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Collection of receivables
Notification
Commercial financing often involves the taking of a security interest in or the purchase of receivables. See Commentary.Scope of U.C.C. Article 9 and Commentary.Sale of receivables. To realize the value of receivables, the secured party (either one who has loaned against the value of receivables or one who has purchased receivables) must be able to collect from the party obligated on the receivable. Article 9 supplies some of the tools in U.C.C. 9-607(a): upon the debtor's default, or if otherwise agreed with the debtor, the secured party is entitled to notify the parties obligated on receivables to pay the secured party directly. If a party obligated on a receivable fails to pay in response to such notice, the secured party may then enforce the payment obligation in its own favor. Enforcement would include, for example, filing suit for a money judgment against the party obligated on the receivable.
The timing of notice by the secured party depends upon the terms of the agreement under which the receivables are transferred from the debtor to the secured party. If the receivables are sold outright to the secured party, the agreement will typically provide that the secured party may notify those obligated on receivables immediately (see U.C.C. 9-607(a): "If so agreed, . . . ). Such authorization may also be given in cases where receivables have been assigned for purposes of security (often referred to as "notification financing"). If the agreement does not authorize notification ("non-notication financing"), the secured party may notify those obligated on receivables only upon default by the debtor (i.e. upon default by the transferor of the receivables).
An example will be helpful. Recall Example 1 from Commentary.Scope of U.C.C. Article 9, in which a retailer takes chattel paper from a consumer purchasing furniture on installment credit. If the retailer ("debtor") sells its chattel paper to a financier ("secured party"), the agreement of sale will likely authorize the financier to notify consumers immediately to make all further payments to the financier. If the retailer has assigned the chattel paper as security for a loan from the financier, the assignment may provide for such notification ("notification financing"). If the assignment does not provide for such notification ("non-notification" financing), the financier may only notify consumers to pay the financier if the retailer defaults on its obligations to repay its loan from the financier.
Recourse
In some sales of receivables, the purchaser ("secured party") agrees to assume all of the risk that receivables may not be paid. Such a purchase is said to be "without recourse." In other sales, the seller ("debtor") agrees to allow the purchaser to charge back against the seller all uncollectible receivables ("with recourse") or some percentage or some types of uncollectible receivables ("partial recourse"). If the purchaser has recourse, it must conduct its collection and enforcement efforts in a commercially reasonable fashion, and it may deduct from collections made reasonable expenses of collection and enforcement, including attorney's fees. U.C.C. 9-607(c), (d). The requirement of commercial reasonableness assures that a seller is not saddled with charged back receivables that the purchaser made no commercially reasonable attempt to collect. There is no such requirement when the sale is without recourse for the obvious reason that the seller will not be saddled with uncollected receivables.
If a debtor has assigned receivables for purposes of security, the secured party will be entitled to a deficiency to the extent that collection of receivables is insufficient to satisfy the debt, unless the parties have agreed otherwise.. U.C.C. 9-608(a)(4). In such cases too the secured party must conduct its collection and enforcement efforts in a commercially reasonable fashion, and may deduct from collections made reasonable expenses of collection and enforcement, including attorney's fees. U.C.C. 9-607(c), (d).
Secured receivables
In some cases receivables will themselves be secured, either by real property, personal property, or fixtures. In such cases, the secured party may enforce the debtor's rights with respect to the collateral that secures the obligation if the party obligated on the receivable refuses or is unable to pay. U.C.C. 9-607(a)(3). Return to our example in which the retailer has sold chattel paper taken from consumers buying furniture. As mentioned above, the financier could then notify the account debtor (the consumer buyer) to pay the financier and could, if necessary, sue to enforce such payment in the event the consumer does not pay. In addition, if the consumer does not pay and has no defense to payment, the financier may foreclose on the collateral (the furniture), starting with repossession. Of course the financier cannot foreclose on that collateral if the consumer debtor pays in accordance with the retail installment contract. Or take another case, adapted from Lovelady v. Bryson Escrow, Inc. (sale of a restaurant business in which part of the purchase price was evidenced by a promissory note secured by equipment and a leasehold interest in real property). Suppose the sellers in Lovelady assigned the buyer's note and leasehold mortgage to secure their own financing, and suppose that the sellers thereafter defaulted in repaying the loan. As mentioned above, the financier could then notify the buyer to pay the financier. If the buyer defaults in its obligations under the promissory note, but not otherwise, the financier could then foreclose on the leasehold mortgage. U.C.C. 9-607(b) aids the secured party seeking non-judicial foreclosure on a mortgage that secures an obligation where the obligation itself has been used as collateral.
Modification, Discharge, or Defenses to Receivables
If a receivable is itself not secured it may be uncollectible simply because the obligor on the receivable is unable to pay. Even if able to pay, the obligor may claim that its obligation has been discharged by previous payment to the obligee, or that its obligation to the obligee has been modified (e.g. reduced or extended) in an agreement with the obligee, or that it has a claim against the obligee that it may offset against the obligation or a defense to payment of the obligation (e.g. breach of warranty in the sale of goods). Article 9 addresses these issues in a series of provisions in Part 4 entitled "Rights of Third Parties." You may have studied some of these issues in the first year Contracts course.
(1) U.C.C. 9-405 addresses the question of the extent to which a modification of a contract between the obligor and obligee made after the obligation has been assigned is effective against the assignee. For example, consider the lawyer who agrees for a flat fee to draft documents necessary to effectuate the estate plan of clients. The lawyer has assigned the accounts (the obligation of the clients to pay for services rendered) to a bank to secure a loan. After the assignment, the lawyer agrees with a client to reduce the fee because of the client's decision that simplifies the estate plan. To what extent is this modification of the fee agreement effective against the bank?
(2) U.C.C. 9-406(a)-(c) addresses the question of the extent to which an obligor's payment to the obligee will discharge an obligation that has been assigned. If the client referred to in the preceding paragraph pays the lawyer, does the client nonetheless remain liable to the bank or has the obligation been discharged? We address this problem in part of Problem.Collection of receivables.
(3) U.C.C. 9-403 and U.C.C. 9-404 address the question of the extent to which the obligor may assert against an assignee the claims and defenses it has against the obligee. Suppose the client in the preceding example claims malpractice, or suppose that the obligor on chattel paper claims that defects in the furniture it purchased on credit amount to a breach of warranty. May the client or the furniture purchaser assert those claims, either affirmatively or as a defense to payment, against the assignee of the receivable? We address this third set of issues somewhat more in Commentary.Assertion of claims and defenses against assignees and Problem.Collection of receivables.
Deposit accounts
U.C.C. 9-607(a)(4) and U.C.C. 9-607(a)(5) govern a different type of collection, the application of deposit accounts to a secured obligation. Application of deposit accounts to a secured obligation is not the collection of receivables and therefore merits this separate comment. A secured party may take a security interest in a deposit account of the debtor (e.g. funds owing to a debtor by a bank, including a savings and loan association or credit union). See U.C.C. 9-102(a)(29). In some cases, the secured party will be the bank itself. If the debtor defaults in its obligation to a secured party that is also the bank in which the debtor maintains the deposit account that serves as collateral, the secured party may collect simply by applying the balance in the account to the secured obligation. If the secured party is not the bank in which the debtor maintains the deposit account, and if the secured party has perfected its security interest by control (U.C.C. 9-104(a)(2),(3)), the secured party may collect by instructing the bank to pay the balance of the deposit account to the secured party.