ucc article 9 notice of assignment

• Frost Brown Todd

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

Apr 22, 2020

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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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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)

It’s Not Nice to Pay an Invoice Twice: Payment Demands During COVID-19 by Assignees of Accounts Under UCC Section 9-406

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The mail room just received a piece of unregistered first-class mail from a company you don’t recognize. The letter floats around the office for a couple of days before landing on the desk of your accounts payable clerk, who is taking the week off. The clerk returns and determines that the letter seems to be some sort of collection scam–the letter says to pay some collection company for an account receivable you owe to one of your vendors. But that vendor is set up for ACH debits, and a payment just went out the day before your A/P clerk returned. Because there’s nothing to pay, your A/P clerk round-files the notice. Three more payments go out before you receive notice and complaint from the collection company: it’s suing you for not paying those same four invoices. First, the bad news: You still owe the collection company for the invoices. Next, the worse news: You call your critical vendor to say that you have to pay all future amounts over to the collection company, and your vendor threatens to withhold critical deliveries. Your vendor says that the collection company is gouging them on late fees and attorneys and isn’t owed another penny. How did this become your problem?

The Legal Framework

Article 9 of the Uniform Commercial Code (the “UCC”) provides a powerful collection tool for lenders and purchasers of accounts receivable. An “account debtor” (the party obligated to pay an account receivable) may be obligated to pay the same invoice twice if it receives a proper notice from an assignee but nonetheless pays the original owner of the account receivable. Assignments and Pledges of Accounts Payees on accounts, payment intangibles, and promissory notes (“payment obligations”) may freely assign the obligations, notwithstanding any restrictions in the agreement between the account debtor and the payee/assignor. Section 9-406(d) of the UCC renders the anti-assignment term and any default resulting from violation of that term ineffective. This allows payees/assignors to monetize payment obligations through pledge or sale. The term “assignee” in the context of Section 9-406 means either a purchaser of a payment obligation or a secured party with a security interest in the payment obligation. Effective Notification An assignee may provide notice to the account debtor of the assignment or pledge under Section 9-406(b). A proper notice must be authenticated (signed, which includes electronic signatures). A notice that is authenticated may nonetheless be ineffective under either of the following circumstances:

• If it does not reasonably identify the rights assigned.
• At the option of an account debtor, if the notification tells the account debtor to pay the assignee less than the full amount of any installment or other periodic payment. 

Proof of Assignment An account debtor may request proof from the assignee that the assignment was made under Section 9-406(c). Proof could consist of the signed agreement in which the assignor pledges or assigns the payment obligation. A filed financing statement, in and of itself, is not sufficient proof. If the assignee fails to “seasonably” comply with the request for proof, then the account debtor may discharge the payment obligation by paying the assignor without risking the double-payment consequence described below. “Seasonably” means “timely,” but is not defined as a specific time frame. But official comment 4 to Section 9-406 explains that an account debtor that has received notification of an assignment and has requested reasonable proof of the assignment may discharge its obligation by paying the assignor when payment is due (or even earlier if reasonably necessary to avoid risk of default), but that paying the assignor substantially before the payment is due will not discharge the obligation unless the assignee has failed to seasonably provide requested proof of the assignment. Consequences for Failing to Pay Assignee Except as noted above, paying the assignor rather than the assignee after receiving a valid notification from the assignee does not discharge the underlying payment obligation, and the assignor can seek to enforce the payment obligation directly against the account debtor. This means that the account debtor may have to pay twice unless it can recover the double payment from the assignor. Defenses to Payment The assignee does not obtain greater rights to payment than the assignor. As provided in Section 9-404, “the rights of an assignee to an assigned or pledged payment obligation are subject to (1) all terms of the agreement between the account debtor and assignor and any defense or claim in recoupment arising from the transaction that gave rise to the contract, and (2) any other defense or claim of the account debtor against the assignor which accrues before the account debtor receives a notification of the assignment authenticated by the assignor or the assignee.”

Suggested Procedures Upon Notification

Because businesses are increasingly under stress, especially small businesses that may have entered into factoring agreements by which they’ve sold or pledged their accounts to hard money-lenders for quick cash at a discount, businesses should expect to see more diversion notices from banks, factors, and other finance companies. The UCC is pretty unforgiving if a company is late to respond. A business is wise to do the following:

• Determine whether the notice meets requirements for effective notice and complete a checklist. To download a Sample Account Assignment Checklist, click here .
• Immediately notify the accounts payable department (or whomever is responsible for cutting checks and sending wires) of the assignment, and freeze any payments to the debtor.
• If contacted by an attorney for the assignee or the assignor, refer the attorney to the company’s legal counsel. Once an attorney knows that the business is represented by counsel, the attorney cannot ethically have further contact with the company without consent of its attorney (internal or external).
• Contact the legal department and provide a completed checklist. To download a Sample Account Assignment Checklist, click here .
• Determine whether the amount claimed by the assignee is correct. The company may have paid a prior invoice before receiving the notice, or there may be an outstanding billing dispute between the company and the assignor.
• Contact the assignee for any missing items of proof, or to assert contras, set-offs, or counterclaims. 
• Notify the assignor of the notice and the company’s obligation to pay the assignee. If a payment is due or will become due shortly, notify the assignor that payment may be slightly delayed while the company awaits a response on the request for proof.
• If the assignee is entitled to payment, update payment information in the business’s system. Follow procedures for verifying payment information.
• If a request for proof has not been satisfied, and a payment obligation risks default, make the payment to the assignor after a final notice to the assignee. Consult legal counsel before doing this.
• If the assignor disputes the assignee’s right to be paid, consult with the company’s lawyer about whether to interplead the amounts owed (pay the funds to the court and let the assignor and assignee fight over them).

Practical Considerations

If you’re receiving one of these notices, it’s not necessarily a sign that your vendor is in trouble with its lender or factor but it can be. If you have an ongoing business relationship with a cash-strapped vendor, you could find yourself with the problem in the example above. A desperate vendor that can’t pay workers or keep the lights on may be better off pulling its workers or withholding goods and services, even though by doing so it would breach its agreement with you. The breach creates a counterclaim that can be offset against the receivable, which is bad for the lender or factor. Each of the parties has something to lose and something to gain, so quick action to negotiate a settlement in which each party gets less than it wants can head off a more disastrous result.   

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§ 9-209. DUTIES OF SECURED PARTY IF ACCOUNT DEBTOR HAS BEEN NOTIFIED OF ASSIGNMENT.

(a) [Applicability of section.]

Except as otherwise provided in subsection (c), this section applies if:

(1) there is no outstanding secured obligation; and

(2) the secured party is not committed to make advances, incur obligations, or otherwise give value.

(b) [Duties of secured party after receiving demand from debtor.]

Within 10 days after receiving an authenticated demand by the debtor , a secured party shall send to an account debtor that has received notification of an assignment to the secured party as assignee under Section 9-406(a) an authenticated record that releases the account debtor from any further obligation to the secured party.

(c) [Inapplicability to sales.]

This section does not apply to an assignment constituting the sale of an account , chattel paper , or payment intangible .

Uniform Commercial Code § 9-406. Discharge of Account Debtor; Notification of Assignment; Identification and Proof of Assignment; Restrictions on Assignment of Accounts, Chattel Paper, Payment Intangibles, and Promissory Notes Ineffective, NY CLS UCC § 9-406