How New York UCC, Article 9, applies to the sale and purchase of accounts receivable
August 2019 | EXPERT BRIEFING | BANKING & FINANCE
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@example.com. Mr Siddiqi can be contacted on +1 (212) 922 2200 or by email: firstname.lastname@example.org. Ms Metro can be contacted on +1 (212) 922 2200 or by email: email@example.com.
© Financier Worldwide
John Kissane, Sabih Siddiqi and Celinda Metro
Watson Farley & Williams LLP