Be Careful What You Look For: It Could Be an Authenticated Record

The use of the term “authenticate” affects many provisions of the UCC. For example, in Section 9-203, which governs the enforceability of security agreements, the requirement to make a security agreement enforceable has been broadened from the requirement of a signed writing to the allowing of any authenticated record to evidence the agreement. UCC '9-203(b)(3)(A). The drafters intended this change to fulfill an evidentiary requirement in the nature of the Statute of Frauds. UCC '9-203 cmt. 3.

The issue presented in In re Communications Dynamics, centers on the effect of the word “authenticated” in the context of UCC '9-404(a)(2). Section 9-404(a) is the Revised Article 9 corollary to Section 9-318(1) of pre-revised Article 9. Section 9-404(a) provides that an assignee of an interest takes an assignment subject to claims and defenses of account debtors except in certain limited circumstances. Section 9-404(a) states in pertinent part:

(a) Unless an account debtor has made an enforceable agreement not to assert defenses or claims, and subject to subsections (b) through (e), the rights of an assignee are subject to

(1) all terms of the agreement between the account debtor and assignor and any defense or claim in recoupment arising from the transaction that gave rise to the contract; and

(2) any other defense or claim of the account debtor against the assignor, which accrues before the account debtor receives a notification of the assignment authenticated by the assignor or assignee. (Emphasis added)

Section 9-318(1) of the pre-revised Article 9 stated in pertinent part: “the rights of an assignee are subject to … (b) any other defense or claim of the account debtor against the assignor which accrues before the account debtor receives notification of the assignment.” The underlying reasoning for this provision is that “an assignee can take no greater rights than the assignor.” Commerce Bank, N.A. v. Chrysler Realty Corporation, 244 F.3d 777, 783 (10th Cir. 2001). “The fact that [an assignee] has a perfected security interest and [an account debtor] does not, makes no difference because the [assignee's] secured status comes into play only after it is shown the [assignor] was entitled to payment of funds.” Id. When comparing Section 9-404(a)(2) with pre-revised Section 9-318(1), the only major change was the addition of the authentication requirement. There is no mention in the Official Comments of why the authentication requirement was added.

Section 1-201 of the UCC states that “[a] person 'notifies' or 'gives' a notice or notification to another person by taking such steps as may be reasonably required to inform the other person in ordinary course, whether or not the person actually comes to know of it.” It further provides that, “a person 'receives' a notice or notification when: (1) it comes to that person's attention; or (2) it is duly delivered in a reasonable form under the circumstances at the place of business through which the contract was made or at another location held out by that person as the place of receipt of such communications.”

Several courts have dealt with the question of proper notification under section 9-318(1) of the pre-revised Article 9. In Chase Manhattan Bank v. New York, 40 N.Y. 2d 590, 595 (1976), the Court of Appeals in New York held that filing a UCC-1 financing statement with the appropriate state office was not sufficient to notify account debtors of an assignment. The court stated in pertinent part:

The point is that a paper filed with a State office solely as a commercial repository under the code in order to give constructive notice to all the world is not actual notice. … The indexing and the filing is for the benefit of outsiders whose duty it may be to search the index and read the indexed statements before they extend credit. Id. at 595.

In holding that actual notice to an account debtor regarding an assignment was necessary to take away the account debtor's rights, the court discussed the burden of the actual notice requirement:

The diligent assignee need not be hurt by the actual notice provision in Section 9-318 … he may protect his rights by verifying the specific accounts assigned and notifying account debtors of the assignment. If there be any reason for non-notification, as in the case of some industries, then the assignee should be aware of the risk he is assuming. Id. at 594.

Other courts have found that even though the assignee or assignor did not send a written notice to account debtors an account debtor's receipt of actual notice was sufficient to allow for the loss of the account debtor's setoff rights under Section 9-318(1). In In re Bancroft Dairy, 10 B.R. 920 (Bankr. W.D. Mich 1981) several alleged account debtors brought suit against Bancroft, who filed for relief under Chapter 11 of the Bankruptcy Code. The account debtors argued that they never received proper notification regarding the assignment of several accounts. The account debtors never received a formal written notice or any tangible communication of the assignment. However, one of the insiders of the account debtors was involved in the assignment of the accounts because he was an officer of several of the account debtors and an officer for Bancroft and actually signed several of the documents regarding the assignment. The court found that the knowledge of the assignment by the officer was enough to establish the account debtors had actual knowledge of the assignment and therefore had lost their setoff rights. The court pointed to the language “it comes to his attention” in the definition of “receives” notice or notification and interpreted it to mean that the receiving of knowledge by an insider of a company is enough to satisfy the notification requirement in Section 9-318(1). Id. at 926.

In Bank of Kansas v. Hutchinson Health Serv., Inc., 13 Kan.App.2d 421 (1989), the Court of Appeals of Kansas found that even though notice of an assignment was not sent in the ordinary course of business, the receipt of actual notice of the assignment was sufficient for Section 9-318(1). The dispute arose between the Bank of Kansas (“Bank”) and the state of Kansas regarding reimbursement funds owed by the Kansas Department of Social Rehabilitation Services (“SRS”) to Hutchinson Health Services, Inc., (“HHS”) a nursing home operator. The Bank held a perfected security interest in HHS's accounts receivable while the state of Kansas claimed a right of setoff for delinquent employment contributions owed by HHS. The issue regarding notification arose because the state of Kansas was never properly notified in the ordinary course of business. However, the SRS received notification that it was named a defendant by the Bank regarding the Bank's assertion that it had priority over the funds. The court found that this notification was sufficient actual notice in regard to 9-318(1).

The Underlying Decision

In October 2003, the Bankruptcy Court in the District of Delaware announced its decision in In re Communications Dynamics, Inc., 2003 WL 22345713 (Bankr. D. Del.). The court held that the authentication requirement in Section 9-404(a)(2) was satisfied by the viewing of a credit report downloaded from Dun & Bradstreet that contained information of the assignment, even though the assignee and assignor never took an affirmative act to authenticate any record. The relevant facts are as follows. The creditor moved for relief from the automatic stay in order to exercise its rights of setoff or recoupment based on a pre-petition distribution agreement entered into with the debtor. Pursuant to that agreement, the debtor was to sell goods at a standard price set by the creditor/account debtor. If the debtor could not sell the goods for the standard price, it would be owed credits by the creditor/ account debtor for the difference in the standard price and the actual sale price. The debtor then entered into a credit agreement, which granted a lender a lien on substantially all of its assets. The debtor subsequently filed for bankruptcy. The creditor/account debtor brought the adversary proceeding in question to assert its right in setoff and recoupment to recover the amounts owed for pre-petition goods provided to the debtor against the pre-petition credits it owed the debtor. The lender intervened in the adversary proceeding, asserting its security interest in all of the debtor's assets.

One of the arguments raised by the creditor/account debtor was that it never received a properly authenticated notice from the assignee (lender) or the assignor (debtor) as required pursuant to '9-404(a)(2) of the UCC, and that therefore the lender's lien was subject to the account debtor's right of set-off. The lender and debtor countered by arguing that when the creditor/account debtor downloaded a credit report from Dun & Bradstreet in the ordinary course of business, the receipt of the information in the report was sufficient notice of the assignment of the interests to the lender. Interestingly, neither the lender nor debtor argued that the credit report was actually authenticated by the debtor. Rather, they asserted that the authentication requirement should not force the assignor or assignee to mail a signed writing to every account debtor.

The court agreed with the debtor and lender. The court pointed out that there was no case law interpreting the authentication requirement of Section 9-404(a) and that the Official Comments to that section “shed little light on this issue.” After reviewing the above disclosed cases regarding notification and the predecessor to Section 9-404, Section 9-318 of the pre-revised UCC, which had no authentication requirement, the court found “almost all notifications [of an assignment] were deemed sufficient.” The court did acknowledge that the addition of the authentication requirement “must mean more than actual or constructive notice is required.” However, the court asserted that it did not mean the actual delivery of a formal notice, reasoning that a notification sent to all account debtors made “no commercial sense” and “would be a tremendous change from Section 9-318.” Furthermore, if such a change was mandated by Section 9-404(a)(2), the court asserted that the Comments would have specified this.

The court then reviewed the definition of the term “authenticate.” Upon examining the Official Comments, the court found that the term “authenticate” “expresses the goal of allowing notice by modern electronic means of delivery of information.” Furthermore, it allows “electronic symbols to stand for the signature of a party.” The court determined that it would be consistent with the above Comments for the actions of the creditor in obtaining a credit report off the Web site of a respected third party to meet the requirement of authentication under '9-404.

Discussion

The court's reasoning allowing the downloading of a credit report to satisfy the authentication requirement of Section 9-404(a)(2) seems flawed for several reasons. First, the court ignores the plain language of the UCC's definition of “authenticate.” Second, the court's decision does not fully analyze or discuss the cases involving notification under Section 9-318(1). Finally, the court failed to analyze the use of the term “authenticate” in other sections of the UCC.

The Plain Language of the UCC

The Communications Dynamics decision appears to erase the authentication requirement in Section 9-404(a)(2) by not requiring an affirmative act by the assignee or assignor to adopt the record. The holding ignores the language of the UCC's definition of “authenticate” and reasons that the Official Comments should have specified that the drafters intended to make a change in the law by adding an authentication requirement. The language of Section 9-102(7) however defines “authenticate” as requiring the debtor “to sign; … or to execute or otherwise adopt a symbol.” This language clearly requires an affirmative act by the assignee or assignor.

Furthermore, as stated by the court in Chase Manhattan Bank v. New York, the requirement of sending written notice to the identified account debtors has been held not to be overly burdensome. Since courts have already held that the sending of written notice was required under Section 9-318, the Communications Dynamics court was mistaken in its analysis that the authentication requirement would result in a new burden on assignees. Moreover, while the Hutchinson and Bancroft courts required only actual notice, the facts in those cases were not typical. First, in Bancroft the suit was between several entities where one individual was an insider to entities on both sides of the suit. Second, in Hutchinson, while no formal notice regarding the assignment was received, an official notice regarding the court proceeding was sent to the affected account debtor. Therefore, these cases are distinguishable from the typical notification of assignment situation.

Moreover, it can be argued that the purpose of a credit report on the Internet and filing a financing statement in a state office are identical. Both are used as resources for outsiders to determine whether they should enter into certain transactions. Neither of the resources constitutes an affirmative action to inform third parties. As pointed out in Chase, this type of notice is merely constructive and does not meet the threshold notice requirement of Section 9-404(a)(2) and would not have met the requirements of former Section 9-318.

Finally, many commercial transactions include a lender with a lien on receivables. This in and of itself, merely because it was picked up on a Dun & Bradstreet Report that was reviewed by the account debtor, should not be sufficient to eliminate an account debtor's set off rights. In other words, it is commonly understood that the mere existence of a security interest in an account does not cut off the account debtor's rights unless he is notified by the assignor or assignee of the existence of the assignment.

Other Sections of the UCC

The court's analysis is also deficient because it does not review the use of “authenticate” in other sections of the UCC. The Official Comments state that the terms defined in Section 9-102 are all of the defined terms used in more than one section. UCC Section 9-102 cmt. (a). Since “authenticate” is a defined term, it is inferred that the drafters wanted a uniform definition of the term. As stated above, the Official Comments of Section 9-203 state that an authenticated record is meant to satisfy a formal evidentiary requirement in the nature of the Statute of Frauds. This is incongruous to the court's holding regarding the meaning of “authenticated” in Section 404(a). If the court's reading of “authenticate” was applied to Section 9-203, the parties could authenticate a security agreement with no adoption of the agreement.

Moreover, the court does not address UCC Section 9-406 in its interpretation of the notice requirement of UCC Section 9-404. UCC Section 9-406 states that an account debtor on an account, chattel paper, or payment intangible may discharge its obligation by paying the assignor until, but not after, the account debtor receives notification authenticated by the assignor or the assignee, that the amount due or to become due has been assigned and that the payment is to be made to the assignee. An effective notification must be authenticated, which normally means sending notice on the notifying person's letterhead or on a form in which the notifying person's name appears. UCC Section 9-406 cmt. 2. Although UCC Section 9-406 includes an additional requirement that the notice indicate that payment is to be made to the assignee, the remainder of the notice requirement is similar to Section 9-404 in that the rights and obligations of account debtors are altered by the receipt of a notification, authenticated by the assignor or the assignee. Comment 2 to Section 9-406 suggests that some actual form of notice must be sent to the account debtor to satisfy the authenticated notice requirement.

Conclusion

The court's approach departs from the intent behind the definitions of “authenticate,” and in effect therefore substantially dilutes the authentication requirement in Section 9-404(a)(2). Entities that are a party to commercial transactions should be aware of this decision, as normal due diligence (ie, checking a Dun & Bradstreet Report) may have the effect of altering one's right to protect its interests.

The equipment leasing industry should have a particular interest in the impact of the case. Initially, equipment lessors often find themselves as “account debtors” with respect to the purchase price of equipment being leased. Knowledge that the equipment vendor has granted a lien on its accounts to a third party would put the lessor in a position of having forfeited its set-off rights with respect to amounts owing to the vendor. By the same token, a lessor's secured creditor may benefit from this decision in that a lessee of the lessor who is aware that the lease has been pledged as collateral would also lose its set-off rights as against the lessor's creditor. [Note, this situation is more likely to arise with respect to a non-finance lease since a finance lease usually contains an express agreement not to assert defenses. It should also be noted that the receipt of an authenticated notice, in whatever form, does not affect the account debtor's right of recoupment and defenses or claims arising out of the same transaction that gave rise to the account. In fact, the court in In re Communication Dynamics, Inc. ultimately allowed the account debtor to recoup the sale credits against its pre-petition claim, finding that the credits arose out of a single integrated business transaction.]

A recent bankruptcy court decision out of the District of Delaware found that a document contained on a Web site was an authenticated notice under UCC 9-404 notwithstanding the lack of affirmative action taken by the assignor or assignee. In re Communications Dynamics, Inc. WL 22345713 (Bankr. D. Del. 2003) is the first decision in which the authentication requirement to an account debtor in Section 9-404(a)(2) of the Uniform Commercial Code (UCC) is interpreted. This holding adds a new element to the UCC's definition of authentication and seems to ignore the plain language of the Code. This decision could have an impact on the leasing industry as the definition of an account debtor under Section 9-102(a)(3) of the UCC includes not only a lessee but will also include a lessor in conjunction with its own accounts payable.

'Authenticate' and the UCC

UCC Section 9-102(7) defines “authenticate” as: “(A) to sign; or (B) to execute or otherwise adopt a symbol, or encrypt or similarly process a record with the present intent of the authenticating person to identify the person and adopt or accept a record.” The definition of “authenticate” refers to a “record” which the UCC defines as: “information that is inscribed on a tangible medium or which is stored in an electronic or other medium and is retrievable in perceivable form.” UCC '9-102(69). According to the Official Comments, the term “authenticate” replaces “sign” and “record” replaces “writing” and “written” in many of the provisions in revised Article 9. UCC '9-102 cmt. 9(a)-(b). The adoption of these terms is meant to modernize the UCC and to deal with rapidly developing technology. UCC '9-102 cmt. 9(a). The UCC is very broad in its approach to the adoption of new technology; even a message left on a “digital voice messaging system” can qualify as a record. Id. The only limitation expressed by the drafters was that “human memory does not qualify as a record.” Id.

The use of the term “authenticate” affects many provisions of the UCC. For example, in Section 9-203, which governs the enforceability of security agreements, the requirement to make a security agreement enforceable has been broadened from the requirement of a signed writing to the allowing of any authenticated record to evidence the agreement. UCC '9-203(b)(3)(A). The drafters intended this change to fulfill an evidentiary requirement in the nature of the Statute of Frauds. UCC '9-203 cmt. 3.

The issue presented in In re Communications Dynamics, centers on the effect of the word “authenticated” in the context of UCC '9-404(a)(2). Section 9-404(a) is the Revised Article 9 corollary to Section 9-318(1) of pre-revised Article 9. Section 9-404(a) provides that an assignee of an interest takes an assignment subject to claims and defenses of account debtors except in certain limited circumstances. Section 9-404(a) states in pertinent part:

(a) Unless an account debtor has made an enforceable agreement not to assert defenses or claims, and subject to subsections (b) through (e), the rights of an assignee are subject to

(1) all terms of the agreement between the account debtor and assignor and any defense or claim in recoupment arising from the transaction that gave rise to the contract; and

(2) any other defense or claim of the account debtor against the assignor, which accrues before the account debtor receives a notification of the assignment authenticated by the assignor or assignee. (Emphasis added)

Section 9-318(1) of the pre-revised Article 9 stated in pertinent part: “the rights of an assignee are subject to … (b) any other defense or claim of the account debtor against the assignor which accrues before the account debtor receives notification of the assignment.” The underlying reasoning for this provision is that “an assignee can take no greater rights than the assignor.” Commerce Bank, N.A. v. Chrysler Realty Corporation, 244 F.3d 777, 783 (10th Cir. 2001). “The fact that [an assignee] has a perfected security interest and [an account debtor] does not, makes no difference because the [assignee's] secured status comes into play only after it is shown the [assignor] was entitled to payment of funds.” Id. When comparing Section 9-404(a)(2) with pre-revised Section 9-318(1), the only major change was the addition of the authentication requirement. There is no mention in the Official Comments of why the authentication requirement was added.

Section 1-201 of the UCC states that “[a] person 'notifies' or 'gives' a notice or notification to another person by taking such steps as may be reasonably required to inform the other person in ordinary course, whether or not the person actually comes to know of it.” It further provides that, “a person 'receives' a notice or notification when: (1) it comes to that person's attention; or (2) it is duly delivered in a reasonable form under the circumstances at the place of business through which the contract was made or at another location held out by that person as the place of receipt of such communications.”

Several courts have dealt with the question of proper notification under section 9-318(1) of the pre-revised Article 9. In Chase Manhattan Bank v. New York , 40 N.Y. 2d 590, 595 (1976), the Court of Appeals in New York held that filing a UCC-1 financing statement with the appropriate state office was not sufficient to notify account debtors of an assignment. The court stated in pertinent part:

The point is that a paper filed with a State office solely as a commercial repository under the code in order to give constructive notice to all the world is not actual notice. … The indexing and the filing is for the benefit of outsiders whose duty it may be to search the index and read the indexed statements before they extend credit. Id. at 595.

In holding that actual notice to an account debtor regarding an assignment was necessary to take away the account debtor's rights, the court discussed the burden of the actual notice requirement:

The diligent assignee need not be hurt by the actual notice provision in Section 9-318 … he may protect his rights by verifying the specific accounts assigned and notifying account debtors of the assignment. If there be any reason for non-notification, as in the case of some industries, then the assignee should be aware of the risk he is assuming. Id. at 594.

Other courts have found that even though the assignee or assignor did not send a written notice to account debtors an account debtor's receipt of actual notice was sufficient to allow for the loss of the account debtor's setoff rights under Section 9-318(1). In In re Bancroft Dairy, 10 B.R. 920 (Bankr. W.D. Mich 1981) several alleged account debtors brought suit against Bancroft, who filed for relief under Chapter 11 of the Bankruptcy Code. The account debtors argued that they never received proper notification regarding the assignment of several accounts. The account debtors never received a formal written notice or any tangible communication of the assignment. However, one of the insiders of the account debtors was involved in the assignment of the accounts because he was an officer of several of the account debtors and an officer for Bancroft and actually signed several of the documents regarding the assignment. The court found that the knowledge of the assignment by the officer was enough to establish the account debtors had actual knowledge of the assignment and therefore had lost their setoff rights. The court pointed to the language “it comes to his attention” in the definition of “receives” notice or notification and interpreted it to mean that the receiving of knowledge by an insider of a company is enough to satisfy the notification requirement in Section 9-318(1). Id. at 926.

In Bank of Kansas v. Hutchinson Health Serv., Inc., 13 Kan.App.2d 421 (1989), the Court of Appeals of Kansas found that even though notice of an assignment was not sent in the ordinary course of business, the receipt of actual notice of the assignment was sufficient for Section 9-318(1). The dispute arose between the Bank of Kansas (“Bank”) and the state of Kansas regarding reimbursement funds owed by the Kansas Department of Social Rehabilitation Services (“SRS”) to Hutchinson Health Services, Inc., (“HHS”) a nursing home operator. The Bank held a perfected security interest in HHS's accounts receivable while the state of Kansas claimed a right of setoff for delinquent employment contributions owed by HHS. The issue regarding notification arose because the state of Kansas was never properly notified in the ordinary course of business. However, the SRS received notification that it was named a defendant by the Bank regarding the Bank's assertion that it had priority over the funds. The court found that this notification was sufficient actual notice in regard to 9-318(1).

The Underlying Decision

In October 2003, the Bankruptcy Court in the District of Delaware announced its decision in In re Communications Dynamics, Inc., 2003 WL 22345713 (Bankr. D. Del.). The court held that the authentication requirement in Section 9-404(a)(2) was satisfied by the viewing of a credit report downloaded from Dun & Bradstreet that contained information of the assignment, even though the assignee and assignor never took an affirmative act to authenticate any record. The relevant facts are as follows. The creditor moved for relief from the automatic stay in order to exercise its rights of setoff or recoupment based on a pre-petition distribution agreement entered into with the debtor. Pursuant to that agreement, the debtor was to sell goods at a standard price set by the creditor/account debtor. If the debtor could not sell the goods for the standard price, it would be owed credits by the creditor/ account debtor for the difference in the standard price and the actual sale price. The debtor then entered into a credit agreement, which granted a lender a lien on substantially all of its assets. The debtor subsequently filed for bankruptcy. The creditor/account debtor brought the adversary proceeding in question to assert its right in setoff and recoupment to recover the amounts owed for pre-petition goods provided to the debtor against the pre-petition credits it owed the debtor. The lender intervened in the adversary proceeding, asserting its security interest in all of the debtor's assets.

One of the arguments raised by the creditor/account debtor was that it never received a properly authenticated notice from the assignee (lender) or the assignor (debtor) as required pursuant to '9-404(a)(2) of the UCC, and that therefore the lender's lien was subject to the account debtor's right of set-off. The lender and debtor countered by arguing that when the creditor/account debtor downloaded a credit report from Dun & Bradstreet in the ordinary course of business, the receipt of the information in the report was sufficient notice of the assignment of the interests to the lender. Interestingly, neither the lender nor debtor argued that the credit report was actually authenticated by the debtor. Rather, they asserted that the authentication requirement should not force the assignor or assignee to mail a signed writing to every account debtor.

The court agreed with the debtor and lender. The court pointed out that there was no case law interpreting the authentication requirement of Section 9-404(a) and that the Official Comments to that section “shed little light on this issue.” After reviewing the above disclosed cases regarding notification and the predecessor to Section 9-404, Section 9-318 of the pre-revised UCC, which had no authentication requirement, the court found “almost all notifications [of an assignment] were deemed sufficient.” The court did acknowledge that the addition of the authentication requirement “must mean more than actual or constructive notice is required.” However, the court asserted that it did not mean the actual delivery of a formal notice, reasoning that a notification sent to all account debtors made “no commercial sense” and “would be a tremendous change from Section 9-318.” Furthermore, if such a change was mandated by Section 9-404(a)(2), the court asserted that the Comments would have specified this.

The court then reviewed the definition of the term “authenticate.” Upon examining the Official Comments, the court found that the term “authenticate” “expresses the goal of allowing notice by modern electronic means of delivery of information.” Furthermore, it allows “electronic symbols to stand for the signature of a party.” The court determined that it would be consistent with the above Comments for the actions of the creditor in obtaining a credit report off the Web site of a respected third party to meet the requirement of authentication under '9-404.

Discussion

The court's reasoning allowing the downloading of a credit report to satisfy the authentication requirement of Section 9-404(a)(2) seems flawed for several reasons. First, the court ignores the plain language of the UCC's definition of “authenticate.” Second, the court's decision does not fully analyze or discuss the cases involving notification under Section 9-318(1). Finally, the court failed to analyze the use of the term “authenticate” in other sections of the UCC.

The Plain Language of the UCC

The Communications Dynamics decision appears to erase the authentication requirement in Section 9-404(a)(2) by not requiring an affirmative act by the assignee or assignor to adopt the record. The holding ignores the language of the UCC's definition of “authenticate” and reasons that the Official Comments should have specified that the drafters intended to make a change in the law by adding an authentication requirement. The language of Section 9-102(7) however defines “authenticate” as requiring the debtor “to sign; … or to execute or otherwise adopt a symbol.” This language clearly requires an affirmative act by the assignee or assignor.

Furthermore, as stated by the court in Chase Manhattan Bank v. New York, the requirement of sending written notice to the identified account debtors has been held not to be overly burdensome. Since courts have already held that the sending of written notice was required under Section 9-318, the Communications Dynamics court was mistaken in its analysis that the authentication requirement would result in a new burden on assignees. Moreover, while the Hutchinson and Bancroft courts required only actual notice, the facts in those cases were not typical. First, in Bancroft the suit was between several entities where one individual was an insider to entities on both sides of the suit. Second, in Hutchinson, while no formal notice regarding the assignment was received, an official notice regarding the court proceeding was sent to the affected account debtor. Therefore, these cases are distinguishable from the typical notification of assignment situation.

Moreover, it can be argued that the purpose of a credit report on the Internet and filing a financing statement in a state office are identical. Both are used as resources for outsiders to determine whether they should enter into certain transactions. Neither of the resources constitutes an affirmative action to inform third parties. As pointed out in Chase, this type of notice is merely constructive and does not meet the threshold notice requirement of Section 9-404(a)(2) and would not have met the requirements of former Section 9-318.

Finally, many commercial transactions include a lender with a lien on receivables. This in and of itself, merely because it was picked up on a Dun & Bradstreet Report that was reviewed by the account debtor, should not be sufficient to eliminate an account debtor's set off rights. In other words, it is commonly understood that the mere existence of a security interest in an account does not cut off the account debtor's rights unless he is notified by the assignor or assignee of the existence of the assignment.

Other Sections of the UCC

The court's analysis is also deficient because it does not review the use of “authenticate” in other sections of the UCC. The Official Comments state that the terms defined in Section 9-102 are all of the defined terms used in more than one section. UCC Section 9-102 cmt. (a). Since “authenticate” is a defined term, it is inferred that the drafters wanted a uniform definition of the term. As stated above, the Official Comments of Section 9-203 state that an authenticated record is meant to satisfy a formal evidentiary requirement in the nature of the Statute of Frauds. This is incongruous to the court's holding regarding the meaning of “authenticated” in Section 404(a). If the court's reading of “authenticate” was applied to Section 9-203, the parties could authenticate a security agreement with no adoption of the agreement.

Moreover, the court does not address UCC Section 9-406 in its interpretation of the notice requirement of UCC Section 9-404. UCC Section 9-406 states that an account debtor on an account, chattel paper, or payment intangible may discharge its obligation by paying the assignor until, but not after, the account debtor receives notification authenticated by the assignor or the assignee, that the amount due or to become due has been assigned and that the payment is to be made to the assignee. An effective notification must be authenticated, which normally means sending notice on the notifying person's letterhead or on a form in which the notifying person's name appears. UCC Section 9-406 cmt. 2. Although UCC Section 9-406 includes an additional requirement that the notice indicate that payment is to be made to the assignee, the remainder of the notice requirement is similar to Section 9-404 in that the rights and obligations of account debtors are altered by the receipt of a notification, authenticated by the assignor or the assignee. Comment 2 to Section 9-406 suggests that some actual form of notice must be sent to the account debtor to satisfy the authenticated notice requirement.

Conclusion

The court's approach departs from the intent behind the definitions of “authenticate,” and in effect therefore substantially dilutes the authentication requirement in Section 9-404(a)(2). Entities that are a party to commercial transactions should be aware of this decision, as normal due diligence (ie, checking a Dun & Bradstreet Report) may have the effect of altering one's right to protect its interests.

The equipment leasing industry should have a particular interest in the impact of the case. Initially, equipment lessors often find themselves as “account debtors” with respect to the purchase price of equipment being leased. Knowledge that the equipment vendor has granted a lien on its accounts to a third party would put the lessor in a position of having forfeited its set-off rights with respect to amounts owing to the vendor. By the same token, a lessor's secured creditor may benefit from this decision in that a lessee of the lessor who is aware that the lease has been pledged as collateral would also lose its set-off rights as against the lessor's creditor. [Note, this situation is more likely to arise with respect to a non-finance lease since a finance lease usually contains an express agreement not to assert defenses. It should also be noted that the receipt of an authenticated notice, in whatever form, does not affect the account debtor's right of recoupment and defenses or claims arising out of the same transaction that gave rise to the account. In fact, the court in In re Communication Dynamics, Inc. ultimately allowed the account debtor to recoup the sale credits against its pre-petition claim, finding that the credits arose out of a single integrated business transaction.]