Imagine receiving a letter from an unfamiliar lender directing you to stop paying a vendor and instead remit all future payments to the lender. Ignore it, and you could face liability for paying the wrong party. Comply without verification, and you could expose your company to fraud or disrupt your vendor relationship.
Under Section 9-406 of the Uniform Commercial Code (“UCC”), a lender with a valid assignment or security interest in a vendor’s receivables may have the legal right to collect payment directly from customers. The key is not to ignore the notice, nor to blindly follow it. Instead, pause payments, verify the lender’s rights, and determine who is legally entitled to receive payment before taking action.
Key Takeaways
The “Double Payment” Trap: Paying your vendor after receiving a valid UCC § 9-406 notice from its lender can result in your company being legally forced to pay the exact same invoice a second time.
Do Not Ignore the Notice: Even if your vendor tells you the notice is a mistake, claims they are in a dispute with the lender, or begs you to keep paying them directly, you must still comply with an effective notice or risk double payment.
Freeze First, Verify Later: The safest immediate step when receiving a notice of assignment is to put a hard hold on all pending payments to that specific vendor until the situation is verified.
Take Steps to Verify: You have the right to protect yourself. Ensure the notice meets statutory requirements, demand proof of the assignment, and check public UCC government websites to confirm the lender’s security interest.
Be Transparent with Your Vendor: Assuming the vendor relationship is one you care about, let your vendor know what you are doing and why.
What is a UCC § 9-406 Notice?
A UCC § 9-406 Notice is a formal letter addressed to “account debtors” (a party obligated to pay an account receivable, i.e., a debt) from a lender (an “assignee”) demanding that the account holder direct any amounts owed to the assignee as opposed to the original vendor (an “assignor”). This situation typically arises when a vendor pledges or assigns their accounts receivable as collateral to a lender in exchange for cash or financing.
When accounts receivable are used as collateral, UCC § 9-406 permits the lender/assignee to provide notice of the assignment to account debtors and demand that any future payments owed to the vendor/assignor be sent directly to the lender/assignee instead. The notice letter will identify a vendor/assignor, explain the secured nature of the assignment, and identify a total debt owed. The letter will also typically, but not always, attach proof of the assignment. Finally, the letter may come directly from the lender/assignee but often comes from a law firm/collection agency acting on its behalf.
Importantly, once this notice is sent, your payment obligation to the vendor/assignor is formally transferred or “assigned” and you can discharge your debt only by paying the lender/assignee.
What Happens if You Ignore the Notice?
Article 9 of the UCC imposes strict liability once an effective notice is sent. This means that if you receive a legally effective notice and you nevertheless pay the vendor/assignor, your payment does not discharge your debt and is legally ineffective. The lender/assignee can now file a lawsuit to recover the payment directly from you and the court will require you to pay the lender/assignee even though you already paid the vendor/assignor. Put plainly, the entire burden of the mistake falls on you regardless of whether you ultimately can claw your money back from the wrongfully paid party.
What Should You Do When You Receive a UCC § 9-406 Notice?
Step 1: FREEZE. Immediately place a hold on all payments to the vendor/assignor in your accounting system. You do not want to risk paying the wrong party.
Step 2: VERIFY. Review the notice carefully to ensure it meets the statutory requirements. For the notice to be effective it must do the following:
- Be signed/authenticated (electronic signatures are typically sufficient) (UCC § 9-406(a));
- Reasonably identify the rights assigned (UCC § 9-406(b)(1));
- Request the full debt from you (the UCC allows you to reject notices that ask you to make a payment less than the total amount owed or pay only a portion/installment of an invoice) (UCC § 9-406(b)(3)).
Typically, lender/assignors attach proof of the assignment to help reasonably identify the rights assigned. However, if they do not attach proof, you are entitled to ask for proof and withhold payments until proof is provided. See UCC § 9-406(c).
Finally, you should independently verify that the lender/assignor perfected a lien against your vendor. State government websites generally offer free or low-cost UCC searches. For example, if the vendor is located in New York, you can search the New York Department of State’s Uniform Commercial Code database located here.
Step 3: PAY. Once you have verified and confirmed the notice is valid, update your payment systems to ensure all future funds are directed to the lender/assignor until you are formally notified by the lender/assignor that the debt has been satisfied. The lender/assignor has an obligation to let you know when the debt is satisfied and you should continue making payments until you receive formal notice that the debt is extinguished.
Frequently Asked Questions:
Q: Our vendor has objected to the payment, what should we do?
A: This is the most common way companies fall into the double-payment trap. Oftentimes, a vendor may claim that it is in a dispute with the lender/assignor (typically a bank) and demand you continue payments to the vendor. Vendors may even threaten to withhold future deliveries or services if you do not direct payments directly to them. Do not take legal advice from your vendor. Once an effective notice is sent, you are legally obligated to pay the lender/assignor. If you listen to your vendor, you could be exposed to significant liability, including being forced to make a second payment for the same amount directly to the lender/assignor. Your vendor can take recourse against the lender/assignor if it believes it is entitled to the debt. That is not your battle.
Q: When can we go back to paying our vendor?
A: You must continue paying the lender until you receive a formal, authenticated release or termination notice directly from the lender. Do not take your vendor’s word that the debt has been satisfied. While we recommend keeping track of payments made against the stated debt, the vendor/assignor is legally obligated to disclose to you when it has recouped enough (possibly from multiple account debtors) to satisfy the subject debt.
Q: Do I need to notify the vendor once I receive notice?
A: This is a business decision. You are not legally required to notify your vendor, but it is often a best practice for relationship purposes. If you decide to notify your vendor, be sure to continue redirecting payments (assuming the notice is effective) and explain to your vendor that you are legally bound to do so. Your vendor should understand that your communication is a professional courtesy, not an opportunity for them to plead their case to you.
Q: Our contract with the vendor says they aren’t allowed to assign our contracts or accounts receivable to a third party, so can’t we just ignore the lender/assignee?
A: No, you cannot ignore the lender/assignee. UCC § 9-406 contains a specific rule that generally overrides “anti-assignment clauses” in commercial contracts except in very limited circumstances. See UCC § 9-406(d) and contact your lawyer with any questions.
Q: The lender is demanding we pay the full invoice amount, but the vendor owes us a credit for defective goods. Do we have to pay the lender the full amount?
A: No. You generally retain all your typical normal commercial defenses (including set-offs). The lender/assignee steps into the vendor/assignor’s shoes – meaning you owe the lender/assignee only what you actually owe the vendor/assignor.
Conclusion
Most standard UCC § 9-406 notices can be handled smoothly by using the framework above. Train your staff to identify these notices and take immediate action to freeze any payments until you can verify the assignments. Remember, never trust either the lender or vendor until you do your homework.
While the rules and framework seem generally straightforward, they can get messy quickly. If you receive a notice and you are not sure whether it is legally effective or you are embroiled in a messy he-said/she-said battle with your vendor and their lender, freeze any payments and reach out to your lawyer. A quick and accurate legal review on the front end is vastly cheaper than paying the same invoice twice.