Certain types of collateral is actually debt that is owed to the debtor. For instance, say Secured Party 1 has a security interest in the debtor’s accounts. In that situation, the debtor may have sold an item in exchange for payment in 30 days from the sale. This is an example of an account as collateral, but also an account is debt that is owed to the debtor. There is no value in the collateral until the debt to the debtor has been satisfied. So, how does Secured Party 1 enforce against that obligation?
The types of collateral that fall into this situation are:
- Accounts
- Chattel paper
- Instruments
- Payment intangibles
Notification to “Account Debtor”
Rather than having the account debtor pay the debtor who in turn pays the secured party, there is a way to cut the middle man out. In other words, the secured party could demand payment specifically from the account debtor and use that to satisfy the debtor’s obligation. There are certain ways to make this occur. See 9-607.
- The secured party must notify the account debtor that the payment is now due to the secured party, rather than the debtor.
- The only way the account debtor can resolve the obligation to the debtor is by paying the secured party (so account debtor’s should do a little research to avoid paying twice).
- Secured party can distribute some of the collections to the debtor, if agreed upon in the security agreement.
A debtor may likely agree to this arrangement because the secured party has more experience collecting or can collect for loss costs. Additionally, if the debtor defaults, then having this arrangement at the beginning will help maintain the relationships the debtor may have with customers.
9-404(a) – Affects payment amount
9-406(a); 9-607(a) – Affects who payments need to be made to.
Defenses the Account Debtor may have against paying
The account debtor has the same defenses against the secured party as they would have had if the debtor was the one who needed to be paid.
Proceeds of Collection
Proceeds go first to the creditor, then to junior interests, then to the debtor.
Disclaimer
The content contained in this article may contain inaccuracies and is not intended to reflect the opinions, views, beliefs, or practices of any academic professor or publication. Instead, this content is a reflection on the author’s understanding of the law and legal practices.
