Your Notice of Assignment Is Not As Protective As You Think
Written By: Robby Dube, Esq., Senior Associate, Eckland & Blando LLP and Daniel Cragg, Esq., Partner, Eckland & Blando LLP
The authenticated notice of assignment protects the factor from the account debtor “paying over notice” and sets a cutoff date for the account debtor setting off any sums owed to the factor by sums owed to the account debtor by the factoring client. While it is essential to send the authenticated notice of assignment as soon as possible, this does not provide as much protection as a factor might think. This is because an authenticated notice of assignment only protects against claims in setoff, they do not protect against claims in recoupment.
Let us explain. A factor’s right to the collateral is subject to the Uniform Commercial Code Section 9-404. Section 9-404(a)(2) governs setoff, providing that an account debtor’s right to setoff is extinguished after it receives the authenticated notice of assignment. But, Section 9-404(a)(1) is not so generous. That section provides that a factor’s rights are subject to “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.” UCC § 9-404(a)(1). This is recoupment: the ability to offset damages by the damages owed to the account debtor under the transaction itself. Notice that there is no temporal cut-off. Regardless of when an authenticated notice of assignment is sent, the account debtor always has a right to recoupment (assuming the account debtor’s attorney remembers to plead recoupment instead of setoff).
This means that the value of the accounts could be significantly less than the factoring client may lead the factor to believe. If the factoring client owes the account debtor sums under the transaction giving rise to the contract, that will reduce the amount the factor is able to recover in the event of litigation. This alarming possibility raises an important question: what is covered under setoff vs. recoupment? The answer is not as clear as might be assumed.
Setoff is supposed to be limited to transactions entirely separate from the transaction giving rise to the contract itself.[1] This usually means torts, e.g., damage to persons, property, fraud, etc.[2] Recoupment is supposed to be limited to the transaction giving rise to the contract itself, e.g., breach of contract claims or quasi-contract claims (potentially promissory estoppel, unjust enrichment claims, quantum meruit claims, etc.).[3] Some courts view recoupment as broader than setoff while others have held the opposite, leaving the exact contours subject to a state by state determination.[4]
Notwithstanding this, a few hypotheticals help illustrate setoff and recoupment:
Hypothetical A:
Factor is assigned $100,000 in staffing accounts receivables from Client and sends an authenticated notice of assignment on January 1, 2025, to the Account Debtor. On December 31, 2024, the Client hit Account Debtor’s truck with their forklift, causing $20,000 in damages.
Here, setoff is easily applied. The Client owes the Account Debtor $20,000 for an incident that was not part of the contract and it accrued before the authenticated notice of assignment was received. Thus, the Account Debtor can offset the $100,000 owed to Factor by $20,000, leaving Factor only receiving $80,000.
Hypothetical B:
The same facts as Hypothetical A, but now the Client hits the Account Debtor’s truck with its forklift on January 2, 2025. Now, the Account Debtor has no right to setoff against Factor, it will owe Factor the full $100,000 and will have to sue the Client separately for the $20,000 in damages.
Hypothetical C:
The Factor is assigned $100,000 in accounts receivables from a construction contract and sends an authenticated notice of assignment on January 1, 2025. On March 1, 2025, the Account Debtor discovers that the Client has performed deficient work, costing Account Debtor $20,000 to fix and repair.
Here, the Account Debtor is not entitled to setoff, because the damage spawns from the failure to perform the contract itself, not from outside the contract. But the Account Debtor is entitled to recoupment, even though the damage arose after the authenticated notice of assignment. Thus, the Factor will only recover $80,000.
These hypotheticals establish a basic framework for setoff vs. recoupment. But the differences between two can easily get blurred. For instance, if the Client has multiple contracts with the Account Debtor, can sums owed between the contracts be offset against one another, because they’re different contracts? Or can Account Debtor use recoupment because the contracts are really just part of the same series of transactions? Courts have gone both ways.[5]
Or, take fraud. As a tort, it should be separate from the contract itself. But what if the Client lied to the Account Debtor to get the contract in the first place, i.e., fraud in the inducement? Is that part of the transaction giving rise to the contract, making it subject to recoupment? Or is it separate from the contract, subject only to setoff? Again, courts have been inconsistent, but the majority find that such a scenario would give rise to a claim in recoupment.[6]
What is clear, is that business torts, i.e., business defamation, tortious interference with contract, etc. are outside the transaction giving rise to the contract, and thus are subject to setoff, not recoupment.
Finally, what if the contract is at will, meaning in effect that each day of performance is a new contract of sorts? It would seem, if there is no contract, there cannot be a transaction giving rise to a contract. But contracts can be formed by the parties’ conduct and performance as well. Courts do not appear to have addressed this issue, and any determination would be highly fact dependent.
Now, to be clear, neither setoff nor recoupment allows the Account Debtor to affirmatively recover from the Factor.[7] They only reduce the amount the Account Debtor may have to ultimately pay the Factor.[8] That being said, the Account Debtor may still have direct claims against the Factor or try to recover under theories of joint venture or alter ego. Those claims are exceedingly difficult for an Account Debtor to prove.
So, what is a Factor to do? It should still always send the authenticated notice of assignment as soon as it can. But it is imperative that the Factor conduct robust due diligence to ensure the Account Debtor will have no claims arising from the contract that gives rise to the accounts receivables themselves. Finally, if the Factor is looking at litigation to collect on its accounts receivables, it must conduct an honest cost/benefit analysis that takes into account potential setoff and recoupment defenses.
About Daniel Cragg, Esq., Partner, Eckland & Blando LLP
Daniel J. Cragg’s practice focuses on complex personal injury matters, commercial litigation, labor & employment law, factoring and asset-based lending, admiralty and maritime law, and procedurally complex cases, including cases against the government. Daniel has represented clients in State and Federal trial court and in administrative proceedings at the Federal, State and local levels. He has also argued before the U.S. Court of Appeals for the Eighth Circuit, the Minnesota Supreme Court, and the Minnesota Court of Appeals.
Daniel is a cum laude graduate of William Mitchell College of Law. He received his B.A. in history and international studies from the Virginia Military Institute.
Daniel is also a Rule 114 qualified civil adjudicative neutral and available to arbitrate complex civil matters.
About Robby Dube, Esq., Senior Associate, Eckland & Blando LLP
Robert “Robby” Dube grew up working in his family’s small business and ranch, so he understands the needs of businesses and works tirelessly to advocate for them in a cost-effective manner. He is a zealous litigator, having briefed, argued, and won numerous motions before both state and federal courts across the country, including maritime and admiralty cases, and has won cases in every stage of the litigation process, including trial. Robby also has deep experience with the factoring industry and the customs industry, litigating for and advising clients across the country.
Robby is deeply experienced with pursuing claims against all levels of government, including bid protests, municipal litigation, challenging terminations for cause, drafting requests for equitable adjustments, and producing government contract compliance guides for businesses. He has engaged in significant Administrative Procedures Act challenges against states and the federal government at the district courts and Circuit courts, winning unanimous decisions.
[1] Goldwell of New Jersey, Inc. v. KPSS, Inc., 622 F. Supp. 2d 168, 196 (D.N.J. 2009) (“Setoff is a counterclaim arising from an independent claim that a party has against its adversary.”).
[2] But see Brunswick Corp. v. Clements, 424 F.2d 673, 675 (6th Cir.1970) (noting that “a tort claim is not automatically asserted as setoff against contract claims”).
[3] McCarthy Improvement Co. v. Manning & Sons Trucking & Utilities, LLC, Civil Action No.: 2:17-cv-03290-JMC, 2018 WL 3009021, at *4 (D.S.D. June 14, 2018) (holding that an account debtor's claims against an assignor is limited to recoupment); U.S. Bank Nat’l Ass’n v. U.S. Rent a Car, Inc., No. 10-3900 (JRT/JJK), 2011 WL 3648225, at *5 (D. Minn. Aug. 17, 2011) (rejecting an unjust enrichment claim against the factor)
[4] Compare O’Connor v. Insurance Company of North America, 622 F.Supp. 611, 615 n. 2 (N.D.Ill.1985) with Reiter v. Cooper, 507 U.S. 258, 265 n. 2 (1993); Cox v. Doctor's Assoc., Inc., 245 Ill.App.3d 186, 184 Ill.Dec. 714, 613 N.E.2d 1306, 1315 (Ill.App.Ct.1993) (“Recoupment is in the nature of a cross-action in which a defendant alleges that it has been injured by a breach by plaintiff of another part of the contract on which the action is founded.”).
[5] Koken v. Legion Ins. Co., 900 A.2d 418, 426 (Pa. Commw. Ct. 2006) (permitting setoff but noting that “debts must arise between same persons and entities “although the debts may arise from multiple contracts.”); University Medical Center, 973 F.2d 1065, 1081 (3d Cir. 1992) (permitting recoupment and noting “Transaction” requires that both claims arise out of the “identical transaction,” or out of a “single integrated transaction, so that it would be inequitable for the debtor to enjoy the benefits of that transaction without also meeting its obligations.”); LifeBrite Hosp. Grp., LLC v. ECHP, Inc., No. 1:24-CV-00303-VMC, 2024 WL 5118478, at *6 (N.D. Ga. Dec. 16, 2024) (finding an MSA and a note are part of the same transaction, allowing recoupment).
[6] Compare In re Integrated Res., Inc., 157 B.R. 66, 73 (S.D.N.Y. 1993) (“Recoupment is permitted based on fraud in the inducement of the very transaction out of which a claimed fraudulent transfer arose.”); Holford v. Powers (In re Holford), 896 F.2d 176, 178 (5th Cir.1990) (allowing recoupment of loss caused by fraud in the inducement of a lease through underpayment of rent due under the lease)80 C.J.S. Set–Off and Counterclaim § 34, at 44 (1953) (“Defendant may recoup for fraud or deceit which induced the making of a contract”); Hanna v. Hope, 86 Or. 303, 308, 168 P. 618, 619 (1917) (“In recoupment against the claim asserted by the defendants Hope he may set up the damages alleged to flow from their fraud in inducing the purchase for which the mortgage was given.”) with Mellon Bank, N.A. v. Pasqualis-Politi, 800 F. Supp. 1297, 1302 (W.D. Pa. 1992), aff’d sub nom. Bhatla v. U.S. Cap. Corp., 990 F.2d 780 (3d Cir. 1993) (finding no recoupment available from fraud in the inducement claim); Croxton v. Maggiore, 2017-Ohio-1535, ¶ 43, 88 N.E.3d 1236, 1244 (no recoupment for fraud in the inducement claim as it did not arise of the contractual transaction).
[7] Liquid Cap. Exch., Inc. v. BDC Grp., Inc., No. 20-CV-89-CJW-MAR, 2020 WL 12309714, at *4 (N.D. Iowa Dec. 16, 2020).
[8] Novartis Animal Health US, Inc. v. Earle Palmer Brown, LLC, 424 F. Supp. 2d 1358, 1364 (N.D. Ga. 2006)
The views expressed in the Commercial Factor website are those of the authors and do not necessarily represent the views of, and should not be attributed to, the International Factoring Association.