In our last post we talked about anti-assignment provisions in contracts, and we mentioned "legal overrides" that might help. So, what are the legal overrides?
They are found in four sections of the UCC (Sections 9-406, 9-407, 9-408 and 9-409, for the academics out there). Some overrides dispense only with limitations on the grant of a security interest, while others go further and also invalidate restrictions on security interest enforcement(permitting the bank to foreclose on the collateral). You will inevitably wonder: why would they be treated differently? Well, a simple answer is for policy reasons: where the law is meant to make it easier for the borrower to get credit, it will override more restrictions in the collateral that, without the overrides, could not have been pledged.
The collateral that gets the most protection is what entitles the borrower to get paid: A/R, payment intangibles, promissory notes and chattel paper. Here, the law allows the bank to foreclose on A/R, for example, regardless of the borrower’s agreement with its account debtor so that the borrower could finance its A/R. By contrast, weaker overrides only permit the borrower to grant a lien without breaching the restrictions agreed to by the borrower and the other party. This lien is "passive"–the bank can hold a lien but cannot foreclose on it. The less protected collateral categories include healthcare insurance receivables and a really broad category of general intangibles (which includes licenses, permits and franchises for example).
Let’s illustrate the application of the stronger and weaker overrides through a license example.
If the borrower is a licensee, the license is a general intangible, and the weaker overrides would apply. The bank can get a passive lien only: it cannot step into the licensee’s shoes and start using the license or foreclose on it. If the license is sold in a bankruptcy proceeding, however, the bank’s lien would attach to the proceeds (and this is one of the reasons the bank would give value to this type of collateral given weaker overrides). Outside of bankruptcy, the bank may give some value to the license if the licensor’s consent is likely or if its lien would attach to the proceeds not otherwise covered by the weaker overrides.
There are a few extra tidbits. First, if collateral is leasehold interests and letter-of-credit rights, the overrides are in between the stronger and weaker ones. Second, if federal law is implicated (such as with A/R from Uncle Sam or Medicare A/R), the federal law will trump the UCC. Third, securitizations are different from a plain vanilla lien grant, so beware. And finally: overrides won’t help with indirect restrictions rather than outright prohibitions on assignment (such as a provision prohibiting information disclosure that would severely limit the licensee’s ability to pledge its software license rights).
This concludes our discussion of anti-assignment restrictions. The take-away is that if the restricted collateral is critical to the bank’s underwriting decision, the bank is likely to ask for consent from the protected third party as a condition to making the loan rather than choosing to rely on legal overrides.