The classification of an arbitration award under the UCC in a bankruptcy case is determined by the nature of the underlying claim held by the debtor.

In Millennium Bank v. UPS Capital Business Credit, 327 P.3d 335 (Colo. Ct. App. 2014), the Colorado Court of Appeals held that an arbitration award recovered from a supplier of defective paint under a breach of warranty cause of action was not proceeds of an “account”, but rather proceeds of a “general intangible.”

Millennium Bank (“Millennium”) and UPS Capital Business Credit (“UPS”) both issued secured loans to Superior Plaster and Drywall, Inc. (“Superior”). Millennium and UPS then signed a “split collateral” intercreditor agreement. Millennium had first priority over accounts receivable and second priority over general intangibles. UPS had second priority over accounts receivable and first priority over general intangibles.

Superior was a subcontractor hired to perform drywall and paint work for two condominium towers. Problems immediately arose with the paint used by Superior. Akzo Nobel Paints, LLC (“Akzo”), the paint supplier, claimed that Superior’s application techniques were to blame. At the insistence of the general contractor, Superior repainted the condominiums four times and incurred significant cost overruns. The parties eventually went before an arbitration panel, which determined that Akzo owed damages to Superior for Superior’s excess labor and material costs related to repainting the condominiums four times.

Shortly after the arbitration award was issued, Superior filed for bankruptcy. Superior’s award became part of the bankruptcy estate. Millennium and UPS both claimed that they were owed the proceeds of the award. Because of the clear priority detailed in the intercreditor agreement, the outcome of the dispute depended on whether the arbitration award was classified as proceeds of an “account” or as proceeds of a “general intangible.” The lower court held that the funds were proceeds of a “general intangible.”

The Court of Appeals noted that Colorado’s UCC Article 9 is controlling. Under that statute, an “account” is a “right to payment … whether or not earned by performance … for services rendered or to be rendered.” Conversely, a “general intangible” is “any personal property, including things in action, other than” fourteen types of personal property, one of which is accounts.

The Court of Appeals then looked to the underlying nature of the arbitration award received by Superior. The cause of action asserted by Superior in the arbitration proceeding was for a breach of warranty. The claim was not based on a right to payment for services rendered to Akzo. Because the UCC’s definition of “account” clearly requires the payments to be related to services rendered or to be rendered, the award could not be considered proceeds of an “account”. Since it is not proceeds of an “account”, the award must then be proceeds of a “general intangible”.

By classifying the arbitration award as proceeds of a “general intangible”, the Colorado Court of Appeals affirmed the lower court in holding that UPS, as the first priority creditor for general intangibles, was entitled to that portion of the arbitration award. Millennium argued that the awarded funds were proceeds of an “account” because they represented damages that could have been recoverable against Superior’s general contractor (who insisted that Superior repaint the condominiums) under the subcontract. However, the court was not persuaded by this argument. Instead, the court noted that it is not the measure of damages but the nature of the underlying claim on which the damages are based that determines how such proceeds will be categorized.

Overall, the court found that the appropriate way to determine the classification of a settlement or an arbitration award under the UCC is to look carefully at the nature of the underlying claim.