Sale of receivables

     In many cases, the owner of accounts, chattel paper, promissory notes, and payment intangibles will sell those receivables to a buyer rather than assign them for purposes of security.  Article 9 applies to such sales (U.C.C. 9-109(a)(3)), as well as to assignment of receivables for purpose of security, even though we might think of the sale of receivables as conceptually distinct from loans secured by receivables.   There are two reasons why Article 9 applies to such sales.

     First, constructive notice of a transfer of receivables should be given both where the transfer is by sale and where the transfer is by asssignment for purposes of security because in either case the transferor, not having been deprived of something corporeal through a transfer, could transfer the same receivables a second time (or third or fourth) without informing the subsequent transferee(s) of the previous transfer(s).  For example, a garment manufacturer that sells to retailers throughout the country on open account (unsecured credit payable in 30-90 days), will often sell those accounts to a financier (traditionally referred to as a "factor") for immediate cash.  The accounts that it sells are not tangible, but are simply reflected in the financial records of the garment manufacturer.  A dishonest garment manufacturer, having sold the accounts once, might then approach another factor and sell the accounts a second time, showing the second factor the same financial records that it showed the first factor but not informing the second factor of the sale to the first factor.   A dishonest party could perpetrate the same type of fraud by borrowing against the accounts instead of selling them.  These types of fraud will not be possible under a system that: (1) requires the first in time finanicer to give constructive notice to the world of its purchase, (2) sanctions the first in time financier for failure to do so by affording priority in the accounts to a second in time financier that does give constructive notice, and (3) sanctions the first in time financier for failure to do so by avoiding its rights in the receivables in the event of the seller's bankruptcy.  Article 9 provides a simple and uniform method of giving constructive notice.  It thereby affords priority to the first party to give constructive notice, whether the transfer of the accounts or other receivables is by sale or by assignment for purposes of security, and protects the interest purchased in the event of the seller's bankruptcy.

      A second reason that Article 9 applies to sales of receivables is that "in many commercial financing transactions the distinction [between a sale and an assignment for purpose of security] is blurred."  Official Comment 4 to U.C.C. 9-109.   For example, in a sale of accounts the parties may agree that the purchaser may charge back some kind or percentage of uncollected accounts to the seller.  Our garment manufacturer, for example, might agree to buy back from the factor those accounts for which the account debtor asserts a defense to payment (e.g. because the garments sold were defective) but not those accounts that are uncollectible because of an account debtor's insolvency.  To the extent that the garment manufacturer will buy back accounts, the transaction resembles a secured loan; it is as if the garment manufacturer borrowed from the factor, gave the accounts as collateral, and is liable for a deficiency to the extent that the collateral becomes less valuable.  To the extent that the garment manufacturer will not buy back accounts, the transaction resembles a sale; the factor has purchased an asset (the accounts) and bears the risk of decline in value of the asset.   Rather than devising complex rules distinguishing sales from assignments for security, the drafters opted to cover both without attempting a distinction.     

      For definitional convenience, Article 9 uses the vocabulary we typically associate with lending to describe also the parties to and features of a sale of receivables.  Thus, the seller of the receivables is a "debtor," the purchaser of the receivables is a "secured party," the receivables are "collateral," and the sale creates a "security interest" in the collateral.  While this use of  vocabulary is counter-intuitive and thus initially a bit mystifying, the usage facilitates drafting elsewhere in the statute.  Thus, for example, because the drafters want both a purchaser of receivables and a lender that has taken an assignment of the receivables for purposes of security to give constructive notice, the statute can simply say that "the secured party" must file a financing statement (rather than having to say, for example, that "both a secured party and a purchaser of receivables must file a financing statement").  But this drafting technique should not obscure the fact that when an owner of receivables sells them it does not retain any legal or equitable interest in them.  U.C.C. 9-318(a).  Official Comment 5 to U.C.C. 9-109.

     Traditionally, purchasers of certain receivables, notably accounts, have been existing financiers with expertise both in evaluating the credit worthiness of accounts and in collecting accounts.  The price paid for the receivables (e.g. $90,000 for $100,000 worth of receivables) reflects the risk that some accounts may not be paid and the time value of money that the finanicer has advanced to the seller pending later collection from account debtors.  The discount (e.g. $10,000) is analagous to interest that the seller would otherwise pay if it borrowed money from a lender or if it were to issue commercial paper and sell it in the securities markets.  More recently, during the 1980's and 1990's, the sale of a broader range of receivables has assumed increasing importance in commercial financing as a part of the evolution of an alternative financing device commonly referred to as "asset securitization."  Professor Steven Schwarcz describes asset securitization in his article The Impact on Securitization of Revised UCC Article 9, 74 Chicago-Kent L.Rev. 947, 947-48 (1999):

In a typical securitization, a company (usually referred to as the 'originator') sells rights in income-producing or financial assets - such as accounts, instruments, lease rentals, franchise and license fees, and other intangible rights to payment - to a special purpose vehicle ("SPV").  The SPV, in turn, issues securities to capital market investors and uses the proceeds of the issuance to pay for the assets.  The investors, who are repaid from collections of the assets, buy the securities based on their assessment of the value of the assets.  Because the SPV (and no longer the originator) owns the assets, their investment decision often can be made without concern for the originator's financial condition.  Thus, viable companies that otherwise cannot obtain financing because of a weakened fianancial condition now can do so.   Even companies that otherwise could obtain financing now will be able to obtain lower-cost capital market financing.

Professor Lynn Lopucki also comments on asset securitization in his article Death of Liability, 106 Yale L.J. 1, 23-24 (1996) (in which he argues that asset securitization is an effective strategy for judgment proofing the seller of assets):

Asset securitization is by far the most rapidly growing segment of the U.S. credit markets.  Financial historians have traced asset securitization back more than a century, but the boom in asset securitization began in the 1970's with the U.S. government's efforts to encourage the development of secondary mortgage markets.  Once the technique proved successful, it quickly spread to student-loan-backed securities, credit-card-receivable-backed securities and other sectors of finance. 

For a fuller yet concise and clear description of asset securitization and a comparison of its costs and benefits to the costs and benefits of traditional financing vehicles, see S. Schwarcz, The Alchemy of Asset Securitization, 1 Stan. J. Law, Business and Finance 133 (Spring 1995). 

     The increased importance of asset securitization as a financing vehicle prompted significant changes to Article 9 reflected in the 1998 revisions.  Although former Article 9 applied to "any sale of accounts and chattel paper" (former U.C.C. 9-102(1)(b)), its narrow definition of accounts and its inapplicability to the sale of promissory notes exposed the purchaser of receivables other than accounts or chattel paper to the vagaries (and additional expense of complying with or receiving legal opinions about) non-uniform and sometimes obscure state law concerning the sale of receivables.  By significantly expanding the definition of accounts (e.g. to include a right to payment arising out of the use of a credit card and to include health care receivables) (U.C.C. 9-102(a)(2)) and by expanding the coverage of Article 9 to include the sale of promissory notes and payment intangibles (U.C.C. 9-109(a)(3)), Revised Article 9 has simplified and made more predictable the process of giving constructive notice of the sale of receivables and thus has facilitated the process of asset securitization.  P. Shupack, Making Revised Article 9 Safe for Securitizations: A Brief History, 73 Amer. Bkry. L.J. 167 (Winter 1999) reviews the relevant drafting problems and solutions in the Article 9 revision process.