Zadek’s UCC Gold Mines and Land Mines

The Transactional Lawyer, Volume 16

I am honored to have been welcomed by the Editors of The Transactional Lawyer to offer what I hope will be playful yet useful thoughts on the many hidden concepts to be found throughout the various UCC Articles. I hope to point out opportunities for creative drafting as well as suggestions for changes in the Code or the Official Comments, and perhaps even suggestions for PEB Commentaries. I invite readers’ comments and will happily publish them with or without attribution, and especially welcome those who disagree with me.

The subject for this inaugural column is § 9-406(a),¹ the Code subsection that I have memorized because of its importance to my practice, and will focus on the challenges faced by the account debtor and SP1² (each an “innocent” party) upon the account debtor’s receipt of § 9-406 notifications³ from both SP1 and SP2.⁴

Account Debtor Analysis⁵

If the account debtor pays the account to SP2, has it discharged its obligation to SP1 under § 9-406(a)? The subsection refers to payment to “the” assignee, referring to the assignee that provided notification. That would suggest that there could only be one assignee entitled to payment and, while SP2 may be “an” assignee, it is not “the” assignee.⁶ Further, the subsection could have provided that in the case of multiple notifications, the account debtor could discharge the obligation by payment to any assignee, but it did not.

As a practical matter, when an account debtor receives multiple § 9-406 notifications, it either suspends payment until it receives, in the typical language of its accounts payable supervisor, “a court order” or joint instructions from all notifying secured parties as to whom to pay. This delay creates transactional friction and potentially subjects the account debtor to liability for breach of its duty to make payment on time.

The payment delay caused by account debtor confusion might be mitigated, without having to amend § 9-406(a), by a new Official Comment providing that, in the case of multiple notifications, the account debtor will have discharged the obligation by paying the sender of the earliest notification. The resulting dispute between secured parties could then be resolved without subjecting the account debtor to liability or the burden of bringing an interpleader action. Providing the account debtor with this safe harbor would also protect a notifying SP1,⁷ especially if the new Official Comment suggests that SP2’s failure to withdraw its notification might expose it to SP1’s damage claim.

SP1 Analysis⁸

Under present law, the priority dispute between SP1 and SP2 is resolved somewhat imperfectly by Official Comment 5 to § 9-331,⁹ which provides that SP1 can require disgorgement by SP2 if, simply put, SP2 knew or should have known that it was violating SP1’s rights. This necessitates a “knew or should have known” trial, which is contrary to the Code’s philosophy of providing certainty in contracting. The litigation risk would be mitigated with a statement in the Official Comment requiring disgorgement if the account debtor received SP1’s notification before it received SP2’s notification.¹⁰

In the meanwhile, SP1, SP2, and account debtors must live with uncertainty, made ever worse by the vague and misunderstood threat of a claim for tortious interference, which is about as scary as the “you’ll be sorry” refrain occasionally heard in schoolyard disputes.¹¹

There is an interesting history surrounding an important clause in Official Comment 5 to § 9-331 stating, “if a junior secured party conducted or should have conducted a search and a financing statement filed . . . by [SP1] states [the debtor had agreed not to grant a junior security interest in its accounts],” SP2 would likely be required to disgorge collections to SP1. [SB1] For years prior to the drafting of Revised Article 9 I suggested to lecture attendees and clients that they add a negative pledge warning¹² to all UCC filings to discourage SP2s from interfering with their collateral.¹³ My advice appears to have become generally adopted, at least based upon my 30 years of reading UCC filings. When I was asked to co-author Official Comment 5, I used that opportunity to reinforce the effect of my negative pledge warning with the above quoted clause, which I expected would come close to establishing absolute liability on an SP2 that receives payments from account debtors. I was wrong, perhaps because attorneys for the SP1s of the world did not realize the sentence [SB2] is there.

Notes:

1. “an account debtor on an account . . . 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” (italics added).
2. This refers to the secured party that holds the earliest UCC filing.[SB3] 
3. An increasing common occurrence since Merchant Cash Advance funders often send notifications to their merchant’s account debtors without regard to the possibility that a more senior secured party may have sent a notification to that account debtor.
4. This refers to the secured party that holds the later UCC filing.
5. This section discusses the dispute between SP1 and SP2 prior to payment by the account debtor.
6. But cf. § 1-106(1) (unless the statutory context otherwise requires, “words in the singular number include the plural”). This rule does not supply much help since it would not make sense to read the provision as providing a safe harbor if the account debtor were to pay both assignees.
7. Since almost all factors and many asset-based lenders routinely send account debtor notifications, this would give certainty to an account debtor making payment to them, and