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.


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