• A business may sell its goods or provide services on credit (e.g., on account, or in exchange for an instrument or chattel paper)
– But, the business may need cash immediately to pay its operating expenses while waiting for customer to pay
• A business may obtain this operating cash either by:
– Making an outright sale of its payment rights (e.g.,
“factoring”), or
– Borrowing, using the payment rights as collateral
• The most valuable assets of a business are often its rights to payment from its customers (for goods sold or services rendered)
• These rights may be:
– Purely intangible (i.e.,
“accounts” or “payment intangibles”), or
– Embodied in contracts that are “indispensable paper”
(instruments, chattel paper)
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• Plate Lunch has a revolving line of credit with
Bank, under which Plate Lunch can borrow up to
75% of the “face amount” of its accounts
– E.g., if Plate Lunch provides $100,000 in catering services to its clients, Plate Lunch can borrow up to
$75,000 from Bank, secured by those accounts
• Collection of these customer accounts is governed by the Plate Lunch/Bank security agreement
– If Plate Lunch is not in default, Bank may allow Plate
Lunch to collect from its clients directly
– Alternatively, Bank could notify Plate Lunch’s clients to pay their accounts directly to Bank [§ 9-607(a)] (into a
“lockbox,” to be applied to reduce loan balance)
• Plate Lunch instead proposes to sell its outstanding accounts to Atlantic Commercial Finance (ACF)
– As soon as Plate Lunch does a catering job, ACF will pay Plate Lunch 90% of face amount of that account
– ACF then notifies the customer: “Your account has been assigned to ACF, so pay the bill to ACF”
– If customer pays the bill, ACF keeps the 10% “profit”
– If customer ultimately can’t pay, ACF “eats the loss”
• Does Article 9 apply in this transaction?
• Yes, b/c Article 9 applies to a “sale” of accounts [§
9-109(a)(3)]
– “Security interest” includes “any interest … of a buyer of accounts … in a transaction that is subject to Article
9” [§ 1-201(b)(35)]
– Thus, even if ACF “buys” the accounts of Plate Lunch in an outright “sale,” ACF’s interest is deemed to be only a “security interest” vs. 3d parties
– ACF thus must perfect its SI (or it could lose priority to 3d parties)
• Similar rule for “sales” of notes, chattel paper
• Why does Article 9 apply to the sale of accounts by Plate
Lunch, if it was really a sale?
– Problem: it’s hard for 3d parties to tell if assignment of accounts is a “true sale” or just a “loan”
– As a result, Article 9 drafters decided that any assignee of an account (whether by sale or as security) should have to file to give notice to 3d parties
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• Consider allocation of “credit risk” (i.e., the risk that the account debtor ultimately can’t pay)
– Ordinarily, a buyer of an account in a “true sale” (a
“factor”) would take this risk [as in Problem 1]
– If assignment was for security only, the assignor would ordinarily retain the credit risk
– But, by their contract, Plate Lunch (assignor) and
ACF (assignee) can reallocate that risk!
• E.g., Plate Lunch could “sell” its accounts to ACF, but with Plate Lunch having the duty to “buy back” any account that remains unpaid after 90 days
• Rather than let Plate Lunch and ACF use the “form” of the transaction to avoid Article 9, the drafters applied Article 9 to all assignments of accounts
(whether absolute, or given as security)
– § 9-109 cmt 4 (“This approach generally has been successful in avoiding difficult problems of distinguishing between transactions in which a receivable secures an obligation and those in which the receivable has been sold outright. In many commercial financing transactions the distinction is blurred.”)
• Plate Lunch instead proposes to sell its outstanding accounts to Atlantic Commercial Finance (ACF)
– As soon as Plate Lunch does a catering job, ACF will pay Plate Lunch 90% of face amount of that account
• Even if this is really a “sale,” Article 9 applies to the transaction [§ 9-109(a)(3)]
– ACF’s interest is deemed to be a “security interest”
– ACF must then perfect that interest by filing a UCC-1
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• For a SI in goods, secured party may only enforce its
SI after debtor defaults [§§ 9-609, 9-610]
• However, an assignee of accounts or chattel paper can collect from the account debtor even prior to the assignor’s default , if assignor so agrees [§ 9-607(a)]
– E.g., upon buying Plate Lunch’s accounts, ACF will notify Plate Lunch’s customers to pay ACF directly
(this is called “notification” financing )
• First Bank hired Dewey,
Cheatum & Howe (DCH) to represent First Bank in litigation
• DCH assigned its accounts to
Vincent Bonebreaker
• First Bank owes DCH $25,000 in legal fees
• First Bank gets a letter from
Bonebreaker: “your account has been assigned to me; direct your payment to me”
• What should First Bank do?
Assignor
(Dewey, Cheatum)
Assignee
(Bonebreaker)
Account Debtor
(First Bank)
§ 9-102. Definitions and Index of Definitions.
(a) [Article 9 definitions.] In this article: …
(3) “Account debtor” means a person obligated on an account, chattel paper, or general intangible.
The term does not include persons obligated to pay a negotiable instrument, even if the instrument constitutes part of chattel paper.
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§ 9-406. Discharge of Account Debtor ….
(a) [Discharge of account debtor; effect of notification.] 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 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.
• Suppose that DCH’s representation of First Bank was negligent (and arguably unethical)
• Can First Bank refuse to pay, or must it pay the account to
Bonebreaker anyway?
• Once First Bank gets notice DCH has assigned the account to Bonebreaker, it can’t discharge its obligation by paying DCH directly [§ 9-406(a)]
– If it pays DCH directly, First Bank is still liable to pay
Bonebreaker $25,000 to satisfy the account
– If First Bank had paid DCH before receiving notice, the account would have been discharged
• A factor that buys an assignor’s accounts will typically provide notification of assignment to account debtors “at the point of sale”
• Note: First Bank (the account debtor) can request proof that DCH actually assigned the account to Bonebreaker [§ 9-406(c)]
– Until reasonable proof is provided, First Bank can still satisfy its obligation by paying DCH [§ 9-406(c)]
§ 9-404. Rights Acquired by Assignee; Claims and
Defenses Against Assignee
(a) [Assignee’s rights subject to terms, claims, and defenses; exceptions.] Unless an account debtor has made an enforceable agreement not to assert defenses or claims
... the rights of an assignee 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.
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• Unless First Bank (the “account debtor” in Problem
2) made an enforceable agreement not to assert defenses, First Bank can raise this defense against the assignee Bonebreaker [§ 9-404(a)(1)]
– The defense arose out of contract for legal services;
Bonebreaker “stands in the shoes” of assignor (DCH)
– § 9-404, Comment 1: in this situation, it “makes no difference whether the defense or claim accrues before or after the account debtor is notified of the assignment”
§ 9-404. Rights Acquired by Assignee; Claims and
Defenses Against Assignee
(b) [Account debtor’s claim reduces amount owed to assignee.] Subject to subsection (c) …, the claim of an account debtor against an assignor may be asserted against an assignee under subsection (a) only to reduce the amount the account debtor owes .
(c) [Rule for individual under other law.] This section is subject to law other than this article which establishes a different rule for an account debtor who is an individual and who incurred the obligation primarily for personal, family, or household purposes.
• First Bank may have cause of action against DCH for negligence in tort (malpractice)
• However, First Bank cannot assert this claim against Bonebreaker to recover sums already paid to Bonebreaker [§ 9-404(b) and Comment 3]
– Other consumer protection laws might protect an individual account debtor and permit affirmative recovery [§ 9-404(c)] (wouldn’t apply to First Bank)
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• A retail seller of goods may sell not for cash or on open account, but in exchange for rights embodied in
“indispensable paper”
– E.g., Buyer signs an installment contract under which
Buyer agrees to pay in installments, Seller retains SI in goods (“chattel paper”) [§ 9-102(a)(11)]
– E.g., Buyer signs promissory note to repay unpaid purchase price, but without granting a SI in the goods
(“instrument”) [§ 9-102(a)(47)]
• To obtain financing, seller may assign an instrument or chattel paper either:
– By outright sale, or
– By assignment as security for a loan
• As with accounts, a sale of instruments or chattel paper is deemed to create a SI [§ 1-201(b)(35)]
– Art. 9 applies to sale of instrument or chattel paper [§
9-109(a)(3)]
– Buyer of instrument or chattel paper must thus perfect its SI, either by filing [§ 9-312(a)] or by taking possession [§ 9-313(a)]
§ 9-330. Priority of Purchaser of Chattel Paper or
Instrument.
(a) [Purchaser’s priority: security interest claimed merely as proceeds.] A purchaser of chattel paper has priority over a security interest in the chattel paper which is claimed merely as proceeds of inventory ... if:
(1) in good faith and in the ordinary course of the purchaser’s business, the purchaser gives new value and takes possession of the chattel paper or obtains control of the chattel paper under Section 9-105; and
(2) the chattel paper does not indicate that it has been assigned to an identified assignee other than the purchaser.
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§ 9-330. Priority of Purchaser of Chattel Paper or
Instrument.
(a) [Omitted]
(b) [Purchaser’s priority; other security interests.] A purchaser of chattel paper has priority over a security interest in the chattel paper which is claimed other than merely as proceeds of inventory subject to a security interest if the purchaser gives new value and takes possession of the chattel paper or obtains control of the chattel paper under Section 9-105 in good faith, in the ordinary course of the purchaser’s business, and without knowledge that the purchase violates the rights of the secured party.
§ 9-330. Priority of Purchaser of Chattel Paper or
Instrument.
(d) [Instrument purchaser’s priority.] Except as otherwise provided in Section 9-331(a), a purchaser of an instrument has priority over a security interest in the instrument perfected by a method other than possession if the purchaser gives value and takes possession of the instrument in good faith and without knowledge that the purchase violates the rights of the secured party.
– Section 9-330(a) will apply where the first assignee was merely financing the debtor’s inventory (where loan balance was underwritten based solely on inventory)
– Section 9-330(b) will apply where the first assignee was financing essentially all of the debtor’s operations/assets (a “true floating lien”)
• First Bank has a perfected SI in all inventory, chattel paper and accounts (presently owned and afteracquired) of Stan’s Farm Implement Co. (Stan’s), perfected by a 2011 UCC-1 filing
• Oct. 2015: Stan’s sells a tractor to Crouch, who signs an installment contract (Stan’s retains a PMSI)
• First Bank now has a SI in the Crouch contract, both directly (it is after-acquired “chattel paper”) and as proceeds (it is “proceeds” of inventory)
8

• As BOCB, Crouch took the tractor itself free of the SI that
Stan’s had granted to First
Bank (when the tractor was inventory) [§ 9-320(a)]
• So when (if ever) could First
Bank later repossess the tractor from Crouch?
• First Bank has perfected SI in all inventory, chattel paper and accounts (presently owned and afteracquired) of Stan’s (perfected by 2011 UCC-1)
• Jan. 2015: John Deere Acceptance Corp. (JDAC) takes a PMSI in Stan’s Deere-brand inventory
– JDAC complies w/ § 9-324(b) notification requirement
• Oct. 2015: Stan’s sells a Deere tractor to Crouch on an installment contract, takes PMSI in tractor
– Stan’s then assigns the Crouch contract to JDAC
• Both First Bank and JDAC have a SI in the Crouch contract. Which has first priority?
– First Bank could collect Crouch’s remaining installment payments (i.e., it could notify Crouch to begin making his installment payments to First
Bank) [§ 9-607(a)(1)], and apply them to Stan’s debt
– First Bank could repo the tractor from Crouch, but only if Crouch was in default under his contract
§ 9-324. Priority of Purchase-Money Security
Interests.
(a) [Omitted]
(b) [Inventory purchase-money priority.] . . . [ A perfected purchase-money security interest in inventory has priority over a conflicting security interest in the same inventory, has priority over a conflicting security interest in chattel paper or an instrument constituting proceeds of the inventory and in proceeds of the chattel paper, if so provided in Section 9-330 , and ... also has priority in identifiable cash proceeds ... received on or before the delivery of the inventory to a buyer, if: [the purchase-money secured party takes the steps necessary to qualify for PM superpriority].
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§ 9-330. Priority of Purchaser of Chattel Paper or
Instrument.
(a) [Omitted]
(b) [Purchaser’s priority; other security interests.] A purchaser of chattel paper has priority over a security interest in the chattel paper which is claimed other than merely as proceeds of inventory subject to a security interest if the purchaser gives new value and takes possession of the chattel paper or obtains control of the chattel paper under Section 9-105 in good faith, in the ordinary course of the purchaser’s business, and without knowledge that the purchase violates the rights of the secured party.
• JDAC’s purchase money priority in the tractor [§ 9-
324(b)] extends to the Crouch contract if JDAC also qualifies for priority under § 9-330
• Is JDAC protected by § 9-330(b)?
– JDAC paid new value for the contract, and
– JDAC took possession of K, and
– JDAC acted in good faith and in the ordinary course of its business, and
– Did JDAC act w/out knowledge that its purchase of the contract violated First Bank’s rights (unknown)
– Installment Ks for sale of goods are customarily transferred by indorsement (signature) and delivery of possession of K
– Contract “embodies” right to payment
– Thus, while SI in chattel paper can be perfected by filing [§ 9-312(a)], perfection by possession is preferable to prevent negotiation of K to BFP
• Neighborly Finance (NF) is proposing to buy chattel paper generated by sales of furniture by
Easy Ed’s Home Store
– NF wants to protect against the risk that Easy Ed’s might “sell the same contracts twice” (and the potential loss of priority under § 9-330), but doesn’t want to take possession of the contracts
• What can NF do to avoid this risk?
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• Possibility: NF could perfect by filing a UCC-1 and instead “legend” Easy Ed’s contracts rather than taking possession of them
– E.g., Easy Ed’s form K contract could state, on its face: “This contract and the rights arising hereunder have been assigned to Neighborly Finance and may not be assigned to any other person w/out the prior written consent of Neighborly Finance.”
– A subsequent assignee of a contract bearing this legend could not qualify for priority under § 9-330(b)
• Risk: Easy Ed’s may cheat, enter into contracts with customers that don’t bear that legend
• Stan’s sells Deere tractor to Perry on account
• Both First Bank, JDAC claim priority
– First Bank (which has a perfected SI in afteracquired accounts)
– JDAC (which had a perfected PMSI in Deerebranded inventory)
• Who has first priority?
A. First Bank (first to file)
B. JDAC (PM superpriority)
C. Equal priority
• First Bank would have priority over JDAC under first to file or perfect [§ 9-322(a), (b)]
– JDAC had PM superpriority over First Bank as to the Deere inventory, and that priority extends to cash proceeds, but not to accounts [§ 9-324(b)]
– This result reflects codification of traditional preference that commercial law recognized for those financing accounts [§ 9-324, cmts. 8, 9]
• Thus, a PM financer like Deere (financing
Deere-brand inventory) would address this risk in its security agreement with Stan’s
• Security agreement would permit Stan’s to sell
Deere-brand inventory in ordinary course, but only in sales producing: (1) cash, (2) instruments, or (3) chattel paper (any other sales would be unauthorized)
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