. Assignment of Proceeds.

(a) In this section, "proceeds of a letter of credit" means the cash, check, accepted draft, or other item of value paid or delivered upon honor or giving of value by the issuer or any nominated person under the letter of credit . The term does not include a beneficiary's drawing rights or documents presented by the beneficiary.

(b) A beneficiary may assign its right to part or all of the proceeds of a letter of credit. The beneficiary may do so before presentation as a present assignment of its right to receive proceeds contingent upon its compliance with the terms and conditions of the letter of credit .

(c) An issuer or nominated person need not recognize an assignment of proceeds of a letter of credit until it consents to the assignment.

(d) An issuer or nominated person has no obligation to give or withhold its consent to an assignment of proceeds of a letter of credit, but consent may not be unreasonably withheld if the assignee possesses and exhibits the letter of credit and presentation of the letter of credit is a condition to honor .

(e) Rights of a transferee beneficiary or nominated person are independent of the beneficiary's assignment of the proceeds of a letter of credit and are superior to the assignee's right to the proceeds.

(f) Neither the rights recognized by this section between an assignee and an issuer , transferee beneficiary , or nominated person nor the issuer's or nominated person's payment of proceeds to an assignee or a third person affect the rights between the assignee and any person other than the issuer, transferee beneficiary, or nominated person. The mode of creating and perfecting a security interest in or granting an assignment of a beneficiary's rights to proceeds is governed by Article 9 or other law. Against persons other than the issuer, transferee beneficiary, or nominated person, the rights and obligations arising upon the creation of a security interest or other assignment of a beneficiary's right to proceeds and its perfection are governed by Article 9 or other law.