Opinion ID: 543772
Heading Depth: 2
Heading Rank: 1

Heading: RCS's Right to Set Off

Text: 16 Section 409.318(1) of the Wisconsin Uniform Commercial Code provides: 17 (1) Unless an account debtor has made an enforceable agreement not to assert defenses or claims arising out of a sale as provided in s. 409.206 the rights of an assignee are subject to: 18 (a) All the terms of the contract between the account debtor and assignor and any defense or claim arising therefrom; and 19 (b) Any other defense or claim of the account debtor against the assignor which accrues before the account debtor receives notification of the assignment. 20 WIS.STAT. Sec. 409.318(1). The Bank asserts that section 409.318 is inapplicable because the Bank's security interest in Kase Haus's accounts receivable was not an assignment of those accounts as collateral. Settled case law, however, contradicts both the Bank's allegation that section 409.318(1) does not apply and its post-summary judgment characterization of itself as anything less than an assignee of Kase Haus's accounts receivable. In Matter of Don's Elec., Inc., 65 B.R. 399 (Bkrtcy.W.D.Wis.1986), the lending bank had a perfected security agreement giving it a security interest in a construction contractor's (Don's Electric, Inc.) accounts receivable. After the contractor went into bankruptcy, the bank filed an action to recover amounts owed the contractor against a subrogee to the project owners who had asserted a right to set off. The bank contended that its security interest had priority over the subrogee's right to set off. The bankruptcy court dismissed the bank's claim and noted: 21 Under the law [WIS.STAT. Sec. 409.318(1) ] the assignee of an account obtains nothing more than the assignor had, and all defenses which could have been raised by the account debtor against the assignor are available against the assignee. See Gould v. Jackson, 257 Wis. 110, 42 N.W.2d 489 (1950); Morris F. Fox & Co. v. State, 229 Wis. 44, 49, 281 N.W. 666 (1938); Michalak v. Nowinski, 220 Wis. 1, 7, 264 N.W. 498 (1936). The assignee stands exactly in the shoes of his assignor. Gould, supra, 257 Wis. at 112-13, 42 N.W.2d 489. See also Allison v. Manzke, 118 Wis. 11, 94 N.W. 659, 662 (1903). Accord First Federal State Bank v. Town of Malvern, 270 N.W.2d 818 (Iowa 1978) (bank to which a defaulting contractor had assigned its rights prior to default acquired only such rights as the contractor had in unpaid progress payments and retainages). Thus, while the bank's security interest attaches to the accounts and their proceeds (WIS.STAT. Sec. 409.203), the security interest is subject to all counterclaims, defenses and set-offs which the project owners could assert against Don's. It cannot be doubted that the project owners had the right to set off the expense of completing the work left unfinished by Don's against any amounts owing under the contracts. That is the principal purpose of the retainages. By virtue of completing the projects USF & G is subrogated to the position of the owners and acquires all the rights, defenses and claims which the owners could have asserted against Don's. 22 65 B.R. at 403 (footnote omitted) (emphasis added). 23 A district court arrived at an identical conclusion when applying the Illinois statute that is equivalent to the Wisconsin statute in circumstances similar to those that this case presents. See BarclaysAmerican/Business Credit, Inc. v. Paul Safran Metal Co., 566 F.Supp. 254 (N.D.Ill.1983). BarclaysAmerican/Business Credit, Inc. (Barclays) had a security interest in the accounts receivable of Interstate Smelting & Refining Co. (Interstate) under a loan agreement. Interstate and Paul Safran Metal Company (Safran) had business dealings with each other that resulted in the creation of mutual accounts receivable. Interstate defaulted on its loan with Barclays, and Barclays notified Safran that its account receivable with Interstate should be paid directly to Barclays. Safran contended that under ILL.REV.STAT. ch. 26, Sec. 9-318(1), which is identical in all respects to WIS.STAT. Sec. 409.318(1), it should be allowed to set off its claim against Interstate. The district court ruled in Safran's favor and found that Safran could set off the amount Interstate owed it against Barclays's security interest in Interstate's accounts receivable. Id. at 257. See also United Cal. Bank v. Eastern Mountain Sports, 546 F.Supp. 945, 963-64 (D.C.Mass.1982) (account debtor allowed to set off claims for defective goods against its account receivable in which a bank had a perfected security interest), aff'd, 705 F.2d 439 (1st Cir.1983); In re Chase Manhattan Bank v. State, 40 N.Y.2d 590, 594, 357 N.E.2d 366, 369, 388 N.Y.S.2d 896, 899 (1976) (constructive notice provided by perfection of a security interest by filing a financing statement under the Uniform Commercial Code (UCC) does not suffice to preclude an account debtor's right to set off subsequent debts). 24 For purposes of section 409.318 and the equivalent statute in other states, the courts and the UCC have made no distinction between a party with a security interest in a debtor's accounts receivable and a party who is an assignee of a debtor's accounts receivable. Section 409.502 of the Wisconsin Uniform Commercial Code, which specifies the collection rights of a party with a security interest in collateral consisting of an account, chattel paper, contract right, general intangible, or instrument, states in part: 25 When so agreed and in any event on default the secured party is entitled to notify an account debtor or the obligor on an instrument to make payment to him whether or not the assignor was theretofore making collections on the collateral, and also to take control of any proceeds to which he is entitled under s. 409.306. 26 WIS.STAT. Sec. 409.502(1) (emphasis added). The UCC, which is not a comprehensive codification of commercial law, 1 J. WHITE & R. SUMMERS, UNIFORM COMMERCIAL CODE Sec. 2, at 6 (3d ed.1988), does not define assignment. Nonetheless, treatment under section 409.318 of one with a security interest in an account receivable as an assignee of the account receivable is consistent with section 409.502's implicit description of a secured party who exercises his rights to collect on an assignor's accounts receivable as an assignee. The benefits that a secured creditor enjoys from the summary default remedy contained in section 409.502 are counterbalanced by the account debtor's right under section 409.318 to confront the secured creditor/assignee with any defenses or claims it had against the assignor. If we accepted the Bank's strict rules of construction for interpreting section 409.318, we also would have to find that the summary remedy in section 409.502 for one with a security interest in an account receivable is only available when the debtor is an assignor as strictly defined by the Bank. 27 The Bank's argument that it has priority to Kase Haus's assets because it perfected its security interest by prompt filing is inapposite. While a secured party who properly and promptly files thereby protects its security interest to the maximum possible extent, such protection is not absolute. For example, a perfected security interest is subordinate to the interest of a buyer in the ordinary course of business, even when the buyer is aware of the security interest. See WIS.STAT. Sec. 409.307. Furthermore, a holder in due course of a negotiable instrument, a holder to whom a negotiable document of title has been duly negotiated, and a bona fide purchaser of a security take priority over an earlier security interest even though perfected. See WIS.STAT. Sec. 409.309. As the New York Court of Appeals noted in In re Matter of Chase Manhattan Bank, 40 N.Y.2d at 593, 357 N.E.2d at 369, 388 N.Y.S.2d at 898, the 'first to file' rule, designed to resolve situations where secured parties are competing in asserting superior rights, should not be controlling when the dispute is between a secured party and an account debtor. See also Central State Bank v. State, 73 Misc.2d 128, 129-30, 341 N.Y.S.2d 322 (N.Y.Ct.Cl.1973) (situation where account debtor sought set-off against secured creditor's claim to debtor/assignor's accounts receivable is not a situation where two creditors with perfected interests are competing to subordinate the other's right to attach proceeds belonging to and held by the debtor; account debtor may assert right to set off under UCC Sec. 9-318). 28 The UCC counsels against hypertechnical rules of construction that undermine the UCC's underlying purposes and policies. Section 401.102 states that Chapters 401 to 409 shall be liberally construed and applied to promote its underlying purposes and policies, which include efforts to simplify, clarify and modernize the law governing commercial transactions. WIS.STAT. Sec. 401.102(1)-(2). Commentators have noted that a further purpose of the UCC is simply that the law of commercial transactions be, so far as reasonable, liberal and nontechnical. 1 J. WHITE & R. SUMMERS, supra, at 14. We believe that our interpretation of section 409.318 approximates these objectives and sensibly reconciles the benefits to secured creditors/assignees found in section 409.502 with the safeguards available to account debtors under section 409.318. Under the Bank's proposed rendering of section 409.318, an account-debtor restaurant with a right to set off against the accounts receivable of a restaurant supplier would face the prospect of paying twice for its supplies in the event that the supplier defaults on a loan secured by a bank's security interest in the supplier's accounts receivable. A more sensible result would ensue from our reading of sections 409.318 and 409.502: the restaurant's claim against the assignor/supplier is set off against the bank's summary demand for payment on the assigned account. We therefore reject the Bank's claim that RCS may not rightfully raise the defense of set-off under section 409.318. 29 Subsection (1) of section 409.318 of the Wisconsin Uniform Commercial Code provides that an assignee's rights are subject to any defenses or claims of the account debtor arising out of the contract between the account debtor and the assignor, and any other defense or claim of the account debtor against the assignor which accrues before the account debtor receives notification of the assignment. (emphasis added). Subsection (26) of section 401.201 provides in part that [a] person 'receives' a notice or notification when (a) it comes to his attention; or (b) it is duly delivered at the place held out by him as the place for receipt of such communications. Thus, in order to preclude RCS's right to set off under section 409.318, the Bank would have been obliged to notify RCS that it was the assignee of Kase Haus's accounts receivable. See 9 W. HAWKLAND, UNIFORM COMMERCIAL CODE SERIES Sec. 9-318:03, at 304-05 (1986). RCS first received notification from the Bank that it was the assignee of Kase Haus's accounts receivable and that RCS therefore was obliged to pay the Bank for any indebtedness arising from its transactions with Kase Haus on July 18, 1988. RCS's claim against Kase Haus arose and was settled well before RCS received the Bank's July 18, 1988, collection letter. The district court therefore did not err when it found that the protections of Sec. 409.318 were available to RCS.