12.5.6.2 Notes - Babson v. Village of Ulysses | rauvinj | November 02, 2012

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12.5.6.2 Notes - Babson v. Village of Ulysses

Original Creator: Kessler, Gilmore & Kronman Current Version: rauvinj
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NOTE

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1. With respect to the freedom of the contracting parties to modify or rescind without the assignee's consent, does the Nebraska court in the principal case seem to take a more extreme position than the Massachusetts court took in Homer v. Shaw, supra p. 1538?

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2. If you were counsel to a Nebraska bank, would you advise it, in the light of the Babson case, to rely on an assignment of rights under an executory contract? Suppose the proceeds of an executory contract represented the only available security for a proposed bank loan. In the terminology of Article 9, how would you classify such collateral, and what would the bank have to do, under Article 9, in order to perfect its security interest in the borrower's executory contract rights? Read, again, the discussion of the relevant Article 9 provisions in the Notes following Shiro V. Drew, supra p. 1452, and Speelman v. Pascal, supra p. 1492. Supposing that the bank had taken whatever steps were necessary (if, indeed, any were) to perfect its security interest in the contract rights assigned to it, would the bank be protected against the loss of its collateral as the result of a modification or rescission of the contract made without its consent? According to §9-318(2), the answer appears to be a qualified "yes." That subsection provides as follows:

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So far as the right to payment or a part thereof under an assigned contract has not been fully earned by performance, and notwithstanding notification of the assignment, any modification of or substitution for the contract made in good faith and in accordance with reasonable commercial standards is effective against an assignee unless the account debtor has otherwise agreed but the assignee acquires corresponding rights under the modified or substituted contract. The assignment may provide that such modification or substitution is a breach by the assignor.

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The official comment to §9-318(2) explains the policy of that section:

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Prior law was in confusion as to whether modification of an executory contract by account debtor and assignor without the assignee's consent was possible after notification of an assignment. Subsection (2) makes good faith modifications by assignor and account debtor without the assignee's consent effective against the assignee even after notification. This rule may do some violence to accepted doctrines of contract law. Nevertheless it is a sound and indeed a necessary rule in view of the realities of large scale procurement. When for example it becomes necessary for a government agency to cut back or modify existing contracts, comparable arrangements must be made promptly in hundreds and even thousands of subcontracts lying in many tiers below the prime contract. Typically the right to payments under these subcontracts will have been assigned. The government, as sovereign, might have the right to amend or terminate existing contracts apart from statute. This subsection gives the prime contractor (the account debtor) the right to make the required arrangements directly with his subcontractors without undertaking the task of procuring assents from the many banks to whom rights under the contracts may have been assigned. Assignees are protected by the provision which gives them automatically corresponding rights under the modified or substituted contract. Notice that subsection (2) applies only so far as the right to payment has not been earned by performance, and therefore its application ends entirely when the work is done or the goods furnished.

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The Massachusetts annotation to U.C.C. §9-318(2) remarks: "The freedom of modification and substitution allowed by subsection (2) would change Massachusetts law. Under present [i.e., pre-Code] law the original parties could not modify the contract to the prejudice of the assignee without his consent. Homer v. Shaw, 212 Mass. 113, 117, 93 N.E. 697 (1912). "

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The New York version of §9-318(2) amended the official Code version to make the modification provision read: "any modification of or substitution for the contract made in good faith, in accordance with reasonable commercial standards and without material adverse effect upon the assignee's rights is effective against an assignee. . . ." With respect to the New York amendment, the Permanent Editorial Board for the Uniform Commercial Code, in Report No.2 (1964), commented:

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The New York limitation in subsection (2) is necessarily implied from the applicable requirements of good faith and observance of reasonable commercial standards. Material modifications adversely affecting the assignee's rights or the assignor's ability to perform, without the assignee's consent, would not conform to these standards. Thus the proposed New York change is unnecessary.

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3. The Restatement of Contracts First did not contain a provision dealing expressly with the power of assignor and obligor to modify or rescind their contract without the assignee's consent. Recall, however, that the Restatement First did address the closely related issue of the power of promisor and promisee to vary the promisor's duties without the consent of a third party beneficiary (in §§142 and 143, reprinted supra p. 1425). What explains the Restatement First's failure to provide for the similar problem of contractual modification by obligor and assignor?

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This puzzling omission has been cured in the Restatement Second by the inclusion of a section (§338(2)) that is nearly identical in its wording to U.C.C. §9-318(2). Compare §9-318(2) of the Code with §311 of the Restatement Second, reprinted supra p. 1426, dealing with the contractual modification of duties owed to a third party beneficiary. Who fares better under these provisions, an assignee or a contract beneficiary? In light of these provisions, would a lender on the security of executory contract rights have greater protection against subsequent modifications or rescission as a third party beneficiary than he would as an assignee? For contradictory answers to the question, see Comment, Contract Rights as Commercial Security: Present and Future Intangibles, 67 Yale L.J. 847, 888-892 (1958); 2 G. Gilmore, Security Interests in Personal Property §41.3 (1965). Assuming that there is something in the third party beneficiary idea, how should the hypothetical Nebraska bank referred to in Note 2 go about turning itself into a "beneficiary"? Or should it claim to be both "beneficiary" and "assignee" of the underlying contract?

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February 15, 2015

12.5.6.2 Notes - Babson v. Village of Ulysses

12.5.6.2 Notes - Babson v. Village of Ulysses

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