UCC §§9-406 and 9-408 have provided much grist for the mill in this column, including about judicial decisions that misconstrue them as well as their sometimes less-than-symbiotic relationship with other statutory provisions. These provisions are important to understand because, in certain circumstances, they will override contractual and statutory restrictions on the ability to place liens on or to transfer assets. One obvious policy reason for such override is to facilitate extensions of credit. Unfortunately, the provisions themselves are fairly complex and so often present challenges for judges and practitioners alike to navigate.

The scope of Article 9 itself adds to that complexity. Many lawyers don't realize that Article 9 applies not just to security interests in assets but also to outright assignments of certain assets, such as promissory notes, accounts, chattel paper and payment intangibles, and that's certainly true of 9-406 and 9-408 (something the Permanent Editorial Board of the UCC is trying to make clear in a draft PEB Commentary issued on Dec. 10, 2019).

In addition, these UCC anti-assignment provisions may override certain state laws in a way that conflicts with the principles underlying those state laws. That is of particular concern when it comes to state law organizational statutes dealing with LLC's and partnerships.

Fortunately, the Code drafters and official commentators have recently tried to address the last of these issues—the intersection of 9-406 and 9-408 with state LLC and partnership statutes. In mid-2018, the American Law Institute (ALI) and National Conference of Commissioners on Uniform State Laws (NCCUSL) adopted amendments to the Official Text of UCC §§9-406 and 9-408 (the 2018 Amendments) that would make those sections inapplicable to a security interest in a general partnership, limited partnership or limited liability company. We discuss those amendments below.

UCC Anti-Assignment Provisions

UCC §§9-406 through 9-409 override prohibitions on asset transferability and liens, albeit in different ways. A thumbnail summary is as follows:

Section 9-406 (with exceptions for health-care-insurance receivables) applies to sales and pledges of accounts and chattel paper, and to pledges of payment intangibles (a type of general intangible) and promissory notes, but not to sales of payment intangibles or promissory notes (other than in enforcement of remedies post-default).

UCC §9-408 is similar in scope to §9-406, but its override provisions apply to sales of promissory notes, payment intangibles and health-care-insurance receivables and to pledges of health-care-insurance receivables and general intangibles (other than payment intangibles).

The override provisions of §9-408 as to statutory restrictions apply to sales of health-care-insurance receivables, payment intangibles and promissory notes, and to pledges of health-care-insurance receivables, general intangibles (including payment intangibles) and promissory notes.

Section 9-406 allows the assignee/secured party to enforce the counterparty's obligations. Section 9-408 ("override-lite") does not.

(UCC §§9-407 and 9-409 apply, respectively, to transfers of or security interests in lease agreements and in proceeds of letters of credits and letter-of-credit rights, but since those sections do not apply to LLC and partnership interests they are beyond the scope of this article.)

An interest in an LLC or partnership can constitute either a "general intangible" under UCC Article 9 or a "security" under UCC Article 8. How the interest is categorized determines the rules governing perfection, priority, and restrictions on assignment. The anti-assignment provisions of §§9-406 and 9-408 may therefore apply to restrictions on assignment in LLC agreements and limited partnership agreements. However, determining how and to what extent 9-406 and 9-408 override these contractual and state law prohibitions on assignments of LLC and partnership interests is by no means a straightforward exercise.

As noted above, an ownership interest in an LLC or partnership that has not opted into UCC Article 8 would constitute a general intangible under Article 9. Importantly, while sales of accounts, chattel paper, payment intangibles and promissory notes are covered by Article 9, sales of general intangibles that are not payment intangibles are not (see §9-109). So a restriction on sale of an LLC membership interest or a partnership interest will be outside of Article 9 and therefore not overridden by 9-406 or 9-408. That being said, §9-408 does apply to pledges of general intangibles, so a prohibition on a pledge of that ownership interest would be overridden by 9-408.

In addition, if the right in respect of the LLC or partnership interest is restricted to the right to receive proceeds from such ownership interest (such as distributions to limited partners), that interest may constitute a specific type of general intangible—namely a "payment intangible" under Article 9. Sections 9-406 and 9-408 both apply to payment intangibles. Section 9-406 overrides contractual restrictions on pledges of payment intangibles and §9-408 overrides contractual restrictions on sales of payment intangibles, so a prohibition on a pledge or sale of a payment intangible will be subject to the override provisions of §§9-406 or 9-408.

In reaction to the above, certain states (including Delaware, Texas, Colorado, and Virginia) have either made changes to their organizational statutes excluding LLC interests and partnership interests entirely from the scope of the UCC anti-assignment provisions and/or adopted changes to §§9-406 and 9-408 stating that these sections are not applicable to an interest in a partnership or limited liability company. The policy reasons for these exclusions include, most importantly, the desire to protect freedom of contract and the "pick-your-partner" principle (i.e., that co-owners of a private organization such as a LLC or limited partnership should be able to determine the counterparties with whom they do business).

As a result, there remains considerable confusion and lack of consistency about how and to what extent the override provisions of 9-406 and 9-408 apply to prohibitions on pledges of membership and partnership interests, as well as on assignments or pledges of the right to proceeds of such interests.

In addition, the overrides in both §§9-406 and 9-408 of contractual restrictions on assignment are limited to restrictions in an agreement between the account debtor and an assignor. With respect to an LLC or partnership interest that constitutes a general intangible, the issuer of the interest (i.e., the LLC or partnership) is the account debtor and the member or partner is the assignor. However, arguably §§9-406 and 9-408 do not apply to an LLC or partnership agreement since it is an agreement among the members of the LLC or partnership and not an agreement between the account debtor and assignor.

The 2018 Amendments are attempts by ALI and NCCUSL to resolve these uncertainties regarding the interaction between the Article 9 override provisions and LLC and partnership agreements and statutory provisions. They do so by simply excluding grants of security interests in ownership interests in partnerships and LLCs from those sections. The 2018 Amendments have not yet been adopted in any states although they were proposed for adoption in Massachusetts in December 2019.

Conclusion

Because the anti-assignment provisions differ across jurisdictions, practitioners and parties in interstate transactions may find themselves having to sift through overlapping and potentially conflicting provisions, left to determine which state's laws and provisions apply and what truly constitutes collateral securing the debtor's obligations.

In transactions involving LLCs and limited partnerships organized in jurisdictions that have not yet excluded grants of LLC or partnership interests from the Article 9 anti-assignment provisions, practitioners must continue to engage in a complex multi-pronged analysis of the interests to be assigned (e.g., a payment intangible versus a general intangible that is not a payment intangible), the applicable law, and the applicable Article 8 and Article 9 provisions (and any exceptions or exclusions thereto).

For transactions involving assignments of payment intangibles, chattel paper, accounts, health care-insurance receivables, lease agreements, promissory notes, general intangibles and letter of credit rights, there is already a patchwork quilt of case law interpreting the UCC anti-assignment provisions. Adoption of the 2018 Amendments could provide meaningful clarity to courts, contracting parties, and practitioners, as to the scope of UCC §§9-406 through 9-409. However, if and to what extent New York or other jurisdictions will adopt the 2018 Amendments remains to be seen.

As suggested previously in this column, the above concerns emphasize the benefits, wherever possible, of getting the consent and cooperation of the issuer in obtaining a lien on an LCC or partnership interest. Issuer involvement—such as by "opting in" to Article 8, consenting to the assignment and agreeing to allow a transferee upon foreclosure of the pledged interest to become a member or partner in the issuer—can best position the secured party to place a lien on the entire LLC or partnership interest (as opposed to solely the rights to dividends and distributions) and reap the benefits of Article 8 coverage, including "protected purchaser" status. It also may enable the secured party to receive payments of dividends and distributions on such interests directly from the issuer, rather than seeking to obtain such payments from the debtor.

Practitioners should consider how such collateral will be classified under the UCC and the potential consequences thereof, and take necessary steps to achieve the desired result for their client. To paraphrase the Greek philosopher Heraclitus (and numerous songwriters since), "the only constant is change," so stay tuned for further developments and changes to the text of the UCC, including the enactment of the 2018 Amendments in various jurisdictions.

Barbara M. Goodstein is a partner at Mayer Brown. Anastasia N. Kaup, an associate in the firm's banking and finance group, assisted in the preparation of this article.