Assignment of Contract Rights – March 2013


Yesterday, the Massachusetts Supreme Judicial Court again issued a decision of practical import to commercial lenders involved in taking assignments of a borrower's contract receivables as loan collateral. The opinion is a good one for lenders.


In Reading Co-operative Bank v Suffolk Construction Company, Inc., the borrower had assigned Reading its right to receive payment under a contract with Suffolk as partial collateral securing a revolving line of credit. Proper notice of the assignment was provided Suffolk, but it instead made 12 payments directly to the borrower totaling over $3.8 Million. The borrower subsequently ceased business operations with an outstanding debt due the bank on its line of credit of just under $1.5 Million. Reading sued Suffolk for the misdirected payments, having only recovered $430,000 through other collection efforts.


Suffolk contended that the bank was entitled to no more than its "actual damages" rather than the total value of the misdirected payments. (For reasons unclear from the SJC's decision, a jury determined that the bank had only suffered actual damages in the amount of $533,348, notwithstanding the $1 Million + loan balance outstanding.) Suffolk also argued that it was entitled to credit offsetting the judgment by the amount of a personal guaranty given as additional collateral to support the LOC, which the bank had yet to enforce.


Applying Article 9 of the UCC, the SJC held that once an account debtor (Suffolk) receives notification of assignment, it could discharge its contractual obligation to the borrower only by paying the assignee (Reading). Accordingly, Suffolk remained obligated in full under the contract, and, upon the borrower's default, the bank was entitled to enforce its borrower's contractual obligations and recover all misdirected payments. (Of course, the UCC assures against a windfall to the bank by providing a detailed framework for distribution of excess funds recovered from an account debtor after satisfaction of the loan balance and collection costs.)


In a reassuring note, the Court found support for its decision in the UCC's purpose to "simplify, clarify and modernize the law governing commercial transactions," and went on to add that: "Setting an assignee's recovery at the total value of all wrongfully directed payments offers greater clarity and certainty to lenders, whose remedy upon default would otherwise be subject to a jury's determination of actual loss, which may be unpredictable." The Court also cited with approval a case from Ohio recognizing that strict construction of Article 9 "preserves the goals of commercial stability and reliability" because "lenders will not lend in such an uncertain climate that depends on litigation for resolution."


Finally, the Court rejected Suffolk's argument that it was entitled to an offsetting credit for the amount of the personal guaranty. In doing so, the SJC affirmed the fundamental principle familiar in practice that a secured creditor's rights and remedies upon a debtor's default are cumulative and may be pursued simultaneously or in any order the creditor chooses. Banks have discretion in the exercise of such rights and remedies. While Reading had the "unfettered right" to apply the guaranty to the borrower's debt, it was under no obligation to do so, and was free to pursue other means of recovery as it deemed appropriate.