There are a number of aspects to a contract signed between a factoring company and a client. Although, every contract is unique in its legal requirements, there are a number of common clauses in factoring agreements that can be discussed.
We advise any company considering using the services of a factoring company to consult UK Finance.
UK Finance is a trade organisation that was formed in July 2017. About 300 companies belong to UK Finance. They provide a range of banking and financial services including factoring. It is an organisation with a wide remit that includes overseeing the regulations for credit and payment related services. UK Finance has also assumed the role previously occupied by ABFA or the Asset Based Financial Association. It is a role that involves managing the interests of independent and bank-owned factoring firms. ABFA pioneered the system for transferring clients between factoring companies.
UK Finance runs seminars, educational programmes and does lobbying for the factoring industry. However, a key aspect of their work is to get all its members to commit to a self-regulatory code. There are 6 clauses to this code that are worth mentioning here:
- All members abide by the code;
- All members act with integrity and treat clients and guarantors fairly;
- All members provide timely and transparent information to clients and guarantors;
- All members ensure all legal documentation is written clearly and without ambiguity;
- All members provide timely services in accordance with their legal agreements; and
- All members operate their own complaints procedure. They should make details of these procedures available to The Professional Standards Council of UK Finance if requested.
The most scrutinised aspects of a factoring deal remain the cost of the administration charge as a percentage of turnover and the finance charge as a percentage of funds used. In particular, a company seeking factoring services should look at how the charges are calculated and what services are included in the administration charge. In particular some companies using factoring companies underestimate the cost of paying the factoring company a per day rate for every invoice that remains unpaid after the maturity date. This is sometimes called a refactoring charge.
Another cost might be a minimum annual administration charge. This cost might be uneconomic if a company has achieved only a small volume in sales. New small businesses are apt to over-estimate their first-year sales and consequently jeopardise their finances early on.
While in years gone by a factoring firm providing non-recourse factoring would pay for the costs incurred in chasing up unpaid debt, it is increasingly rare. It is becoming the case that with both recourse and non-recourse factoring that these costs are now passed onto the client. Additionally, a factoring firm will often charge separately for filing documents, supplying copy documents, paying third parties, increasing debtor limits and inspecting records.
Changing the Factoring Agreement
There is an asymmetry in the abilities of the client and the factoring firm to change their agreement – namely, factoring firms can do it easily. However, that is the not the case for the client company.
This asymmetry arises out of the factoring firm retaining the right to change its prepayment scheme if a debtor goes beyond its credit limit. Various other situations that threaten profit can be used by factoring companies to unilaterally alter its agreement with a client.
Thus, a prospective clients looking for factoring services should look for these clauses in factoring agreements. In this way they are aware that cash flow might be impaired by suspension or reduction in prepayment funds. And, also by extra charges that the factoring firm might levy in light of a late payment by a debtor.
It is often not possible to get these clauses removed, but it is possible to insist on a period of notice from the factoring firm. This allows time for the client to put in place mitigations.
There is a common perception in business that one of the major contractual imbalances in an agreement between a client and a factoring company is in the terms of termination. Previously, factoring companies have insisted on a minimum contract period of 3 years, with a period of notice up to 12 months.
In such a scenario the client has to organise with the factoring company a transference of unpaid invoices to a new factoring company. This is so cash flow is not interrupted. Recently, this practice is on the wane. Reputable factoring companies will legislate for the continuing collection of unpaid invoices for a client. In the event of a client going into debt with a factoring firm that it seeks to leave, unpaid invoices will be reassigned to pay the outstanding sum owed to the factoring company.
Companies need to pay attention to the clauses in a contract that relate to bad debt. A client might make a delivery to a customer prior to sending a copy of the invoice to its factoring company. The key question is: will the factoring firm make prepayment before it has done due diligence on an invoice? If not, then the client might have delivered goods or services for which they cannot receive invoice financing.
Following on from this, there are clauses relating to the event that a debtor goes insolvent. How are debts recovered and what is the order of priority for paying debts?
A factoring firm doesn’t involve itself in disputes between a client and its customers relating to the quality of work done or goods delivered. Similarly, disputes about invoices or terms of contract are areas stipulated in factoring agreements that are not suitable for factoring prepayments. If a factoring company cannot collect payment for an invoice because of such disputes, the factoring firm will usually retain the right of recourse to claim the cost from its client. The best factoring agreements give the client a grace period to chase up debts before they become legally liable for the debt.
Guarantees and Indemnities in Factoring Agreements
If a factoring firm is asked to provide prepayment for an invoice where the debtor belongs to a group of companies, the factoring firm may seek to secure guarantees and indemnities regarding this invoice from the other companies in the group. These guarantees might even be with shareholders and individual directors.
This could cause friction between the client company and its customers. Nevertheless, some factoring firms faced with large prepayments cannot risk being left with a large outstanding invoice burning a hole in the company finances. In such a case, those who signed guarantees and indemnities become directly liable for a debt if an invoice remains unpaid. This might not seem unfair, especially if the factoring firm is making large prepayments. However, the indemnifier should consider:
- If the failure to secure the funds is due to a fault in the factoring agreement;
- If the factoring firm dealing with an insolvent debtor fails to obtain a waiver from the bank holding a charge on company’s debts; or
- If the debtor goes insolvent.
The last situation should be of least concern. This is because a factoring firm should have robust protocols in place to avoid losing money due to an insolvency. Afterall, the onus is on the funder to put in place systems to prevent a debtor avoiding payment.
As mentioned in an earlier post, the relationship between a client and a factoring company is often viewed as a marriage – it is a relationship that should build trust and be mutually rewarding. However, it is worth being certain that the ‘marriage contract’ (in this case the contract between the client and the factoring company) treats both parties fairly in the case of a money dispute. Ignorance is not a successful legal position. Better instead for the client to make sure they have found the right ‘partner’. That means carefully considering the contract, the law surrounding the contract and common practice. It is also worth consulting UK Finance.