UCC Security Interest Lesson: Nemo Dat Quot Non Habet

The title of this short post is a common law maxim that “no one can give what he does not have.”  The maxim was at the heart of the Northern District of Indiana’s opinion in Infinaquest v. Directbuy, 2014 U.S. Dist. LEXIS 61739 (N.D. Ind. 2014) (.pdf) related to an alleged UCC security interest.

Money flow.  Infinaquest was a dispute between parties owed money under contracts they had with a debtor company.  One of the creditors claimed to have a security interest in the debtor’s receivables (the “Lender”).  The opposing side (actually, two creditors, one of which was a franchisor) held contractual set-off rights to the debtor’s receivables (collectively, the “Franchisors”).  Based on the agreements between the parties, the Franchisors routinely swept the debtors accounts and collected their payments, with the debtor then receiving the net.  In short, the debtor got its money after the Franchisors got theirs. 

Problem.  In Infinaquest, the debtor defaulted, but the Franchisors were able to grab $400,000 before the Lender, which claimed the 400k was the Lender’s, not the Franchisors’.  The legal issue was whether the Lender took its alleged security interest subject to the Franchisor’s contractual set-off rights.  The case and the resulting opinion of the Court is fairly complicated.  Certain provisions of the UCC are sliced and diced, including the definitions of “account debtor” and “assignee.”  Please read the opinion for a deeper analysis. 

Argument.  The Franchisors contended that the debtor “could only assign an interest in what it actually possessed,” and the debtor did not own the receivables outright.  Since the debtor’s rights to the money were subject to the Franchisors’ rights, any alleged security interest in the debtor’s receivables was subject to the set-off rights of the Franchisors.  “In other words, it was not possible for [the debtor] to give away what it did not have.”  Nemo dat quot non habet. 

Subject to.  The Court agreed with the Franchisors.  The debtor’s interest in its account was subject to the Franchisors’ contractual set off.  The outcome also was consistent with the UCC, Ind. Code Sec. 26-1-9.1-203(b)(2):  “a security interest is enforceable against the debtor and third parties with respect to the collateral only if … the debtor has rights in the collateral or the power to transfer rights in the collateral to a secured party.”  The lesson is that one cannot grant a security interest in property it does not own or control.

The Court granted summary judgment to the Franchisors, who were defendants in the suit brought by the Lender.  The Lender based its cause of action on theories of conversion and tortious interference with a contract, both of which failed as a matter of law.  The $400,000 in question belonged to the Franchisors, who exercised control over it pursuant to their contractual set-off rights.  The Franchisors were justified in taking the debtor’s money from the debtor’s accounts, to the detriment of the Lender.