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A bank was found entitled to recover the full value of all payments from a prime contractor that were misdirected to the subcontractor, where the prime contractor had acknowledged the subcontractor’s assignment agreement with the bank and had agreed to make payments directly to the bank instead of to the subcontractor.  The subcontractor had assigned its accounts receivable on the project to the Bank as security for a line of credit it maintained with the Bank.  Apparently someone in the accounting department of the prime contractor had not noted the assignment agreement when making payment to the sub.  In a lawsuit against the prime contractor, the court held that the Bank was not limited to recovering only its actual damages for the breach of contract but was entitled, under the uniform commercial code (UCC) statute, to recover the full amount of all the checks that were misdirected.

The prime contractor argued that the actual damages should be the bank’s recovery rather than the total value of the wrongfully misdirected payments.  The court found that where an account debtor (prime contractor) receives notification of an assignment but nonetheless pays only the assignor (subcontractor), the account debtor remains obligated in full under the contract, and upon the assignor’s default, the assignee may enforce the account debtor’s contractual obligations to the full amount even it that far exceeds the actual damages of the bank. Reading Co-Operative Bank, 984 N.E.2d 776 (Mass. 2013).

In rejecting the prime contractor’s argument, the court explained its reasoning as follows:

 Here, the UCC provides a coherent and comprehensive scheme under which an account debtor remains fully obligated on a contract when it wrongfully misdirects payments. See G.L. c. 106, § 9–405 (a ). Application of the common-law measure of damages advanced by [Contractor] would undermine this scheme by effectively forgiving a portion of an account debtor’s outstanding contractual obligation whenever such obligation exceeds the assignee’s actual damages.

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In view of art. 9’s comprehensive scheme for recovery and distribution of funds due pursuant to an assignment and notification thereof, we conclude that art. 9 displaces the common law on the question of the measure of a secured creditor’s recovery under G.L. c. 106, § 9–405. Where an account debtor receives notification of an assignment but nonetheless makes payments to the assignor, it remains obligated in full under the operative contract. G.L. c. 106, § 9–405 (a ). Accordingly, the proper measure of the assignee’s recovery under G.L. c. 106, § 9–405, is the total value of all payments wrongfully misdirected. Here, the jury found [Contractor] liable under art. 9 for wrongful misdirection of ten checks totaling $3,015,000.49. The judge properly entered judgment against Suffolk in this amount.

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There is no question that application of art. 9 on these facts leads to a harsh result, because [Contractor] is obligated to pay the bank nearly six times the bank’s actual loss as determined by the jury. However, the result is neither illogical nor absurd; the Legislature has ensured against a windfall to assignees like the bank by mandating that they disburse recovered funds in excess of their actual losses plus reasonable expenses of collection and enforcement.

Because the assignee Bank’s actual damages are not relevant to the amount of the sum the prime contractor as account debtor must pay under the UCC statute, and because the secured creditor’s rights and remedies are cumulative and may be exercised simultaneously, the court concluded that the common-law doctrine of mitigation of damages does not apply to claims brought by the Bank under UCC.

Comment:  This case certainly demonstrates the grave importance of maintaining accounting and documentation systems that flag special requirements concerning making payments to subcontractors and suppliers – and being sure that all appropriate accounting personnel are informed. As seen in this case, the consequences of inadvertently misdirecting payments is just too great not to exercise extreme caution.

About the author: Article written by J. Kent Holland, Jr.,  a construction lawyer located in Tysons Corner, Virginia,  with a national practice (formerly with Wickwire Gavin, P.C. and now with Construction Risk Counsel, PLLC) representing design professionals, contractors and project owners.  He is founder and president of a consulting firm, ConstructionRisk, LLC, providing consulting services to owners, design professionals, contractors and attorneys on construction projects.  He is publisher of ConstructionRisk.com Report and may be reached at Kent@ConstructionRisk.com or by calling 703-623-1932.  This article is published in ConstructionRisk.com Report, Vol. 15, No. 8 (Aug 2013).

Copyright 2013, ConstructionRisk, LLC