The Uniform Commercial Code (UCC) provides a comprehensive legal framework for secured transactions in the United States, guiding lenders and borrowers through the process of creating, perfecting, and enforcing security interests. One key aspect of secured lending is ensuring that the lender’s security interest properly attaches to the borrower’s assets. UCC Section 9-406, which deals with the discharge of account debtors, offers critical guidance for lenders in this crucial area.
UCC Section 9-406 addresses the rights and obligations of account debtors, who owe payment or performance under an account, chattel paper, or a promissory note, when a security interest has been created in those assets. In essence, this section governs when an account debtor is allowed to discharge their obligations by paying the assignor (the borrower) or the secured party (the lender).
Key provisions of UCC Section 9-406 include:
- Account debtor discharge: An account debtor can discharge its obligation by paying the assignor until it receives notification that the payment has been assigned to a secured party and that payment should be made directly to the secured party.
- Notification: The secured party must provide proper notification to the account debtor to redirect payment. The notice must reasonably identify the rights assigned, the assignor, and the secured party.
- Waivers and agreements: UCC Section 9-406 prohibits certain agreements between the assignor and the account debtor that impair the rights of the secured party without its consent. For instance, an agreement that limits the assignor from assigning its assets to an assignee or modifies the terms of payment or releases the account debtor from its obligations without the secured party’s consent is generally unenforceable.
To effectively attach to assets in a secured transaction, your company’s lending agreement should incorporate specific language that aligns with UCC Section 9-406’s requirements. Key elements to include are:
- Granting clause: The lending agreement should include a clear and comprehensive granting of security interest clause that outlines the assets being assigned as collateral. This clause should explicitly state that the borrower is granting a security interest in their accounts, chattel paper, or promissory notes to secure the repayment of the financial transaction.
- Notification requirement: The agreement should contain a provision requiring the borrower to notify their account debtors of the assignment of their payment obligations to the secured party. The provision should specify the required content of the notice and the timeline for providing the notice to account debtors.
- Consent to assignment: The lending agreement should include a clause in which the borrower agrees not to enter into any agreements with account debtors that impair the secured party’s rights without the secured party’s prior written consent. This ensures that the borrower cannot modify the terms of payment or release account debtors from their obligations without the lender’s approval.
- Payment redirection: The agreement should include language authorizing the secured party to notify account debtors to redirect their payments directly to the secured party if the borrower defaults or if the lender has reasonable grounds to believe the borrower’s performance is at risk.
Understanding and adhering to the provisions of UCC Section 9-406 is crucial for lenders and borrowers involved in secured transactions. By incorporating the necessary language into lending agreements, lenders can effectively attach to assets and protect their security interests, while borrowers can ensure they remain compliant with the UCC.
The team at Wilkie Puchi L.L.P. has extensive experience in representing lenders, funders, and other providers of a host of financial products. Our team can prepare and advise on Secured Business Loans and Receivables Purchase Agreements, and analyze those documents and others to protect your business. Contact us today to schedule a consultation.
Blake Wilkie is the Managing Principal of Wilkie Puchi L.L.P. Through his career, he has served fintech funders and alternative finance providers in both law firm and in-house counsel settings. In those roles, he gained invaluable experience advising a multitude of large and small companies regarding federal, state, and local laws, as well as developing and implementing comprehensive collection strategies and enforcement procedures. From pre-litigation matters through final resolution, he is trained to identify a wide variety of legal issues that arise on a day-to-day basis, how to respond to them, and how to prevent them before they arise in the future. After graduating from the W.P. Carey School of Business at Arizona State University, Blake obtained his J.D. from the Sandra Day O’Connor College of Law at Arizona State University, where he was a Managing Editor of the Arizona State Law Journal.