UCC Article 9-107 Analysis and Commentary: Control of Letter of Credit Right

1. Introduction to UCC Article 9-107

UCC Article 9 governs secured transactions, providing rules on how security interests in personal property are created, perfected, and enforced.

Within Article 9-107 defines what it means for a secured party to have control of a letter-of-credit right. This provision is crucial for professionals dealing with collateral involving letters of credit.

1.1 Statutory Overview of UCC Article 9-107

Article 9-107 is concise, providing a single-sentence rule for control of letter-of-credit rights. The statute reads:

“A secured party has control of a letter-of-credit right to the extent of any right to payment or performance by the issuer or any nominated person if the issuer or nominated person has consented to an assignment of proceeds of the letter of credit under Article 5-114(c) or otherwise applicable law or practice.”​

In simpler terms, this means a secured creditor gains control over a debtor’s right to payment under a letter of credit only if the letter-of-credit’s issuer (or a nominated person) consents to the assignment of the letter-of-credit proceeds to that secured party.

The following sections break down the key terms and requirements in this rule for clarity.

1.2 Key Definitions in UCC Article 9-107

Several defined terms in the UCC can be found in Article 9-107:

• Secured Party: The UCC Article 9-102 defines a “secured party” as the person in whose favour a security interest is created or provided for under a security agreement​. In practical terms, this is the creditor or lender holding the security interest in the collateral.

• Letter-of-Credit Right: A “letter-of-credit right” means a right to payment or performance under a letter of credit, whether or not the beneficiary has demanded or is currently entitled to demand payment​. Notably, this term excludes the beneficiary’s right to draw or demand payment under the letter of credit itself. In effect, the letter-of-credit right refers to the economic benefit (the proceeds payable) from the letter of credit, rather than the procedural right to present documents for payment.

• Issuer: An “issuer” is the bank or other entity that issues the letter of credit​. The issuer undertakes to honour drafts or demands for payment as stated in the letter of credit’s terms.

• Nominated Person: A “nominated person” is a party authorised by the issuer to pay, accept, negotiate, or otherwise give value under the letter of credit. Common examples include a confirming bank or another bank designated to pay on the letter of credit. The issuer, by agreement or standard practice, will reimburse a nominated person that honours the letter of credit.

• Proceeds of a Letter of Credit: “Proceeds” refers to the cash, check, accepted draft, or other item of value paid out by the issuer or a nominated person upon honour of the letter of credit​. These are the funds or value that the beneficiary receives when the letter of credit is drawn. (Importantly, proceeds do not include the beneficiary’s drawing rights or the documents presented to trigger payment​.)

With these definitions in mind, we can interpret exactly what Article 9-107 requires for a secured party to have control of a letter-of-credit right.

2. When Does a Secured Party Have “Control” of a Letter of Credit Right?

In secured transactions law, obtaining control of certain collateral (like deposit accounts, investment property, or letter-of-credit rights) is a method of perfecting a security interest and gaining priority.

For a letter of credit right, Article 9-107 specifies the conditions under which control is established. Essentially, two elements must be satisfied:

2.1 There is a letter-of-credit right (right to payment under a letter of credit)

The debtor (usually as the letter-of-credit’s beneficiary) must have a right to payment or performance from the issuer or a nominated person.

The law says “to the extent of any right to payment or performance,” indicating that control can apply to the whole or a portion of the letter-of-credit proceeds.

If only part of the proceeds is assigned as collateral, the secured party’s control extends only to that portion. (Article 5 explicitly allows a beneficiary to assign part or all of the proceeds​, and UCC 9-107 reflects this by tying control to whatever portion of the right is subject to the assignment.)

2.2 Consent by the issuer or nominated person to an assignment of proceeds

The secured party will have control only if the issuer or nominated person has consented to the assignment of the letter-of-credit’s proceeds to that secured party. This requirement comes directly from letter-of-credit law.

UCC Article 5-114(c) states that an issuer or nominated person “need not recognise an assignment of proceeds of a letter of credit until it consents to the assignment”.

In other words, even if a security agreement purports to give the secured party an interest in the letter-of-credit proceeds, the issuer (the bank) is not bound to pay anyone other than the original beneficiary unless the issuer agrees to the assignment.

UCC Article 9-107 incorporates this principle: the moment of “control” is when that necessary consent has been given.

The consent might be obtained under Article 5-114(c) or under other applicable law or standard practice (for example, if the letter of credit is governed by international rules or another jurisdiction’s law that likewise requires consent for assignments).

What matters is that the letter-of-credit issuer or its agent has acknowledged the secured party’s interest.

Once consent is in place, the secured party effectively steps into the beneficiary’s shoes regarding the proceeds, and the issuer or nominated person will pay the secured party (or as directed by the secured party) when honouring the letter of credit.

Stated plainly, control under UCC Article 9-107 is achieved when the secured party’s claim to the letter of credit proceeds is recognised by the bank that issued the letter (or its nominated paying agent).

Without that recognition (consent), the secured party may have an agreement with the debtor, but it does not have the actionable control over the letter of credit right as defined by the UCC.

3. The Role of Article 5 (Letters of Credit) in Interpreting UCC Article 9-107

UCC Article 5, which governs letters of credit, provides the backdrop for interpreting Article 9-107. The cross-reference to Article 5-114(c) in the statute is crucial.

It ensures that the secured transactions rules in Article 9 do not override the fundamental letter of credit principle that an issuer deals only with its beneficiary unless it consents to deal with a third-party assignee.

By conditioning control on the issuer’s or nominated person’s consent, Article 9-107 harmonises with Article 5’s requirements.

The mention of “otherwise applicable law or practice” in Article 9-107 further acknowledges that many letters of credit are subject to customary rules or laws (such as commonly used international letter of credit rules) which similarly prohibit or limit assignments absent consent.

Thus, no matter the governing framework of the letter of credit, the secured party’s path to control is the same: obtain the issuer’s agreement to pay the assignee.

This coordination between Article 9 and Article 5 protects the integrity of the letter of credit transaction while still allowing its proceeds to serve as collateral.

4. Conclusion: Article 9-107

UCC Article 9-107 provides a clear and authoritative rule: a secured party has control of a letter of credit right only when the letter-of-credit’s issuer or nominated person consents to an assignment of its proceeds in favour of that secured party.

By focusing on the statute’s language and the definitions of its key terms, we see how Article 9 links the creation of a security interest in letter of credit proceeds to the consent-based mechanics of letter of credit law.

This enables a security interest in a letter of credit right to be ineffective against the letter of credit issuer (and thus not fully perfected or enforceable) until the issuer acknowledges it.

A lender taking a security interest in a borrower’s letter of credit proceeds must secure the issuer’s consent to truly control that collateral.

In sum, UCC Article 9-107 stands as an authoritative guide within Article 9, delineating exactly when a secured party’s interest in letter of credit rights becomes legally operative and protected.