You’ve financed your business using your receivables. Now you find that the funder has sent letters to your customers. Those letters say “Section 9-406 of the Uniform Commercial Code” and tell customers to pay the funder, not you. Your customers write you. You wonder what to say? Your answers will have an impact on your customer relationships and your cash flow.
A 9-406 Notice is a letter from a business’s lender to its customers telling them to pay the lender, not the business, what they owe. It is often used when a business has given its accounts receivable (a.k.a., what its customers owe) as collateral when it received money or a loan. The letter identifies the business, explains why the assignment is secured, and gives the total amount that is owed. It usually (though not always) comes with documentation proving the assignment, and it is often sent by a law firm or debt collection agency acting on the lender’s behalf.
Once a customer has an effective notice, the only way it gets rid of what it owes is to pay the lender. If it pays the business later, that doesn’t count. The lender can then sue the customer and make it pay that invoice all over again. That one rule drives everything below. Here’s how to handle it.
Communicate with Customers
Step one: do not tell your customers to ignore the notice. It is tempting, but if you call up the customer and tell them to continue paying you, they don’t have to do that. And if they do pay you anyway, they would still be liable for that money to the funder. Customers are frequently told that the vendor’s conflict with its funder is none of their business and that the vendor should seek redress from the funder. That advice is correct. If you think the lender doesn’t have a right to the money, you take action against the lender. You don’t go after the customers.
Step two: assume the customer has stopped sending you payments. The standard advice a customer gets on receiving one of these letters is to put all payments on hold until they find out what’s going on. You should be prepared for the customers’ payments to you to dry up while that’s going on. Plan your cash flow around that now, not after the first missed check.
Step three: communicate with customers professionally. You don’t have to call your customers, but it’s a good idea to do it anyway, to maintain a good relationship. The message should simply state that if the notice is valid, the customer is legally required to redirect payments. Don’t make it an argument, and don’t use it to threaten not to deliver products or services in the future. Remember, it is in your best interest not to antagonize your customers.
Notice Is Effective
Step four: check whether the notice is effective. Not every letter meets the statute. To count, a notice has to be signed or authenticated somehow - an e-sign will usually do. It must reasonably identify the rights assigned. It must request payment of the full debt; a customer may reject a notice that asks for less than the total owed or for only an installment of an invoice.
Step five: look for proof of the assignment. If the lender has not included a copy of the assignment with the notice, your customer can ask for proof and refuse to pay until the lender produces it.
Step six: search the UCC filings against your business. Try searching for your business on the state government’s website. It is usually free or not expensive. That search will tell you whether the lender has filed a lien against your business. If your company is in New York, for example, that means the Department of State’s UCC database.
Know, too, which arguments will not help. A clause in your customer contracts barring assignment of your receivables generally will not stop the notice, because Section 9-406(d) of the Code overrides such clauses in commercial contracts except for very few limited exceptions. One thing does work in your favor: Customers can still use normal commercial defenses against you, like set-offs. Since the lender is just standing in your shoes, they only get what the customer really owes you - so if you owe the customer a credit for some bad goods, that lowers what the lender can collect from them.
Formal Release
Step seven: track what the funder collects and obtain a formal release. You want to know exactly when the debt is paid off. So you should track every payment the lender receives for the debt, even if the payments come from different people. Let your customers know that they should keep paying the lender until they get a real, authenticated release or termination letter from them. They should not just listen to your word that you paid the debt. The lender must notify the customers once the debt is satisfied.
Bottom line: this battle over what’s owed is between you and your funder. Your customers are just trying to protect themselves, and if you try to drag them into this, you’ll probably lose their trust and make your situation worse. Your time is better spent double-checking that your funder is right and then focusing on resolving the debt issue with them. If you are not sure whether the lender’s letter is valid, or if you have a dispute with your customers or the lender, talk to a lawyer right away.
