What is a Factoring Agreement?
A factoring agreement is considered to be a basic part of running a factoring business. A factoring agreement for clients sets forth the key business arrangements within a factoring relationship and is increasingly subject to negotiation in the factoring industry, as well as part of the basis for drafting agreements tailored to clients’ or their factors’ needs. If a client’s credit is good, the client often gets the standard form factoring agreement prepared by a factor and makes few demands on the terms of that agreement. If the client has any credit issues, however, the factoring agreement becomes much more or a negotiation than it is between two counterparties with stronger credit.
The fact that a client’s credit may dictate major portions of the business arrangements in any particular factoring relationship does not mean that the basic terms of a factoring agreement remain unchanged from transaction to transaction. The factors want to receive an adequate return on their investment , even when factoring businesses with poor credit. There is a corresponding need to make sure that the capital invested in a factoring transaction is not prematurely lost in transactions where the counterparty has shaky credit. Given this need, the factoring agreement’s core terms have been evolving over the past few years.
At the most basic level, a factoring agreement is an agreement between a factor and a client (the business entity factoring invoices) setting forth the terms and conditions under which the factor will purchase invoices from the client in exchange for a fee. Setting forth these terms is the need for the factoring agreement itself. Beyond this purpose, however, the factoring industry has added many terms to the basic factoring agreement to account for changing credit needs and circumstances.
Given the basic purposes of a factoring agreement, the purpose of each of the sections of a factoring agreement can be outlined as follows:
These purposes are the basic steps and critical business terms of factored transactions. Please note that these terms are constantly under review as both the counterparty industries and risks evolve.
Features of a Factoring Agreement Template
The key elements that should be included in a factoring agreement template are various terms of sale, recourse or non-recourse factoring, time periods, account databases, accounts receivables collections, and other agreements between both parties. A factoring agreement template should include a section that outlines the recourse versus the non-recourse factoring terms.
The factoring company may purchase some invoices for cash up front while retaining the risk on other invoices. This type of factoring does not give the factor any recourse in the event the customer refuses to pay. A non-recourse factoring agreement template might state that unpaid invoices may result in a buy-back by the client rather than the factoring company accepting the loss of its investment in those invoices.
A factoring agreement template may include sections that outline the practices of the factoring company in collecting on slow and uncollectible accounts. The factoring company may request that the factoring agreement template set out the procedures it will follow before reporting unpaid invoices to credit reporting agencies.
A factoring agreement template typically will require the business to inform its customers of the direct involvement of the factoring company in the collection of its valid invoices. Small businesses have some concern with notifying customers of their inclusion in a factoring arrangement as it can signal to those customers that the small business is experiencing financial problems.
A factoring agreement template may be used as a general form that is adapted for specific dealings with a factoring company or for a particular transaction. A factoring agreement template may be incorporated in the overall factoring agreement between a factoring company and its client.
Advantages of a Factoring Agreement Template
A factoring agreement template provides significant advantages over drafting an agreement from scratch. Writing and drafting a custom agreement can be extremely time-consuming. A factoring agreement template allows the drafter to focus on customizing key areas of an agreement while ensuring all necessary terms are included in the draft.
The structure of any agreement created is very important. A factoring agreement template has set the standard structure for such agreements. Without this structure, the drafter may inadvertently omit some crucial component. Most importantly, the specific components of a factoring agreement, certain terms need to be included. An example of such a component is the notice provision. The purpose of the notice provision is to designate to whom the parties are to issue notices regarding the agreement. If this is not done, the parties will likely have difficulty determining how to give the other party notice regarding certain issues.
In addition, using a template when drafting a factoring agreement can help a drafter ensure that he or she has a comprehensive understanding of the substantive legal provisions required for a valid agreement. A drafter may customize certain areas of the agreement but still have a solid understanding of the factors that need to be included. Writing or drafting an agreement from scratch may require extra research to ensure that the drafter is aware of all the substantive legal provisions needed for a valid factor agreement. This can be time-consuming, particularly if the drafter is not familiar with all of the provisions for such an agreement.
Finally, simplifying the process of creating an agreement can be very beneficial to offset costs and expenses. For instance, using a template may reduce the legal fees associated with the drafting and negotiation of the agreement.
Common Mistakes to Avoid in Factoring Agreement Drafting
Businesses, in a bid to cut costs or because they are short on time, may use an internet-sourced template or have an in-house lawyer create their factoring agreement. In either case, they run the risk of developing a one-size-fits-all document that doesn’t serve the particular needs of the business and allows loopholes for the factor to withhold funds or collect from your customers directly. It is important to work with an attorney to develop a factoring agreement tailored to your business plan.
Common pitfalls include:
• Ambiguous definition of Default: Factors often expect that a percentage of receivables will go bad. They do not expect all receivables to be collected on time and come due at the same time. A factor is expecting that default on some invoices is acceptable. It is, therefore, important to allow flexibility in your definition of default to reflect that the same percentage of default is acceptable, regardless of the total amount being factored.
• Personal Guarantees Made by an Owner/Officer with no Independent Business Assets: Owners/officers typically feel that their business’ assets must be sufficient to cover the factoring debt and therefore offer personal guarantees as an added security. While the creditor may not seek to enforce the guarantees if the business defaults, it is unlikely that the officers/owners would appreciate being sued or having to consider bankruptcy personally.
• Selling Accounts Receivable to More Than One Factor: Factors take into consideration the total accounts receivable balance, even if not factoring the entire balance. Multiple or split factoring can lead to confusion and potential double-dipping by factors trying to collect on the same invoice/receivable.
• No Limitation on Interest Charges: High interest rates are standard within the factoring industry. However, depending on the stated interest rate, the effective rate can be substantially higher. You must determine a maximum effective interest rate upfront.
• Failing to Create a Cleary Defined Dispute Resolution Process: A dispute resolution process should be included in every agreement. Failure to provide a defined process can lead to unnecessary litigation.
Customizing your Factoring Agreement Template
It’s important to remember that a factoring agreement template is just that—a template. It’s essential to customize this model to meet the unique needs of your business. There are a few factors that usually require tweaking when it comes to an agreement.
The scope of the agreement
When dealing with factoring agreements from a third party, always read through the clauses relating to the scope of the agreement and what is covered or not covered by it. Some of the most common are:
Collaterals: These generic agreements may not have the right clauses covering the collateral your business would like or the one they choose may not be suited to your associations or industry.
Pricing: The percentages that factorers offer generally differ depending on their policies, so the cost of financing could be more expensive for some. When looking at these agreements, be sure to check the cost of advancing money to your operation to see if there are any hidden costs.
Indemnification: This is one of the most sophisticated areas of any contract , so it may be best to get legal advice when going through it. This clause is there to cover finances if and when the business defaults and allocates risk. For example, if the debt is sold, the agreement should indicate who is responsible for it.
Understanding your options
If you aren’t completely satisfied with the changes you made to the template, then you may consider sitting down for a conversation with the other party. Many factoring agreements can actually be negotiated. If you’re unsure of how to move forward with the negotiations, you may want to consider finding expert legal advice from a law firm that specializes in commercial factoring and other financial services.
Is your business considering the use of a factoring agreement template? Let us help you understand them for future use —without hiring outside help or incurring fees! Call for help today.
Legal Issues in Factoring Agreements
When entering into a factoring agreement, there are several legal considerations that must be taken into account. The first is the governing jurisdiction. This pertains to where the principal office of the business, the buyers and sellers are located, and where the principal office of the factoring company is domiciled. It is advisable to obtain legal counsel from a factoring attorney who is licensed in the state where your business is located, along with the jurisdiction where the principal office of the factor is located in order to ensure proper compliance with both states’ laws.
In addition to determining the proper jurisdiction, companies should review the clauses in the agreement to ensure they meet compliance requirements. For instance, you must verify that the clause dealing with notification of ownership of accounts receivable complies with the Uniform Commercial Code ("UCC") and properly notifies the debtor or buyer of the change in ownership of accounts. Similarly, companies should review the clauses dealing with notice of assignment of accounts receivable to ensure that the clause accurately notifies the third parties related to the account that the account has been assigned.
Companies should also weigh the pros and cons of the clauses found in the factoring agreement, including the right of the factor to make demand for payment directly to the buyers or debtors; any costs, fees, or commissions, or fees to be paid to the factor; the payment terms for those fees and commissions; the personal liability of the owners of the company under the factoring agreement; the extent of control the factor has over the company’s business; and the termination provisions. Each clause in the factoring agreement has its own repercussions that will ultimately govern how the agreement works under certain circumstances. The impact of each clause should be weighed against the needs of the company.
Lastly, it is important for the company to consult an attorney who is experienced in factoring agreements to review the entire agreement and determine whether it is in the best interests of the company. In general, companies should rely on an attorney with a background in both factoring agreements and corporate law to ensure that the interests of the company are properly protected.
Selecting the Right Factoring Company
While searching for a promising factoring agreement template to use in your business, you could always find fluid templates for different factoring scenarios. You can trust that these free samples will give you a good foundation for the right factoring contract. Despite the availability of samples, finding the right factoring company is key towards reaping all the benefits such a contract brings.
In order to choose the right factoring company, it is essential that you do your homework. When searching online, look for these two things:
Although internet research is a good starting point, personal referrals and word of mouth will provide you with more reliable options. A preference towards local creditors should be high in your factor search list. The closer they are, the more chances are that you will meet a professional individual who will assist you with the factoring process. Once you have a few numbers you can call, you must pay attention to how they respond to your concerns and questions. Different companies will charge different fees, but there are industry standard rates and terms to strive for. Not all companies will give you the same deal, as they will strive to get the most out of your contractual partnership.
Stay away from companies that make your own concerns sound unimportant. If you don’t feel respected, there is no point in doing business together.
What other companies are saying is also important when selecting a factoring partner. Reviews are found all over the interweb, so looking around is the best thing to do in order to get all the relevant feedback. What information you will find online will help you understand how stable and capable a factoring company is.
Conclusion: How to Maximize the Benefits of Factoring Agreement Templates in Business
By embracing factoring agreement templates, businesses can streamline their financial management and gain greater control over their cash flow. Having a template in place ensures that they adhere to industry standards, keep things tax compliant, and maintain transparency in their financial dealings with factoring partners. This can be an invaluable resource for any business looking to grow and expand while effectively managing their receivables.
In addition to efficiency, these templates provide a roadmap for what to expect from a factoring agreement. They set clear expectations for both the business and the factor, minimizing the likelihood of disputes down the line. It’s the ideal situation for both parties.
For businesses that are just getting started with factoring, having a standard template can help reduce the time and expense associated with hiring legal counsel . This provides companies a free and easy way to determine if they are prepared to move forward with factoring, without requiring a big commitment.
It’s also worth noting that using a template helps to level the playing field and avoid additional costs along the way due to contract negotiations. And for those that might discover they need a bit more information or clause negotiation, there’s the option to bring in a professional.
With that said, many businesses and factors are able to draft, review, and understand the terms of the agreement once they’ve worked with a template. No matter the outcome, factoring is a highly effective way to leverage receivables to support and grow business. By utilizing a template for the agreement, they are improving their chances for success.