Friday, March 27, 2009

Prior Assignment of Contract Rights vs. -- Later Filed Financing Statement: Battle for Priority under U.C.C. Section 9-109

Kennedy v. Healthstone Staffing, LLC, 2009 WL 281777 (Cal.App. 1 Dist.) Feb. 6, 2009
(Not Officially Published -- See Cal. Rules of Court, Rules 8.1105, 8.1110, 8.1115)

Accounts receivable are valuable assets, and commonly used as collateral to secure loans. Lenders commonly structure credit facilities to allow for advances up to a specified percentage of accounts receivable.

This case pitted a lender secured by "all assets" against the prior assignee of the debtor's contract. The debtor had a purportedly valuable contract to furnish foreign nurses to hospitals. Previous to the arrival of the secured lender, the debtor had borrowed money from a third party and gave the prior lender an assignment of the contract. The subsequent secured lender challenged the first lender's priority in the contract, by claiming that it had lost priority due to a failure to file a financing statement, as required by U.C.C. Section 9-109(a)(which subjects the sale of accounts payment intangibles and promissory notes to the Uniform Commercial Code) and Section 9-310(a)(which generally requires filing to obtain perfection).

The original lender argued that it was protected by two separate exceptions to the filing requirements. The first, § 9-109(d)(7), excludes from Article 9 the assignment of a single account in full or partial satisfaction of a pre-existing indebtedness. The second exemption provides that a security interest is perfected when there is an assignment of accounts or payment intangibles which individually or in the aggregate does not transfer a "significant part" of these outstanding accounts receivable. §9-309(2).

In this case, there was testimony that the original lender took an outright, absolute, assignment of a contract as payment for a prior loan, in part so that it would not need to actually file a UCC financing statement to protect its position. The appellate court found this persuasive.

It dismissed the second lender's contention that because the assigned contract covered multiple nurses, that it was an assignment of multiple accounts receivable, and thus not elibible for the no-filing exception.

How is the second lender to protect itself from this situation, since a review of the public financing statements would not disclose any third party interest in the contract? Presumably this would not be an issue if the borrower's financial statements had been prepared properly. If there were an absolute assignment of a contract in payment of a debt, the borrower's financial statements should exclude both the prior debt, and the contract at issue, and the lender would not rely on it for collateral. Reliance on audited financial statements might help protect the lender, but this is not practicable in many situations.

If any prior lenders are listed in the borrower's financial statement, the second lender could check to verify the position and claims of the prior lender. If contracts of significant value are listed as part of the borrower's assets, the second lender could also take possession of the original contract, and obtain a certification from the contract payor that it had not received any notice of assignment, that it would not make any contract payments to any third parties without the lender's consent, and that on receipt of written notification from the lender it would make payments on the contract to the lender. Although taking possession of the original of a standard contract would not replace filing a financing statement in the manner allowed for negotiable instruments or chattel paper (see §9-313(a), taking possession of the original could be helpful evidence to establish that it had not in fact had been sold outright, and at a minimum would help to flush out any problems of this nature.


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Silvia Jacinto said...

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