Collection of receivables
1. Notification
Commercial financing often involves the taking of a security interest in a receivable. See Commentary.Scope of U.C.C. Article 9 and Commentary.Sale of receivables. To realize the value of a security interest in a receivable, the secured party 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 party obligated on the receivable to pay the secured party directly. (Notice the parallel between this remedy and the remedy afforded lenders secured by rents and profits of real property by Cal. Civ. Code 2938(c)(3)). If the party obligated on the receivable fails to pay in response to such notice, the secured party is entitled to 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 right to receive payment was transferred from the debtor to the secured party. For example, if the receivable is sold outright to the secured party, the agreement is likely to 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 the receivable has 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 the debtor's default.
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 may authorize the financier to notify consumers immediately to make all further payments to the financier. The agreement may even provide for such notification if the retailer has assigned the chattel paper as security for a loan from the financier. If the agreement does not provide for such notification, the financier may only notify consumers to pay the financier if the retailer defaults on its obligations to repay a loan from the financier.
2. 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"). Where 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 where the sale is without recourse for the obvious reason that the seller will not be saddled with uncollected receivables.
Where 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).
3. Secured receivables
In some cases an obligation owed by a third party to a debtor may itself 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. 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, where 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 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 the sellers' subsequent borrowing and the sellers later defaulted. 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 nonjudicial foreclosure on a mortgage that secures an obligation where the obligation itself has been used as collateral.
4. 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 to the obligee has been modified (e.g. reduced or extended) in an agreement with the obligee, or that its obligation has been discharged by previous payment to 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. Here we alert you to the issues, with the appropriate statutory references.
(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 transferred (either sold or assigned for purposes of security) 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 assigns her 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 transferred. 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?
(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.
4. Deposit accounts
Collection with respect to deposit accounts merits separate discussion. 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. U.C.C. 9-607(a)(4). This is the functional equivalent of the common law right of set off. Where the secured party is not the bank in which the debtor maintains the deposit account, and where 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 at which the debtor maintains the account to pay the balance of the deposit account to the secured party. U.C.C. 9-607(a)(5).