Disputes Between Creditors: Garnishing Accounts Receivable Subject to Another Lien

When a business fails, it almost never has enough assets left to pay all the creditors, and it doesn’t always file bankruptcy. When there is no bankruptcy, ,the law generally allows creditors to race to grab what they can, either through obtaining judgments or enforcing liens and other security interests. One legal question that remained unresolved in Oregon until a recent ruling was whether a creditor who had filed a public notice of a security interest in accounts receivable had to do more to preserve its rights against a garnishment of those receivables.

Every state has enacted Article 9 of the Uniform Commercial Code as the relevant law for security interests in personal property, including intangible property such as accounts receivable. Normally, Article 9 is fairly straightforward. A creditor who files a notice with the relevant state office (the Secretary of State in both Oregon and Washington) or takes possession of the collateral (as a pawnshop does) will beat almost any other creditor. This rule was created to limit secret liens and promote visibility of a debtor’s financial situation when borrowing. If lender thought they might be surprised, they might not lend.

The Code also includes a provision that recognized principles of prior law may be considered to fill gaps in the coverage of the law. This has led to a disagreement between courts in different states and federal circuits when applying the “first to file” rule to accounts receivable. Because accounts receivable may not be directly identifiable when the creditor files the notice, but can be identified when the debtor defaults on its loan, some courts have ruled that the creditor has to take some action after default, or its rights would be considered waived. Other courts have ruled that the filing of the notice is enough of a notice and that if the lender can trace funds grabbed by another creditor, they can get it back.

The Oregon Court of Appeals weighed in on the subject in one of its last opinions of 2013. A business had borrowed money from a lender and put up its accounts receivable, and their proceeds, as collateral. The lender filed its notice of the security agreement and renewed the notice when required. When the borrower defaulted, it informed the lender it could work out the problem, and as a result, a new promissory note, subject to the original security agreement, was signed. At the same time, the borrower settled a debt with another creditor, but failed to pay as agreed, and the second creditor obtained a judgment against the debtor. The second creditor then garnished the debtor’s various customers and received about $67,000. As might be expected, the original lender was not happy, and demanded the second creditor pay it the money. Instead, the two creditors found themselves fighting over the money in court.

The Court of Appeals, when the case reached it, looked at the two possible interpretations of the law and decided that the experts who wrote Article 9, and the legislature that passed it, probably intended the filing of the notice to be enough. As a result, it ruled that the original lender should get the money.

Lenders who have filed notices in Oregon can rest assured that they do not need to rush to collect on accounts receivable, but they should keep alert in case another creditor does get a judgment to save themselves the expense of having to fight the other creditor. Other creditors are probably best served by searching the Secretary of State’s records, and, if another lien is discovered, talk to a lawyer before trying to collect the collateral.

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