Receipts Act was not finally promulgated until 1933 or enacted by any State until 1934. Consequently in 1941 the experience of both businessmen and the courts with it had been limited. Considering particularly the Ohio situation, the Ohio common law with respect to the assignment of accounts receivable was unsettled prior to 1941 with the result that banks in Ohio had done very little accounts receivable financing and consequently were relatively inexperienced in this field. Similarly, in Missouri and California the common-law rule required notification to account-debtors in order to have a valid assignment of accounts receivable against subsequent assignees with the result that in these two States there was little accounts receivable financing, at least by banks, prior to the enactment of their statutes in 1943. To the Massachusetts subcommittee the conclusion seemed justified, therefore, that the process that had taken place in the case of recording legislation was that its sponsors had simply picked up a type of legislation used in another field (and with relatively short experience in this field) and by a deductive process concluded to apply it to accounts receivable financing. The conclusion also seemed justified that even if bankers in Ohio, Missouri, and California stated that accounts receivable financing by banks was increasing in those States, this statement meant little or nothing if prior to the legislation the banks did practically no financing of this kind whatsoever.

BACKGROUND OF VALIDATION LEGISLATION

The alternative theory of validation legislation stems from basically different concepts and reasoning than does recording legislation. Proponents of validation legislation say that recording as developed in the case of real estate and as partially developed in the case of chattel mortgages cannot possibly work in the case of accounts receivable because of the inherent difference in the nature of the property concerned. They further say that although the mechanical difficulties of recording are simplified by the trust receipt formula many of the objectionable features of recording still exist. Proponents of validation point out that by reason of the abstract and short term nature of accounts receivable, the infinite variation of their size and length of life, the fact that they are continually being increased or decreased by further shipments, payments on accounts, returns or allowances, accounts receivable are highly "fluid" and accounts receivable financing, of necessity, is likewise of a highly "fluid" nature. In actual operations in accounts receivable financing it has been found that there is a steady flow of assignments from the borrower-assignor to the lender and a steady flow of payments by accountdebtors reducing or paying off the accounts receivable. În volume operations this may well reach in the case of a single lender as high as 1,000 transactions in a day. In this type of operation it is of the utmost importance that the mechanism used be reduced to the simplest possible form.

In looking for precedents for a sound method of regulating this type of instrumentality, the surprisingly close parallel of accounts receivable to negotiable instruments is to be observed. Of course, in negotiable instruments the indebtedness is evidenced by and embodied in a writing having special attributes of its own, whereas accounts receivable may not be evidenced by any writing or if they are, by correspondence or contracts not reduced to any simplified form.

However, both negotiable instruments and accounts receivable represent an indebtedness between two or more parties. Both are instrumentalities of commerce playing an important part in keeping the wheels of commerce moving rapidly. Negotiable instruments, historically and functionally, are built around the concept of ready transferability. Accounts receivable, as used in accounts receivable financing, are dependent upon transferability. Certainly accounts receivable are much more akin to negotiable instruments than they are to real estate or to tangible chattels.

OUT OF THE CUSTOMS OF MERCHANTS

Having in mind this parallel and looking at the development of the law of negotiable instruments it is well known that this law developed out of the customs of merchants. During the long period beginning early in the Middle Ages in which modern trade and business enterprise have slowly developed merchants came to employ certain practices and customs which were found to meet their needs and to work effectively. These practices and customs in due time were developed with sufficient certainty to be referred to as the "law merchant." As cases and problems arose under these customs and practices they were submitted to and determined by the merchant's own courts, which with the vast

background of continental experience to draw upon had developed a large body of commercial law. In the course of time in England the jealousy on the part of the royal judges of the ancient mercantile courts began to dissipate and the law merchant came gradually to be recognized as an invaluable adjunct to the common law which was not by nature attuned to the needs of a commercial nation. The fusion of common law and the custom of merchants was greatly accelerated by the decisions of the great Lord Mansfield, and the codification of a part of the mercantile law in the English Bills of Exchange Act and in our own Uniform Negotiable Instruments Law is merely one of the natural consequences of the tendency to practical development of Anglo-American law.

In the case of accounts receivable, it was at one time the common law of England and the United States that choses in action could not be assigned. Later, assignments were recognized in equity and still later in the law courts, either by common law decisions or as a result of a statutory enactment. With the growth of accounts receivable financing the practice of transferring accounts grew to substantial volume and as indicated earlier in this article the courts have laid down a very substantial number of rules with respect to such assignments of accounts. Where in 1941 the volume of accounts receivable financing reached $2,500,000,000, the customs and practices of merchants who have handled this business, as developed and rationalized by court decision, offer the best possible guide to rules to govern the operation of the business.

Validation legislation, therefore, enacts into statutory law a group of operating rules developed from the practice of merchants and common law decisions of the courts. These rules were developed not only in New York and in States following that rule but in Massachusetts and in States following the Massachusetts rule. As between the New York and Massachusetts rule, the former was chosen in preference to the Massachusetts rule simply to meet the problem created by the amendment to section 60a of the Bankruptcy Act.

EFFECT OF TYPES OF LEGISLATION ON DIFFERENT CLASSES OF INTERESTED PARTIES

If an analysis is made of the relative desirability of recording and validation legislation on the various classes of interested parties the great preponderance of arguments favor validation.

The classification of parties interested in and affected by accounts receivable legislation are four in number, namely, the lender-assignee, the borrower-assignor, the account-debtor and the competing or general creditor. Considering the effect of legislation on these four classes of parties in order, the lender is interested in the type of legislation that is more likely to produce the most business and the greatest over-all return on business done. On this test it is to be observed that the only lenders favoring recording legislation are banks in Ohio, Missouri, and California having a very limited background of experience in accounts receivable financing. On the other hand, banks in New York, Massachusetts, Michigan, and Illinois, all large commercial States with sufficiently favorable common law rules to permit a substantial volume of accounts receivable business, all favor validation legislation. Similarly factors and finance companies with an even longer background of experience all strongly support validation legislation.

The principal reason consistently advanced by experienced lenders in favor of validation is that in their judgment a much greater volume of business can be done on the validation principal than under recording. Recognizing the fluid nature of accounts receivable financing and the objection of borrowers to recording these lenders are convinced that recording would deter the over-all volume of business. They look upon recording as an artificial superstructure imposed upon the natural flow of business that would deter, decrease, and slow up that flow in the same manner that a detour imposed on a traffic artery deters and interferes with the flow of traffic.

The Ohio bankers contend that recording would be a great protection to the bank or lender that might find itself to be in the position of an innocent subsequent assignee of accounts which had already been assigned to a prior assignee. Lenders supporting validation reply that this situation would only arise in the case of a dishonest borrower deliberately defrauding the lender and that it is not possible to guard against deliberate dishonesty by legislation. They add that the proper supervision and control of accounts receivable loans is a vastly superior guard against a dishonest borrower than any recording statute ever could be; that experience has shown that deliberate deception of this type has been of negligible proportions; that if a borrower is dishonest and seeks to defraud his bank he can easily find means of doing so whether or not there is a recording statute;

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and that insurance is a better form of protection against the isolated dishonest borrower than any legislation seeking to "legislate" honesty.

Insofar

So far as the borrower-assignor is concerned, every argument favors validation. Recording requires the publication of financing statements for all to see and observe whether or not those observing have any legitimate reason to do so. as the borrower is entitled to privacy in obtaining loans of this type, such privacy is lost. The public recordation of accounts receivable loan arrangements not only puts the borrowers' creditors on notice but may put one or more of his account-debtors on notice. In a certain percentage of cases, this is likely to interfere with the relationship between the borrower and his account-debtors, his customers. Borrowers consistently report that they are concerned with this possible interference with their relationship with their customers and object to recording because of it.

It may be that account-debtors would not be seriously affected either by recording or validation legislation. Both types of statute have specific provisions protecting the account debtor. If a preference were had for either type it would seem that the account-debtor would favor validation (assuming he is satisfactorily protected under such statute) because validation involves the least interference with normal procedures and relations with the borrower-assignor. If there is public recordation of financing arrangements a careful account-debtor might well feel that this put him on notice of assignments of accounts by the borrower to the lender and obligated the account-debtor to inquire into the situation and even to make payment of the accounts owed by him to the lender. This involves trouble, inconvenience, and risk. It interferes with normal relations with the borrower. When these possibilities are appreciated it seems almost certain that account-debtors would object to recording, if in fact they do not now do so.

EFFECT ON GENERAL CREDITOR

There have been strong differences of opinion as to whether recording or validation legislation is preferable from the point of view of the general creditor or other creditors of the borrower competing with the lender-assignee. This class is represented chiefly by credit men's associations and there appears to be disagreement among various credit men's groups. Credit men advocating recording legislation contend that under validation assignments of accounts receivable may be secret with the result that if a borrower-assignor goes into bankruptcy general creditors are suddenly faced with the fact that the bankrupt has "hocked" his accounts receivable.

It is obvious that the postulate on which this argument rests is that the borrower-assignor goes into bankruptcy or otherwise fails in business with insufficient assets to pay his creditors. Assuming there is reason that a general creditor would object to this type of situation, before an appraisal is made of the importance of this argument it would seem to be desirable to consider the relative extent of the problem giving concern. The statistical department of Dun & Bradstreet, Inc., issues regularly so-called vital statistics of industry and commerce. In these published statistics Dun & Bradstreet, Inc., shows, among other things, for the years 1900 to date, the annual total number of business enterprises listed for continental United States by Dun & Bradstreet, Inc., as seekers of commercial credit. These listings include all types of business which are seekers of commercial credit in the accepted sense of the term; namely, manufacturers, wholesalers, retailers, building contractors, and certain types of commercial service, including public utilities, water carriers and air lines. These same statistics show for the same period the number and percentage of such listed business enterprises which were business failures. Business failures are defined as discontinuances of industrial and commercial enterprises involving loss to creditors. These statistics prepared by Dun & Bradstreet, Inc., show that the percentage of annual business failures to total business enterprises during the entire period 1900 to date range from a high of 1.53 percent in 1932 to a low of 0.05 percent in 1944.

The crux of the problem so far as credit men representing general creditors are concerned would appear to be, therefore, whether they are to base their judgment as to the desirability of different types of legislation upon the maximum 1.53 percent of business failures or upon the minimum 98.47 percent of successful business enterprises. If the great majority of successful business enterprises was not affected one way or another by the type of legislation involved there might be justification in basing one's reasoning exclusively on the small percentage of business failures. But if the great majority of successful business enterprises and business as a whole are benefited by validation legislation as distinguished from

recording it is shortsighted for credit men to ignore these benefits and consider only the cases of business failures.

Proponents of validation contend that validation, as compared to recording, will produce a substantially greater volume of accounts receivable financing and thereby benefit business as a whole. They also contend that in the minimum of 98.47 percent of business enterprises continuing to operate general creditors will be benefited by accounts receivable financing because the supplying of the borrower-assignor with ready cash will mean that he will pay his bills more promptly. Not only that, the careful lenders on accounts receivable will insist that the borrower pay his trade debts promptly and the general creditors will reap the benefit of this pressure.

Proponents of validation, therefore, strongly urge that a balance of all the factors involved, even in the case of the general creditor, favors validation. Certainly judging the situation from the cumulative point of view of lenderassignee, borrower-assignor, account-debtor and general creditor the great preponderance of arguments favor validation.

PROBLEM OF "SECRECY"

The bete noir of validation, according to proponents of recording, is secrecy. It is contended that secrecy and secret liens are an evil thing and that the policy of the courts and of Congress in enacting the Chandler Act has been to destroy secret liens. Recording provides for publicity; therefore it is good. Validation does not provide for publicity; therefore it is bad.

In passing it may be commented that from the point of view of the general social and economic welfare there are certainly some limits to the extent to which general publicity should override the field of privacy. Of course, the incidence of litigation is many times higher in the case of business failures than in the case of successful continuing business operations, with the result that a disproportionate amount of attention is given by the courts to those cases where a secret lien has wrought a hardship. Further, many other situations may be pointed to where "secrecy" or "privacy" is approved by business practice and legal rules. For example, if a borrower borrows money and pledges notes receivable the lien created on the notes is not publicly recorded and very few credit men in deciding whether to extend credit to such a borrower would insist on seeing the physical notes receivable.

Assuming, however, that secrecy and secret liens are objectionable the real problem is whether recording legislation eliminates this problem. It has been pointed out above that recording enthusiasts recognize the impossibility of recording in the case of accounts receivable each individual assignment as is done in the case of real-estate and chattel mortgages. In order to avoid mechanical impossibility recording statutes merely require the recording of a financing arrangement. But in achieving mechanical simplicity much of the value of notice is lost. A potential creditor considering whether he will extend credit to a borrower does not know whether the amount of accounts assigned is $500 or $5,000. A potential creditor does not know the nature of the financing arrangement nor the effect that it has on the borrower's balance sheet. To the careful credit checker the notice obtained from recording cannot possibly be more than a starting point in the investigation of the borrower's credit. The most enthusiastic sponsors of recording admit that at most it is a red flag calling for further inquiry. Almost certainly such further investigation would involve a request for a balance sheet or direct inquiry from the borrower or other sources of information as to the credit of the borrower.

If, however, the notice acquired from recording simply serves as a red flag calling for further investigation why does not a validation statute constitute a general red flag calling for investigation? Accounts receivable financing is a natural aid to smaller businessmen. Everybody hopes and expects that after the war small-business men will thrive and prosper and there is a great opportunity for accounts receivable financing to play an increasingly important part in aiding small business. If this situation actually develops or if accounts-receivable financing is used as much as it was immediately before the war, will not every interested party recognize the probability that any small-business men and many large-business men may be assigning their accounts receivable? If so, will not such general practice, with or without a recording statute, constitute a red-flag warning interested parties to inquire about assignments of accounts receivable?

Proponents of validation contend that neither the prospective lender nor the prospective trade creditor obtains any knowledge of real value from the recording required by a recording statute and that such notice as is obtained can more

effectively be obtained by direct request to the borrower for balance sheets, direct inquiries with respect to accounts receivable financing and agreements that the borrowers will give notice if he commences accounts-receivable financing at a future date. Since recording is merely a red flag, the diligent lender or credit man will obtain this information in any event. Already the practice is reasonably widespread for responsible lenders on accounts receivable to report accountsreceivable financing arrangements to Dun & Bradstreet, Inc., and similar agencies. Proponents of validation, instead of urging or seeking secrecy, recommend that this practice be cultivated and developed. Responsible proponents of validation desire proper notification of accounts receivable financing fully as much as the advocates of recording but contend that the appropriate place for such notification is through the ordinary trade and credit channels. Circulated in this way information will be available to persons entitled to receive it, namely, those considering the extension of credit, and it will be as complete as the needs and diligence of the person making the inquiry demands. On the other hand notice obtained through public recording is neither adequate nor necessary. Being thus of little value, it certainly does not justify the discarding of simple procedures evolved by many years of practice, the creation of the artificial superstructure of recording and the basing of the rights of the parties upon this superstructure.

RESOLUTION ADOPTED BY THE EXECUTIVE COUNCIL OF THE MASSACHUSETTS BANKERS ASSOCIATION, BOSTON, MASS., ON FEBRUARY 11, 1948

Whereas the Executive Council of the Massachusetts Bankers Association has today passed a resolution endorsing identical Senate and House bills, S. 826 and H. 2412, providing for the amendment of section 60a of the Bankruptcy Act, but has been informed that certain groups propose to oppose the enactment of these bills unless concurrently therewith the Congress amends section 70 of the Bankruptcy Act to provide for Federal recording of accounts-receivable financing; and Whereas for many years banks and other lenders in Massachusetts have done a substantial volume of accounts-receivable financing, particularly for small businesses on a nonrecording basis and in 1945 the Massachusetts Legislature enacted legislation providing for the continuance of such business and the codification of common-law rules under which such business was done, which practices, commonlaw rules and statute are now working satisfactorily; and

Whereas it is the strong belief of banks in Massachusetts that an amendment of the Bankruptcy Act requiring Federal recordation of accounts-receivable financing would not work satisfactorily in practice; would substantially decrease the volume of accounts-receivable financing; would be productive of substantial litigation on matters of technical detail related to recording requirements; would produce only an illusory and superficial solution to the secret-lien problem; would change long established principles that property rights in bankruptcy proceedings as well as otherwise should be determined by State law; and would constitute substantial and objectionable interference with States' rights and the wishes of the people and the Legislature of Massachusetts: Now, therefore, be it

Resolved: That the executive council of the Massachusetts Bankers Association hereby registers its strong objection to any amendment of the Bankruptcy Act or any other enactment of Congress providing for Federal recording of accounts receivable or similar types of financing; and be it further

Resolved: That the president of the association in its behalf be and he hereby is empowered to advise the members of the appropriate committees and subcommittees of the Congress before whom the foregoing matters are pending of the considered position of the members of this association as expressed herein.

I, Sidney S. Ayers, of Boston, Mass., hereby certify that I am the secretary of the executive council of the Massachusetts Bankers Association, and that the foregoing is a true copy of a resolution unanimously adopted at a duly called meeting of the executive council of the Massachusetts Bankers Association held in Boston, Mass., on February 11, 1948.

SIDNEY S. AYERS,
Executive Secretary.