One of the questions that often comes up with clients, prospective clients and referral sources is whether a factoring company is purchasing accounts receivable by providing a factoring facility or if they are making a secured loan with the accounts receivable as collateral.  The truth is that you will get a different answer depending on who you ask and the details of the factoring facility in question.  

Before we get too far into this discussion let me make it clear that I am not a lawyer and that this blog posting is informational only and is not a substitute for legal advice from a lawyer who specializes in these types of transactions. My staff and I have worked with some great lawyers to whom we can refer you if that is of interest (make a comment to me and I will send you the information).   

Over the years, our staff members have had this discussion with business men and lawyers in New York, London, Chicago, Los Angeles, Hong Kong and Beijing.  The answer comes down to how exactly the factoring facility or loan against accounts receivable is structured, and in what legal jurisdiction the company and factor are operating.  The following is a short list of some structural items that can help determine whether the financing facility is the sale of an asset or a loan against accounts receivable as collateral.  

• Is the factoring facility recourse or non-recourse?  The term recourse, when used in factoring, means the factoring company takes the payment risk of the factoring client's customer.  If the customer doesn't pay, usually within 120 days from the factor invoice due date because of financial inability, the factoring company will pay its client like a credit insurance company would pay.  If a factoring facility is non-recourse then a judge may be more likely to think of the facility as a sale of an asset instead of a secured loan.  What can complicate this issue is whether or not all the invoices are purchased by the factoring company as non-recourse.  Typically a factoring facility will be blended with both recourse and non-recourse invoices.

• Did the owner of the business with the financing facility provide a personal guaranty?  If the owner has guaranteed the performance of the accounts receivable with a personal guaranty, the factoring facility may ultimately be determined to look more like a secured loan.  

• Is the factoring facility "notification".  Notification for this purpose is defined as whether the customers of the factored client are put on notice, either through writing on the invoice itself, or by other means, that all payments owed by the customer for the sold receivables need to be paid directly to the commercial finance company or factor.  Notification will make the facility look more like a sale of an asset (i.e. selling accounts receivables) and less like a secured loans and receivables.  

These are just some of the issues that help determine how a factoring facility can be viewed.  In most circumstances the matter of whether a factoring facility is determined to be a selling accounts receivable or a secured loan is a function of semantics and doesn't really impact the process by which your business is financed.  However, a basic understanding of these issues can help provide some questions to ask any commercial finance company with which you are considering doing business.

Feel free to post a comment with any questions you have and I will do my best to answer them, or refer you to someone who can.