Lenders often require their borrowers grant them a security interest in their accounts in order to secure the borrowers’ loan obligations. Accounts are arguably one of the most liquid types of collateral available to secured lenders and can sometimes lead to substantial recovery for lenders when loans go bad.

Although the creation, attachment, and perfection of a security interest in accounts are fairly straightforward under the Nebraska Uniform Commercial Code (the “UCC”), foreclosing accounts is no easy task. You cannot send the sheriff or your local repo agent to collect a third-party’s legal obligation to pay your borrower. Fortunately, the Nebraska Supreme Court recently confirmed a secured lender’s right to collect its borrower’s accounts and identified the applicable requirements and procedures in its decision of First State Bank Nebraska v. MP Nexlevel, LLC, 307 Neb. 198, 948 N.W.2d 708 (2020). But, as discussed below, the path to the decision was riddled with a puzzle of complicated statutory language and lender-hostile precedents from other jurisdictions.

The Facts of the Case

The case transpired like many familiar loan transactions. The bank loaned money to Husker Underground, a local construction business, and Husker Underground granted the bank a security interest in essentially all of its assets. In particular, Husker Underground granted the bank a security interest in its accounts: money third parties owed the debtor for construction services Husker Underground had performed.

The bank properly perfected its security interest in Husker Underground’s accounts by filing a financing statement with the Nebraska Secretary of State. A few years later, Husker Underground stopped making loan payments, and the bank declared Husker Underground in default. Upon Husker Underground’s default, the bank began exercising its remedies to collect Husker Underground’s obligations.

The bank liquidated its collateral to minimize losses, including Husker Underground’s accounts. Among other things, the bank attempted to liquidate Husker Underground’s accounts, as set forth in Part 6, Article 9 of the UCC. It sent deflection notices to one of Husker Underground’s account debtors — a company that owed Husker Underground money for construction projects — and demanded the account debtor pay all amounts due on the accounts directly to the bank instead of Husker Underground.

One of Husker Underground’s account debtors, MP NexLevel, ignored three of the bank’s deflection notices. Despite the warning in the bank’s notices indicating there may be adverse consequences for MP NexLevel if it continued to make its payments to Husker Underground rather than the bank, MP NexLevel paid Husker Underground more than $400,000 after receiving the bank’s notices. As a result, the bank filed suit against MP NexLevel to recover the amounts paid by MP NexLevel to Husker Underground after the bank sent its deflection notices.

The District Court Decision

MP NexLevel was not involved with the bank’s loan to Husker Underground and did not have any agreements with the bank. MP NexLevel’s contract was with Husker Underground, not the bank. What legal obligations did MP NexLevel owe to the bank? The law governing this matter is a complicated web formed by various sections of UCC Article 9.

First, after a debtor’s default, UCC §9-607(a)(1) allows a secured lender (the bank) to send deflection notices to its debtor’s (Husker Underground) account debtor (MP NexLevel), demanding the account debtor pay all amounts due on the account directly to the secured lender. Importantly, this section of the UCC does not create an independent duty owed by the account debtor to the secured lender; instead, any obligation the account debtor owes the secured lender is based on the agreement between the debtor and the account debtor.

Second, once an account debtor receives a valid deflection notice from a secured lender, the account debtor may only discharge its account obligations by paying the secured lender instead of the debtor according to UCC §9-406(a).

Third, in the event an account debtor ignores a secured lender’s deflection notices and continues paying the debtor, the account debtor has failed to discharge its payment obligations on the accounts. At that point, UCC §9-607(a)(3) allows a secured lender to step into its debtor’s shoes and sue the account debtor to enforce the account debtor’s payment obligations on the account.

When MP NexLevel ignored the bank’s notices, the bank stepped in to Husker Underground’s shoes and sued MP NexLevel for breach of contract to collect the more than $400,000 still due on the account, even though MP NexLevel had already paid these amounts to Husker Underground. The bank requested the district court to enter judgment in its favor, but the district court declined. The district court based its ruling on the text of UCC §9-406(a), which uses the word “assignment” and “assignee” rather than “security interest” and “secured creditor.” The district court held that only creditors with outright assignments of their borrowers’ accounts can use UCC §9-406(a) to enforce those assignments, but it does not apply to secured lenders with security interests in accounts. Since the bank had a security interest — not an outright assignment — the district court dismissed the bank’s case. The district court’s decision essentially stripped the bank of its security interest and left the bank without any option to collect over $400,000 of its collateral.

The Supreme Court’s Decision and the Law

The bank appealed the district court’s decision to the Nebraska Supreme Court, which reversed the district court. Relying on principles of statutory interpretation presented by the bank’s counsel, the Nebraska Supreme Court held there is no meaningful distinction between an “assignment” and a “security interest” for purposes of UCC Article 9 and a secured lender’s right to enforce its security interest in accounts. The Nebraska Supreme Court’s ruling confirms a secured lender can enforce a security interest in its debtor’s accounts similar to other tangible personal property, such as equipment and inventory.

The First State Bank Nebraska Court summarized the enforcement of security interests in accounts this way: Following a default — a term Article 9 leaves for the parties to define in their loan documents — the secured lender sends a notice directly to the account debtor instructing the account debtor to pay the secured lender directly. The account debtor may ask for proof the secured lender has a security interest in the account at hand. In most cases, the proof consists of the lender’s security agreements and other loan documentation showing the debtor is in default. Once the secured lender has provided satisfactory proof of its security interest or the account debtor failed to request such proof, the account debtor can only discharge its obligations on the account by paying the secured lender. The account debtor that opts to ignore the notices and continues paying the debtor is not discharging its debts on the account. In turn, the secured lender can step into its debtor’s shoes to enforce the account debtor’s payment obligations on the account.

The Nebraska Supreme Court correctly interpreted UCC Article 9. Any contrary ruling would have been inconsistent with the UCC’s comprehensive regulation of security interests in personal property, such as accounts, and had disastrous consequences for secured lenders who rely upon accounts as an important type of collateral. Were UCC §9-406(a) only to apply to “assignments” of accounts instead of security interests, many secured lenders would be without any avenue to legally require an account debtor to turn over funds due on an account. Instead, the Nebraska Supreme Court wisely ruled that the “assignee” in UCC §9-406 included a secured creditor with a presently exercisable security interest in its debtor’s accounts. First State Bank Nebraska, 307 Neb. at 220, 948 N.W.2d at 725. For Nebraska lenders, the decision confirms accounts are valuable collateral that a secured creditor has the legal right to collect when the lender is enforcing its rights and remedies under Article 9 of the UCC.