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The Anti-Assignment Override Provisions
Like the knight in a game of chess, UCC Sections 9406(d) and 9408(a) are one of the most powerful, yet least understood, sections of the Uniform Commercial Code. On their face, they appear to override anti-assignment provisions in agreements that would limit the grant of a security interest. But do these sections really work?
In general, Section 9406(d) overrides (renders “ineffective”) a term in an agreement between an account debtor and an assignor or in a promissory note to the extent such term prohibits or restricts the creation, attachment, perfection or enforcement of a security interest in an account, chattel paper, payment intangible, or promissory note (or to the extent the security interest may give rise to a breach or termination of the underlying agreement or note). Section 9408(a) overrides a term in a promissory note or in an agreement between an account debtor and a debtor to the extent such term would impair the creation, attachment or perfection of a security interest in a promissory note, health care insurance receivable, or general intangible (or to the extent the security interest may give rise to a breach or termination of the underlying note, receivable or general intangible).
A 9406(d) example is a provision in a license agreement that prohibits the licensor from granting a security interest to a third party in the royalties payable by the licensee under the license. The “account debtor” in this example is the licensee, and the right to payment of the royalties is an “account.” Section 9406(d) renders this provision unenforceable. A 9408(a) example is a provision in a license agreement that prohibits the licensee from granting a security interest to a third party in its rights under the license. The “account debtor” in this example is the licensor, and the rights of the licensee under the license are a “general intangible.” Section 9408(a) renders this provision unenforceable.
An important distinction between Section 9406(d) and 9408(a) is that, whereas 9406(d) overrides restrictions on creation, attachment, perfection and enforcement, Section 9408(a) leaves out the word “enforcement.” In other words, Section 9408(a) allows the third party in this example to take a security interest in the licensee's rights under the license, but does not permit the third party to step into the shoes of the licensee and enforce the license against the licensor (without the latter's consent). More about this later.
Sections 9406(d) and 9408(a) sound good in theory, but how do they hold up in practice? These sections were included in Revised Article 9, which took effect in most states on July 1, 2001. Although more than 10 years have elapsed since then, there is still very little case law on the subject. When advising clients, the best approach is to read the comments and use common sense. This article points out a few pointers, and potential pitfalls.
Choice of Law
A threshold question is always: What is the applicable choice of law? Say, for example, that your security agreement is governed by New York law. Your borrower, as licensee, has entered into a material license agreement with a company located in Germany, and the license is governed by German law. The agreement contains the usual “anti-assignment” provision prohibiting either party from assigning the license without the prior written consent of the other party.
Is it a breach of this provision for the borrower to grant a security interest in the license absent the consent of the licensor? Comment 3 to Section 9401 suggests that German law, not New York law, would govern in this situation. See, e.g., Fox-Greenwald Sheet Metal Co. v. Markowitz Bros. Inc., 452 F.2d 1346 (DC Cir. 1971) (applying the law governing interpretation of the contract that was assigned). Accordingly, New York 9408(a) would not apply and the anti-assignment provision would be effective, assuming that is the result under German law. Is the grant of a security interest in the license nonetheless still valid? Perhaps. The assignment may be valid under New York law as between the assignor and assignee, even though under German law the assignment (absent consent) may result in a breach or termination of the license being assigned. See generally, Section 9401(a). While beyond the scope of this article, such an assignment may also give rise to a tort claim for intentional interference of contract by the obligor against the assignee.
Another choice of law issue relates to the non-uniformities of Section 9406(d) and 9408(a) from state to state. See the section below with respect to transfers of interests in partnerships or limited liability companies.
Assignment vs. Security Interest
Most anti-assignment provisions are general in nature; they do not expressly prohibit the grant of a security interest. Most practitioners take the view, however, that the grant of a security interest is a type of assignment, and therefore included within the anti-assignment provision. (See Official Comment 26 to Section 9102; Fox-Greenwald Sheet Metal Co. v. Markowitz Bros. Inc., 452 F.2d 1346,1349n4 (DC Cir. 1971); WebBank v. Am.Gen. Annuity Serv. Corp., 2002 UT 88, 54 P3d 1139, 1143n5 (Utah 2002)).
Scope of 9406(d) and 9408(a)
Section 9406(d), broadly speaking, covers payment streams, and 9408(a) covers intangible rights. It is important to read the sections closely, however, to see exactly what they cover and what they do not. For example, neither section addresses restrictions on the assignment of investment property. Therefore, an owner of restricted stock in a corporation may not grant a security interest in the stock in reliance on these sections. This issue also comes up in the context of limited liability membership interests and limited partnership interests, which may be, depending on the circumstances, either “investment property” (not within 9408(a)), or “general intangibles” (and therefore within 9408(a)). Certain states, such as Delaware and Virginia, have amended 9406 and 9408 to expressly provide that these sections do not apply to an interest in a partnership or limited liability company.
Another area of confusion is equipment leases. The lease will typically prohibit transfer or assignment of the lessee's rights in the equipment and in the lease itself. Neither Section 9406(d) nor Section 9408(a) applies to equipment (“goods”). Section 9406(d) applies to leases (“chattel paper”), but subject to Section 9407 and Section 2A-303. In general, a restriction in a lease prohibiting the lessor from assigning its rights in the rental stream would be overridden by Section 9406(d) and 9407.
Yet another “scope” question is whether Section 9408(a) would override a negative pledge on intellectual property that is the subject of a license. For example, assume a party licenses a patent to another party, and the license agreement contains a prohibition on the grant by the licensor of a security interest in the patent. Does Section 9408(a) override this prohibition? The answer is unclear. Section 9408(a) seems to address only prohibitions on the assignment of the agreement itself (the assigning party's contractual rights), not the underlying property subject to the agreement.
Federal Preemption
Of course, Sections 9406(d) and 9408(a) cannot override federal law. For example, if the account debtor is the federal government or a federal government agency, the secured party must still abide by the procedures contained in the Assignment of Claims Act of 1940, as amended (31 USC ' 3727, 41 USC ' 6305) in order to enforce the claim against the account debtor. And a secured creditor may take a security interest in the proceeds of the sale of a federal broadcasting license, but not in the license itself (In re Tracy Broad. Corp., 696 F3d 1051 (10th Cir. 2012)).
Yet another area of concern is non-exclusive licenses of federal patents. Cases interpreting the Patent Act have held that a nonexclusive license of a patent does not transfer a property interest to the licensee; therefore, even if 9408(a) overrides the anti-assignment provision, it could be argued that the secured party has no security interest because there is nothing to attach. See Comment 3 to Section 9408; In re CFLC, Inc., 89 F.3d 673 (9th Cir. 1996).
Enforcement
As indicated, Section 9408(a) does not give the secured party the right to enforce the contract being assigned to the extent the anti-assignment provision would be effective under law other than Section 9408(a) (or (c)). See 9408(d). Why is this so?
The drafters of Section 9408 tried to balance the interests of the debtor (who is seeking financing and therefore would benefit from being able to grant a security interest in general intangibles such as licenses or franchise agreements) and the interests of the third party (such as a licensor or franchisor who is protected from the “adverse effects arising from the security interest”). See Comments 2 and 6 to Section 9408. Notwithstanding the inability to enforce the security interest, the secured party is still put in a better position vis-a-vis a bankruptcy trustee and other creditors of the debtor. For example, the secured party could claim a security interest in the proceeds from the sale of a franchise or a license, both inside and outside the debtor's bankruptcy. See Comments 7 and 8 to Section 9408; In re Tracy Broad. Corp., 696 F3d 1051 (10th Cir. 2012).
Case Law
As mentioned, to date, there is very little case law interpreting Sections 9406(d) and 9408(a).
Section 9406(d)
This Section was derived from former Section 9318(4), which rendered unenforceable restrictions on the assignment of accounts or the creation of security interests in chattel paper or general intangibles for money due or to become due. Former Section 9318(4), in turn, was based on the common law rule against restrictions on the assignment of rights to payment. The account debtor should not care who receives payment.
One case involving Section 9406(d) is Filer, Inc. v. Staples, Inc. (2011 U.S. Dist. LEXIS 20051). In this case, a manufacturer of file folders, HFP, entered into two agreements with Staples for the sale of products and manufacturing services. The agreements prohibited HFP from assigning the agreements without Staples' prior written consent, which was not obtained. HFP assigned the agreements anyway to a company called Filer. The latter then brought a breach of contract claim against Staples. The court held that Filer had no legal rights under the agreements, notwithstanding Section 9406(d) (Section 9408(a) was not discussed) because the assignment between HFP and Filer was for the purpose of collection of an account, in satisfaction of a pre-existing indebtedness, and therefore outside the scope of Revised Article 9. See Section 9109(d)(5)-(7).
Section 9408(a)
This Section is new (enacted as part of Revised Article 9). One case interpreting Section 9408(a) is 321 Henderson Receivables Origination LLC v. Sioteco, 173 Cal.App.4th 1059 (2009). At issue was an anti-assignment clause in an annuity contract issued as part of a structured settlement agreement. The court held that Section 9408(a) of the California Uniform Commercial Code overrode the anti-assignment clause; the California UCC does not contain the model UCC provision excluding annuities.
Section 9406(f)
Other cases have interpreted Section 9406(f), which makes legal restrictions on assignment generally ineffective. Compare Stone St. Capital, LLC v. Cal. State Lottery Com., 165 Cal.App.4th 109 (2008) (the more specific lottery statute prohibiting assignment prevails over Section 9406(f)) with Tex. Lottery Comm'n v. First State Bank of Dequeen, 254 S.W.3d 677 (Tex. App. 2008) (Section 9406(f) supersedes the anti-assignment provisions of the Texas lottery act).
Section 9408(c)
Finally, one case focused on 9408(c), which overrides rules of law that would restrict the creation of a security interest. (Note that 9408(c) was not adopted in New York.) See In re Chris-Don, Inc., decided by the United States District Court in New Jersey (367 F. Supp.2d 696 (D. NJ 2005). In this case, the Chapter 7 trustee sold the debtor's liquor license and held the proceeds in trust.
One creditor asserted a lien on the proceeds based on a security interest in the debtor's business assets. The New Jersey Alcoholic Beverage Control (ABC) statute prohibits a licensee from using a liquor license as collateral for a loan. The court held that the liquor license is not personal property under the ABC statute, and therefore not a general intangible subject to Section 9408. In re Chris-Don is probably limited to its facts; it's hard to say if another court would rely on this case outside the liquor license context.
Practical Limitations
Most contracts are not simple. License agreements, in particular, are often highly complex, involving an array of rights, remedies and obligations that “go both ways.” For example, there may be cross-licenses (each party granting a license to the other in different intellectual property rights), mutual payment obligations, and a host of other rights and remedies, such as indemnities, reporting obligations, and so on.
Section 9406(d) will override an anti-assignment provision, as applied to Party A's right to receive a royalty from Party B, if that right is taken in isolation. But what happens if that right is subject to performance by Party A of various contractual obligations to Party B? Nothing in Section 9406(d) overrides these other obligations, and Party B still has set-off rights, to the extent provided by Section 9404(a). See Comment 5 to Section 9406. See also Example 3 contained in Comment 6 to Section 9408 (a nondisclosure term in a license is enforceable even though the practical effect is to restrict the licensee's ability to use its rights under the license as collateral).
Special Rules
Practitioners should keep in mind the following special rules:
- Section 9406(d) applies to a security interest in accounts, chattel paper, payment intangibles, and promissory notes; however, it does not apply to a sale of a payment intangible or a promissory note. Instead, Section 9408(a) applies to a sale of a payment intangible or a promissory note.
- Section 9406(d) does not apply to an assignment of a health care insurance receivable. Instead, Section 9408(a) applies to this type of receivable.
Conclusion
A careful analysis of the facts surrounding the agreement containing the anti-assignment provision, together with a review of the foregoing pitfalls, is appropriate before concluding that Section 9406(d) or Section 9408(a) (as applicable) will be truly effective in overriding the anti-assignment provision in that agreement.
Like the knight in a game of chess, UCC Sections 9406(d) and 9408(a) are one of the most powerful, yet least understood, sections of the Uniform Commercial Code. On their face, they appear to override anti-assignment provisions in agreements that would limit the grant of a security interest. But do these sections really work?
In general, Section 9406(d) overrides (renders “ineffective”) a term in an agreement between an account debtor and an assignor or in a promissory note to the extent such term prohibits or restricts the creation, attachment, perfection or enforcement of a security interest in an account, chattel paper, payment intangible, or promissory note (or to the extent the security interest may give rise to a breach or termination of the underlying agreement or note). Section 9408(a) overrides a term in a promissory note or in an agreement between an account debtor and a debtor to the extent such term would impair the creation, attachment or perfection of a security interest in a promissory note, health care insurance receivable, or general intangible (or to the extent the security interest may give rise to a breach or termination of the underlying note, receivable or general intangible).
A 9406(d) example is a provision in a license agreement that prohibits the licensor from granting a security interest to a third party in the royalties payable by the licensee under the license. The “account debtor” in this example is the licensee, and the right to payment of the royalties is an “account.” Section 9406(d) renders this provision unenforceable. A 9408(a) example is a provision in a license agreement that prohibits the licensee from granting a security interest to a third party in its rights under the license. The “account debtor” in this example is the licensor, and the rights of the licensee under the license are a “general intangible.” Section 9408(a) renders this provision unenforceable.
An important distinction between Section 9406(d) and 9408(a) is that, whereas 9406(d) overrides restrictions on creation, attachment, perfection and enforcement, Section 9408(a) leaves out the word “enforcement.” In other words, Section 9408(a) allows the third party in this example to take a security interest in the licensee's rights under the license, but does not permit the third party to step into the shoes of the licensee and enforce the license against the licensor (without the latter's consent). More about this later.
Sections 9406(d) and 9408(a) sound good in theory, but how do they hold up in practice? These sections were included in Revised Article 9, which took effect in most states on July 1, 2001. Although more than 10 years have elapsed since then, there is still very little case law on the subject. When advising clients, the best approach is to read the comments and use common sense. This article points out a few pointers, and potential pitfalls.
Choice of Law
A threshold question is always: What is the applicable choice of law? Say, for example, that your security agreement is governed by
Is it a breach of this provision for the borrower to grant a security interest in the license absent the consent of the licensor? Comment 3 to Section 9401 suggests that German law, not
Another choice of law issue relates to the non-uniformities of Section 9406(d) and 9408(a) from state to state. See the section below with respect to transfers of interests in partnerships or limited liability companies.
Assignment vs. Security Interest
Most anti-assignment provisions are general in nature; they do not expressly prohibit the grant of a security interest. Most practitioners take the view, however, that the grant of a security interest is a type of assignment, and therefore included within the anti-assignment provision. (See Official Comment 26 to Section 9102; Fox-Greenwald Sheet Metal Co. v. Markowitz Bros. Inc., 452 F.2d 1346,1349n4 (DC Cir. 1971);
Scope of 9406(d) and 9408(a)
Section 9406(d), broadly speaking, covers payment streams, and 9408(a) covers intangible rights. It is important to read the sections closely, however, to see exactly what they cover and what they do not. For example, neither section addresses restrictions on the assignment of investment property. Therefore, an owner of restricted stock in a corporation may not grant a security interest in the stock in reliance on these sections. This issue also comes up in the context of limited liability membership interests and limited partnership interests, which may be, depending on the circumstances, either “investment property” (not within 9408(a)), or “general intangibles” (and therefore within 9408(a)). Certain states, such as Delaware and
Another area of confusion is equipment leases. The lease will typically prohibit transfer or assignment of the lessee's rights in the equipment and in the lease itself. Neither Section 9406(d) nor Section 9408(a) applies to equipment (“goods”). Section 9406(d) applies to leases (“chattel paper”), but subject to Section 9407 and Section 2A-303. In general, a restriction in a lease prohibiting the lessor from assigning its rights in the rental stream would be overridden by Section 9406(d) and 9407.
Yet another “scope” question is whether Section 9408(a) would override a negative pledge on intellectual property that is the subject of a license. For example, assume a party licenses a patent to another party, and the license agreement contains a prohibition on the grant by the licensor of a security interest in the patent. Does Section 9408(a) override this prohibition? The answer is unclear. Section 9408(a) seems to address only prohibitions on the assignment of the agreement itself (the assigning party's contractual rights), not the underlying property subject to the agreement.
Federal Preemption
Of course, Sections 9406(d) and 9408(a) cannot override federal law. For example, if the account debtor is the federal government or a federal government agency, the secured party must still abide by the procedures contained in the Assignment of Claims Act of 1940, as amended (31 USC ' 3727, 41 USC ' 6305) in order to enforce the claim against the account debtor. And a secured creditor may take a security interest in the proceeds of the sale of a federal broadcasting license, but not in the license itself (In re Tracy Broad. Corp., 696 F3d 1051 (10th Cir. 2012)).
Yet another area of concern is non-exclusive licenses of federal patents. Cases interpreting the Patent Act have held that a nonexclusive license of a patent does not transfer a property interest to the licensee; therefore, even if 9408(a) overrides the anti-assignment provision, it could be argued that the secured party has no security interest because there is nothing to attach. See Comment 3 to Section 9408; In re CFLC, Inc., 89 F.3d 673 (9th Cir. 1996).
Enforcement
As indicated, Section 9408(a) does not give the secured party the right to enforce the contract being assigned to the extent the anti-assignment provision would be effective under law other than Section 9408(a) (or (c)). See 9408(d). Why is this so?
The drafters of Section 9408 tried to balance the interests of the debtor (who is seeking financing and therefore would benefit from being able to grant a security interest in general intangibles such as licenses or franchise agreements) and the interests of the third party (such as a licensor or franchisor who is protected from the “adverse effects arising from the security interest”). See Comments 2 and 6 to Section 9408. Notwithstanding the inability to enforce the security interest, the secured party is still put in a better position vis-a-vis a bankruptcy trustee and other creditors of the debtor. For example, the secured party could claim a security interest in the proceeds from the sale of a franchise or a license, both inside and outside the debtor's bankruptcy. See Comments 7 and 8 to Section 9408; In re Tracy Broad. Corp., 696 F3d 1051 (10th Cir. 2012).
Case Law
As mentioned, to date, there is very little case law interpreting Sections 9406(d) and 9408(a).
Section 9406(d)
This Section was derived from former Section 9318(4), which rendered unenforceable restrictions on the assignment of accounts or the creation of security interests in chattel paper or general intangibles for money due or to become due. Former Section 9318(4), in turn, was based on the common law rule against restrictions on the assignment of rights to payment. The account debtor should not care who receives payment.
One case involving Section 9406(d) is Filer, Inc. v.
Section 9408(a)
This Section is new (enacted as part of Revised Article 9). One case interpreting Section 9408(a) is 321
Section 9406(f)
Other cases have interpreted Section 9406(f), which makes legal restrictions on assignment generally ineffective. Compare
Section 9408(c)
Finally, one case focused on 9408(c), which overrides rules of law that would restrict the creation of a security interest. (Note that 9408(c) was not adopted in
One creditor asserted a lien on the proceeds based on a security interest in the debtor's business assets. The New Jersey Alcoholic Beverage Control (ABC) statute prohibits a licensee from using a liquor license as collateral for a loan. The court held that the liquor license is not personal property under the ABC statute, and therefore not a general intangible subject to Section 9408. In re Chris-Don is probably limited to its facts; it's hard to say if another court would rely on this case outside the liquor license context.
Practical Limitations
Most contracts are not simple. License agreements, in particular, are often highly complex, involving an array of rights, remedies and obligations that “go both ways.” For example, there may be cross-licenses (each party granting a license to the other in different intellectual property rights), mutual payment obligations, and a host of other rights and remedies, such as indemnities, reporting obligations, and so on.
Section 9406(d) will override an anti-assignment provision, as applied to Party A's right to receive a royalty from Party B, if that right is taken in isolation. But what happens if that right is subject to performance by Party A of various contractual obligations to Party B? Nothing in Section 9406(d) overrides these other obligations, and Party B still has set-off rights, to the extent provided by Section 9404(a). See Comment 5 to Section 9406. See also Example 3 contained in Comment 6 to Section 9408 (a nondisclosure term in a license is enforceable even though the practical effect is to restrict the licensee's ability to use its rights under the license as collateral).
Special Rules
Practitioners should keep in mind the following special rules:
- Section 9406(d) applies to a security interest in accounts, chattel paper, payment intangibles, and promissory notes; however, it does not apply to a sale of a payment intangible or a promissory note. Instead, Section 9408(a) applies to a sale of a payment intangible or a promissory note.
- Section 9406(d) does not apply to an assignment of a health care insurance receivable. Instead, Section 9408(a) applies to this type of receivable.
Conclusion
A careful analysis of the facts surrounding the agreement containing the anti-assignment provision, together with a review of the foregoing pitfalls, is appropriate before concluding that Section 9406(d) or Section 9408(a) (as applicable) will be truly effective in overriding the anti-assignment provision in that agreement.
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