Non-Recourse Factoring

To understand the concept behind non-recourse factoring, one must first understand the history of factoring. Imagine you are a tea merchant in Southampton, England, in 1780. The colonies in America are now a sovereign nation, and the British are emigrating to the states in record numbers, creating a strong demand for English tea. Distributors start popping up in places like Boston, New York and Wilmington. You want to sell your tea to distributors in the new country, but this is a tremendous risk. You need to fill a boat with your commodity, sail it to America, unload your tea in Boston Harbor, and then hope that you receive payment from the American distributor at some future date.

In the days before Dun & Bradstreet was a household name and Al Gore invented the Internet, merchants in the old country had to rely on a network of trusted people who could vouch for the creditworthiness and trustworthiness of customers in the new country. In some instances, the trusted people themselves became trade merchants who not only would vouch for the buyer, but who would also take the risk of non-payment out of the transaction by either fronting the cash to the seller in England or by actually taking possession of the goods, paying the English merchant, retitling the goods, and flipping them to the ultimate buyer. Credit may or may not have been part of the final transaction.

These early trade merchants were the first known factors. As business practices evolved, so too did the factoring industry. Eventually, factoring companies began not only vouching for the buyer and fronting money to the seller, but also collecting the sales proceeds directly from the buyers and passing the collections along to the seller, minus a factoring commission. Since the factor was advancing funds to the seller and was being paid to vouch for the buyer, the seller had no risk in the transaction if the buyer turned out to be a bad egg. The factoring company was out whatever it advanced to the seller. This became known as non-recourse factoring.

For the first 200 years, factoring companies stuck with industries they knew best: apparel, dry goods, textiles and furniture. By concentrating in the eastern United States and sticking with known industries, they could continue to collect fees for their expertise in vouching for the creditworthiness of their clients’ customers.

In the late 20th century, entrepreneurial factoring companies entered the scene, offering most of the services of the old-line factors, minus the voucher for the buyer. In this stage of factoring evolution, the factoring company became more a financial institution than a trade merchant. Fewer and fewer factoring companies offered non-recourse factoring because the risks were simply too great and the rewards too minimal. Hence, “recourse factoring” (also known as “full-recourse factoring”) was born.

Today, some factoring companies advertise non-recourse factoring as a gimmick to attract recourse factoring business. Very few are true non-recourse factoring arrangements. Agreements can be cleverly drawn so that many loopholes exist, loopholes that allow the factor to revert to the seller any invoice, whether it was purchased on a non-recourse or full-recourse basis. Often, the client is sold a supposed non-recourse factoring arrangement, but nothing the client sells to the factor “qualifies” for non-recourse treatment. A side agreement is then made to allow the factor to buy certain receivables on a full-recourse basis and others on a supposedly non-recourse basis.

In any event, many of the risks of non-payment are never fully transferred from seller to factor regardless of how the transaction is defined. For example, if there is any dispute (real or imagined) between seller and buyer, the factor can put the invoice back to the seller. If the buyer is in breach of any part of the factoring agreement, any invoice factored during such breach may be put back to the seller.

Recently, the concept of “modified non-recourse factoring” has evolved. The term usually refers to a factoring transaction in which the factor will assume the “credit risk” of the buyer for a limited time after the factored invoice becomes due. In most factoring agreements, “credit risk” means the bankruptcy of the buyer. In a modified non-recourse arrangement, the factoring company is essentially vouching for the buyer up to a point. For example, a typical modified non-recourse arrangement protects the seller from any potential buyer bankruptcy filings for a period of 60 days after the due date of the invoice. If there is a bankruptcy filing by the buyer between the date the invoice is factored and this prescribed period, the factor takes the hit. If for any other reason the invoice is not paid by the buyer (after the prescribed period), the factor puts the invoice back to the seller and the seller takes the hit.

Author: Tony Furman
Copyright 2009
Interstate Capital Corp.

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