Factoring: Recovering on Accounts Not Purchased

When I first started representing factors, the Client sold all of its accounts to the Factor although all accounts were not eligible for advances.  Back then, factoring was on a maturity basis and although advances were made at the time the account was assigned, the advance was made as a loan which was repaid when the purchase price was paid on the average maturity date.  Factors received a factoring commission (discount) plus interest on the advances made through the maturity date when the Factor paid the purchase price.

Also, the Factor purchased all of the Client’s accounts – even those that were not credit approved.  The Factor might have even made advances against non-credit approved accounts.  The denial of credit approval might have had nothing to do with the credit worthiness of the account debtor -it could have been because the Factor had already taken on the maximum risk it was willing to take for that account debtor.  Or, the Factor might not have been willing to take any risk for that account debtor.  In those situations, the Factor would likely not even advance against the non-credit approved account unless it felt the Client was strong enough to absorb the loss.

In modern factoring, the Factor often purchases accounts and pays for them immediately, maintaining a reserve for potential losses, which reserves might be released from time to time, especially after receipt of payment on the accounts purchased.  Often, in modern factoring, factors do not purchase all of the Client’s accounts.  In those situations, factors typically take a security interest in other assets including the accounts not purchased.  This is to protect the factor from losses when it purchases accounts with recourse.

A recent case from the Superior Court of Connecticut needs to be considered as it may cause concern to the factoring industry.

Factor King entered into a factoring agreement with AEG of New England, LLC and send notification letters to account debtors including the Housing Authority for the City of Meriden, CT (the “Housing Authority”).

The factoring agreement also granted Factor King a “first priority security interest in the Collateral.” Collateral was defined as “all [AEG]’s now owned and hereafter acquired Accounts, Chattel Paper, Inventory, Equipment, Instruments, Investment Property, Documents, Letter of Credit Rights, Commercial Tort claims, and General Intangibles.”

Thereafter, the Housing Authority made a payment in the amount of $2,217,750 to AEG (not Factor King) for work performed for the Housing Authority.  As you can imagine, Factor King demanded payment from the Housing Authority and eventually brought an action to recover the wrongful payment.

Factor King argued that when an account debtor receives notice that an amount due on an account has been assigned and that payment is to be made to the assignee, it cannot pay the assignor to discharge the debt and that if the account debtor does pay the assignor, it remains liable to the assignee for the same amount . See UCC § 9-406(a).  Factor King further asserted that it had a claim for an account stated because there was a fixed amount owed by the Housing Authority to AEG, AEG had assigned all of its accounts to Factor King, and the Housing Authority received notice of this assignment.

The Court, however, noted that the flaw in Factor King’s argument was that it had provided no evidence that the amount the Housing Authority paid to AEG was on invoices that Factor King had actually purchased from AEG pursuant to the factoring agreement.

The Court noted:

The factoring agreement demonstrates that [Factor King] did not purchase any accounts receivable simply by entering into the agreement. Pursuant to the agreement, AEG would offer to sell certain accounts to [Factor King], accounts that would be listed on a schedule, and [Factor King] could decide which accounts to purchase. Indeed, the factoring agreement provides that [Factor King] may decline to purchase an account, and appears to contemplate the purchase of only “Eligible Accounts,” defined as “an Account that is acceptable for purchase as determined by [Factor King] in the exercise of its reasonable sole credit or business judgment.”

The Court also noted that

Without exercising its option to purchase an invoice offered for sale by AEG, there would be no transfer of the legal right to receive payment on those invoices.

[Factor King] has submitted no evidence that it was assigned a specific legal right to recover on the specific invoices related to the alleged misdirected payment. *** Accordingly, [Factor King] is not entitled to summary judgment on its account stated claim.

Pleading a goods sold and delivered or services rendered complaint is not a difficult task but certain things must be kept in mind in order to better assure recovery.  Other courts have recently held that a secured party does not have an independent cause of action to recover on collateral pledged.  Thus, the drafter needs to assure that the complaint demonstrates the secured party’s right to recover and how that right was derived.

It is unclear from the published decision whether Factor King asserted its rights as a secured party (as opposed to a purchase) or whether the Court just got it wrong.

TAKE AWAY:  The “old” method of purchasing all accounts but only advancing against eligible accounts should be considered in your factoring agreements.  Also, when taking a security interest in all assets and placing account debtors on notice of the factor’s rights to the accounts and their proceeds, the factor is acting as a secured party and not as an owner of the accounts and needs to enforce its security interest in order to collect those accounts as a secured party.

 Factor King, LLC v. Housing Authority for the City of Meriden et al.


Forum Shopping. An Important Tactic.

George Orwell wrote in Animal Farm, “All animals are equal, but some animals are more equal than others.”  W.C. Fields created a film (using one of his favorite statements) “Never Give a Sucker an Even Break.”  Each of these is an important lesson in contemporary bankruptcy and litigation practice.

Although judges are subject to great scrutiny before being accepted for their positions, not all judges are created equal, nor are all courts created equal.  There are trends and local precedential rulings that may make some courts more favorable than others.  Similarly, there are some benches that may be more or less desirable for a particular matter.

Some judges are quick in making decisions while others delay.  Some are busy yet remain sensitive to the exigencies of the matters before them, while others (as in any other trade) are more concerned with their Friday morning golf game than the emergency motion filed late on Thursday.

Some have an incredible insight to the issues before them while others, despite superior academic credentials, just can’t see the forest from the trees.

The fact is that your legal matter is important and the last thing you want is to be stuck with a judge that has a preconceived prejudice against you or your client or your legal issue.

Nearly thirty years ago, when Eastern Air Lines was preparing to file its Chapter 11 proceedings it wanted to file in New York, a favorable bankruptcy court for the issues that Eastern envisioned would be confronted.  In order to qualify to file in New York, Eastern needed an affiliated debtor that could file in the Southern District of New York.  Ionosphere Clubs, Inc., the airline’s first class lounge was located in New York and became the lead debtor in a complex case, which enabled Eastern to file in New York where it felt it would be treated better that it might be treated elsewhere.

Things have not changed since the Eastern Airlines case.

The recent Chapter 11 filings by Sears are an excellent example of the importance of forum shopping.  Sears, headquartered in Illinois, along with some 50 affiliates organized under the laws of Delaware, Michigan, Florida, Illinois, Washington, Texas, Pennsylvania and New York selected the Southern District of New York to file its cases.  And not only did they file in the SDNY, where there are three sub-jurisdictions (Manhattan, Westchester and Poughkeepsie) they filed in Westchester County, where there is only one bankruptcy judge, thus assuring the particular judge that will preside over their cases.

Whether you are a lender about to provide accommodations to a soon to be debtor-in-possession or any other party about to commence a lawsuit, it is important to know and understand the court to which you are about to subject yourself.  Should the action be commenced in state or federal court?  Should it be brought in another available jurisdiction?  Is arbitration an available method to resolve the dispute?  Each available option should be considered.

While recently researching for an article I was asked to write on merchant cash advance litigations.  I noticed that MCAs are doing better in some courts than in others. So of course, they are bringing their actions in the courts where they are treated better.

While this blog is traditionally devoted to cases in being, this posting is more generic and intended to advise lenders to be careful before committing to an unknown jurisdiction where your worst nightmares may be experienced.

Litigation remains a chess game where the strategy must be carefully considered before obligating yourself to a forum.

The Guaranty: The Document of Last Resort

Once upon a time (before the time of computer-based loan documents) asset-based lenders utilized a pre-printed 4-page Security Agreement (Accounts Receivable) and similar documents to immortalize their agreements with their borrowers.  These agreements were printed on a single 11×17 piece of paper with a cover page (titled Security Agreement (Accounts Receivable) and identification of the parties), 2 pages of terms and conditions (in 20 or so paragraphs) and page 4 – the critical last page after the fold, the Guaranty.

These pre-word processing agreements were rarely negotiated except for a rare change typed in the margin by iteration with an asterisk to note the place of the change.

Life was simple and, unlike today, lawyers were not making a living negotiating ABL loan agreements.

Page 4 remained the critical document, conveniently hidden on the last page and containing critical waivers that protected the lender should the borrower or its principal do the wrong thing.

As a practitioner in the twenty-first century I enjoy making a living when borrowers attempt to negotiate the most mundane terms of a Loan and Security Agreement.  I am skilled at finding a middle ground protecting my lending clients while accommodating a language issue raised by borrower’s counsel who is demonstrating his worth to his borrower client.

But when it comes to negotiating terms of a Guaranty, I am reminded of my mentor when I was cutting my teeth as an ABL lawyer, who said to a borrower trying to negotiate a guaranty: “Do you want to borrow my money? Are you going to pay it back? Then just sign the agreement.”

A recent decision out of the Superior Court of Pennsylvania, is indicative of the power of the personal guaranty.

Borrower obtained a loan from Lender, which was secured by a note giving Lender a lien and security interest in Borrower’s asset (i.e., the collateral for the loan). In pertinent part, the Lender’s note provided that Borrower would pay the outstanding balance and interest by a certain date or a default would occur under the note.

The Borrower’s principal gave a guaranty, which provided (in part):

For good and valuable consideration, Guarantor absolutely and unconditionally guarantees full and punctual payment and satisfaction of Guarantor’s Share of the Indebtedness of Borrower to Lender, and the performance and discharge of all Borrower’s obligations under the Note and the Related Documents. This is a guaranty of payment and performance and not of collection, so Lender can enforce this Guaranty against Guarantor even when Lender has not exhausted Lenders remedies against anyone else obligated to pay the Indebtedness or against any collateral securing the Indebtedness, this Guaranty or any other guaranty of the Indebtedness. Guarantor will make any payments to Lender or its order, on demand, in legal tender of the United States of America, in same-day funds, without set-off or deduction or counterclaim, and will otherwise perform Borrowers obligations under the Note and Related Documents.

The guaranty also specifically stated that the:

 Guarantor also waives any and all rights or defenses based on suretyship or impairment of collateral…. [and the guarantor also] waives and agrees not to assert or claim at any time any deductions to the amount guaranteed under this Guaranty for any claim of setoff, counterclaim, counter demand, recoupment or similar right, whether such claim, demand or right may be asserted by the Borrower, the Guarantor, or both

These very standard guaranty provisions should never be overlooked or negotiated away.

We will save you the gory details of this case other than to point out that the guarantors claimed that the guaranty and the related agreements were against public policy.  The Court ruled:

Public policy is more than a vague goal which may be used to circumvent the plain meaning of a statute. …

Public policy is to be ascertained by reference to the laws and legal precedents and not from general considerations of supposed public interest. As the term “public policy” is vague, there must be found definite indications in the law of the sovereignty to justify the invalidation of a contract as contrary to that policy. Only dominant public policy would justify such action. In the absence of a plain indication of that policy through long governmental practice or statutory enactments, or of violations of obvious ethical or moral standards, the Court should not assume to declare contracts contrary to public policy. The courts must be content to await legislative action.

It is only when a given policy is so obviously for or against the public health, safety, morals or welfare that there is a virtual unanimity of opinion in regard to it, that a court may constitute itself the voice of the community in so declaring. There must be a positive, well-defined, universal public sentiment, deeply integrated in the customs and beliefs of the people and in their conviction of what is just and right and in the interests of the public weal. Only in the clearest cases, therefore, may a court make an alleged public policy the basis of judicial decision.

The court declined to follow the guarantors’ suggestion recognizing that UCC section 3-605 explicitly permits a separate agreement of a party to waive the defense of impairment of collateral.

Appellants signed separate agreements—the guaranties—explicitly waiving “any and all rights or defenses based on suretyship or impairment of collateral….. [Guarantors] have not argued they are not parties. Accordingly, after construing the plain language of the statute, as we must, …because [Guarantors] signed separate agreements providing for waiver, section 3605 does not permit [Guarantors] recourse. [citing UCC -3605(i)(2)].

[Guarantors] however, argue that their waiver—notwithstanding the language of section 3605—violates the … UCC’s anti-waiver provisions. ….[Guarantors], however, have not presented any argument addressing the present version of Article 9 and any pertinent anti-waiver provisions. Absent any such argument, it would be inappropriate for us to adopt the[ir] reasoning …

Bottom line is that the guaranties were upheld and the Lender was entitled to recovery.

Always keep in mind the value of a personal guaranty.  Whenever a borrower protests the terms of a guaranty I am reminded of the wisdom of my client-mentors when I was cutting my teeth as an ABL lawyer, “Do you want to borrow my money? Are you going to pay it back? Then just sign the agreement.”

In these times of extraordinary competition and the need to employ funds are you willing to ignore that sound advice?



  1. Michael Hartley and S. Kent Hartley v. Stephen J. Hynes, Douglas J. Hynes, Leslie A. Hynes and Midlantic Erectors, Inc. (October 19, 2018) 2018 WL 5093975


Borrower made an assignment for the benefit of creditors and assignee briefly operated the business pending an auction.  Following the auction conducted by the assignee, Bank brought an action against Guarantor for a deficiency judgment as well as for actual fraud.  The fraud claim was dismissed after the Bank presented its case, but the deficiency judgment was granted.

Guarantor appealed arguing that (1) he did not owe a deficiency because the trial court improperly applied the law regarding the commercial reasonableness of the disposition of Borrower’s assets at the auction and because the disposition was not commercially reasonable, and (2) in the alternative, the trial court erred in calculating the amount owed in the deficiency judgment.

The Guarantor later argued that the assignor/auctioneer was acting as an agent of the Bank.

The Bank responded by pointing out that it had no duty to show the sale was commercially reasonable because it did not market or sell Borrower’s assets, the assignee handled the liquidation of Borrower, including the sale of assets. The Bank asserted in the alternative that even if it had to establish the question of commercial reasonableness, the evidence in the record established that the sale was commercially reasonable. The Bank also maintained that the trial court did not err in calculating the deficiency judgment.

The record demonstrated that the Borrower opted to enter into an assignment for the benefit of creditors to wind down the business and that the Bank suggested that Borrower retain the assignee. The Borrower’s board of directors and shareholders executed a trust agreement and an assignment for the benefit of creditors which specifically named the assignee.

The Borrower transferred its property to assignee “so that the property so transferred may be expeditiously sold or liquidated” with the proceeds distributed to creditors. Pursuant to the ABC, a trust was created and “its object shall be the orderly liquidation of assets and property of [Borrower] and the distribution of the proceeds of the liquidation to creditors of [Borrower.]” Assignee’s duties were to sell and dispose of secured creditors’ collateral, pay the unsecured creditors off with funds not subject to any valid liens, and “to do and perform any and all other acts necessary and proper for the orderly liquidation or other distribution *** and the distribution of the proceeds therefrom to the creditors of Borrower.

The trial court addressed Guarantor’s counsel, stating:

The problem you have, is that there just is inadequate testimony that had [assignee] acted in a different way, or the bank acted in a different way, there would have been a different result.

The appellate court, wrote:

[The UCC] provides that, “[a]fter default, a secured party may sell *** or otherwise dispose of any or all of the collateral ***.” Unless there is an agreement to the contrary, the debtor is liable for any deficiency that results from the sale ***. Absent such an agreement, the only defenses available to a debtor against a deficiency judgment are lack of reasonable notice of the sale and commercial unreasonableness of the sale.

The court further stated:

An assignment for the benefit of creditors is a voluntary transfer by a debtor of [its] property to an assignee in trust for the purpose of applying the property or proceeds thereof to the payment of [its] debts and returning the surplus, if any, to the debtor. ***A debtor may choose to make an assignment for the benefit of creditors, which is an out-of-court remedy, rather than to petition for bankruptcy, because assignments are less costly and completed more quickly.*** The assignment is  ‘a unique trust arrangement in which the assignee (or trustee) holds property for the benefit of a special group of beneficiaries, the creditors.’ *** The assignee owes a fiduciary duty to the creditors. Absent some defect in the creation of the assignment itself, an assignment passes legal and equitable title to the debtor’s property from the debtor to the assignee. In such case, the assignment is valid without the consent of any of the debtor-assignor’s creditors

The appellate court affirmed the trial court’s rejection of Guarantor’s argument that the assignee was an agent for the Bank, finding that Borrower retained the assignee and that under the UCC a disposition by an assignee for the benefit of creditors is, by statute, commercially reasonable.

Even if the Bank was required to prove that the sale ***was commercially reasonable, section 9-627(c)(4) provides that a sale approved by an assignee for the benefit of creditors *** is commercially reasonably. “Every aspect of a disposition of collateral, including the method, manner, time, place, and other terms, must be commercially reasonable.” *** “commercially reasonable” means that the disposition is made: (1) in the usual manner on any recognized market; (2) at the price current in any recognized market at the time of the disposition; or (3) otherwise in conformity with reasonable commercial practices among dealers in the type of property that was the subject of the disposition. *** Whether a sale is commercially reasonable is a question of fact.

So what are our takeaways from this case?

  • A lender will not be liable for commercially unreasonable disposition of collateral if it did not sell the assets.
  • The assignee (or consultant) retained by the borrower (and approved by its board and officers) will not be deemed to be an agent of the lender.
  • The assignee in an ABC owed a fiduciary duty to the creditors of the assignor.
  • Notwithstanding, a sale by an assignee in ABC is commercially reasonable by statute.

The court noted that ABCs are less costly and completed more quickly.  This method of liquidating a company has had a significant renaissance in recent years for this very reason.  Where small and middle market Chapter 11 cases once dominated the Bankruptcy Court dockets they are now rare.  Small and middle market companies just cannot afford to go bankrupt.

This case is a good example of how ABCs are effectively taking the place of small and middle market liquidating Chapter 11s and the benefits of that process.


MB Financial Bank, as successor in interest to American Chartered Bank v. Clayton D. Jacobs and Dwyer Products Corp., Appellate Court of Illinois, August 23, 2018, 2018 IL App (1st) 171939-U

Caveat: Right to Assign versus the Power to Assign

It is common for parties to include provisions that prohibit the assignment of a document or the rights thereunder.  Section 9-408 is entitled Restrictions on Assignment of Promissory Notes, Health-care Receivables, and Certain General Intangibles Ineffective.  In fact the Official Comments to 9-408 states:

This section makes ineffective any attempt to restrict the assignment of a …. promissory note, whether the restriction appears in the terms of the promissory note…….

9-408 states, in part:

… a term in a promissory note … which term prohibits, restricts, or requires the consent of the person obligated on the promissory …. the assignment or transfer of… the promissory note, … is ineffective to the extent that the term:

A recent decision from the Delaware Bankruptcy Court sheds light on why you may not take comfort in the protection described in the Official Comment.

The Delaware case involved the proof of claim filed by a purchaser of three notes. The Debtor objected to the claim on the grounds that the notes were not assignable.  The Note provided:

Neither this Note, the Loan Agreement ….. nor all other instruments executed or to be executed in connection therewith . are assignable by Lender without the Borrower’s written consent and any such attempted assignment without such consent shall be null and void.

The Court noted that claims trading has changed the face of bankruptcy and that the claims trading industry is “robust and fruitful” and added: that

Delaware courts, while ‘recognize[ing] the validity of clauses limiting a party’s ability to assign its rights, generally construe such provisions narrowly because of the importance of free assignability.’

However, the Court focused on the distinction between the power to assign and the right to assign.

Citing a prior decision the Court said:

When a provision restricts a party’s power to assign, it renders any assignment void.  . However, in order for a court to find that a contract’s clause prohibits the power to assign, there must be express language that any subsequent assignment will be void or invalid. Without such express language, the contract merely restricts the right to assign.

The Court concluded that by including the language contained in the Note – “attempted assignment without such consent shall be null and void” – denied the seller of the Note the power to assign, rendering the assignment void.

The buyer of the Note argued that the anti-assignment provision should not be effective because the debtor breached the terms of the note and its loan agreement.  The Court dismissed this argument.

The Court then engaged in an analysis of 9-408 that we believe to be flawed, and we will not discuss it here.

The Court concluded that the anti-assignment clause denied the seller the power to assign and was legally binding.  Thus, the Court held that the transfer of the Note was void.

Had the agreement between the seller and the buyer provided that the buyer could  enforce  the seller’s rights in the Note, the outcome may have been different.  Instead, the debtor’s objection to the proof of claim filed by the buyer was allowed and, we assume, that the time for the seller to file a proof of claim had passed, resulting in a windfall to the debtor’s estate at the expense of the buyer of the notes.

The point is that when taking a note (or other included obligation) by assignment be sure to do sufficient due diligence to assure that the seller of the note has the power to assign.


In re Woodbridge Group of Companies, LLC, 2018 WL 3131127, June 20,2018