The Uniform Commercial Code (UCC) provides a number of post-default remedies a secured lender can pursue without commencing litigation or any judicial intervention whatsoever. This alert, and Parts 2 and 3 to follow, describe some of these remedies.
One of the most cost-effective remedies is a secured party’s right to collect and enforce amounts payable to the debtor.1 The extent of the right and the process to be followed depends, in part, on the nature of the collateral.
Accounts Receivable and Promissory Notes
The UCC grants the holder of a security interest in accounts receivable the right after default to directly collect the receivables from the account debtor. The secured party can simply notify the account debtor to make payment directly to the lender. Unless the loan documents provide otherwise, this can be done without advance notice to the borrower or debtor. The secured party may also enforce the obligations of the account debtor and enforce the rights of its borrower with respect to any property securing the account receivable as long as it proceeds in a commercially reasonable manner. Although the applicable provision of the UCC does not mention promissory notes, it refers to account debtors or others obligated on collateral to make payment. This language clearly applies to promissory notes, so the same process applies.
One possible difficulty when collecting accounts receivable involves the lender’s lack of detailed information. Often, required accounts receivable reporting only includes the name of the account debtor (or a shortened or abbreviated version thereof) and the amount and aging. Obviously more information is usually needed in order to notify the account debtors, and gathering this information after default can be time consuming and expensive. During this delay, the borrower can continue to collect its receivables, diminishing the amount available to the lender. To help protect against this, a lender can require that the borrower include in the required financial reporting the full name and contact information for each account debtor. When including this type of provision, lenders should resist requests from borrowers that the information only be provided upon request or after default, as a borrower may become uncooperative after default and less likely to provide the information.
It is important to note that the UCC provisions allowing the secured party to collect accounts receivable do not impose any duty on the account debtor or other person obligated on the collateral to pay the secured party. As a result, the secured party may need to judicially enforce payment if the account debtor does not pay voluntarily. However, if the account debtor continues to pay the borrower after it receives the notification from the secured party, it does so at its peril. Payments made to the borrower after receipt of proper notice do not discharge the obligation.2 In other words, if the account debtor pays the account to the borrower after notification, the account debtor is still liable to the secured party for the amount paid, thereby subjecting itself to potential double payment.
Deposit Accounts
The lender’s self-help remedy with respect to a security interest in a deposit account depends on how the security interest was perfected. If it was perfected because the lender is the bank at which the deposit account is maintained, the lender can simply apply the balance in the account to the debt secured. If the security interest is perfected by the lender becoming the depository bank’s customer with respect to the account or by entering into a control agreement with the depository bank and the debtor, the lender can direct the depository bank to pay the balance of the account to the lender subject, in the case of perfection by a control agreement, to the terms and requirements of the control agreement. Again, this can be done without advance or other notice to the borrower or debtor, except as may be required under the loan documents or the control agreement.
Securities Accounts and Commodities Accounts
One of the most common ways for a secured party to perfect a security interest in a securities account is to enter into a control agreement under which the financial intermediary agrees to comply with entitlement orders (directions to transfer or redeem the securities in the account) from the secured party without further consent by the debtor (i.e., account holder). In this situation, after default, the secured party can notify the financial intermediary to transfer the securities in the account to the lender or to sell the securities3 and pay the proceeds to the lender. Unlike an account debtor that owes no duty to the secured party, the financial intermediary is contractually obligated to honor these instructions.
A secured party can perfect a security interest in a commodities account by entering into an agreement among the secured party, the debtor (i.e., commodity customer), and the commodity intermediary (e.g., broker) under which the commodity intermediary agrees to apply any value distributed on account of the commodity contract(s) as directed by the secured party without further consent of the commodity customer. After default, the secured party can notify the commodity intermediary to pay to the lender any value distributed on account of the commodity contract(s). Similar to a securities intermediary under a control agreement, the commodity intermediary is contractually obligated to honor these instructions.
The UCC provides a variety of non-judicial and self-help tools that can assist a secured lender in realizing on its collateral after default without the time and expense of litigation. This alert, together with upcoming Part 2 – Sale of Collateral and Part 3 – Strict Foreclosure, describes the general procedures and outcomes for these tools. Experienced legal counsel can help the lender select the appropriate remedy, navigate the specific requirements, and avoid potential pitfalls and problems.
The Thought Leadership Committee of Barclay Damon’s Restructuring, Bankruptcy & Creditors’ Rights Practice Area issues alerts and blogs on an ongoing basis to keep clients, colleagues, and friends up to date on important developments in the insolvency space. If you have any questions regarding the content of this alert, please contact the author, Robert Wonneberger, Thought Leadership Committee chair, at rwonneberger@barclaydamon.com, or Janice Grubin or Jeff Dove, Restructuring, Bankruptcy & Creditors’ Rights Practice Area co-chairs, at jgrubin@barclaydamon.com and jdove@barclaydamon.com.
1These rights are granted by the UCC and do not need to be discussed in the security agreement or other loan documents. However, the exercise of these rights is subject to any limitations or additional requirements set forth in the loan documents.
2The applicable UCC provision uses the term “assignee” (which is not defined in the statute) rather than “secured party.” Some courts have held that secured parties holding a security interest do not qualify as assignees, so the provision does not apply. The 2022 revisions to the UCC contain definitions of “assignor” (which includes a party granting a security interest) and “assignee” (which includes a secured party). However, unless and until the amendments are universally adopted, a secured party should check with its counsel regarding this issue.
3See upcoming Part 2 for considerations when the secured party is selling collateral.