Saturday, June 9, 2012

FYI: Ill App Ct Holds Account Debtor Had No Right of Set Off in Action By Assignee

The Illinois Appellate Court, First District, recently held that the Uniform Commercial Code did not permit an account debtor to use separate and unrelated debt owed to the account debtor by the assignor as a set off against an assignee of the accounts receivable, ruling that setoffs against assigned debt are limited to actual causes of action or viable legal claims that "accrued" prior to notice of an assignment. 
A copy of the opinion is available at:
A trucking company ("Assignor") filed for bankruptcy protection.  During the bankruptcy proceedings, the Assignor assigned its accounts receivable to a factoring company ("Plaintiff-assignee"), which held a secured lien on the Assignor's accounts receivable.  Among the assigned accounts receivable were invoices that Account Debtor, a construction firm, owed Assignor for trucking services provided to Account Debtor by Assignor.   The mutual exchange of services between the Assignor and the Account Debtor historically allowed the Assignor and Account Debtor to set off their respective invoices against each other.  
Plaintiff-assignee brought an action against Account Debtor to collect on the accounts receivable that it acquired in the bankruptcy proceedings.   In response, Account Debtor sought to set off unpaid amounts the Assignor owed Account Debtor for services Account Debtor had previously provided to Assignor.   
The parties filed cross-motions for summary judgment.  Denying both motions, the circuit court held a trial, after which the court entered judgment in Plaintiff's favor.  Account Debtor appealed.  The Appellate Court affirmed.
As you may recall, with respect to setoffs against assigned accounts receivable, the Uniform Commercial Code ("UCC") provides:
"Unless an account debtor has made an enforceable agreement not to assert defenses or claims, . . . the rights of an assignee are subject to:  (1) all terms of the agreement between the account debtor and assignor and any defense or claim in recoupment arising from the transaction that gave rise to the contract; and (2) any other defense or claim of the account debtor against the assignor which accrues before the account debtor receives a notification of the assignment . . ."  810 ILCS 5/9-404(a).
In analyzing whether the UCC allowed a setoff of the debt assigned to Plaintiff-assignee against the unrelated debt owed to Account Debtor by the Assignor, the Court examined whether the unrelated debt constituted "any other defense or claim . . . against the assignor which accrue[d]" before the Account Debtor had notice of the assignment of the accounts-receivable debt.
In so doing, the Court noted a dearth of Illinois case law interpreting whether Subsection 9-404(a)(2) permits setoffs for unrelated debt, or whether a cause of action must accrue prior to notice of an assignment.  Relying therefore on non-Illinois authority, the Court examined the question of when a defense or claim "accrues" for purposes of section 9-404-(a)(2), and concluded that a claim "accrues" when the claim gives rise to a viable cause of action. 
Looking to the UCC policy goals of simplicity and elimination of commercial uncertainty, the Court noted that this interpretation allows the value of accounts to be determined with reasonable certainty at the time of assignment.  The Court distinguished this interpretation of "accrue" from a "fiscal" interpretation, according to which a claim is considered accrued when an obligation to pay is simply incurred.  The Court pointed out that a fiscal approach in a case such as this would not allow an accurate determination of assigned accounts due to the risk of a post-assignment claim against an assignor.
Rejecting the Account Debtor's assertions that the Court's interpretation rendered subsection 9-404(a)(2) meaningless, the Court noted the distinct purposes of subsections 9-404(a)(1) and 9-404-(a)(2).  The Court pointed out that subsection (a)(1) allows setoffs arising out of the same transaction that gave rise to the assigned asset, and that subsection (a)(2) allows setoffs based on matters not connected to the assigned asset, but limits such setoffs to claims that matured into a cause of action prior to notice of the assignment.
The Court also ruled that the Illinois Code of Civil Procedure did not allow a setoff based on a contract or indebtedness separate from and unrelated to the debt assigned, such as the debt Account Debtor sought to set off in this case.  See 735 ILCS 5/2-403(a); R.A.N. Consultants, Inc. v. Peacock, 201 Ill. App. 3d, 67, 559 N.E.2d 283(1990).
Accordingly, the Appellate Court held that Account Debtor could not set off the debt it owed Plaintiff-assignee against amounts Assignor owed to Account Debtor, as the amounts Assignor owed to Account Debtor has not yet developed into a cause of action prior to notification of the assignment of the accounts receivable.

Ralph T. Wutscher
McGinnis Tessitore Wutscher LLP
The Loop Center Building
105 W. Madison Street, 18th Floor
Chicago, Illinois 60602
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