Opinion ID: 445533
Heading Depth: 1
Heading Rank: 2

Heading: Rights in the Proceeds of the Collateral.

Text: 35 When Handy & Harman bought the refining lots from Coronado, it gave Coronado in return its promise to pay for them. Handy & Harman's promise to pay constitutes the proceeds of the collateral. Sec. 9306(1); Matthews v. Arctic Tire, Inc., 106 R.I. 691, 694, 262 A.2d 831, 833 (1970). In the classification of the code, the promise to pay is an account. Sec. 9106. (The government has a security interest in the account by virtue of the security agreement and also under Sec. 9306(2).) 36 Handy & Harman contends that Sec. 9318(1) permits it to offset against the government's claim the $30,000 debt that Coronado owed Handy & Harman. Section 9318(1) provides: 37 (1) Unless an account debtor has made an enforceable agreement not to assert defenses or claims arising out of a sale as provided in Section 9206 the rights of an assignee are subject to 38 (a) All the terms of the contract between the account debtor and assignor and any defense or claim arising therefrom; and 39 (b) Any other defense or claim of the account debtor against the assignor which accrues before the account debtor receives notification of the assignment. 40 Handy & Harman is the account debtor, and the government is the assignee of the account by virtue of the security agreement and by operation of Sec. 9306. See U.C.C. Appendix I Sec. 9-306 (1977) (Reasons for 1972 Change) (secured party has an automatic right to proceeds, unless otherwise agreed); Investment Service Co. v. North Pacific Lumber Co., 261 Or. 43, 492 P.2d 470 (1972); Western Decor & Furnishings Industries, Inc. v. Bank of America National Trust & Savings Association, 91 Cal.App.3d 293, 302-3, 154 Cal.Rptr. 287, 292 (1979); B. Clark, The Law of Secured Transaction Under the Uniform Commercial Code 11-22, p 11.5 (1980) (accounts generated as proceeds from the sale of inventory are subject to the rules of Sec. 9-318 just as they would be were they assigned as original collateral). See also Sec. 9502(1). 41 An offset is generally a valid defense or claim under Sec. 9318(1). See, e.g., E.A. Farnsworth, Contracts 787-88, Sec. 11.8; Gilmore, The Assignee of Contract Rights and His Precarious Security, 74 Yale L.J. 217, 228-29 (1964); 3 Williston, Contracts (3d ed.) 181-82, Sec. 432. We see no reason to depart from the general rule in this case. The government contends that its status as secured lender should alter the operation of Sec. 9318(1) and prevent Handy & Harman from asserting the offset. While the argument may have a surface appeal, it does not withstand scrutiny. 42 The typical inventory financer lends money to the debtor in return for a security interest in inventory and proceeds arising out of the sale of inventory. The security agreement in the case before us conforms to this pattern. If the debtor becomes insolvent, the security interest allows the financer to satisfy his claim against the debtor by taking possession of the collateral, Sec. 9503, and by making collections on the debtor's accounts. Sec. 9502. In the case of inventory that already has been sold and is no longer in the debtor's possession, so long as the security interest still continues in the inventory, the secured party can maintain an action against the purchaser for repossession or conversion. See U.C.C. Sec. 9-306 Comment 3 (1977). 43 The typical inventory financer has an additional cause of action against a buyer who has not fully paid his account. This action sounds in contract and is based upon the assignment of the account to the financer as proceeds from the sale of inventory. This action on the account is unrelated to the action for conversion; it exists whether or not there is a cause of action for conversion and whether or not the security interest continues in the collateral. Although the financer has two possible causes of action against a purchaser, one in conversion and the other in contract, he may of course have only one satisfaction. Id. 44 By its terms Sec. 9318 allows a defense only to the suit based on the assignment of the account. Section 9318 does not apply when the suit is for repossession or conversion since the basis for a conversion suit is the secured party's superior property interest in the inventory itself, not the assignment of the account held by the debtor. Thus, so long as the security interest continues in the collateral, the inventory financer need not fear Sec. 9318(1) offsets because an action for conversion is available. It is only when the security interest has been cut off (e.g., by a buyer in ordinary course or by Sec. 9301(1)(c)) and the financer must resort to an action on the account that Sec. 9318(1) may become a bar to complete satisfaction. But if the security interest has been cut off, there is no reason to favor the inventory financer over the account debtor who has offsets. In the absence of an enforceable security interest, the usual rules of priority favoring secured parties are inapplicable. See In re Chase Manhattan Bank v. New York, 40 N.Y.2d 590, 388 N.Y.S.2d 896, 357 N.E.2d 366 (1976); Investment Service Co. v. North Pacific Lumber Co., 261 Or. 43, 492 P.2d 470 (1972). In sum, Sec. 9318 should not be interpreted to restore the inventory financer to the preferred status of a secured party when that preference has been taken away by other provisions of the code. See, e.g., Secs. 9301(1)(c), 9307. See generally, Nickles, Enforcing Article 9 Security Interests Against Subordinate Buyers of Collateral, 50 Geo.Wash.L.Rev. 511, 548-52 (1982). 45 The case before us fits this pattern. The Sec. 9318 offset issue arises only if the district court finds the government's security interest has been cut off by Sec. 9301(1)(c). There may be cases where the inventory financer wants to maintain an action on the debt even though the security interest continues in the collateral and an action for conversion would be possible. This would not change our interpretation of Sec. 9318, however. The financer must choose between the two theories of recovery, either suing for conversion as a secured party and thereby avoiding possible Sec. 9318 defenses, or suing on the account as an assignee and being subject to Sec. 9318 defenses. 46 We recognize that the inventory financer has legitimate interests to be protected. But the account debtor's interest is no less legitimate. In the leading case of Seattle-First National Bank v. Oregon Pacific Industries, Inc., 262 Or. 578, 582, 500 P.2d 1033, 1035 (1972), the Supreme Court of Oregon discussed the tensions that led to the compromise in Sec. 9318:It was necessary to permit at least some setoffs to be asserted in order to protect the obligor from being unduly prejudiced by the assignment; but this right of setoff had to be limited in order to give some value and stability to the assignment so that it could be used as an effective security device. If an obligor could not assert any of the defenses or setoffs against an assignee which he could have asserted against his creditor, the assignor, the obligor would be extremely prejudiced by an assignment. On the other hand, if the obligation assigned could be obliterated or diminished by events happening after the assignment and notice of assignment to the obligor, the assignment would be precarious collateral. 47 The code in other circumstances penalizes a secured lender who fails to monitor his debtor's activities. See, e.g., Secs. 9103(1), 9306(3). We think the secured lender should also bear the risk that, if his security interest fails and an action on the account is necessary, unsecured creditors may have setoffs arising out of the debtor's activities. 48 The cases cited by the government in opposition are unpersuasive. Associates Discount Corp. v. Fidelity Union Trust Co., 111 N.J.Super. 353, 268 A.2d 330 (1970), and Citizens National Bank v. Mid-States Development Co., 177 Ind.App. 548, 380 N.E.2d 1243 (1978), are not on point because they deal with offsets against cash proceeds held by banks in deposit accounts. Cash proceeds are not accounts within the meaning of the code, see Sec. 9106, and Sec. 9318(1) is thus not applicable. In First National Bank & Trust Co. v. Iowa Beef Processors, Inc., 626 F.2d 764 (10th Cir.1980), the court refused to permit an offset against a security interest claimed in an account as proceeds. The only authorities cited, however, were Associates Discount Corp. and Citizens National Bank which, as noted, are not on point. We think the court in Iowa Beef misconceived the issue and created an unwarranted exception to the operation of Sec. 9318. See Nickles, Enforcing Article 9 Security Interests Against Subordinate Buyers of Collateral, 50 Geo.Wash.L.Rev. 511, 548-52 (1982). The Iowa Beef court should have focused instead on whether the account debtor in that case was a buyer in ordinary course who took the collateral free of the security interest. 49 We conclude that Handy & Harman may, pursuant to Sec. 9318(1), offset the debt that Coronado owes it against the account in which the government had an unperfected security interest. 50