Variation By Agreement: UCC Article 9 © Cravath, Swaine & Moore LLP. All rights reserved.

Variation By Agreement UCC Article Broad policy favoring freedom of contract in commercial dealings Article 1-201(b)(3) defines “agreement” as broader than just the record or oral bargain of the parties, including “Course of performance” “Course of dealing” “Usage of trade” (all defined in Article ) Thus, Article 1 suggests that a lawyer should consider the agreement of the parties along with any course of dealing between them in addition to the applicability of the Code and any other law.

Variation by Agreement Are there limitations to ability to freely contract? Article 1-302(b) provides that the parties may not disclaim the following obligations imposed by the Code: good faith, diligence, reasonableness, care There are also specific limitations in various Code Articles, specific formulas for disclaiming obligations, and some courts have suggested provisions so fundamental they are not subject to variation, even though they do not relate to good faith, reasonableness or care. (Becker v. Nat’l Bank & Trust Co., 32 UCC Rep. Serv (1981), court determined parties couldn’t agree to change meanings of certain terms or fundamental concepts)

Variation by Agreement What about UCC Article 9? Parties cannot “contract out” from provisions created to protect third parties, such as rules in Article 9 concerning perfection and priority of security interests. See comment 2 to old Article 1—102 “... the effect of an agreement on the rights of third parties is left to specific provisions of this act. The rights of third parties under Section [of former Article 9] when a security interest is unperfected, for example, cannot be destroyed by a clause in the security agreement.”

Variation by Agreement UCC Article 9 : Freedom of contract is largely illusory— --common practice for lenders and their counsel to draft loan papers --debtors in need of funds may not understand what they are signing --statutory limitations on waiver and variance create a “level playing field” for all parties involved

Variation by Agreement Express Limitations in UCC Article 9: expressly prohibits waivers and variances of specific rights given to a “debtor” and duties of secured party (subject to three limited waivers in 9-624) Similar to prior law, but expanded – Revised 9 almost tripled the number of statutes creating non-waivable rights and duties Revised 9 also broadened the scope of “debtor” to include “obligor” which picks up “guarantor” as well (whether a guarantor is a debtor—and thus a party with non-waivable rights or whom secured party owes a non-waivable duty—frequently litigated before this clarification)

Variation by Agreement Official Comment 2 to explains why Article 9 contains these express limitations: “... in the context of rights and duties after default, our legal system traditionally has looked with suspicion on agreements that limit the debtor’s rights and free the secured party of its duties. As stated in former Section 9-501, Comment 4, ‘no mortgage clause has ever been allowed to clog the equity of redemption.’ The context of default offers great opportunity for overreaching. The suspicious attitudes of the courts have been grounded in common sense. This section... codifies this long-standing and deeply rooted attitude. The specified rights of the debtor and duties of the secured party may not be waived or varied except as stated. Provisions that are not specified in this section are subject to the general rules in [Section 1-302].”

Variation by Agreement Official Comment 3: “... This section provides generally that the specified rights and duties ‘may not be waived or varied.’ However, it does not restrict the ability of parties to agree to settle, compromise, or renounce claims for past conduct that may have constituted a violation or breach of those rights and duties, even if the settlement involves an express ‘waiver.’”

Variation by Agreement 9-602’s list of non-waivable provisions: 9-207(b)(4)(C) – use and operation of consumer goods collateral by secured party – debtor’s right to a response to requests for accounting, lists of collateral, and statement of account from secured party 9-607(c) – secured party’s duty re: collection and enforcement of collateral in commercially reasonable manner 9-608(a) and 9-615(c) – secured party’s duty re: application or payment of noncash proceeds of collection, enforcement, or disposition in a commercially reasonable manner (cont)

Variation by Agreement 9-602’s list of non-waivable provisions (cont): 9-608(a) and 9-615(d) – rights to special method of calculating surplus or deficiency in certain dispositions to the secured party – if taking collateral without judicial process, secured party’s duty to do so without breach of peace 9-610(b), 9-611, 9-613, – disposition of collateral (parties can contract what is “commercially reasonable”) 9-615(f) – calculation of deficiency or surplus when disposition made to secured party/secondary obligor (cont)

Variation by Agreement 9-602’s list of non-waivable provisions (cont): – duty to give explanation of calculation of a surplus or deficiency in consumer goods transaction 9-620, 9-621, – acceptance of collateral in satisfaction of the obligation (strict/partial foreclosure) – redemption of collateral – permissible waivers (discussed infra) and – secured party’s liability for failure to comply with this article

Variation by Agreement 9-624’s three express waivers: (a) Waiver of disposition notification—debtor/obligor can waive this right of disposition of collateral under only by agreement entered into and authenticated after default (b) Waiver of mandatory disposition of consumer goods—debtor/obligor may waive this disposition right under 9-620(e) only by agreement entered into and authenticated after default (c) Waiver of redemption right—debtor/obligor may waive this right under only by agreement entered into and authenticated after default

Variation By Agreement But see 9-603: “The parties may determine by agreement the standards measuring the fulfillment of the rights of a debtor or obligor and the duties of a secured party under a rule stated in Section if the standards are not manifestly unreasonable.” (Agreed standards do not apply to the duty under Section to refrain from breaching the peace.)

Variation by Agreement Any other Article 9 provisions that can be varied? – “This article does not preclude subordination by agreement by a person entitled to priority.” Official Comment 2: “The preceding sections deal elaborately with questions of priority. This section makes it entirely clear that a person entitled to priority may effectively agree to subordinate its claim. Only the person entitled to priority may make such an agreement: a person’s rights cannot be adversely affected by an agreement to which the person is not a party.”