Collecting from a Borrower’s Account Debtor: Does the Lender Need a Separate Assignment of Accounts, or Will Its Security Agreement Suffice?

Secured creditors whose collateral includes its borrowers’ accounts are empowered by Article 9 to collect money that is owed to borrowers from their borrowers’ account debtors, by a simple notice process. The secured creditor can notify account debtors of the security interest and advise them that they should pay the secured creditor directly, instead of paying the borrower.

But an account debtor sometimes refuses to pay the secured party. In that instance, the secured party may elect to sue the account debtor to enforce its right to be paid. Account debtors have defended such claims based on the language of key UCC provisions. This article will discuss one of the arguments made by account debtors — that a mere security agreement does not give the lender an enforceable claim to its borrower’s accounts—and that a separate assignment of the account may be required.

Secured Party Sends Notice Under UCC § 9-607

UCC § 9-607 provides that secured creditors can, in essence, stand in the shoes of their borrowers in collecting money owed to those borrowers. The collected funds can be applied to the secured party’s debt. It states: “If so agreed, and in any event after default, a secured party: (1) may notify an account debtor … to make payment or otherwise render performance to or for the benefit of the secured party … [and] (3) may enforce the obligations of an account debtor … to make payment … to the debtor….”

In simpler terms, this provision allows the secured creditor to ignore procedures required for other kinds of collateral — for example, taking possession of collateral and arranging for a “commercially reasonable” sale. Instead, simply notifying the account debtor to pay the secured creditor, if done properly, is sufficient. Moreover, the section clearly permits the secured party to “enforce” the account debtor’s obligation.

Code Drafters Use the Terms “Assignor” and “Assignee” in Addition to “Secured Party” and “Account Debtor”

UCC § 9-406 fills in some important details relating to the collection procedure. For example, it discusses what the notification should say in order to be effective, and it tells the account debtor how to discharge the debt owed to the borrower. However, § 9-406 uses the terms “assignor” and “assignee,” instead of “secured party” and “debtor,” which are the terms used in § 9-607.

§9-406(a) provides:

[A]n account debtor … 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.[1]

This differing terminology has resulted in some account debtors arguing that the secured party must have a separate assignment of those accounts — not just a security agreement — in order to enforce its claim against an account debtor. Adding to the confusion, the terms “assignee” and “assignor” are not defined in the UCC, leaving parties to debate whether they carry a different meaning than “secured party.”

Recent Cases Suggest the Terms Are Roughly Synonymous

A handful of courts have addressed this issue. The most recent is First State Bank v. MP Nexlevel.[2] In that case, the bank, which had a security interest in the accounts of its borrower, tried to collect one such account using the notice mechanism described in §§ 9-607 and 9-406. When the account debtor, MP Nexlevel, refused to pay the bank, the bank sued to collect the account. The trial court, on summary judgment, held that the bank had not shown that it had an assignment of the account and therefore could not enforce its security interest against MP Nexlevel. The Nebraska Supreme Court reversed, holding that the term “assignment” and its derivatives under § 9-406(a) apply to presently exercisable security interests granted under a security agreement.

The court in First State Bank relied in part on Comment 5 of § 9-406, which it said indicates that the drafters intended the term “assignment” to include contingent transfers for security. In discussing certain types of assignments, Comment 5 identifies “assignment of an account (whether outright or to secure an obligation)” and “assignments of rights to payment as security and other assignments of rights to payment such as accounts and chattel paper.”  Comment 5 additionally includes a hypothetical involving a security interest that applies § 9-406.

Other cases reaching the same or similar conclusions include ARA Inc. v. City of Glendale,[3] Maine Farmers Exchange v. Farm Credit of Maine,[4] and In re Apex Oil Co.,[5] see also Lake City Bank v. R.T. Milord Co.,[6] Magnolia Financial Group v. Antos,[7] ImagePoint Inc. v. JPMorgan Chase Bank[8] and Swift Energy Operating v. Plemco-South.[9]

The opposing view, that an assignment is not the same as a security interest and that a security agreement, without an assignment, may be insufficient, is set forth in Durham Commercial Capital Corp. v. Ocwen Loan Servicing LLC.[10] In that case, the Eleventh Circuit held that a lender with a security interest in accounts had no cause of action under § 9-406 against an account debtor that paid the debtor, instead of the secured party, after receiving an instruction to pay the secured party. The court’s analysis focused on what it said was the lack of a private right of action in favor of the secured party under UCC § 9-406. The court’s reasoning has been criticized by at least one commentator.[11]

The issue was also discussed in IIG Capital LLC v. Archipelago L.L.C.[12] In that case, IIG Capital was a factor that brought suit to collect on its customer’s accounts. The New York Supreme Court held that the account debtors’ motion to dismiss the causes of action for breach of contract and account stated was properly denied. In dicta, the court disagreed with the proposition that a secured party with a security interest is the equivalent of an assignee for purposes of UCC § 9-406, but it did not provide substantive analysis.

Conclusion

The secured creditor seeking to collect its borrower’s accounts should be careful to review UCC §§ 9-607 and 9-406. Lacking a separate assignment of accounts from its borrower, it may encounter a defense based on the rationale used by the Eleventh Circuit in Durham. The better analyses indicate that a secured party does not need a separate assignment of those accounts in order to be successful, but these recent cases suggest the issue is not without doubt.