ucc assignment of accounts receivable

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When Your Vendor’s Lender Demands You Pay It Instead of Your Vendor

Apr 22, 2020

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Blockchain and Banking Blog Blogs Coronavirus Response Team Tax & Finance Considerations

Vincent E. Mauer

A commercial lender’s favorite collateral is often a borrower’s accounts receivable. This collateral is the building block of countless revolving lines of credit that provide borrowers with working capital and flexibility. Lenders prefer accounts receivable as collateral because it is similar to cash, unlike collateral that must be fed and liquidated (assets that must be insured, stored, marketed and sold). Additionally, the Uniform Commercial Code (“UCC”) permits lenders to collect accounts receivable directly from the borrower’s customers without using judicial process, thus saving time and money. [1]

After a loan agreement “goes bad” and the lender declares a default, the lender’s options for collection of accounts receivable collateral include giving notice to persons whose accounts owed to a borrower were pledged by that borrower to the lender (the borrower’s customer is a “payor”), [2] that is, accounts receivable in which the lender has a UCC Article 9 Security interest. [3] The primary operative provision is UCC 9-406, which states in part:

• Subject to subsections (b) through (i), an account debtor on an account , chattel paper , or a payment intangible may discharge its obligation by paying the assignor [borrower] 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 [ payor] may discharge its obligation by paying the assignee [Lender] and may not discharge the obligation by paying the assignor [Borrower] .
• Subject to subsection (h), notification is ineffective under subsection (a): (1) if it does not reasonably identify the rights assigned; (2) . . . [a limitation applicable to payment intangibles that are not accounts   receivable, for example insurance settlements]; or (3) at the option of an account debtor, if the notification notifies the account debtor to make less than the full amount of any installment or other periodic payment to the assignee, even if: (A) only a portion of the account , chattel paper , or payment intangible has been assigned to that assignee; (B) a portion has been assigned to another assignee; or (C) the account debtor knows that the assignment to that assignee is limited. [4]
• Subject to subsection (h), if requested by the account debtor [ payor], an assignee [lender] shall seasonably furnish reasonable proof that the assignment has been made . Unless the assignee complies, the account debtor may discharge its obligation by paying the assignor, even if the account debtor has received a notification under subsection (a).

(Emphases added.) Ordinarily, the above-quoted statute means that, after a borrower defaults, the lender can give a “notification” to its borrower’s customers ( payors) [5] and demand that amounts owed to the borrower instead be paid to the lender if the lender has a perfected security interest in its borrower’s receivables.

There are a few common concerns faced by our payor clients who receive notifications from their secured vendor’s secured lenders.

The first thing a  payor must understand is that neither (a) the borrower’s granting of a security interest in its accounts receivable, nor (b) a lender’s notification under UCC 9-406, will change the amount owed, the terms of the account debt, or the payor’s rights such as a discount for returned merchandise or prompt payment. A  payor who receives a lender’s notification should, therefore, take a deep breath and determine exactly what is owed to the vendor that granted the security interest to the lender.

In my experience,  payors who receive a lender’s notification nearly always choose to alert their vendor (the lender’s borrower) of the notification. The statute neither permits nor prohibits such action. Typically, the payor’s communication is, in part, an effort by the payor to (i) alert its vendor that a payment may not be coming, (ii) assess the vendor’s stability so the payor can determine if it needs to find a new source for the goods and services supplied by the vendor, and (iii) to seek information on whether the lender’s notification is real and appropriate.

Contacting the vendor is understandable. It is natural for a  payor to seek information from the party with whom it regularly does business rather than a probable stranger, the lender. Vendor-provided information, however, comes with a caveat: If the vendor asserts that the lender’s notice to the payor is in error and should be ignored, the payor accepts that advice at its own risk. The UCC provision quoted above clearly states that a  payor who has received an appropriate lender’s notification cannot discharge its debt to the vendor by paying the vendor instead of the lender.

Rather, or in addition to, contacting the vendor, a  payor can choose to contact the lender and request evidence that payment to the lender is appropriate. In this event, the UCC requires the lender to provide “reasonable proof that the assignment was made.” This usually means evidence that the vendor granted a security interest to the lender and that the accounts receivable created by the payor’s debt to the vendor is covered by that security interest. A  payor should take advantage of this opportunity to communicate with the lender and request “proof,” if either (a) the vendor asserts that the lender’s notice to payor is wrongful, or (b) the lender’s “notification” seems inadequate. This is a proper response to payor’s concerns. [6]

In my experience, lenders often ignore a  payor’s request for “proof” following a lender’s “notification.” There are many possible reasons for this inaction by the lender. [7] Whatever the rationale, however, the result is the same. According to UCC 9-406 comment 4:

[e]ven if the proof is not forthcoming, the notification of assignment would remain effective, so that, in the absence of reasonable proof of the assignment, the account debtor could discharge the obligation by paying either the assignee or the assignor. Of course, if the assignee [lender] did not in fact receive an assignment, the account debtor [ payor] cannot discharge its obligation by paying a putative assignee who is a stranger [a fraudster] .

(Emphasis added). Given the last sentence in this comment, the only safe action by payor is payment to the vendor, not the lender, if the lender failed to respond to payor’s request for “proof.”

As noted above, the lender’s notification to payor does not alter the terms of the payor’s obligations to the vendor. For example, if a  payor has received a notification from a lender and has requested reasonable proof of the assignment, payor may discharge its obligation by paying the assignor at the time when payment is due, even if the account debtor has not yet received a response to its request for proof. This is a warning for lenders to think about their borrower’s collection cycle when sending notifications to payors.

If a  payor deals with a large vendor or one with diverse operations, the vendor may have more than one secured lender. Vendors can have two or more secured creditors each with a security interest in the vendor’s accounts payable. [8] Sophisticated payors will often discover this fact when they do an online search with the appropriate Secretary of State’s office. Unfortunately, the UCC’s official commentary is silent on the payor’s duties in this situation. See, however, comment 7 to UCC 9-406:

For example, an assignor [vendor] might assign the same receivable to multiple assignees [. . . .] Or, the assignor could assign the receivable to assignee-1, which then might re-assign it to assignee-2, and so forth. The rights and duties of an account debtor in the face of multiple assignments and in other circumstances not resolved in the statutory text are left to the common-law rules. See, e.g., Restatement (2d), Contracts Sections 338(3), 339.

When faced with this problem, counsel must determine which state’s common law applies and find the non-UCC answer from applicable law.

Finally, clients often ask whether a particular lender notification is an appropriate and effective “authenticated” notification. The answer depends on the circumstances of the notification. Fortunately, there are plenty of court decisions that can provide guidance on this question. One example is Swift Energy Operating, LLC v. Plemco-South Inc. , 157 So.3d 1154 (La. Ct. App. 2015), where a borrower did business with an account receivable factor, the secured party. The borrower and factor sent an email to the payor which was the alleged lender notification under Louisiana’s version of UCC 9-406. In response to that email, the payor’s employee directed the lender to contact the payor’s appropriate office. The payor’s employee, however, did not sign and return the acknowledgment that payor received the lender’s notification. The lender subsequently failed to contact the payor’s accounts payable office as directed and the payor paid its obligation to the vendor rather than the lender/account receivable factor. Litigation was initiated in an effort to determine if payor was nonetheless liable to the lender for failure to follow the lender’s notification.

The Louisiana Court of Appeals held that the email was not an “authenticated” notification in compliance with the statute. The court reasonably held that the required notice must be directed to the appropriate payor department or employee when the lender has notice of that department. The court ruled:

[W]e find that the notice required by La.R.S. 10:9-406(a) was not effected prior to Swift Energy’s payment to Plemco–South. Given the size of its operation, we find that Swift Energy maintained reasonable routines for communicating significant information through its departmentalization policy, and both Factor King and Plemco–South were timely made aware of the proper department for delivery of the required notice. Had either Ms. Gleberman or Mr. Stigall followed Ms. Keo’s instruction, notice would have been effected to the appropriate department well before the payment to Plemco–South at issue.

Id. at 1164.

The UCC’s provision for nonjudicial collection of accounts receivable collateral is important and valuable to lenders. Unfortunately, it regularly raises questions and concerns for recipients of lender notifications. Experienced counsel can help their payor clients resolve concerns, determine who to pay, and possibly smooth any tensions between the payor and its vendor by demonstrating that the payor exercised every opportunity to protect the vendor before paying the lender.

For more information, please contact Vince Mauer or any attorney in Frost Brown Todd’s Financial Services industry team.

[1]  This post does not address a lender’s efforts to control accounts receivable collateral while the lending relationship is intact, such as use of a lockbox to receive payments and control over the borrower’s bank accounts into which the accounts receivable payments are deposited by the borrower (whether by check or wire transfer).

[2]  For purposes of this blog post, I will use the term “Payor” for the borrower’s customer who owes money to the borrower and whose debt to borrower is subject to a security interest in favor of the lender. This blog post is written from a Payor’s perspective.

[3]  A warning for lenders: According to the Ohio Supreme Court, this remedy is not fully available against the collateral of a borrower whose customer, the Payor, is a government entity. See MP Star Financial Inc. v. Cleveland State Univ. , 837 N.E.2d 758 (Ohio 2005) ( “provision of UCC making an account debtor liable to an assignee of accounts receivable, for payments made to assignor after receiving notice of assignment, does not apply to payments made by an account debtor that is a governmental unit.”).

[4]  Under subsection (b)(3), an account debtor that is notified to pay an assignee less than the full amount of any installment or other periodic payment has the option to treat the notification as ineffective, ignore the notice, and discharge the assigned obligation by paying the assignor [vendor]. This is a convenience for Payors and a warning to lenders.

[5]  For the typical recipient of this notice (a Payor), the borrower whose account was assigned is a vendor, a business that sells goods or services to you and grants its lender a security interest in the account receivable generated by that sale.

[6] Comment 3 to UCC 9-406 states: “[i]f an account debtor [Payor] has doubt as to the adequacy of a notification, it may not be safe [for the Payor] in disregarding the notification unless it [Payor] notifies the assignee [lender] with reasonable promptness as to the respects in which the account debtor considers the notification defective.” So, a Payor with concerns may be better off to seek information from the lender rather than making its own decision concerning the adequacy of the notification.

[7]  I have occasionally counseled lender clients to ignore a Payor’s request for “proof.” The reasons for this advice are beyond the scope of this blog post.

[8]  Hopefully, there is an Intercreditor Agreement addressing lien priorities and which lender(s) can send a lender notification.

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It’s Not Nice to Pay an Invoice Twice: Payment Demands During COVID-19 by Assignees of Accounts Under UCC Section 9-406

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For a printable PDF version of this article, please click here.

The mail room just received a piece of unregistered first-class mail from a company you don’t recognize. The letter floats around the office for a couple of days before landing on the desk of your accounts payable clerk, who is taking the week off. The clerk returns and determines that the letter seems to be some sort of collection scam–the letter says to pay some collection company for an account receivable you owe to one of your vendors. But that vendor is set up for ACH debits, and a payment just went out the day before your A/P clerk returned. Because there’s nothing to pay, your A/P clerk round-files the notice. Three more payments go out before you receive notice and complaint from the collection company: it’s suing you for not paying those same four invoices. First, the bad news: You still owe the collection company for the invoices. Next, the worse news: You call your critical vendor to say that you have to pay all future amounts over to the collection company, and your vendor threatens to withhold critical deliveries. Your vendor says that the collection company is gouging them on late fees and attorneys and isn’t owed another penny. How did this become your problem?

The Legal Framework

Article 9 of the Uniform Commercial Code (the “UCC”) provides a powerful collection tool for lenders and purchasers of accounts receivable. An “account debtor” (the party obligated to pay an account receivable) may be obligated to pay the same invoice twice if it receives a proper notice from an assignee but nonetheless pays the original owner of the account receivable. Assignments and Pledges of Accounts Payees on accounts, payment intangibles, and promissory notes (“payment obligations”) may freely assign the obligations, notwithstanding any restrictions in the agreement between the account debtor and the payee/assignor. Section 9-406(d) of the UCC renders the anti-assignment term and any default resulting from violation of that term ineffective. This allows payees/assignors to monetize payment obligations through pledge or sale. The term “assignee” in the context of Section 9-406 means either a purchaser of a payment obligation or a secured party with a security interest in the payment obligation. Effective Notification An assignee may provide notice to the account debtor of the assignment or pledge under Section 9-406(b). A proper notice must be authenticated (signed, which includes electronic signatures). A notice that is authenticated may nonetheless be ineffective under either of the following circumstances:

• If it does not reasonably identify the rights assigned.
• At the option of an account debtor, if the notification tells the account debtor to pay the assignee less than the full amount of any installment or other periodic payment. 

Proof of Assignment An account debtor may request proof from the assignee that the assignment was made under Section 9-406(c). Proof could consist of the signed agreement in which the assignor pledges or assigns the payment obligation. A filed financing statement, in and of itself, is not sufficient proof. If the assignee fails to “seasonably” comply with the request for proof, then the account debtor may discharge the payment obligation by paying the assignor without risking the double-payment consequence described below. “Seasonably” means “timely,” but is not defined as a specific time frame. But official comment 4 to Section 9-406 explains that an account debtor that has received notification of an assignment and has requested reasonable proof of the assignment may discharge its obligation by paying the assignor when payment is due (or even earlier if reasonably necessary to avoid risk of default), but that paying the assignor substantially before the payment is due will not discharge the obligation unless the assignee has failed to seasonably provide requested proof of the assignment. Consequences for Failing to Pay Assignee Except as noted above, paying the assignor rather than the assignee after receiving a valid notification from the assignee does not discharge the underlying payment obligation, and the assignor can seek to enforce the payment obligation directly against the account debtor. This means that the account debtor may have to pay twice unless it can recover the double payment from the assignor. Defenses to Payment The assignee does not obtain greater rights to payment than the assignor. As provided in Section 9-404, “the rights of an assignee to an assigned or pledged payment obligation are subject to (1) all terms of the agreement between the account debtor and assignor and any defense or claim in recoupment arising from the transaction that gave rise to the contract, and (2) any other defense or claim of the account debtor against the assignor which accrues before the account debtor receives a notification of the assignment authenticated by the assignor or the assignee.”

Suggested Procedures Upon Notification

Because businesses are increasingly under stress, especially small businesses that may have entered into factoring agreements by which they’ve sold or pledged their accounts to hard money-lenders for quick cash at a discount, businesses should expect to see more diversion notices from banks, factors, and other finance companies. The UCC is pretty unforgiving if a company is late to respond. A business is wise to do the following:

• Determine whether the notice meets requirements for effective notice and complete a checklist. To download a Sample Account Assignment Checklist, click here .
• Immediately notify the accounts payable department (or whomever is responsible for cutting checks and sending wires) of the assignment, and freeze any payments to the debtor.
• If contacted by an attorney for the assignee or the assignor, refer the attorney to the company’s legal counsel. Once an attorney knows that the business is represented by counsel, the attorney cannot ethically have further contact with the company without consent of its attorney (internal or external).
• Contact the legal department and provide a completed checklist. To download a Sample Account Assignment Checklist, click here .
• Determine whether the amount claimed by the assignee is correct. The company may have paid a prior invoice before receiving the notice, or there may be an outstanding billing dispute between the company and the assignor.
• Contact the assignee for any missing items of proof, or to assert contras, set-offs, or counterclaims. 
• Notify the assignor of the notice and the company’s obligation to pay the assignee. If a payment is due or will become due shortly, notify the assignor that payment may be slightly delayed while the company awaits a response on the request for proof.
• If the assignee is entitled to payment, update payment information in the business’s system. Follow procedures for verifying payment information.
• If a request for proof has not been satisfied, and a payment obligation risks default, make the payment to the assignor after a final notice to the assignee. Consult legal counsel before doing this.
• If the assignor disputes the assignee’s right to be paid, consult with the company’s lawyer about whether to interplead the amounts owed (pay the funds to the court and let the assignor and assignee fight over them).

Practical Considerations

If you’re receiving one of these notices, it’s not necessarily a sign that your vendor is in trouble with its lender or factor but it can be. If you have an ongoing business relationship with a cash-strapped vendor, you could find yourself with the problem in the example above. A desperate vendor that can’t pay workers or keep the lights on may be better off pulling its workers or withholding goods and services, even though by doing so it would breach its agreement with you. The breach creates a counterclaim that can be offset against the receivable, which is bad for the lender or factor. Each of the parties has something to lose and something to gain, so quick action to negotiate a settlement in which each party gets less than it wants can head off a more disastrous result.   

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How New York UCC, Article 9, applies to the sale and purchase of accounts receivable

August 2019   |  EXPERT BRIEFING  |  BANKING & FINANCE

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The sale of accounts receivable is a viable option for sellers to increase cash flow. Likewise, purchasing accounts receivable at a discount can be a good business opportunity. When buying accounts receivable, purchasers must comply with Article 9 of the New York Uniform Commercial Code (UCC) in order to record the change in ownership.

This article explores the methods by which a party can sell (assignor) its accounts receivable (debt) to a purchaser (assignee) and mitigate future risks associated with non-payment by the party obligated to pay into the account (debtor).

Introduction: application of the UCC to assignments

Determining who owns an account receivable can be difficult because accounts are intangible in nature. Article 9 of the UCC protects purchasers of accounts receivable by providing a method to record ownership. Recording the sale of the receivable is accomplished by filing a UCC financing statement. The filing serves multiple purposes. It can be used to show ownership and require payment from the debtor, provides notice of sale to other creditors and can be used to defeat or rank competing claims to the same account in bankruptcy.

Article 9 states that a purchaser or assignee receives a “security interest” through assignment. This may raise concerns for a buyer that wants to obtain full rights in the accounts receivable and not just a security interest, which is commonly given to secure a loan but does not include enforcement rights until a default. In addition, the sale of an account is recorded in the same manner as a security interest serving as collateral, namely, by filing a UCC-1 financing statement. However, according to the official comments to the UCC, despite the somewhat confusing language, the assignee in fact obtains full ownership over the account receivable it purchases. Use of terminology such as “security interest” is merely a drafting convention, and “has no relevance in distinguishing sales from other transactions”.

Assignability of a debt (i.e., accounts receivable)

General conditions of the UCC Article 9. There are three general conditions, outlined below, that must be satisfied to effect the sale of an account receivable under Article 9.

First, assignment must fall within the scope of “account”: An “[a]ccount… means a right to payment of a monetary obligation whether or not earned by performance: … for services rendered or to be rendered”. A debt which relates to the provision of goods, and not just services, also satisfies the conditions necessary to effect assignment of a debt. While the definition of “account” under the UCC does not explicitly include goods, the official comment provides that the definition of “account” is not limited to just “goods or services”, rather, the definition has “expanded”.

Second, when purchasing accounts receivable or debts for goods sold, the filing of a UCC financing statement (UCC-1) by the purchaser is mandatory.

Third, notice to the debtor may be given. If the assignee decides that it wants the debtor to pay it directly, then notice to the debtor is required under the UCC. Without notice, the debtor “may discharge its obligation by paying the assignor until, but not after, the account debtor receives a notification”. Notice is often not provided until there is a default by the assignor because companies often sell their accounts receivable and continue to collect the amounts due from customers on behalf of the assignee. This is often done because the assignor does not want its customers to know it is using accounts receivable to finance its business. Furthermore, the assignor may have a better ability to collect due to close business ties.

Effect of contractual anti-assignment provisions. A party to a contract may want to prohibit assignment for a variety of reasons. However, New York generally favours assignments. In fact, under New York law, while violation of contractual language prohibiting assignment or requiring the approval of one party may trigger a breach of contract by the assignor, this does not invalidate the transfer. In order to make an assignment ineffective, contractual language must be very explicit, such as a provision stating that any attempted assignment is “void”.

The UCC provides additional protection to accounts receivable, in that anti-assignment provisions are ineffective if they attempt to restrict the sale or grant of a security interest in an account. Thus, accounts receivable may be sold despite contractual restrictions prohibiting such transfers.

Validity of an assignment

Legal requirements for valid assignment. In general, “a security agreement is effective according to its terms between the parties, against purchasers of the collateral, and against creditors”. A security interest (i.e., assignment) is enforceable if value was given, the assignor had the authority to transfer its rights in the collateral to the secured party and the assignor authenticated a security agreement that provides a description of the collateral (defining “authenticate” as “to sign, or with present intent to adopt or accept a record, to attach to or logically associate with the record an electronic sound, symbol, or process” such as an electronic signature).

The term security agreement is defined in the UCC as “an agreement that creates or provides for a security interest”. As discussed, the term “security interest” is a UCC drafting convention and is not distinguished from a sale.

Validity of assignment of part of a debt. Partial assignments are valid and enforceable. H Co., Ltd. v. Michael Kors Stores, LLC (2009) found that “an assignment may be for ‘a part only of the designated payment’”. In addition, Terino v. LeClair (1966) found that “debt which was partially assigned was to be created and payment was to become due in the future did not render equitable assignment invalid”.

Rights and title that passes from the assignor to the assignee. When assignment is performed correctly, the assignee receives all rights, title and interest possessed by the assignor with respect to the debt (i.e., accounts receivable). The assignor will have no remaining power over, or interest in, the debt.

As per the UCC, the assignee receives unencumbered rights as existing under the original contract and those arising from the original transaction. The rights of an assignee are subject to: (i) all terms of the agreement between the account debtor and assignor and any defence or claim in recoupment arising from the transaction that gave rise to the contract; and (ii) any other defence or claim of the account debtor against the assignor which accrues before the account debtor receives a notification of the assignment authenticated by the assignor or the assignee.

In addition, the purchaser of the debt takes the debt subject to previously recorded sales or filed financing statements conveying or covering the same debt. For example, financing banks often take a security interest in all of a debtor’s property, including accounts. If the description in the prior-filed financing statement covers “accounts” of the assignor “generally”, the assignee will need to obtain an intercreditor agreement subordinating the financing bank’s interest in the account or the assignee’s interest will remain subject to the prior-filed security interest of the financing bank.

The assignee may assign the debt to another party. The new assignee will have the same rights, privileges, and interest in the debt. Further, “[i]f a secured party assigned a perfected security interest, a filing [of a UCC financing statement] is not required to continue the perfected status of the security interest against creditors of and transferees from the original debtor”. However, it is good practice to file an amendment identifying the new secured party or owner of the receivable.

Automatic assignment of future debts. The UCC provides that, subject to certain exceptions, a security agreement may create a security interest in after-acquired collateral, and may provide that accounts are sold in connection with future advances. Accordingly, so long as the description in the financing statement continues to accurately describe the collateral (i.e., the debt), no new filing is required. Therefore, the assignee may specify in its assignment agreement with the assignor that future debts are assigned to the assignee “as they arise” or similar language.

Perfection, priority and notice of assignment

What to file . New York requires the filing of form UCC-1, financing statement. A financing statement must have the assignor’s proper corporate name (not the trade name), the assignee’s name, and an indication of the collateral (i.e., the debt and the specific account receivable). The UCC indicates that financing statements should contain: the assignor’s address, whether the assignor is an individual or organisation, registration numbers and the assignee’s address. A financing statement is effective for five years and may be renewed for an additional five years.

Where to file . Under the UCC, the general rule is that the place for filing is a debtor’s location. However, in the context of assignment, location of the debtor does not affect the validity of the financing statement. Rather, it is the location of the assignor that is important. If the assignor is a corporation or similar corporate entity, filing must be done in the state of incorporation. If the assignor is an individual, then in the state of the assignor’s residence. If the assignor is an unincorporated business, then in the state of the assignor’s principal place of business or chief executive office. Generally, financing statements are filed with the Secretary of State’s office in the appropriate jurisdiction. In addition, any person can file a financing statement if the assignee authorises the filing in an authenticated (signed) record or agreement.

How long to file. Generally, there is no time period within which a security interest must be perfected by filing the financing statement. However, New York follows the “first in time, first in right” rule. Thus, the assignee’s security interest should be perfected as soon as possible to prevent another purchaser or creditor from priming the assignee’s security interest.

Preservation of assignment rights in bankruptcy

Importance of perfection for bankruptcy. In the event of bankruptcy by either the debtor or assignor, whether or not a debt has been perfected will play a critical role in determining the value of a claim against the debtor’s estate. The assignee, in effect, stands in the shoes of the assignor. Therefore, if neither the assignee nor the assignor have perfected their security interest against the debtor, then the assignee will be an unsecured creditor in the debtor’s bankruptcy.

In the event that the assignor declares bankruptcy and the assignee has not filed appropriate financing statements, the accounts sold to the assignee may become an asset of the debtor’s estate. In this scenario, the assignee is an unsecured creditor. If, however, the assignee has filed the appropriate financing statement conveying the accounts were sold to the assignee, the accounts are not considered property of the debtor or its bankruptcy estate.

The sale of receivables is a common way for businesses to finance ongoing operations including the purchase of inventory. If the proper formalities are followed, a purchaser can be reasonably assured that they have priority to, and ownership of, the account receivable.

John Kissane is a partner and Sabih Siddiqi and Celinda Metro are associates at Watson Farley & Williams LLP. Mr Kissane can be contacted on +1 (212) 922 2200 or by email: [email protected]. Mr Siddiqi can be contacted on +1 (212) 922 2200 or by email: [email protected]. Ms Metro can be contacted on +1 (212) 922 2200 or by email: [email protected].

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UCC Collateral Description: What You Should Include

What Should You Include in Your UCC Collateral Description?

A perfected security interest is nothing without a collateral description . A properly perfected security interest requires compliance with Article 9, which includes a Security Agreement and the subsequent filing of the UCC-1 Financing Statement with collateral descriptions in both. In today’s post, we’ll review what to include in a UCC collateral description.

What Is a Sufficient Collateral Description According to Article 9?

First, what is collateral ? Collateral can be either tangible or intangible. Some forms of tangible collateral are consumer goods, equipment, inventory and farm products. Some forms of intangible collateral are instruments which include any written evidence of the right to receive money, documents of title and receipts, chattel paper, accounts, general intangibles, healthcare receivables and supporting obligations.

Then, what makes a collateral description sufficient ? Article 9-108 provides the following:

(a) Except as otherwise provided… a description of personal or real property is sufficient, whether or not it is specific, if it reasonably identifies what is described.

(b) [Examples of reasonable identification.]

Except as otherwise provided in subsection (d), a description of  collateral  reasonably identifies the collateral if it identifies the collateral by:

(1) specific listing;

(2) category;

(3) except as otherwise provided in subsection (e), a type of  collateral   defined in [the Uniform Commercial Code];

(4) quantity;

(5) computational or allocational formula or procedure; or

(6) except as otherwise provided in subsection (c), any other method, if the identity of the  collateral   is objectively determinable.

Watch Out for these Common Collateral Mistakes

Collateral descriptions will vary based on the collateral used to secure the credit; however, there are key pieces of information that are sometimes overlooked or inadvertently omitted.

• Don’t Forget the After-Acquired Collateral: phrases like “now owned or hereafter acquired” or “now existing and hereafter arising” are technically not required under Article 9, but experts agree it is smart to include the phrasing so as to not limit recovery.
• Don’t Add Limiting Language: be careful when identifying collateral located at a specific address or acquired within a certain time frame. Adding limits to the language could do more harm than good. ( Check out this post for an example of limitation by address. )
• Say What You Mean, Mean What You Say: be aware of what may or may not be included in “all compassing” phrases such as “all proceeds thereof.” If you expect the security interest to include all accounts/accounts receivable, it’s best to include those terms in the collateral description.

Remember 1st Source Bank?

Remember the 1 st Source Bank case? In this case, the key issue was whether the language describing specific heavy machinery and “ all proceeds thereof ” included the debtor’s accounts and accounts receivable.

1st Source Bank arranged for the lease or sale of certain equipment to K & K Trucking and J.E.A. Leasing (Debtors), which was subject to a security interest that was described in the UCC filing according to the above language.  The terms “accounts” and “accounts receivable” were not included in the description of the collateral.

Subsequent to the 1st Source Bank UCC filing, the Debtors entered financing contracts with several other banks. These other banks, in turn, filed UCCs which specifically identified “ all accounts receivable now outstanding or hereafter arising ” as part of the collateral description.  When the debtor defaulted, these banks took control of the collateral, including the accounts receivable.  1st Source Bank objected based on its claimed priority security interest.

The issue before the court was whether the language referring to “all proceeds thereof” was sufficient to put future creditors on notice that 1st Source Bank held a security interest in “accounts” and “accounts receivable.”

The court determined “all proceeds thereof” did not include “accounts” and “accounts receivable.”

Why? Because “Although the statutory definition of the term ‘proceeds’ appears admittedly broad, accepting [1 st Source Bank]’s interpretation of the statute would render the term ‘accounts’—a category defined separately in Chapter 9—meaningless. See Tenn. Code Ann. § 47-9-102(a)(2).”

Consequently, 1st Source Bank’s security interest was not perfected with respect to accounts and accounts receivable , providing the other banks a priority status even though their filings were recorded after 1st Source Bank.

Collateral is Key

Because the collateral that underlies a security interest is the key protection afforded to creditors in the case of debtor default or bankruptcy, collateral must be properly described in UCC filings. The description of collateral needs to put prospective creditors on notice so that prospective creditors have reason to inquire further about existing security interests . Be careful, there’s a fine line between being too specific and too generic.

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Five Key Points Regarding the Assignment of Receivables in Healthcare Transactions

In the healthcare investment arena, the securing of credit facilities is complicated by the so-called “anti-assignment” provisions of the Social Security Act and its implementing regulations. These provisions do not prohibit a provider from assigning or granting an effective security interest in Medicare and Medicaid receivables, but do prohibit any assignee or secured party from directly receiving the proceeds of such receivables. As a result, traditional securing structures must be modified and institutions that finance healthcare entities must consider the following:

• Required Offset Waivers . As part of the Medicare enrollment process, enrollees are required to obtain offset waivers from their financing institutions for deposit accounts maintained with such financing institutions that will directly receive proceeds from Medicare or Medicaid receivables. As a result, until these proceeds are moved to a different deposit account at the direction of the provider, financing institutions are unable to offset against funds on deposit in the initial deposit account that holds Medicare or Medicaid receivables against outstanding loans. For this reason, a provider should be required to segregate its receivables into two different lockboxes: one dedicated to the receipt of Medicare and Medicaid receivables (and subject to the offset waiver) and one dedicated to the receipt of all other receivables (and not subject to the offset waiver).
• Provider-Controlled Receivables . Regulations promulgated by CMS require that all proceeds of Medicare and Medicaid receivables must be initially paid to a deposit account with respect to which only the provider can give instructions. As a result, such a deposit account cannot be subject to a customary UCC “control agreement” whereby the bank agrees to give the lender the right to direct the disposition of funds in the deposit account. The lender, therefore, cannot obtain a direct security interest in such a deposit account through the use of a control agreement. However, the lender will continue to have an indirect security interest in all amounts on deposit in the deposit account as proceeds of its perfected security interest in the Medicare and Medicaid receivables themselves (which would arise by making the appropriate UCC-1 filings and executing a security agreement covering the receivables with the relevant debtor/borrower). Nevertheless, a lender’s recourse against such proceeds of Medicare and Medicaid receivables is limited until they are moved out of the initial deposit account.
• Double Lockbox Structure . To address the inability of a lender to offset against the initial deposit account or obtain a direct security interest in such deposit account through use of a control agreement, lenders commonly require a “double lockbox” structure. As indicated above, the provider should already have segregated its receivables payments into two dedicated lockboxes. The lender will require that all proceeds deposited in the dedicated Medicare/Medicaid lockbox account be swept out on a daily basis to either the nongovernment lockbox account or another deposit account subject to the control of the lender. Lenders and providers will commonly enter into agreements with the depositary bank whereby the provider instructs the depositary bank to sweep the contents of this account into a lender-controlled lockbox account at the end of each day. If the borrower ever desires to change these standing instructions, the agreement governing such account will normally require that the borrower provide 3–10 days’ prior written notice of such change to both the lender and the bank and/or provide that the bank will notify the lender of the change a certain number of days prior to the instructions becoming effective. Moreover, the loan agreement with the borrower will commonly provide that an unauthorized change in the standing instruction to move funds to the lender-controlled lockbox account will result in an immediate default that would suspend the obligation of the lender to continue making loans to the borrower.
• Self-Help Unavailable . In the event of a default, traditional UCC “self-help” provisions generally cannot be used to cause the account debtor on Medicare and Medicaid accounts receivable (the U.S. government) to pay the lender directly, because CMS regulations prohibit assignees from directly receiving Medicare and Medicaid receivables. These regulations do contain exceptions to this prohibition against paying an assignee directly; however, a court order would be required and the assignee may be liable for overpayments as if it were the provider.
• Other Governmental Healthcare Programs . Lenders financing healthcare entities that have other types of healthcare-related governmental receivables, such as Energy Employees Occupational Illness Compensation Program Act receivables or Black Lung Benefits Act receivables, face similar restrictions on the assignment of receivables under the Federal Assignment of Claims Act. Although the Federal Assignment of Claims Act contains a financing exception for claims aggregating at least $1,000, in order for an assignment of receivables to comply with the exception, the lender must comply with burdensome notice filing requirements and the assignment must generally occur as part of the financing and prior to the performance of the government contract. This latter requirement creates challenges in the healthcare industry, where claims are generated after services are provided to patients. As a result, financing institutions often utilize the double lockbox structure for all types of healthcare-related governmental receivables.

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Assignment of Accounts Receivable – Trap for the Unwary

By  Steven A. Jacobson

Most businesses are familiar with the mechanics of an assignment of accounts receivable. A party seeking capital assigns its accounts receivable to a financing or factoring company that advances that party a stipulated percentage of the face amount of the receivables.

The factoring company, in turn, sends a notice of assignment of accounts receivable to the party obligated to pay the factoring company’s assignee, i.e. the account debtor. While fairly straightforward, this three-party arrangement has one potential trap for account debtors.

Most account debtors know that once they receive a notice of assignment of accounts receivable, they are obligated to commence payments to the factoring company. Continued payments to the assignee do not relieve the account debtor from its obligation to pay the factoring company.

It is not uncommon for a notice of assignment of accounts receivable to contain seemingly innocuous and boilerplate language along the following lines:

Please make the proper notations on your ledger and acknowledge this letter and that invoices are not subject to any claims or defenses you may have against the assignee.

Typically, the notice of assignment of accounts receivable is directed to an accounting department and is signed, acknowledged and returned to the factoring company without consideration of the waiver of defenses languages.

Even though a party may have a valid defense to payment to its assignee, it still must pay the face amount of the receivable to the factoring company if it has signed a waiver. In many cases, this will result in a party paying twice – once to the factoring company and once to have, for example, shoddy workmanship repaired or defective goods replaced. Despite the harsh result caused by an oftentimes inadvertent waiver agreement, the Uniform Commercial Code validates these provisions with limited exceptions. Accordingly, some procedures should be put in place to require a review of any notice of assignment of accounts receivable to make sure that an account debtor preserves its rights and defenses.

• Announcement

§ 9-102. DEFINITIONS AND INDEX OF DEFINITIONS.

(a) [Article 9 definitions.]

In this article:

(1) " Accession " means goods that are physically united with other goods in such a manner that the identity of the original goods is not lost.

(2) " Account ", except as used in "account for", means a right to payment of a monetary obligation, whether or not earned by performance, (i) for property that has been or is to be sold, leased, licensed, assigned, or otherwise disposed of, (ii) for services rendered or to be rendered, (iii) for a policy of insurance issued or to be issued, (iv) for a secondary obligation incurred or to be incurred, (v) for energy provided or to be provided, (vi) for the use or hire of a vessel under a charter or other contract, (vii) arising out of the use of a credit or charge card or information contained on or for use with the card, or (viii) as winnings in a lottery or other game of chance operated or sponsored by a State , governmental unit of a State, or person licensed or authorized to operate the game by a State or governmental unit of a State. The term includes health-care-insurance receivables . The term does not include (i) rights to payment evidenced by chattel paper or an instrument , (ii) commercial tort claims , (iii) deposit accounts , (iv) investment property , (v) letter-of-credit rights or letters of credit, or (vi) rights to payment for money or funds advanced or sold, other than rights arising out of the use of a credit or charge card or information contained on or for use with the card.

(3) " Account debtor " means a person obligated on an account , chattel paper , or general intangible . The term does not include persons obligated to pay a negotiable instrument, even if the instrument constitutes part of chattel paper .

(4) " Accounting ", except as used in "accounting for", means a record :

(A) authenticated by a secured party ;

(B) indicating the aggregate unpaid secured obligations as of a date not more than 35 days earlier or 35 days later than the date of the record; and

(C) identifying the components of the obligations in reasonable detail.

(5) " Agricultural lien " means an interest in farm products :

(A) which secures payment or performance of an obligation for:

(i) goods or services furnished in connection with a debtor 's farming operation ; or

(ii) rent on real property leased by a debtor in connection with its farming operation ;

(B) which is created by statute in favor of a person that:

(i) in the ordinary course of its business furnished goods or services to a debtor in connection with a debtor 's farming operation ; or

(ii) leased real property to a debtor in connection with the debtor's farming operation ; and

(C) whose effectiveness does not depend on the person's possession of the personal property.

(6) " As-extracted collateral " means:

(A) oil, gas, or other minerals that are subject to a security interest that:

(i) is created by a debtor having an interest in the minerals before extraction; and

(ii) attaches to the minerals as extracted; or

(B) accounts arising out of the sale at the wellhead or minehead of oil, gas, or other minerals in which the debtor had an interest before extraction.

(7) " Authenticate " means:

(A) to sign; or

(B) with present intent to adopt or accept a record , to attach to or logically associate with the record an electronic sound, symbol, or process.

(8) " Bank " means an organization that is engaged in the business of banking. The term includes savings banks, savings and loan associations, credit unions, and trust companies.

(9) " Cash proceeds " means proceeds that are money, checks, deposit accounts , or the like.

(10) " Certificate of title " means a certificate of title with respect to which a statute provides for the security interest in question to be indicated on the certificate as a condition or result of the security interest's obtaining priority over the rights of a lien creditor with respect to the collateral . The term includes another record maintained as an alternative to a certificate of title by the governmental unit that issues certificates of title if a statute permits the security interest in question to be indicated on the record as a condition or result of the security interest’s obtaining priority over the rights of a lien creditor with respect to the collateral.

(11) " Chattel paper " means a record or records that evidence both a monetary obligation and a security interest in specific goods , a security interest in specific goods and software used in the goods, a security interest in specific goods and license of software used in the goods, a lease of specific goods, or a lease of specific goods and license of software used in the goods. In this paragraph, "monetary obligation" means a monetary obligation secured by the goods or owed under a lease of the goods and includes a monetary obligation with respect to software used in the goods. The term does not include (i) charters or other contracts involving the use or hire of a vessel or (ii) records that evidence a right to payment arising out of the use of a credit or charge card or information contained on or for use with the card. If a transaction is evidenced by records that include an instrument or series of instruments, the group of records taken together constitutes chattel paper.

(12) " Collateral " means the property subject to a security interest or agricultural lien . The term includes:

(A) proceeds to which a security interest attaches;

(B) accounts , chattel paper , payment intangibles , and promissory notes that have been sold; and

(C) goods that are the subject of a consignment .

(13) " Commercial tort claim " means a claim arising in tort with respect to which:

(A) the claimant is an organization; or

(B) the claimant is an individual and the claim:

(i) arose in the course of the claimant's business or profession; and

(ii) does not include damages arising out of personal injury to or the death of an individual.

(14) " Commodity account " means an account maintained by a commodity intermediary in which a commodity contract is carried for a commodity customer .

(15) " Commodity contract " means a commodity futures contract, an option on a commodity futures contract, a commodity option, or another contract if the contract or option is:

(A) traded on or subject to the rules of a board of trade that has been designated as a contract market for such a contract pursuant to federal commodities laws; or

(B) traded on a foreign commodity board of trade, exchange, or market, and is carried on the books of a commodity intermediary for a commodity customer .

(16) " Commodity customer " means a person for which a commodity intermediary carries a commodity contract on its books.

(17) " Commodity intermediary " means a person that:

(A) is registered as a futures commission merchant under federal commodities law; or

(B) in the ordinary course of its business provides clearance or settlement services for a board of trade that has been designated as a contract market pursuant to federal commodities law.

(18) " Communicate " means:

(A) to send a written or other tangible record ;

(B) to transmit a record by any means agreed upon by the persons sending and receiving the record; or

(C) in the case of transmission of a record to or by a filing office , to transmit a record by any means prescribed by filing-office rule .

(19) " Consignee " means a merchant to which goods are delivered in a consignment .

(20) " Consignment " means a transaction, regardless of its form, in which a person delivers goods to a merchant for the purpose of sale and:

(A) the merchant:

(i) deals in goods of that kind under a name other than the name of the person making delivery;

(ii) is not an auctioneer; and

(iii) is not generally known by its creditors to be substantially engaged in selling the goods of others;

(B) with respect to each delivery, the aggregate value of the goods is $1,000 or more at the time of delivery;

(C) the goods are not consumer goods immediately before delivery; and

(D) the transaction does not create a security interest that secures an obligation.

(21) " Consignor " means a person that delivers goods to a consignee in a consignment .

(22) " Consumer debtor " means a debtor in a consumer transaction .

(23) " Consumer goods " means goods that are used or bought for use primarily for personal, family, or household purposes.

(24) " Consumer-goods transaction " means a consumer transaction in which:

(A) an individual incurs an obligation primarily for personal, family, or household purposes; and

(B) a security interest in consumer goods secures the obligation.

(25) " Consumer obligor " means an obligor who is an individual and who incurred the obligation as part of a transaction entered into primarily for personal, family, or household purposes.

(26) " Consumer transaction " means a transaction in which (i) an individual incurs an obligation primarily for personal, family, or household purposes, (ii) a security interest secures the obligation, and (iii) the collateral is held or acquired primarily for personal, family, or household purposes. The term includes consumer-goods transactions .

(27) " Continuation statement " means an amendment of a financing statement which:

(A) identifies, by its file number , the initial financing statement to which it relates; and

(B) indicates that it is a continuation statement for, or that it is filed to continue the effectiveness of, the identified financing statement.

(28) " Debtor " means:

(A) a person having an interest, other than a security interest or other lien, in the collateral , whether or not the person is an obligor ;

(B) a seller of accounts , chattel paper , payment intangibles , or promissory notes ; or

(C) a consignee .

(29) " Deposit account " means a demand, time, savings, passbook, or similar account maintained with a bank . The term does not include investment property or accounts evidenced by an instrument .

(30) " Document " means a document of title or a receipt of the type described in Section 7-201 (2).

(31) " Electronic chattel paper " means chattel paper evidenced by a record or records consisting of information stored in an electronic medium.

(32) " Encumbrance " means a right, other than an ownership interest, in real property. The term includes mortgages and other liens on real property.

(33) " Equipment " means goods other than inventory , farm products , or consumer goods .

(34) " Farm products " means goods , other than standing timber, with respect to which the debtor is engaged in a farming operation and which are:

(A) crops grown, growing, or to be grown, including:

(i) crops produced on trees, vines, and bushes; and

(ii) aquatic goods produced in aquacultural operations;

(B) livestock, born or unborn, including aquatic goods produced in aquacultural operations;

(C) supplies used or produced in a farming operation ; or

(D) products of crops or livestock in their unmanufactured states.

(35) " Farming operation " means raising, cultivating, propagating, fattening, grazing, or any other farming, livestock, or aquacultural operation.

(36) " File number " means the number assigned to an initial financing statement pursuant to Section 9-519(a) .

(37) " Filing office " means an office designated in Section 9-501 as the place to file a financing statement .

(38) " Filing-office rule " means a rule adopted pursuant to Section 9-526 .

(39) " Financing statement " means a record or records composed of an initial financing statement and any filed record relating to the initial financing statement.

(40) " Fixture filing " means the filing of a financing statement covering goods that are or are to become fixtures and satisfying Section 9-502(a) and (b). The term includes the filing of a financing statement covering goods of a transmitting utility which are or are to become fixtures .

(41) " Fixtures " means goods that have become so related to particular real property that an interest in them arises under real property law.

(42) " General intangible " means any personal property, including things in action, other than accounts , chattel paper , commercial tort claims , deposit accounts , documents , goods , instruments , investment property , letter-of-credit rights , letters of credit, money, and oil, gas, or other minerals before extraction. The term includes payment intangibles and software .

(43) "Good faith" means honesty in fact and the observance of reasonable commercial standards of fair dealing.

(44) " Goods " means all things that are movable when a security interest attaches. The term includes (i) fixtures , (ii) standing timber that is to be cut and removed under a conveyance or contract for sale, (iii) the unborn young of animals, (iv) crops grown, growing, or to be grown, even if the crops are produced on trees, vines, or bushes, and (v) manufactured homes . The term also includes a computer program embedded in goods and any supporting information provided in connection with a transaction relating to the program if (i) the program is associated with the goods in such a manner that it customarily is considered part of the goods, or (ii) by becoming the owner of the goods, a person acquires a right to use the program in connection with the goods. The term does not include a computer program embedded in goods that consist solely of the medium in which the program is embedded. The term also does not include accounts , chattel paper , commercial tort claims , deposit accounts , documents , general intangibles , instruments , investment property , letter-of-credit rights , letters of credit, money, or oil, gas, or other minerals before extraction.

(45) " Governmental unit " means a subdivision, agency, department, county, parish, municipality, or other unit of the government of the United States, a State , or a foreign country. The term includes an organization having a separate corporate existence if the organization is eligible to issue debt on which interest is exempt from income taxation under the laws of the United States.

(46) " Health-care-insurance receivable " means an interest in or claim under a policy of insurance which is a right to payment of a monetary obligation for health-care goods or services provided.

(47) " Instrument " means a negotiable instrument or any other writing that evidences a right to the payment of a monetary obligation, is not itself a security agreement or lease, and is of a type that in ordinary course of business is transferred by delivery with any necessary indorsement or assignment. The term does not include (i) investment property , (ii) letters of credit, or (iii) writings that evidence a right to payment arising out of the use of a credit or charge card or information contained on or for use with the card.

(48) " Inventory " means goods , other than farm products , which:

(A) are leased by a person as lessor;

(B) are held by a person for sale or lease or to be furnished under a contract of service;

(C) are furnished by a person under a contract of service; or

(D) consist of raw materials, work in process, or materials used or consumed in a business.

(49) " Investment property " means a security, whether certificated or uncertificated, security entitlement, securities account, commodity contract , or commodity account .

(50) " Jurisdiction of organization ", with respect to a registered organization , means the jurisdiction under whose law the organization is formed or organized.

(51) " Letter-of-credit right " means a right to payment or performance under a letter of credit, whether or not the beneficiary has demanded or is at the time entitled to demand payment or performance. The term does not include the right of a beneficiary to demand payment or performance under a letter of credit.

(52) " Lien creditor " means:

(A) a creditor that has acquired a lien on the property involved by attachment, levy, or the like;

(B) an assignee for benefit of creditors from the time of assignment;

(C) a trustee in bankruptcy from the date of the filing of the petition; or

(D) a receiver in equity from the time of appointment.

(53) " Manufactured home " means a structure, transportable in one or more sections, which, in the traveling mode, is eight body feet or more in width or 40 body feet or more in length, or, when erected on site, is 320 or more square feet, and which is built on a permanent chassis and designed to be used as a dwelling with or without a permanent foundation when connected to the required utilities, and includes the plumbing, heating, air-conditioning, and electrical systems contained therein. The term includes any structure that meets all of the requirements of this paragraph except the size requirements and with respect to which the manufacturer voluntarily files a certification required by the United States Secretary of Housing and Urban Development and complies with the standards established under Title 42 of the United States Code.

(54) " Manufactured-home transaction " means a secured transaction:

(A) that creates a purchase-money security interest in a manufactured home , other than a manufactured home held as inventory ; or

(B) in which a manufactured home , other than a manufactured home held as inventory , is the primary collateral .

(55) " Mortgage " means a consensual interest in real property, including fixtures , which secures payment or performance of an obligation.

(56) " New debtor " means a person that becomes bound as debtor under Section 9-203(d) by a security agreement previously entered into by another person.

(57) " New value " means (i) money, (ii) money's worth in property, services, or new credit, or (iii) release by a transferee of an interest in property previously transferred to the transferee. The term does not include an obligation substituted for another obligation.

(58) " Noncash proceeds " means proceeds other than cash proceeds .

(59) " Obligor " means a person that, with respect to an obligation secured by a security interest in or an agricultural lien on the collateral , (i) owes payment or other performance of the obligation, (ii) has provided property other than the collateral to secure payment or other performance of the obligation, or (iii) is otherwise accountable in whole or in part for payment or other performance of the obligation. The term does not include issuers or nominated persons under a letter of credit.

(60) " Original debtor ", except as used in Section 9-310(c) , means a person that, as debtor , entered into a security agreement to which a new debtor has become bound under Section 9-203(d) .

(61) " Payment intangible " means a general intangible under which the account debtor 's principal obligation is a monetary obligation.

(62) " Person related to ", with respect to an individual, means:

(A) the spouse of the individual;

(B) a brother, brother-in-law, sister, or sister-in-law of the individual;

(C) an ancestor or lineal descendant of the individual or the individual's spouse; or

(D) any other relative, by blood or marriage, of the individual or the individual's spouse who shares the same home with the individual.

(63) " Person related to ", with respect to an organization, means:

(A) a person directly or indirectly controlling, controlled by, or under common control with the organization;

(B) an officer or director of, or a person performing similar functions with respect to, the organization;

(C) an officer or director of, or a person performing similar functions with respect to, a person described in subparagraph (A);

(D) the spouse of an individual described in subparagraph (A), (B), or (C); or

(E) an individual who is related by blood or marriage to an individual described in subparagraph (A), (B), (C), or (D) and shares the same home with the individual.

(64) " Proceeds ", except as used in Section 9-609(b), means the following property:

(A) whatever is acquired upon the sale, lease, license, exchange, or other disposition of collateral ;

(B) whatever is collected on, or distributed on account of, collateral ;

(C) rights arising out of collateral ;

(D) to the extent of the value of collateral , claims arising out of the loss, nonconformity, or interference with the use of, defects or infringement of rights in, or damage to, the collateral; or

(E) to the extent of the value of collateral and to the extent payable to the debtor or the secured party , insurance payable by reason of the loss or nonconformity of, defects or infringement of rights in, or damage to, the collateral.

(65) " Promissory note " means an instrument that evidences a promise to pay a monetary obligation, does not evidence an order to pay, and does not contain an acknowledgment by a bank that the bank has received for deposit a sum of money or funds.

(66) " Proposal " means a record authenticated by a secured party which includes the terms on which the secured party is willing to accept collateral in full or partial satisfaction of the obligation it secures pursuant to Sections 9-620 , 9-621 , and 9-622 .

(67) " Public-finance transaction " means a secured transaction in connection with which:

(A) debt securities are issued;

(B) all or a portion of the securities issued have an initial stated maturity of at least 20 years; and

(C) the debtor , obligor , secured party , account debtor or other person obligated on collateral , assignor or assignee of a secured obligation, or assignor or assignee of a security interest is a State or a governmental unit of a State.

(68) " Public organic record " means a record that is available to the public for inspection and is:

(A) a record consisting of the record initially filed with or issued by a State or the United States to form or organize an organization and any record filed with or issued by the State or the United States which amends or restates the initial record;

(B) an organic record of a business trust consisting of the record initially filed with a State and any record filed with the State which amends or restates the initial record, if a statute of the State governing business trusts requires that the record be filed with the State; or

(C) a record consisting of legislation enacted by the legislature of a State or the Congress of the United States which forms or organizes an organization, any record amending the legislation, and any record filed with or issued by the State or the United States which amends or restates the name of the organization.

(69) " Pursuant to commitment ", with respect to an advance made or other value given by a secured party , means pursuant to the secured party's obligation, whether or not a subsequent event of default or other event not within the secured party's control has relieved or may relieve the secured party from its obligation.

(70) " Record ", except as used in "for record", "of record", "record or legal title", and "record owner", means information that is inscribed on a tangible medium or which is stored in an electronic or other medium and is retrievable in perceivable form.

(71) " Registered organization " means an organization organized solely under the law of a single State or the United States by the filing of a public organic record with, the issuance of a public organic record by, or the enactment of legislation by the State or the United States. The term includes a business trust that is formed or organized under the law of a single State if a statute of the State governing business trusts requires that the business trust’s organic record be filed with the State.

(72) " Secondary obligor " means an obligor to the extent that:

(A) the obligor's obligation is secondary; or

(B) the obligor has a right of recourse with respect to an obligation secured by collateral against the debtor , another obligor, or property of either.

(73) " Secured party " means:

(A) a person in whose favor a security interest is created or provided for under a security agreement , whether or not any obligation to be secured is outstanding;

(B) a person that holds an agricultural lien ;

(C) a consignor ;

(D) a person to which accounts , chattel paper , payment intangibles , or promissory notes have been sold;

(E) a trustee, indenture trustee, agent, collateral agent, or other representative in whose favor a security interest or agricultural lien is created or provided for; or

(F) a person that holds a security interest arising under Section 2-401 , 2-505 , 2-711 (3), 2A-508 (5), 4-210 , or 5-118 .

(74) " Security agreement " means an agreement that creates or provides for a security interest.

(75) " Send ", in connection with a record or notification, means:

(A) to deposit in the mail, deliver for transmission, or transmit by any other usual means of communication, with postage or cost of transmission provided for, addressed to any address reasonable under the circumstances; or

(B) to cause the record or notification to be received within the time that it would have been received if properly sent under subparagraph (A).

(76) " Software " means a computer program and any supporting information provided in connection with a transaction relating to the program. The term does not include a computer program that is included in the definition of goods .

(77) " State " means a State of the United States, the District of Columbia, Puerto Rico, the United States Virgin Islands, or any territory or insular possession subject to the jurisdiction of the United States.

(78) " Supporting obligation " means a letter-of-credit right or secondary obligation that supports the payment or performance of an account , chattel paper , a document , a general intangible , an instrument , or investment property .

(79) " Tangible chattel paper " means chattel paper evidenced by a record or records consisting of information that is inscribed on a tangible medium.

(80) " Termination statement " means an amendment of a financing statement which:

(B) indicates either that it is a termination statement or that the identified financing statement is no longer effective.

(81) " Transmitting utility " means a person primarily engaged in the business of:

(A) operating a railroad, subway, street railway, or trolley bus;

(B) transmitting communications electrically, electromagnetically, or by light;

(C) transmitting goods by pipeline or sewer; or

(D) transmitting or producing and transmitting electricity, steam, gas, or water.

(b) [Definitions in other articles.]

The following definitions in other articles apply to this article:

"Applicant" Section 5-102 .

"Beneficiary" Section 5-102 .

"Broker" Section 8-102 .

"Certificated security" Section 8-102 .

"Check" Section 3-104 .

"Clearing corporation" Section 8-102 .

"Contract for sale" Section 2-106 .

"Customer" Section 4-104 .

"Entitlement holder" Section 8-102 .

"Financial asset" Section 8-102 .

"Holder in due course" Section 3-302 .

"Issuer" (with respect to a letter of credit or letter-of-credit right) Section 5-102 .

"Issuer" (with respect to a security) Section 8-201 .

"Issuer" (with respect to documents of title) Section 7-102 .

"Lease" Section 2A-103 .

"Lease agreement" Section 2A-103 .

"Lease contract" Section 2A-103 .

"Leasehold interest" Section 2A-103 .

"Lessee" Section 2A-103 .

"Lessee in ordinary course of business" Section 2A-103 .

"Lessor" Section 2A-103 .

"Lessor's residual interest" Section 2A-103 .

"Letter of credit" Section 5-102 .

"Merchant" Section 2-104 .

"Negotiable instrument" Section 3-104 .

"Nominated person" Section 5-102 .

"Note" Section 3-104 .

"Proceeds of a letter of credit" Section 5-114 .

"Prove" Section 3-103 .

"Sale" Section 2-106 .

"Securities account" Section 8-501 .

"Securities intermediary" Section 8-102 .

"Security" Section 8-102 .

"Security certificate" Section 8-102 .

"Security entitlement" Section 8-102 .

"Uncertificated security" Section 8-102 .

(c) [Article 1 definitions and principles.]

Article 1 contains general definitions and principles of construction and interpretation applicable throughout this article.

A Davis & Jones LLC Company

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Ucc filings for your business – everything you need to know.

October 14, 2019

Entering into financial agreements as a business is an important decision. In fact, financial decisions are some of the most important business decisions that are made every day.

What happens to a business that enters into a financial transaction with another party? What liabilities exist, and what other risks are there to the business that enters into the transaction? How can lenders feel confident in approving businesses for loans or leasing?

What laws govern business to business transactions?

That’s where a UCC filing comes in. UCC filings are the standard for placing liens against other businesses or individuals with collateralized agreements.

This comprehensive guide will go over what a UCC filing is, who they impact, what terms need to be remembered, and how UCC filings on accounts receivable work.

UCC Filings: What They Are and Who They Impact

The Uniform Commercial Code, or UCC, enables businesses to place a lien against another business or an individual. There are different instances in which a UCC filing may be used, including:

• Loans for a small business
• Funding from a venture capital firm
• Leasing equipment or vehicles
• Establishing contracts between parties
• Selling goods and services
• Making bank deposits into a collection account

In each of these instances, the collateral for the UCC will vary. For example, if a business is leasing equipment, the collateral for that particular UCC filing is the equipment that is being leased. If a business is receiving inventory financing, the collateral for that particular UCC filing is the inventory being financed.

UCC filings can place liens against all or part of a business’s assets. An example of this would be when taking out a loan or working with a venture capital firm. The financial institution or lender would file for a UCC and place a lien against the party to which they are lending money.

UCC filings can be placed against businesses for things like bank deposits, bulk/warehouse sales and auctions, letters of credit, negotiable instruments, and sales and leases. With a few exceptions, there is typically only one lienholder per asset. Occasionally, a lender may take a second position. UCC filings prevent businesses from using assets to get multiple loans, which ultimately keeps them from overextending themselves.

UCC filings can also be placed against individuals for personal property, such as vehicles, but not for real estate, such as homes.

Terms to Know Regarding UCC Filings

UCC filings can be complex and overwhelming, but this guide aims to demystify some of that with practical information. Are there terms that don’t make sense? Does all of this seem a little redundant?

The terms to know section of this guide will help you better understand some of the confusing language around UCC filings.

Read through these before continuing to the frequently asked questions:

• UCC-1 Lien: A UCC-1 filing is used when personal property is used as collateral. Personal property can be equipment, inventory, and other assets of a business. They can also be used when purchasing a vehicle – a form is signed when buying the car that gives information on both the buyer and seller, plus the vehicle.
• UCC Blanket Lien: Blanket liens are used when a business or creditor has a vested interested in every asset in your company. Some common reasons a blanket lien might be filed include receiving commercial real estate loans, inventory financing, invoice factoring, SBA loans, or other short-term business loans.
• UCC Financing Statement: After an agreement is completed, a business can file a lien online very quickly for the appropriate jurisdictions. The financing statement must contain specific information to be valid. The information that will need to be provided is the debtor, secured party, and collateral description.
• UCC Security Agreement: When signing for a new loan or lease for equipment, a business will sign a security agreement . The security agreement may be a concise, but clear, statement indicating that the business is entering into a contract and there will be a lien filed against the business for the specified goods or assets.

These terms can hopefully shed some light on common language seen in UCC discussions. Now that the terms have been covered, there are several questions that can be answered.

Frequently Asked Questions

Most of the questions are asked frequently when talking about UCC filings. With this information, business owners and managers should have a clear understanding of how a UCC affects their organization.

What Is A UCC Filing On A Business?

A UCC filing on a business is when a creditor (a lender, financial institution, lessor, etc.) places a lien against another business (or, in some cases, an individual) for specific goods and/or negotiable instruments such as assets. The filing and security agreements are the only things that need to be done to validate the lien.

UCC filings can show up on business credit reports. They have the potential to impact a business’s ability to get further credit, so be wise in working with creditors that place UCC filings.

What Is A UCC Filing Used For?

UCC filings can be used for many things. According to the articles of the Uniform Commercial Code , UCC filings can be used for “sales, leases, negotiable instruments, bank deposits and collections, funds transfer, letters of credit, bulk transfers and bulk sales, documents of title, investment securities, and secured transactions.”

In broader terms, they can be used to secure interests in things like office equipment, technology equipment, specialized machinery, heavy agricultural equipment, and more.

How Much Does It Cost To File A UCC?

This is a tricky question because the answer varies from state to state. Some states have lower fees, while other states may charge upwards of $100 per filing. It’s important to keep in mind that the cost of a UCC filing protects the interest of the creditor.

To get an idea of how much it will cost to file a UCC in a specific state, contact that state’s Secretary of State for a fee schedule.

Are UCC Filings Public Records?

Yes, UCC filings are public records. Any business that wants to know the position of another business can look up their UCC filings and any other public information about them. This makes it difficult to keep the information from potential creditors.

Because they are public records, UCC filings will show up in most other credit and background checks on a company.

Is A UCC Filing Bad?

No, not necessarily. It depends on a business’s financial situation, its business goals, and its credit position. It can, however, impact the ability to get additional credit. When one company has a position for all assets, others may be intimidated by that position.

Make sure that, once a debt is satisfied, that a lien is released with a UCC-3 filing. This ensures a business can look for additional sources of credit.

Can UCC Filings Be Removed?

Yes, a UCC filing can be removed in one of two ways. The first, and easiest, is to have the creditor file a UCC-3 financing statement to effectively remove the lien. The other is to swear an oath of full payment with the Secretary of State.

UCC filings also expire after five years. This means that, if a business has already satisfied its debt, a business won’t renew it and it will simply expire.

UCC Filings on Accounts Receivable

As mentioned, UCCs can be filed on specific goods or on assets. One reason a creditor may file a UCC is for all accounts receivables. This is likely in the event of large financial transactions, like short-term loans, SBA loans, and inventory financing.

The term blanket lien was used previously – that’s what this is. A blanket lien on all assets, including all accounts receivables. While these are not inherently bad or good, they can make additional financing, and even alternative financing, difficult.

It’s important to enter into a UCC security agreement wisely. Read through this blog and commit this information to memory. Know when a UCC may be filed and how to have one removed when a debt is satisfied.

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