How Factoring Companies Treat Linkages in Accounts Receivable
When a business owner wishes to enter into an invoice factoring relationship, the factoring company performs due diligence to ensure that the potential customer is a good fit. One facet of this process is the search for liens, which provides the factor with adequate assurance that it will have clear title to the customer’s receivables. This is critical, as the factoring company will advance considerable funds to the customer.
The following example illustrates why it is important to have a clear title for the accounts receivable group: Let’s say the factoring company has advanced 80% of the face amount of invoices totaling $100,000. Client clients generally pay within 45 days and payments are made to the factor’s lockbox. Between the time funds are advanced and payments are made by customers, the factoring customer has defaulted on a term loan with a local bank. Among the assets pledged to guarantee the loan are the company’s accounts receivable. In other words, the bank, at the time the loan was made, made a UCC statement on all assets used as collateral. This would normally include accounts receivable, so they have a guaranteed interest in this asset. When the company defaulted on the loan, the bank took control of the assets, which included payments on all receivables on the books. If the factoring company had not performed a lien search that would expose the UCC filed by the bank, they would be greatly exposed and lose the $80,000 advanced to the client.
Another example of a lien filed against accounts receivable is when the company has refused to pay federal payroll taxes withheld from employees’ paychecks and their share of FICA and Medicare taxes. After several notices have been sent to the company, the IRS will eventually “play hardball” and file a lien against the company’s assets. Needless to say, the same type of exposure would exist for the factor.
How invoice factoring companies deal with an existing link in accounts receivable:
The above scenarios happen all the time, so it’s important for those considering the use of accounts receivable factoring to understand that there are ways to deal with the situation. In the case of a lien filed by the bank, the factor will often look at the proportional amount of accounts receivable to the total collateral basis so they can get an idea of what the bank might accept as payment to release the lien. about that particular. asset. Some banks are stubborn and won’t do a partial release, but those who realize invoice factoring will help the client increase their working capital base will be willing to compromise. Often they will agree to accept a percentage of the initial advances until the agreed payment on the loan is made. This reduces your exposure and allows your customer to take advantage of invoice factoring. Also, the company has less debt load to deal with.
In the case of a lien filed by the IRS for non-payment of employment taxes, a similar agreement is made. Usually a subordination agreement. With this legal document, the IRS agrees to allow the funding source to have a primary position in the bond so that it is willing to continue the factoring relationship. In return, the agreement provides that a certain amount of the advances will be made to pay delinquent employment taxes.
Whether the accounts receivable lien is held by a bank, a private investor, or the IRS, the lien holder must be flexible and open-minded when working with clients who want to factor invoices.