Chapter 10
CONTRACTS INVOLVING MORE THAN TWO PARTIES

I. ASSIGNMENT AND DELEGATION GENERALLY

A. Assignment distinguished from delegation: Be sure to distinguish assignment from delegation:

1. Assignment: When a party to an existing contract transfers to a third person his rights under the contract, he has made an assignment.

2. Delegation: When an existing party appoints a third person to perform his duties under the contract, he has made a delegation.

3. Combination: Frequently, an existing party will both assign and delegate. That is, he will both transfer his rights to a third person, and appoint the latter to perform his duties. But don't presume that where there is an assignment, there is necessarily a delegation, or vice versa — there will often be just an assignment, or just a delegation.

II. ASSIGNMENT

A. Present transfer: An assignment is a present transfer of one's rights under a contract. Thus a promise to transfer one's rights in the future is not an assignment, even though it may be a contract.

1. No consideration: Because an assignment is a present transfer, no consideration is required for it (just as no consideration is required for a present gift).

B. Terminology: An assignment is a three-part transaction. The "assignor" assigns to the "assignee" the performance due the assignor from the "obligor." (Example: Contractor contracts to paint Owner's house for $10,000. Contractor then assigns to Bank Contractor's right to receive the $10,000 when due. Contractor is the assignor, Bank is the assignee, and Owner is the obligor.)

C. UCC rules: The UCC applies to many assignments, even ones not involving contracts for the sale of goods. In general, if a party assigns his right to receive payment under a contract as security financing, Article 9 of the UCC applies to the terms of the assignment. (Example: Contractor contracts to paint Owner's house for $10,000. Contractor assigns his right to receive payment to Bank, in return for a present payment of $9,500. Even though there is no contract for the sale of goods, Article 9 of the UCC applies to this assignment, and governs such items as whether the assignment must be in writing, the rights of Bank against Owner if Owner does not pay, etc.)

D. Writing: At common law, an assignment of contract rights does not have to be in writing. However, many states have statutes requiring certain types of assignments to be in writing.

1. Article 9: In particular, where a party assigns to a third person his right to receive payment, in a financing-type transaction covered by Article 9 of the UCC, the assignment is not enforceable against either the assignor or the obligor unless the assignor has signed a document called a "security interest." See §9-203.

E. Gratuitous assignments: A "gratuitous assignment" is an assignment that is in the nature of a gift, i.e., one in which the assignor receives nothing of value in return. Gratuitous assignments are generally enforceable, just like ones given for value.

1. Revocability: But gratuitous assignments, unlike ones given for value, are automatically revoked if the assignor: (1) dies; (2) makes a subsequent assignment of the same right to a different person; or (3) gives notice to either the assignee or the obligor that the assignment has been revoked.

a. Becomes irrevocable: But a gratuitous assignment may become irrevocable in some circumstances:

i. Delivery of symbolic document: This can happen if the contract right being assigned is evidenced by a document that commonly symbolizes the right, and that document is delivered to the assignee. (Example: Insured, who owns an insurance policy on his own life, delivers the policy to Friend, with the words, "I am assigning you this policy." At that moment, the assignment becomes irrevocable, even though it was gratuitous.)

ii. Writing: If the assignor puts the assignment in writing, most courts treat it as irrevocable if the writing is delivered to the assignee.

iii. Reliance: If the assignee relies to his detriment on the assignment, and the reliance is reasonably foreseeable by the assignor, the assignment is irrevocable.

iv. Obligor's performance: If the obligor gives the assignee the payment or performance, the assignment becomes irrevocable.

F. What rights may be assigned: All contract rights are assignable, unless they fall within a small number of exceptions, most of which are noted below:

1. Materially alter the obligor's duty: If the obligor's duty would be materially changed by the assignment, the assignment will be disallowed.

a. Personal services contract: This happens most commonly in certain personal services contracts. If there is a special relationship of trust or confidence between the parties, for instance, assignment will usually not be allowed. (Example: Star, a movie star, hires Secretary for a below-market wage, which Secretary agrees to take because she wants to work closely with Star. Star probably cannot assign the contract to Friend, thus requiring Secretary to work for Friend for the same wages, because the assignment would materially alter Secretary's duties.)

2. Materially vary the risk: Assignment will also not be allowed if it will materially vary the risk assumed by the obligor. This is most commonly true of insurance policies.

3. Impairment of obligor's chance to obtain return performance: An assignment may not be made if it would materially impair the obligor's chances of obtaining return performance. (Example: Contractor contracts to paint Owner's house for $10,000, with half the payment to be made before the job starts. Contractor then assigns all of his payment rights to Friend, to discharge a prior bill. A court might reason that since Contractor now stands to get no money, the chance that Owner will pay $5,000 and not receive performance is sufficiently great that the assignment should not be allowed.)

G. Contract terms prohibiting assignment: Normally, if the contract itself contains a clause prohibiting assignment, the courts will enforce the clause. But there are a number of important exceptions.

1. Restatement: Under the Restatement, an anti-assignment clause is generally enforceable, but subject to the following rules:

a. Fully performed: Assignment is allowed if the assignor has already fully performed. (In other words, an assignor who has already earned the right to payment by doing the contracted-for work may always assign the payment right.)

b. Total breach: The right to sue for damages for breach of contract may always be assigned.

c. Ban on assigning "the contract": If the anti-assignment clause states that "the contract" may not be assigned (as opposed to stating that "rights under the contract may not be assigned"), the contract will be interpreted to bar only delegation, not assignment.

d. Damages: An assignment made in violation of an anti-assignment clause does not render the assignment ineffective. All it does is to give the obligor a right to damages against the assignor for breach.

e. Rules of construction: In any event, these rules are merely rules of construction. If the parties clearly manifest a different intent, that intent will be honored.

2. UCC: Where a party assigns his right to payment as security for a loan (bringing the assignment within Article 9 of the UCC), an anti-assignment clause is automatically invalid.

H. Assignee vs. obligor: As a general rule, the assignee "stands in the shoes of his assignor." That is, with a few exceptions, he takes subject to all defenses, set-offs and counterclaims which the obligor could have asserted against the assignor. This is the most important single rule to remember about assignment.

Example: Contractor contracts to paint Owner's house for $10,000. Contractor assigns his right to payment to Wife, to satisfy an alimony obligation. If Owner fails to make payment, Owner may raise against Wife any defense, counterclaim or set-off that Owner could have raised against Contractor. Thus if the work was not done in a merchantable manner, Owner may raise this defense against Wife just as he could have raised it against Contractor.

1. Effect if obligor gives performance to assignor: Once the obligor has received notice of the assignment (from either the assignor or assignee), he cannot thereafter pay (or otherwise give his performance to) the assignor. If he does, he won't be able to use the defense of payment against the assignee. But if the obligor pays the assignor or otherwise gives him the required performance before he has received notice of the assignment, he may use this as a defense against the assignee.

2. Modification of contract: The right of the obligor and assignor to modify the original contract depends mainly on whether the modification takes place before the obligor has notice of the assignment:

a. Before notice: Before the obligor has received notice of the assignment, he and the assignor are completely free to modify the contract. (See UCC §9-318(2).) (Example: Contractor contracts to paint Owner's house for $10,000, does the work, then assigns his right to payment to Bank. Before Owner receives notice of the assignment, Owner and Contractor can together agree to modify the contract, and this will be binding on Bank. For instance, they may agree to reduce the contract price.)

b. After notice of assignment: But after notice of assignment has been given to the obligor, he and the assignor may modify the contract only if the assignor has not yet fully performed. (Example: Same facts as above example. Now, assume that Contractor has already finished painting the house, and that Bank has notified Owner of the assignment. At this juncture, any attempt by Owner and Contractor to lower the contract price will not be binding on Bank.)

i. Assignee gets benefits under modified contract: Where modification is allowed, the assignee gets the benefit of whatever new rights are given to the assignor by the modification.

3. "Waiver of defenses" clause: Many contracts contain "waiver of defenses" clauses, by which one party agrees that if the other assigns the contract, the former will not raise against the assignee defenses which he could have raised against the assignor. Most commonly, the buyer of goods on credit agrees that the seller may assign the installment contract, and that the buyer will not assert against the assignee (usually a bank or finance company) defenses which the buyer might have against the seller. The enforceability of such "waiver of defenses" clauses depends mostly on whether the transaction is a consumer one.

a. "Real" defenses: A waiver-of-defenses clause is never effective as to so-called "real" defenses. "Real" defenses include: (1) infancy, incapacity, or duress; (2) illegality of the original contract; and (3) misrepresentation that induced the buyer to sign the contract without knowledge of its essential terms ("fraud in the essence"). See UCC §9-206(1).

b. Consumer goods: Very importantly, waiver-of-defenses clauses in consumer transactions are basically unenforceable. This stems mainly from an FTC regulation.

i. Commercial contracts: By contrast, the FTC regulation does not apply to commercial contracts. So a business person who, say, buys goods on installment may not raise defenses such as breach of the implied warranty of merchantability against the assignee, typically a financing institution.

4. Counterclaims, set-offs, and recoupment by the obligor: Most states (and the UCC) follow these rules for determining when the obligor may assert a counterclaim, set-off or recoupment in a suit brought against him by the assignee:

a. Claim relates to assigned contract: If the obligor's claim against the assignor is related to the same contract that has been assigned to the assignee, the obligor may use this claim whether it arose prior to or subsequent to the obligor's receipt of notice of the assignment. See UCC §9-318(1). This is called a "recoupment." It may only be used to reduce the assignee's claim, not to yield an affirmative recovery for the obligor.

Example: Contractor agrees to paint Owner's house for $10,000. Contractor assigns to Bank on July 1, and Bank notifies Owner of the assignment on July 2. If Contractor has done the work in a slightly improper or late way (whether the defect occurred before or after the July 2 notice), Owner may assert this as a defense in any suit brought by Bank for the money, and Bank's recovery will be diminished by this amount. (But no affirmative recovery by Owner will be allowed even if the damages aggregate more than $10,000).

b. Claim unrelated to assigned contract: If the obligor's claim against the assignor is not related to the contract which has been assigned, the obligor may assert this claim against the assignee only if the claim accrued before the obligor received notice of the assignment. This is called a "set-off." Like recoupment, a set-off may not yield affirmative recovery.

c. Counterclaims: The obligor may obtain an affirmative recovery against the assignee only if the claim relates to a transaction directly between the obligor and the assignee. This is called a counterclaim. (Example: Same facts as above two examples. Assume that Owner also has a claim against Bank for lending him money at a rate in violation of state usury laws. Assuming that the claim is allowed to be part of the same suit under state practice rules, this claim can not only wipe out any recovery by Bank as assignee of the Contractor-Owner contract, but also may yield an affirmative recovery for Owner. But no claim by Owner relating to the Owner-Contractor contract may yield an affirmative recovery, since only dealings directly between the obligor (Owner) and the assignee/plaintiff (Bank) may yield such a recovery.)

I. Rights of successive assignees of the same claim: Where there are two assignees of the same claim, and assuming that both assignees gave value and the later one did not know about the first, here is the way most states treat their relative rights:

1. Restatement rule: In transactions not governed by Article 9 of the UCC, the Restatement "four horsemen" rule is applied by most states. The subsequent assignee loses to the earlier assignee, unless the subsequent one did one of four things: (1) he received payment or other satisfaction of the obligation; (2) he obtained a judgment against the obligor; (3) he obtained a new contract from the obligor by novation; or (4) he possessed a writing of a type customarily accepted as a symbol or evidence of the right assigned (e.g., a bank book or insurance policy).

2. UCC: In transactions governed by Article 9 of the UCC (most assignments of the right to receive money in return for financing), rights of successive assignees are governed by a filing system. In general, the assignee who files first has priority, regardless of whether he received his assignment first, and regardless of whether he gave notice of the assignment to the obligor first.

J. Rights of assignee against assignor: If the obligor is unable to perform, or in some other way the assignee doesn't obtain the value he expected from the contract, the assignee may be able to recover against the assignor.

1. Gratuitous assignments: If the assignment was a gratuitous one, the assignee probably will not be able to recover against his assignor. Exceptions exist where the assignor interferes with the assignee's ability to collect the performance, or where the assignor makes a subsequent assignment. But in the more common case where the obligor simply fails to perform, the assignee has no claim against the assignor under a gratuitous assignment.

2. Assignments made for value: But it is quite different if the assignment was made for value. Every assignor for value is held to have made a series of implied warranties to the assignee. If these warranties turn out not to be accurate, the assignee may sue the assignor for damages. These warranties are:

a. No impairment: That the assignor will do nothing which will interfere with the assignee's enforcement of the obligation. (Example: Assignor implicitly promises that he will not try to collect the obligation himself, and that he will not assign it to some third party.)

b. Claim is valid and unencumbered: That the assigned claim is a valid one, not subject to any limitations or defenses other than those that have been disclosed. (Example: Contractor agrees to paint Owner's house for $10,000. Contractor performs the work sloppily, giving Owner a partial defense. Contractor then assigns to Bank his right to be paid. Regardless of whether Contractor knows, at the time of assignment, that Owner has a defense, Contractor breaches his implied warranty to Bank if he does not disclose to Bank Owner's defense of non-performance.)

c. Documents valid: That any documents which are delivered to the assignee that purport to evidence the right are genuine.

d. No warranty of solvency or willingness to perform: But the assignor does not warrant that the obligor is solvent, or that he will be willing or able to perform. Thus if the obligor turns out to be unwilling or unable to perform, the assignee has no recourse against the assignor. (Example: Same facts as above example. If Contractor does the work properly, but Owner goes broke, or simply refuses to pay, Bank cannot sue Contractor.)

i. Free to agree otherwise: But the assignor may explicitly agree to guarantee the obligor's performance, in which case the assignee can sue if the obligor fails to perform.

e. Sub-assignees not covered: Unless the assignor indicates otherwise, his warranties do not extend to any sub-assignee, i.e., one who receives the assignment from the assignee.

f. Rules of construction: All of the above rules on warranties are generally common-law, rather than statutory. Most states treat them as rules of construction, which may be varied by showing that the parties intended a different result.