A factoring company (or factor) will buy an unpaid invoice off their client and provide a prepayment representative of a percentage of the invoice value. While there is a working relationship between a seller and its factoring company, it is less clear what the relationship is between the factoring company and the debtor. This post takes a closer look at this relationship.
Legally speaking there is rarely any contractual obligations between a factor and a debtor. The factor is entitled to collect payment from a debtor. The sale of unpaid invoices to a factor makes the factor the assignee of the proceeds of debt collection. However, the contract of sale is originally between the seller and the buyer.
Procedure for Recovering Money Owed in Unpaid Invoices
A factor is most likely to have legal dealings with a debtor under recourse factoring arrangements where the seller is protected against a non-payment of an invoice. In such a situation the onus falls on the factor to implement legal proceedings to recover money owed. This involves the following procedure:
- The factor will go to its client’s office and inspect paperwork. This paperwork will include evidence of a contract of sale, the invoice generated and any relevant credit notes. It is then established if the factor has bought the unpaid invoice in question. The factor will also want to scrutinise the contract of sale to make sure that its client has stayed within the parameters set up by the factoring facility.
- The factor will further look at the contract of sale for any clauses that give legal status to countervailing rights by the buyer. Typically, government departments and department stores demand that they use their own standards of purchase and that the seller agree to give them substantial countervailing rights against the factor as the assignee. A legal expert is needed to assess the factor’s claim as assignee of the debt and any countervailing rights by the debtor, from this it is decided whether a factor can continue to make a legal claim for a debt to be paid.
- Once the legal status of the unpaid invoice has been established and the factor is confident a claim can be enforced to make payment, the factor will note the name, registered number and address of the debtor.
- The factor will need to see any credit notes issued by its client to the debtor and clear proof of how those credit notes were allocated. This is to prevent a debtor insisting an invoice has been accounted for by a credit note.
- The debtor will have been notified when a factoring company has purchased its unpaid invoice. This notification will come with the invoice when it is sent to the debtor. It is called a notice of assignment. The factor will also send out monthly debtor statements that will also include notices of assignment. This is required for disclosed factoring. Some companies opt for undisclosed factoring, which means that the debtor won’t be notified that an outstanding invoice will be collected by a factoring company until the maturity date passes and no payment is forthcoming.
Once it has been established that an unpaid invoice has reached maturity and that payment is due to the factor then the next stage of collection is reached. This is where each unsuccessful application for payment leads to more severe action.
The letters sent by the factoring firm to the debtor use increasingly severe language. Often the wording of these letters is determined in advance by the factor and the client. This allows the client to manage business relations with customers. A late payment doesn’t necessarily mean the end of the relationship.
It is important that any letters sent to the debtor are copied and kept as evidence in case the push for payment eventually ends up in legal proceedings. The same goes for any phone calls made to the debtor asking for payment. Notes must be kept detailing the content of these phone calls. If a debtor can claim that it didn’t receive notice of payment due it can mount a defence that the complaint is not genuine.
Evidence is assembled, legal council is assigned and a formal application is submitted to start legal proceedings. Details of this process are covered in our post about the legal aspects of a factoring pursuing payment through the courts.
The factor is placed in the position of a third party in the sense that the heart of the dispute is between the seller and the buyer. This is altered by notes of assignment which give the factor legal rights of ownership to the payment of an invoice. It is important for the factor to draw the debtor’s full attention to this fact so as to avoid the debtor claiming ignorance on this point.
The factor has to thoroughly research the details of an unpaid invoice before it can pursue legal recourse with any certainty of success. It must establish the debt is not covered by credit notes. It must study the sales contract to make sure the debtor has not asserted any countervailing rights. It must also establish the name, number and address of the debtor. And finally, it must keep copies of any correspondence between the factor and the debtor urging payment of an invoice that is overdue. With all these ducks in a row the factor will be confident enough to sue the debtor in order to reclaim its money.