The New York Court of Appeals, New York State’s highest court, split with the Eleventh Circuit and reversed the lower courts by holding that a security interest is also an assignment of accounts receivable, if that’s how the parties wrote the security agreement.
Consequently, an account debtor who pays the debtor rather than the lender, after having received notice to pay the lender, can end up paying twice, the Court of Appeals said in its November 22 opinion. The account debtor remains obligated to pay the lender, even if the debtor claims there’s a dispute with the lender.
The debtor and the lender entered into a security agreement that the lender perfected by filing a UCC-1. The security agreement granted the lender a security interest in all assets, including accounts receivable.
The security agreement gave the lender the right to instruct account debtors that they must remit payments to the lender, including before default. The debtor also agreed not to interfere with collection by the lender.
The lender gave notice to the account debtor that the account debtor must only pay the lender. The notice went on to say that paying the debtor would not discharge the account debtor’s obligations and that the account debtor would remain liable to the lender.
The debtor went bankrupt, still owing $3 million to the lender. The lender sued the account debtor in state court, alleging that it was entitled to recover from the account debtor under UCC 9-607 for anything the account debtor had paid the debtor after receiving notice to pay the lender.
Affirmed by the intermediate state appellate court, the New York trial court dismissed the complaint, believing that the security agreement was not an assignment of receivables under Section 9-607.
In a unanimous opinion for the six justices now sitting on the Court of Appeals, Associate Justice Rowan D. Wilson reversed, based on the language of UCC §§ 9-607 and 9-406 and “the clear commentary on the relevant sections.”
Section 9-607(a) provides:
If so agreed, and in any event after default, a secured party:
(1) may notify an account debtor . . . to make payment . . . to or for the benefit of the secured party . . .
(3) may enforce the obligations of an account debtor . . . and exercise the rights of the debtor with respect to the obligation of the account debtor . . . to make payment . . . to the debtor . . . .
“Here,” Justice Wilson said, the lender was “the ‘secured party,’ with the authority to enforce the rights of its debtor . . . to collect on the obligations of the account debtor.” He went on to say that the security agreement granted the lender “the right to direct [the debtor’s] debtors to pay [the lender] directly, and bars [the debtor] from interfering with any such direction if given.”
Justice Wilson cited the Official Comments for saying that Section 9-607 “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).”
The account debtor responded by contending that Section 9-406 means that only assignors, not holders of security interests, may employ the payment redirection provisions in that section.
Section 9-406(a) provides that “an account debtor . . . may discharge its obligation by paying the assignor until, but not after, the account debtor receives a notification . . . that the amount due or to become due has been assigned and that payment is to be made to the assignee . . . .”
Justice Wilson responded by saying that 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’ (see UCC Section 1-201 [b] [35]).” In that regard, he said that the “commentary makes clear that a security interest is treated as an assignment.” More particularly, he said that the recently amended commentary now says that an assignment “‘refers to both an outright transfer of ownership and a transfer of an interest to secure an obligation’ (Commentary No. 21 at 4).”
Justice Wilson also quoted the official commentary for saying that a 2007 decision by a different intermediate appellate court in New York and a 2019 decision from the Eleventh Circuit were “incorrect” in ruling that the term “assignment” in Section 9-406(a) refers only to an outright assignment of ownership.
The account debtor argued that a dispute between the lender and the debtor precluded the lender from relying on the assignment. Justice Wilson said that “allowing a claimed dispute to nullify sections 9-607 and 9-406 would render those provisions meaningless by removing the ability to obtain the value of the security whenever the debtor claims a dispute exists.”
Finally, Justice Wilson alluded to concerns by the two lower courts that the account debtor may end up paying twice. “That is the statutory consequence of failing to pay a secured party who has notified the account debtor to pay the secured party directly,” he said.
Justice Wilson reversed, with directions for the trial court to deny the motion to dismiss. He held:
Where they have contractually so agreed, once the secured creditor provides the requisite notification to account debtors, an account debtor cannot discharge its obligation by paying the debtor, but must, instead, pay the secured creditor or ask for proof of assignment from the secured creditor (see UCC 9-406 [a], [c]).
The New York Court of Appeals, New York State’s highest court, split with the Eleventh Circuit and reversed the lower courts by holding that a security interest is also an assignment of accounts receivable, if that’s how the parties wrote the security agreement.
Consequently, an account debtor who pays the debtor rather than the lender, after having received notice to pay the lender, can end up paying twice, the Court of Appeals said in its November 22 opinion. The account debtor remains obligated to pay the lender, even if the debtor claims there’s a dispute with the lender.