Figuring Out Factoring
By Henry E. Seaton
Reprinted from etrucker.com
Q We are a commercial factor that purchased the accounts receivable of small carriers, sending a factoring notice to their customers. One of our assignors who owes us substantial funds has convinced his customer to pay him directly, disregarding our notice. I know that is not legal; can you tell me why not?
A The role of the factor in the supply chain payment loop frequently is misunderstood. This question provides an opportunity to explain the rights and remedies of the factor (a secured creditor who purchases accounts receivables) and of the payor of freight charges – such as a shipper or broker – who receives the notice of assignment (an account debtor).
Article 9 of the Uniform Commercial Code governs the rights and remedies of secured creditors. Section 9-406 provides that an account debtor may discharge its obligation to the carrier only until it receives a notice of assignment. Once it has been so notified, the shipper or broker as the payor “may not discharge the obligation by paying the assignee.”
So shippers’ and brokers’ accounts payable departments must watch factors’ notices of assignments closely and not pay carriers directly until after the factor releases its assignment in writing. The UCC allows an account debtor to question the assignment and notification at the outset. But if the account debtor fails to do so or if the assignment is shown to be valid anyway, it has no option but to honor the payment notification.
After the assignment notice, the account debtor must pay assigned freight charges that are due and owing to the carrier in accordance with its contractual terms. In essence, the factor stands in place of the carrier, and that’s the extent of its rights to payment. Unlike a payor of a negotiable instrument, the factor is not a “holder in due course.” It cannot claim a right to payment if a shipper or broker takes advantage of any counterclaim or offset rights it might have related to services that predated the freight charges in question. See Section 9-404(a).
Typically, factors are sophisticated lenders and fare much better than unsecured creditors if their primary debtors – motor carriers – become insolvent or bankrupt. They have secured lender status and frequently personal guarantees, pledges of unsecured collateral and holdbacks that are unavailable to the account debtor if the carrier for some reason has an uninsured payment obligation to it. And since a factor has no obligation to refund freight charge payments it receives, shippers and brokers understandably are reluctant to lose the important right of offset by failing to withhold payment when the circumstances require it.
Sophisticated factors should ensure the shipping documents prove their assignor was the authorized carrier to whom payment is due. Since the factor has no greater collection rights than its assignor, most factors will not risk purchasing broker invoices unless the carriers have been paid. Otherwise, unpaid carriers could trump their collective efforts on unpaid freight charges.