+(,121/,1(

Citation:
Milton P. Kupfer, Accounts Receivable Financing: A
Legal and Practical Look-See (Part I), 2 Prac. Law. 50
(1956)

Content downloaded/printed from HeinOnline

Tue Apr 2 18:25:02 2019

-- Your use of this HeinOnline PDF indicates your

acceptance of HeinOnline's Terms and Conditions
of the license agreement available at
https://heinonline.org/HOL/License

-- The search text of this PDF is generated from

uncorrected OCR text.

-- To obtain permission to use this article beyond the scope

of your HeinOnline license, please use:

Copyright Information

Use QR Code reader to send PDF

to your smartphone or tablet device
 ACCOUNTS RECEIVABLE
FINANCING:

a legal and practical looli-see

(PART I) By Milton P. Kupfer, of the New York Bar

q's," cautions and safeguards.

ESS than half a century ago, a
mere moment of transit in our 4. Problems in bankruptcy.
Anglo-Saxon legal and economic
history, accounts receivable financ- 5. A brief reference to the provi-
ing was virtually unknown. It now sions of the Uniform Commer-
approximates an annual volume of cial Code specifically applicable
to the field.
ten billion dollars. The office of this
paper will be to dissect the eco-
INTRODUCTION
nomic structure of the mechanism
and to analyze the details of the Purposes of Accounts
legal blueprints that make it tick. Receivable Financing
The treatment will be divided A borrower normally will first
into five parts: seek unsecured credit to the extent
1. An introduction, analyzing the to which he can obtain it. But the
purposes of accounts receivable overwhelming majority of our in-
financing, and the tests of eligi- dustrial and commercial units con-
bility for it. stitute "small business," and re-
quire accommodation for which
2. An analysis of the different types unsecured credit is not readily
of such financing and their re- available. They may require liquid
spective legal incidents. funds for more working capital; or
3. A discussion of the implementa- for expansion purposes; or to take
tion of the operation-its "p's and discounts on merchandise pur-
EDIToR's NOTE: This paper constitutes the principal portions, edited for publication, of two
lectures delivered by the author as part of the course on "Secured Transactions." con-
ducted by the Practising Law Institute at its 1956 Fall Session in New York City.
chased. For these needs, they will
usually resort to their most liquid
asset other than cash-their ac-
counts receivable.
Generally speaking, because of its
inherently self-liquidating and re-
volving nature, accounts receivable
financing is not an apt permanent
source of capital, although it is fre-
quently so employed on a tempo-
rary basis.
Tests of Eligibility
Most, but not all, would-be bor-
rowers can profitably employ ac-
counts receivable financing. A
number of elements enter into the
end-compound of whether it should
be sought or extended.
Adaptability of a borrower's op-
erations to accounts receivable fi-
nancing varies directly with the
percentage of his mark-up and the
rapidity of turnover in his accounts.
Other considerations of almost
equal importance are the number
and reliability of his sales outlets;
the adequacy of his capital in the
light and the nature of his enter-
prise; and the quality of its man-
agement. In his own best interests,
no responsible secured financer will
enter into an accounts receivable
operation until he has satisfied him-
self on these essential criteria.
The greater part of accounts re-
ceivable financing covers sales of
manufacturers and merchants, and,
historically, it was confined, in its
early development, to that area. In
recent years, however, its operation
has been expanded into much
wider, and at times greener, fields.
Illustrations are the financing of
deferred-payment sales and the
leasing plans of commercial and in-
 52 THE PRACTICAL LAWYER
dustrial equipment; the financing,
for department stores, of retail
budget-instalment and charge ac-
counts; the rediscounting of the
paper of small-loan companies and
the smaller consumer-finance com-
panies; and even the financing of
mergers and acquisitions of busi-
nesses. Its operation in the purely
service field is by no means un-
known, although the author has yet
to hear of lawyers' accounts receiv-
able being accepted as collateral! It
could, however, happen, and prob-
ably will before we know it.
THE DIFFERENT TYPES OF
ACCOUNTS RECEIVABLE
FINANCING
The Parties
To every accounts receivable op-
eration there are necessarily three
parties: (1) the lender upon, or
purchaser of, the accounts; (2) the
borrower upon, or seller of, them;
and (3) the debtor upon the ac-
counts assigned. For semantic uni-
formity and brevity, these three
parties will be respectively called
the "assignee," the "assignor," and
the "account-debtor," unless the
context otherwise indicates. (Occa-
sionally, the words "lender" or "se-
cured creditor" will connote the as-
signee, and the word "borrower,"
the assignor. Only exceptionally-
and then obviously-will there be
any departure from the use of "ac-
count-debtor.")
The Two Basic Forms
There are two essential require-
ments to the payment of any ac-
count receivable. First, the assignor
must comply with the terms of his
agreement with, or the order of,
the account-debtor, and secondly,
the latter must be financially able
and willing to pay. The first re-
quirement is called the "merchan-
dise risk," and the second, the
"credit risk." And out of this di-
chotomy arise the two basic forms
of accounts receivable financing.
These are respectively known as
"recourse" and "non-recourse" fi-
nancing, and the terminology in
itself differentiates them.
In both, the assignor necessarily
retains the merchandise risk, be-
cause the fabrication of the goods
or the rendition of the service in
accordance with his commitment
to the account-debtor at all times
rests solely within his control.
In recourse financing, the assig-
nor also retains the credit risk; he
guarantees to the assignee that the
account will be paid at its maturity.
Therefore, both in economics and
in law, the financing transaction,
however the contract may be set
up, constitutes a loan upon the se-
curity of the assigned accounts.
In the non-recourse operation,
the assignee assumes the credit risk,
and, in legal consequence, the oper-
ation constitutes a purchase. (Non-
recourse financing is sometimes
 ACCOUNTS RECEIVABLE FINANCING
called "factoring." Historically, fac-
toring was first associated solely
with inventory financing. When ac-
counts receivable financing - usu-
ally on a non-recourse basis-devel-
oped as an adjunct to inventory
financing, the term was originally
applied to the combined operation.
Latterly, it is occasionally used to
cover both recourse and non-re-
course accounts receivable financ-
ing, with or without a precedent
inventory loan. Therefore, except to
the highly initiated and in the con-
text of a specific operation, the use
of the term is only apt to confuse,
and will be eschewed in this paper.)
The distinction between recourse
and non-recourse financing is of
great importance in the application
of interest and usury laws.
Combining with Inventory
Financing
Inventory financing can be com-
bined with either the non-recourse
or recourse financing of accounts;
traditionally, it was more inti-
mately associated with the former,
although it may, but need not, be
employed in connection with either
type, as the economic "lead line"
which ultimately becomes solely
the accounts receivable operation.
When inventory financing is ab-
sent, the operation is called "pure"
accounts receivable financing, and
this is the more usual form that
it takes.
53
Participations
"Participations" among lenders
in larger accounts receivable opera-
tions are quite common, and are
motivated by the same considera-
tions that underlie the spreading of
the risk in the writing of large pol-
icies in the life insurance field.
Alike on practical and legal
grounds, joint or common owner-
ship of the assigned accounts is un-
desirable. Both legal title and the
operational responsibility should be
vested in and rest upon only one
financer, usually the producing one.
The risk and the profit are divided
proportionately, and the company
originating the business receives an
initial compensation (or so-called
"override") for producing it and to
cover the overhead cost in the man-
agement of the operation.
Function of Banks
The function of banks in ac-
counts receivable financing is also a
matter of considerable interest. In
the first place, they constitute the
wholesalers of credit to the ac-
counts receivable companies. Sec-
ondly, a number of them are en-
gaged directly in the accounts re-
ceivable field. The competition is
not at all unwelcome to finance
companies, although, from the
standpoint of the banks, it presents
both advantages and disadvantages
which are beyond the ambit of this
paper. And finally, the banks fre-
54 THE PRACTICAL LAWYER
quently participate with finance
companies in specific operations,
because it minimizes the risk and
puts at their disposal the specialized
know-how of accounts receivable
companies, thus reducing the over-
all cost of the lending operation.
References
There is not too much legal liter-
ature on the subject, but the two
standard works are FINANCE COM-
PANIES AND FACTORS, by Walter S.
Seidman, published by the Na-
tional Commercial Finance Con-
ference, Inc., New York, and a
portion of SECURED TRANSACTIONS,
by Lester E. Denonn, published by
The Practising Law Institute of
New York. Both are excellent, con-
tain a plenitude of forms, and are
authored by recognized experts in
the field.
IMPLEMENTATION OF THE
OPERATION: ITS "P's AND Q's,"
CAUTIONS AND SAFEGUARDS
The Underlying Contract
and the Assignments
Every accounts receivable opera-
tion starts with the execution of an
underlying contract between the as-
signor and the assignee. It spells
out in detail the rights of the par-
ties, and its contents have become
more or less standard.
When the accounts to be as-
signed have been created by the as-
signor, they are listed on assign-
ment forms or "schedules." Since
the assigned accounts constitute the
very lifeblood of the assignee's se-
curity, all the material documents
pertaining to the assigned accounts
must accompany the assignment
schedule and be contemporaneously
delivered to the assignee at the time
when it makes its advance to the
assignor upon them. These docu-
ments vary with the nature of the
assigned accounts, but must always
include copies of the relevant in-
voices; the original bills of lading
or express receipts evidencing the
delivery of the merchandise or
(where applicable) proof of the
rendition of the service; and all
other papers necessary to effect col-
lection of the assigned accounts. It
is vital that the assignee satisfy him-
self as to the authenticity and legal
competence of these documents.
The assignment-schedules as a
rule must cover specific accounts;
in most jurisdictions, blanket as-
signments are of little, if any, legal
value. See, illustratively, State Fac-
tors Corp. v. Sales Factors Corp.,
257 App. Div. 101, 12 N.Y.S.2d 12
(1st Dep't 1939). However, under
the so-called "floating lien" provi-
sions of the Uniform Commercial
Code (§ § 9-108 and 9-204) and in
the State of New Hampshire under
the language of its Factors Act,
[Perkins v, Lakeport Nat'l Bank,
139 F. Supp. 898 (D.N.H.1955)]
general, or blanket, assignments are
permitted and recognized.
An operation which also em-
 ACCOUNTS RECEIVABLE FINANCING
braces inventory advances is cov-
ered by a supplement to the stand-
ard accounts receivable contract;
the filing requirements of local
Factors Acts (where they exist)
must be complied with; and con-
signment forms, covering the in-
ventory pledged or subjected to the
factor's lien, are executed and deliv-
ered when the advances are made.
Indirect and Direct Collections
There are two methods-indirect
or direct, so-called, for the actual
collection of the assigned accounts.
In the indirect collection pro-
gram, the account-debtors are not
notified of the assignments, and re-
mittances are made to the assignor,
who is obligated promptly to en-
dorse and transmit them in specie
to the assignee-customarily on the
day of their receipt. If it has not
already become apparent, we shall,
a little later, appreciate the eco-
nomic and legal necessity for the
imposition of this requirement.
In the direct collection program,
the account-debtors are forthwith
notified of the assignments, and are
instructed to make their remit-
tances directly to the assignee.
Indirect collection is much more
frequently found in recourse fi-
nancing, and direct collection in
non-recourse financing, but the as-
sociation is by no means inevitable.
Indeed, one of the larger and most
respected financing agencies has re-
cently instituted a non-notification.
55
non-recourse program, for assignors
whose operations and standing
make it adaptable to their business.
In all accounts receivable pro-
grams, the assignee, at periodic in-
tervals (usually monthly) makes
an audit of the assignor's books and
operations, through one of the
members of its own staff. In addi-
tion, when the collection program
is indirect, the assignee causes
periodic spot verification to be
made of the existence of the as-
signed accounts and the amounts
due upon them. This is accom-
plished by direct correspondence
between an auditing concern and a
random selection of the account-
debtors.
Causes of Loss
Experience has demonstrated that
the incidence of loss in an accounts
receivable operation is minimal, al-
most to the vanishing point, if: the
adaptability of the assignor's busi-
ness to accounts receivable financ-
ing has been soundly analyzed and
conceived; the credit standing of
the account-debtors has been sensi-
bly evaluated at the time when the
assignments are tendered for ad-
vances upon them; and the opera-
tion is properly conducted within
the framework above outlined. Of
course, losses do take place, but,
when they do, they are attributable,
largely, if not solely, to what, in air-
travel, would be called "pilot
failure" in one of three aspects:
56 THE PRACTICAL LAWYER
Over-concentration.The first such
cause, over-concentration, is purely
economic and is by no means in-
digenous to the accounts receivable
field. It is basic (a) that the as-
signee should diversify, as among
the types and selection of assignors
whose business he finances, and (b)
that the accounts receivable of any
one assignor should be diversified
as much as the nature of its busi-
ness permits. If the author were
charged with operational responsi-
bility (which none of his clients has
ever "threatened" to entrust to
him), he would view, with a
highly piscatorial eye, financing a
borrower who had only three large
customers, however financially
"good" these customers might be.
All of this is purely an economic
matter, but a very important one.
Fictitious Accounts. The second
cause of loss-the assignment of fic-
titious accounts-brings us into the
legal area. Obviously, if an assignor
ships goods on consignment or,
worse yet, purports to assign "ac-
counts" against "account-debtors"
to whom no merchandise has been
shipped at all, the assignee has no
security for his advances. Neither
the nature of the operation nor the
rates charged for it permit the as-
sumption of any such hazard, and
it is this signpost which points the
path to the importance of checking
the shipping and other documents
adverted to above.
A most intriguing case, involving
the consequence of the assignment
of fictitious-and therefore non-
existent-accounts, is FirestoneTire
& Rubber Co. v. Central Nat'l
Bank, 159 Ohio St. 423, 112 N.E.2d
636 (1953). Unfortunately, space
does not permit following to their
ends all of the legal tentacles that
wound themselves around that case.
Suffice it to say that it dealt with the
respective rights of an assignee-bank
and an "account-debtor" to which
no merchandise had been shipped
but which, nonetheless (and al-
most unaccountably) paid the "in-
voices" therefor. Both were equally
innocent of the fraud of the assign-
or, who was also a conventional
customer of the bank, and the end-
result of the case turned on the ex-
tent to which the bank constituted
a holder in due course of the ac-
count-debtor's payment-checks, and
the application of the principles of
estoppel. A reading of the Firestone
case will not only be rewarding to
those interested in any one of a
number of principles of the law of
negotiable instruments and secured
financing, but will also prove enter-
taining when the images on one's
television-screen pall.
In simpler and, therefore, sharper
focus in this area, is Guttman v.
Whitehall Improvement Corp., 281
App. Div. 528, 120 N.Y.S.2d 786 (1st
Dep't 1953). An assignment of a
valid account receivable for $1,000,
arising out of a shipment of mer-
chandise, was made by the assignor
 ACCOUNTS RECEIVABLE FINANCING
to the Aluminum Corporation of
America (Alcoa). No notification
was given to Alcoa, which trans-
mitted to the assignor its $1,000
check to the latter's order in pay-
ment. At that time, the assignor
owed its landlord $975 for rent, and
it blithely endorsed the check to
the landlord and received the $25
"change" in cash. The assignee then
bestirred himself, and sued the
landlord for the $1,000. Applying
one of the principles laid down in
the Firestone case, it was held that
the landlord was the holder in due
course of the check, and could re-
tain its proceeds as against the as-
signee.
So-called "duplicate" assignments
of the same account are, in practi-
cal experience, extremely rare. In
those infrequent instances in which
they occur, the legal principles are
relatively simple in the states-and
they are in the overwhelming ma-
jority-which do not require notifi-
cation to the account-debtor in or-
der to perfect title to the account
receivable in the assignee.
In such non-notification states,
the first assignment in point of
time prevails, irrespective of (a)
whether either or both assignees
have given notice to the account-
debtor, or (b) the chronology of
such notices, if any. Fortunato v.
Patten, 147 N.Y. 277, 41 N.E. 572
(1895). This, for the reason that the
second "assignee" acquires no inter-
est in the account as such, because,
57
after making the first assignment,
the assignor has no remaining in-
terest in the account to assign.
The applications of that principle
in non-notification states and of the
rule as to holder in due course, laid
down in the Firestone case, are that
[1] if the account-debtor has paid
neither, the first assignee can re-
cover against him, and [2] if the
second "assignee" has received pay-
ment by check drawn directly to its
order, it must pay the amount
thereof to the first assignee. (See
Guttman v. Whitehall Improve-
inent Corp., supra.) The only real
hazard to the first assignee is where
the account-debtor draws its check
to the order of the assignor, who, in
addition to having made duplicate
assignments, goes further and di-
verts the check by endorsing and
delivering it to the second assignee.
Practically, the hazard is rarely en-
countered, because, while an assign-
or's foot may slip once, it is un-
likely that he would allow it to slip
twice in the same place.
One final feature of this whole
matter is so obvious as merely to
require mention. If the account-
debtor, without notice of either of
the duplicate assignments, pays the
assignor or either of the assignees,
he is fully protected and naturally
need not pay any of them, all over
again.
Conversions. The last cause of
loss is the conversion by the assign-
or of the proceeds of assigned ac-
58 THE PRACTICAL LAWYER

counts. It can occur only when the (1938), in the latter's much broader
collection method is indirect. Bene- context), its rule, by a process, as it
dict v. Ratner, 268 U.S. 353 (1925), were, ot legal osmosis, has almost
furnishes a good and conclusive (although, of course, not theoreti-
legal reason for the assignee's in- cally) become "general" law.
sistence upon the prompt turning But even if the Benedict case or
over to him of the account-debtor's its principle had never been heard
checks or their equivalent. of, observance of its mandate would
The Benedict case was a contest still be fiscally imperative, because,
between an assignor's trustee in it a collection is converted, the lend-
bankruptcy and an assignee of his er's security is, to that extent, de-
accounts. Purporting to apply New stroyed. An assignor's hope to
York law, its holding, broadly "make it up" next week out of
speaking, is that, regardless of the other funds is not merely wishful
nature of the collateral, tangible or thinking; it is seldom, if ever,
intangible, if a secured lender per- realized.
mits a borrower to deal with it or Parenthetically, it may be noted
its proceeds as his own, the lender that, if a corporate officer of the
loses the benefit of all of its col- assignor participates in conversions,
lateral. he is personally liable for their
The theory of the ruling is that, amount, even though the converted
if a borrower is permitted to deal funds are placed in the bank ac-
with collateral or its proceeds as his count of, and are used by, the as-
own, the exercise of such dominion signor. The absence of personal
is inconsistent with the effective benefit to him is no defense. Em-
creation of a security-title in the mert v. Drake, 224 F.2d 299 (5th
lender, and that to sustain that title Cir. 1955). To be sure, if an issue
would constitute fraud "in law" as of fact as to the conversion is pre-
against unsecured creditors, even in sented, juries are not averse to tak-
the entire absence of fraud in fact. ing a sympathetic view of the situa-
And this, despite the opinion's rec- tion if the converted funds have
ognition of the truism that, since been used for general corporate
accounts receivable are intangible purposes.
in their nature, they are not suscep- If the officer himself subsequently
tible of the concept of "ostensible becomes bankrupt, his conversion-
ownership" or its consequences. liability, if established, will survive
Although, as noted, the Benedict his discharge, because it constitutes
case purported only to apply New a "willful and malicious injury to
York law (thus adumbrating Erie the property of another" within the
R.R. v. Tompkins, 304 U.S. 64 meaning of the Bankruptcy Act.
 ACCOUNTS RECEIVABLE FINANCING
Hamby v. St. Paul Mercury Indem-
nity Co.,217 F2d 78 (4th Cir. 1954);
cf. Brown v. Garey, 267 N.Y. 167,
196 N.E. 12, cert. denied, 296 U.S.
615 (1935).
* Although there is no substitute
for watchfulness, relatively simple
techniques exist to guard against
and obviate the hazard of over-
concentration, fictitious accounts
and duplicate assignments, and
conversions. Assuming the original
soundness of the assignor's business
operation, no financing assignee
who makes a reasonably realistic
check of the account-debtor's credit
is apt to sustain any serious loss if
he will just watch these three
matters.
Compliance with Formal
Requirements of the
Assignment
The requirements for the perfec-
tion of an assignment of an ac-
count, so as to vest title to it in the
assignee as against all the world,
vary from state to state.
This perfection matter is of no
importance from the account-debt-
or's standpoint, because, as already
observed, if in good faith and with-
out notice of the assignment, he
makes payment either to the as-
signor or to the assignee, he is fully
protected.
Neither is it of much, if any, con-
sequence as between an assignee
and a solvent assignor, because the
assignment is good between the
59
parties, whether or not it has been
technically "perfected" as against
others.
Therefore, the practical signifi-
cance of the perfection concept
arises principally in the event of the
assignor's bankruptcy, because the
date of such perfection is the cut-off
date for the application of the four-
months' period under section 60,
the preference provision of the
Bankruptcy Act, 11 U.S.C. § 96
(1952).
Case Law. Until the compara-
tively recent past, the perfection of
title was governed solely by case
law. The states fell into two classes.
Following the English case of
Dearie v. Hall, 3 Russ. 1 [38 Eng.
Rep. 475 (Ch. 1828)], the first
group, constituting the minority,
held that notification to the ac-
count-debtor was essential to the
perfection of an assignment. The
principle is known as the "English"
or "notification" rule. In such states,
unless the first assignee notified the
account-debtor of the assignment, a
second assignee of the account, who
took his assignment for value and
without notice of the prior assign-
ment (and, of course, himself first
gave notice) prevailed. And as
against an assignor's trustee in
bankruptcy claiming a preference,
in applying the four-months' pe-
riod, title in the assignee was not
perfected until notice to the ac-
count-debtor had been given.
Legally, notification to the ac-
60 THE PRACTICAL LAWYER
count-debtor would hardly seem to
constitute any "overt" act of import
because it furnishes no protection
to the assignor's suppliers or other
unsecured creditors. Therefore-
still remembering that we are deal-
ing with the situation before many
legislatures recently moved in
and took hold-the majority of
the states embraced the so-called
"American" or "validation" rule,
obtaining in New York. It dis-
penses with notices as a necessary
element to the perfection of title,
and holds that the first assignment
in point of time prevails, regardless
of the order in which notice, if any,
to the account-debtor is given.
A variant of this rule, as set forth
in section 173 of the RESTATEMENT
OF THE LAW OF CONTRACTS, pre-
vailed in Massachusetts and several
other states. Although no longer
obtaining in the state of its origin,
it is known as the "Massachusetts"
rule. It accords priority to the first
assignee unless the second assignee,
without notice of the prior assign-
ment, obtains (1) payment or satis-
faction of the account-debtor's obli-
gation; or (2) judgment against the
account-debtor; or (3) a new con-
tract with the account-debtor, by
means of a novation; or (4) deliv-
ery of a tangible token or writing
(such as a promissory note), sur-
render of which would be required
by the account-debtor's contract for
its enforcement.
So far, so good.
The Klauder Case and the Re-
sulting State Statutes. In 1938, the
Chandler Act amended section 60a
of the Bankruptcy Act [11 U.S.C.
§ 96(a) (1952)] so as to step up the
position of a trustee in bankruptcy
from that of a hypothetical judg-
ment-creditor or execution-creditor
to that of a hypothetical bona fide
purchaser. And in 1943, a bomb-
shell was thrown into the area of
all secured lending (and particu-
larly accounts receivable) by the
United States Supreme Court's
opinion in Corn Exchange Nat'l
Bank & Trust Co. v. Klauder, 318
U.S. 434 (1943), interpreting the
Chandler Act amendment.
Without attempting to follow
what many regard as the circuit-
ous legal gyrations by which the
Klauder result was arrived at, suf-
fice it to say that it placed accounts
receivable financing at great risk,
by destroying the efficacy of the
existing signposts of perfection and
leaving the field without a land-
mark.
The matter was finally set aright
generally by the 1950 amendment
to section 60a, but, since the perfec-
tion of title rests upon state law,
it was necessary to resort to the
legislatures to stake out anew work-
able signposts in the accounts re-
ceivable area. (So far as known,
only Ohio regulated the matter by
statute at the time of the Klauder
decision.)
The majority of states, therefore,
now regulate the matter by statute,
 ACCOUNTS RECEIVABLE FINANCING
and the method of perfection to be
required became a warmly debated
policy question. It was generally
agreed that, as an indicium of per-
fection, from a practical standpoint,
neither notice to the account-debtor
nor the marking of the assignor's
books meant anything. The choice,
therefore, narrowed down to the
adoption of either (a) the valida-
tion rule, with or without its Mas-
sachusetts variant; or (b) notice-
filing (also called "recording") of
a general notice of intention to
assign, along the lines first pre-
scribed by the Uniform Trust Re-
ceipts Act.
Twenty-one states now require
notice-filing: Alabama; Arizona;
California; Colorado; Florida;
Georgia; Idaho; Iowa; Kansas;
Louisiana; Missouri; Nebraska;
North Carolina; Ohio; Oklahoma;
Pennsylvania (under the Uniform
Commercial Code); South Caro-
lina; Texas; Utah; Vermont; and
Washington.
The statutes in fifteen states em-
body the validation rule: Arkansas;
Connecticut; Illinois; Indiana;
Maine; Maryland; Massachusetts;
Michigan; Minnesota; New Hamp-
shire; Oregon; Rhode Island;
South Dakota; Virginia; and Wis-
consin.
One (North Dakota) requires
the marking of the account-debtor's
books.
Case-law still governs in the rest.
It will be noted that neither New
61
York nor New Jersey, the original
"homes" of the validation rule, has
any statute on the subject. This, for
the reason that the rule, as laid
down in their cases, is so clear that
no legislation on the subject seemed
necessary. The Uniform Commer-
cial Code embodies the notice-filing
principle.
Conflict of Laws. The day-to-day
conduct of business enters into the
warp and woof of all legal logom-
achy, and frequently-but only
seemingly-complicates a pattern
that might otherwise be simple.
Since accounts receivable transac-
tions almost inevitably cross state
lines, what happens when the as-
signee is domiciled in state A, the
assignor in state B, and the account-
debtor in state C, all differing in
their respective requirements for
the perfection of an assignment?
With which one or more of them
must the assignee comply?
The exploration of the thickets
into which this safari would lead
us would be indeed a fascinating,
but over-long journey. Fortunately,
they have been largely clarified for
us by an opinion written by the
outstanding authority on conflicts
of laws, Judge Goodrich of the
United States Court of Appeals for
the Third Circuit. As a rule of
thumb, it teaches that the domi-
cile of the assignor governs. In re
Rosen, 157 F.2d 997, 999 (3d Cir.
1955). The case has been frequently
cited with approval.
 62 THE PRACTICAL LAWYER
0 As a last word, be it said that,
whatever the statutory requirement
may be, the assignee must comply
with it, not only to protect himself
against a subsequent "assignee,"
but also to preserve unimpaired his
security in the event of the assig-
nor's bankruptcy.
Assignment of Claims Under
Government Contracts
Amazing as it may seem, until
1940, contract claims against the
United States were not assignable,
and the purported assignment of
them conveyed nothing to the as-
signee. This ancient rule, encrusted
in statute, was grounded (a) in the
sovereign's desire to prevent cham-
perty, and (b) more practically, to
protect it against the annoyance of
the assertion of conflicting claims
against it. Long before the harsh
statutory roadblock was demol-
ished, it had become a complete
anachronism, and its intolerability
was highlighted by the necessities
of the defense production program,
which preceded our entry into
World War II.
Accordingly, in 1940, the Assign-
ment of Claims Act was passed. 31
U.S.C. § 203 (1952). It permits the
assignment to financing institutions
of contract claims providing for
payments aggregating $1,000 or
more against the federal govern-
ment. It requires that notice of the
assignment be filed with (1) the
government contracting officer or
the head of his department or
agency; (2) the surety, if any, upon
the contractor's bond; and (3) the
disbursing officer designated in the
government contract. Therefore,
when a financing institution ac-
cepts such an assignment, it must
comply not only with these filing
provisions, but also with the provi-
sions of any state filing statute ap-
plicable to the financing operation
as a whole. The necessity for
this dual compliance is, obviously,
grounded in the separate objects of
the state and federal statutes.
The mere passage of the Assign-
ment of Claims Act did not fill the
bill, because, in practical operation,
the field of the government's right
of recoupment remained largely
uncovered and muddy. In one rul-
ing, the Comptroller General had
held that the government might
hold an assignee liable for moneys
found to be due from the contrac-
tor-assignor as the result of a price
revision under the contract, even
though the government had long
since paid the assignee, and all
transactions between assignor and
assignee had, equally long since,
been terminated. In another, he
ruled that an assignee might be
held liable for the contractor's fail-
ure to pay withholding taxes or
social security contributions of the
contractor's employees.
All of this (and more) was cured
by the 1951 amendment to the act.
In its present form, if a financing
 ACCOUNTS RECEIVABLE FINANCING
assignee, which has complied with
the Federal Assignment of Claims
Act, has been paid, the government
may not recapture any payments
because of any "liability of any na-
ture of the assignor to the United
States . . . whether arising from
or independently of such con-
tract . . . ." This immunity applies
to all government contracts.
Of course, the exoneration does
not apply if the assignee has not
been paid; in that event, the gov-
ernment has its normal right of
set-off. South Side Bank & Trust
Co. v. United States, 221 F.2d 813
(7th Cir. 1955). But even this right
of set-off is further curtailed by the
amendatory act with respect to con-
tracts of the Department of De-
fense, the General Services Admin-
istration, or the Atomic Energy
Commission. In contracts of these
agencies, made in time of war or
national emergency, the insertion
of a so-called "no set-off" clause is
authorized. If inserted, the clause
cuts off (even if the assignee has
not been paid) the government's
right of set-off with respect to all
claims against the assignor (a)
arising independently of the con-
tract, and (b) for any liability of
the assignor to the government,
whether arising from or indepen-
dent of the contract, for renego-
tiation, fines, penalties, and-most
important-taxes, and social se-
curity contributions or the with-
holding or nonwithholding there-
63
of. The amendment also authorizes
the insertion of the "no set-off"
clause, with like effect, in contracts
of any other department or agency
designated by the President. None
such has been so designated to date.
It is, perhaps, needless to add
that, in the case of any contract, if
the assignee has not been paid, it is
subject to defenses or set-offs based
upon the nonperformance by the
assignor of the contract itself.
Interest and Usury
Since the policy that underlies
interest and usury laws and their
substantive and adjective imple-
menting prescriptions are, as among
the states, as varied in color as that
of a chameleon's coat, it is impos-
sible, within reasonable limits, to
delineate their tints and shades. To
do so, even in the accounts receiv-
able field alone, would be the sub-
ject matter of a treatise. Two or
three significant markings are, how-
ever, to be noticed.
In the first place, regardless of
the form of the underlying contract
between assignor and assignee, a
recourse operation constitutes noth-
ing more nor less than a loan of
money, and, as such, the interest
and usury laws will be applied to it.
And secondly-and by the same
token-compensation for the use of
money is interest, whether it be
given the sobriquet of service
charge or any other ingenious label.
64 THE PRACTICAL LAWYER
However, the parties may reason-
ably choose the state interest law
which they wish applied to their
transactions. Since the overwhelm-
ing majority of accounts receivable
transactions cross state lines, this
doctrine is of great practical signifi-
cance.
Let us assume that the assignor
is incorporated or domiciled in state
A; the assignee, in state B; and the
account-debtors, widely scattered
elsewhere. The interest laws of
state A are relatively strict and
harsh; those of state B are not. The
underlying contract may compe-
tently provide that the interest laws
of state B shall alone govern the
operation, and such a provision will
be enforced in the event of the as-
signor's bankruptcy.
This rule was first clearly laid
down by the United States Su-
preme Court in Seeman v. Phila-
delphia Warehouse Co., 274 U.S.
403 (1927), which non constat
Erie R.R. v. Tompkins, 304 U.S.
64 (1938), is still good law. Fahs v.
Martin, 224 F.2d 387 (5th Cir.
1955); Albritton v. GeneralFinance
Corp., 204 F.2d 125 (5th Cir. 1953).
The rule is also integrated into sec-
tion 1-105(6) of the proposed Uni-
form Commercial Code. The state
chosen must bear some reasonable
relationship to the domicile of the
parties and the conduct of the oper-
ation. For illustration, if the assig-
nor is incorporated under the laws
of Delaware and has its principal
business office in Illinois, and the
assignee is incorporated in New
York, the parties may choose any
of these three states; they could not
hit upon the law of Nevada, merely
because one of them happened to
like it.
Restrictions upon Assignments
If A orders one thousand tons of
coal from B-to say nothing of en-
gaging B to make him a suit of
clothes-it is both good morals and
good law that A may insist that the
merchandise be supplied, or the
garment fashioned, by no one but
B, and that the obligation so to do
shall not be assigned. However,
when the contract has once been
performed, the assignability of the
claim for the money due under it is
quite another matter.
For more than a century, simple
choses in action, of which accounts
receivable constitute a part, have,
almost everywhere, been freely as-
signable, either by statute or deci-
sion. It will, therefore, prove sur-
prising to many that, in a majority
of, states, an account-debtor may
effectively prohibit or limit, with-
out his consent, the assignability of
a simple account receivable, and,
for any reason or no reason, refuse
to pay an assignee lending upon the
security of such an account.
It was not until 1951 that the
New York Court of Appeals so
ruled. Allhusen v. Caristo Constr.
Corp., 278 App. Div. 817, 104
 ACCOUNTS RECEIVABLE FINANCING 65

N.Y.S2d 565 (1st Dep't 1951), sible people.

aff'd, 303 N.Y. 446, 103 N.E. 2d 891 From the standpoint of the as-
(1952). California's law is to the signee, the practical impact of the
same effect [Parkinson v. Caldwell, rule is that he must satisfy him-
126 Cal. App. 2d 548, 272 P.2d 934 self, at his peril, that the account-
(1954)], but the minority view is debtor's contract or purchase order
developed in the Tennessee case of does not contain a prohibition or
Third Nat'l Bank v. Olive, 281 restriction of the assignability of
S.W.2d 675 (Tenn. 1955). The con- the account, or, if it does, he must
flicting policy considerations are ob- persuade the account-debtor to
viously imbedded in the respective waive or modify it in such fashion
concepts of freedom of contract, on as to constitute the account realiz-
the one hand, against freedom of able security.
assignment, on the other. Two words of gloss should be
These restrictions and prohibi- added on this patina of restriction.
tions are most frequently found in First, if not expressed in the pur-
the contracts or purchase orders of chase contract or order, it will not
account-debtors whose operations be implied. Schnitzer v. Fruehauf
require multiple subcontracts (like Trailer Co., 283 App. Div. 421, 128
aircraft manufacturers) or those N.Y.S.2d 242 (1st Dep't), aff'd, 307
having numerous sources of supply N.Y. 876, 122 N.E.2d 754 (1954).
(like mail-order houses, or large Secondly and in any event, even if
department store chains). They inserted, it is inapplicable to the
find their justification in the ac- rights inter se of the assignor and
counting difficulties and involve- the assignee; therefore, if the ac-
ment in third-party disputes which count-debtor pays the assignor, the
the purchasing programs of such assignee can obtain the collection
organizations would otherwise in- from him, and, of course, if, dis-
volve. Be it said to the credit of regarding the restriction, the ac-
such concerns that, in many in- count-debtor nevertheless pays the
stances, they are willing either to assignee, the latter may retain the
waive or modify the restrictions payment. Freitag v. The Strand,
where their suppliers are respon- Inc., 205 F.2d 778 (3d Cir. 1953).

EDITOR'S NOTE: In his next instalment, Mr. Kupfer will discuss Problems in Bankruptcy,
and the effect of the Uniform Commercial Code provisions.