Brief Fact Summary. A bank had a security interest in a contract between construction company 1 and a hotel. Because a condition did not occur, the contract between the construction company 1 and the hotel was terminated. The hotel entered into a contract with construction company 2 to do the same work construction company 1 was supposed to. Construction company 2 entered into a sub-contract with a Construction company 3, controlled by the owner of construction company 1.
Synopsis of Rule of Law. An assignee with rights in a contract between parties A and B, does not necessarily have recourse in a contract between parties C and D, after the contract between A and B is terminated in good faith, even if the owner of party D was the owner of party B.
Issue. Where the Plaintiff had rights in Contract 1 between party A and party B, but Contract 1 is terminated, does the Plaintiff have rights in Contract 2 if party A is the same, but party B is not involved?
Held. The court first observes that §9.318(b) of the Tex.Bus. & Com. Code Ann. governs here. This sections reads: "[s]o far as the right to payment or a part thereof under an assigned contract has not been fully earned by performance, and notwithstanding notification of the assignment, any modification of or substitution for the contract made in good faith and in accordance with reasonable commercial standards is effective against an assignee unless the account debtor has otherwise agreed but the assignee acquires corresponding rights under the modified or substituted contract."
• The court first observes that there are two new contracts involved, the one between the Defendant and Pavestone and the one between Pavestone and Pave-Lock Systems, another of Mr. Frownfelter's companies. Thus, one contract was not substituted for the original contract. The court then recognizes Pavestone was not a party to the original contract and there is no evidence that Pavestone knew about the prior security arrangement between the Defendant and FCC. There was also no indication that either of the two aforementioned contracts were ever assigned. As such, "[n]either contract existed in a prior form so as to qualify as a substitution or modification of an earlier contract." Further, since there was no longer privity between the original parties to the assigned agreement, the Defendant could not obtain rights in any of the new contracts. The new contracts were unrelated to the original agreement. It was legally irrelevant that the Defendant and Mr. Frownfelter were "parties to the same general transaction." It is also irrelevant that the Defendant "was aware of Frownfelter's new role at the time the Registry-Pavestone contract."
• The court then recognizes the Plaintiff was not without recourse, because §9-318(2) requires any modification or substitution of the contract to be made in good faith and pursuant to commercial reasonableness. Meaning, those "modifications or substitutions that are fraudulent or intended to circumvent the assignee's rights are ineffective against the assignee."
If an account debtor fails to comply with a valid assignment and improperly pays the assignor, the account debtor may be liable to the assignee for the amount of the improper payment.View Full Point of Law