When a business owner wants to enter into an invoice factoring relationship, the factoring company conducts due diligence to ensure that the potential customer is a good fit. One facet of this process is link hunting, which gives the factor adequate assurances that it will have a clear title to the customer’s accounts receivable. This is essential, as the factoring company will advance considerable funds to the client.
The reason it is important to have a clear title for the set of accounts receivable is illustrated by the following example: Let’s say the factoring company has advanced 80% of the face value of the invoices for a total of $ 100,000. Client clients typically pay within 45 days and payments are made in the factor’s safe deposit box. Between the time funds are advanced and clients make payments, the factoring client has defaulted on a term loan with a local bank. Among the assets committed to guarantee the loan are the company’s accounts receivable. In other words, the bank, at the time the loan was granted, made a UCC statement on all assets used as collateral. Typically this would 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 from all accounts receivable on the books. If the factoring company had not conducted a link search that exposed the UCC presented by the bank, they would be highly exposed and lose the $ 80,000 advanced to the customer.
Another example of a lien filed against accounts receivable is when the business has failed to pay federal payroll taxes withheld from employee paychecks and its share of FICA and Medicare taxes. After several notices have been sent to the business, the IRS will eventually “play hard” and present a bond against the assets of the business. Needless to say, the same type of exposure would exist for the factor.
How invoice factoring companies handle an existing lien on accounts receivable:
The above scenarios happen all the time, so it is 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 bank-filed lien, the factor will often look at the proportional amount of accounts receivable to the total collateral base so that they can get an idea of what the bank might accept as payment to release the lien on that asset. Some banks are stubborn and will not do a biased publication, but those who find that invoice factoring will help the client increase their working capital base will be willing to compromise. They will often agree to accept a percentage of the initial advances until the agreed payment of the loan is made. That reduces your exposure and enables your customers to take advantage of the benefits of invoice factoring. Also, the company has less debt to deal with.
In the case of a bond filed by the IRS for non-payment of payroll taxes, a similar arrangement is made. Typically a subordination agreement. With this legal document, the IRS agrees to allow the funder to have a senior position in the lien so that it is willing to continue the factoring relationship. In return, the agreement establishes that a certain amount of the advances will be made to pay the taxes on the delinquent payroll.
Whether the lien on the accounts receivable 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.