Factoring or Receivables Contracts
The lending practice known as “factoring” provides companies with an upfront payment in exchange for an automatic withdrawal from the company’s account, usually on a daily basis, to pay back the “loan.” The collateral for these “loans” are the businesses’ sales or accounts receivable. These contracts are a method for a business to raise cash quickly as opposed to collecting after customers over a period of months
Factoring or Receivable contracts may specifically include words to the effect that “This is not a loan.” Words of this nature are an attempt to avoid the exorbitant effective interest rates of these arrangements, and therefore liability under a state’s usury statutes. Effective interest rates in these instances can be anywhere from 16% on up. Our firm has seen an interest rate of more than 100%.
One court in a case in New York held that a transaction will be considered to constitute a loan where there is be a borrower and a lender; and it appears that the real purpose of the transaction was, on the one side, to lend money at usurious interest reserved in some form by the contract and, on the other side, to borrow upon the usurious terms dictated by the lender. Donatelli v. Siskind, 170 A.D.2d 433, 434 (2nd Dep’t 1991).
The significant issue to be determined is whether the particular transaction under scrutiny was made in good faith and not as a cover for a loan (72 NY Jur.2d, Interest and Usury § 85), and what effect to give to the required guaranty, a significant factor to be considered in determining whether the transaction is in fact a loan or a purchase and sale.
The area of construction is fertile ground for factoring companies. General construction contractors and subcontractors can be cash-strapped to pay for overhead and depend on loaned money to conduct or complete major construction projects, all the while committing to a daily payback schedule. Liquidity in the construction industry is rare, and credit is typically unavailable from traditional bank lending. The calls our firm gets are from those whose businesses are crippled by this commitment almost to the brink of bankruptcy.
The silver bullet for the factor against its defaulting client is one of the required documents at the time of the execution of the factor contract. It is known as the Confession [or Affidavit of] Judgment. It allows the factor to utterly bypass a lengthy litigation process and achieve Judgment almost immediately. A factor need only file an executed Confession of Judgment and levy on the business assets and sometimes personal assets of the principal(s). A construction company could wake up one day to find multiple assets frozen by the Court’s expedited Judgment.
The reality in the business is that contractors may struggle to finish projects with little or no profit and obtaining retainage, payment balances and overdue modifications or change orders is an expensive and delayed process. A typical factoring transaction involves an invoice or a “receivable.” In its contract to assign the receivable, the factor is entitled to a fee scale based upon its set percentage of the receivable and the probability of timely payment.
Factor or receivable assignments can obviously provide the needed cashflow for a company to pay its workers and purchase materials. But the daily debits from the accounts over time can cripple the business. Absent other provisions protecting the factor, bankruptcy discharge may not always protect the defaulting company. Obviously, the preferred route is to turn to traditional bank lending with disclose interested rates with repayments on schedules other than daily. If you have no option other than to use a factor, a contractor can protect him/herself by abiding by certain standards: use a well-known factor that knowledgeable and sympathetic to the business of its client; be sure you have enough money to pay workers, vendors and the like; be certain all appropriate legal notices are properly filed; maintain comprehensive books and records pursuant to law, and by all means, consult and retain experienced attorneys to guide you through the waters.
Should you have an issue with a Factoring or Receivable assignment contract, contact our attorneys in New York City or Long Island for consultation at (212) 835-1532