If you are looking for the definition of factoring agreements, examples, and the most common terms included in these contracts, you are in the right place.
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In this detailed article, you’ll get information about the following subjects:
Factoring Agreement Definition
Important Disclaimer: This is an informational article, and we are not providing legal advice. We strongly suggest you consult an attorney before signing any contract.
What is a Factoring Agreement?
A factoring agreement is a financial contract that regulates the relationship between a factoring company and a client for the provision of invoice factoring services. These agreements define the financial obligations and rights between parties.
The invoice factoring process involves the purchase of outstanding invoices at a discount in exchange for advanced funding.
Typical Terms Included in a Factoring Contract
In this section, you can find widely used factoring terms and conditions included in factoring contracts.
Please be aware that these are not necessarily the terms included in our contracts. Conditions vary from factor to factor, and our intention in this article is to detail the most widely found in the industry.
Purchase Price and Advance Rates
Each invoice’s purchase price is calculated by taking the original invoice’s face value and deducting all the discounts the client offers to the debtor.
The advance is a percentage (rate) of the purchase price of outstanding invoices sold. That percentage multiplied by the purchase price is the upfront cash the client receives at the time of the accounts receivable purchase transaction.
This money received upfront is not the total cash the client gets. The difference between the purchase price and the advance minus fees and required reserve amounts is sent by the financial institution to the customer when the debtor pays.
Advance rates, typically from 60% to 99%, tend to depend on the industry to which the client belongs. Here you can find more information about factoring advances and their calculation.
Most contracts, especially the full recourse ones, authorize the factor to require and maintain a reserve amount. This reserve is cash collateral that the factoring company holds to protect its interests in the case payments cannot be collected, or other possible disputes arise. The collected amounts exceeding the required reserve amount are released to the client on an ongoing basis, typically once a week on a pre-agreed day.
Credit Facility & Customer Limits
Accounts Receivable Purchase Minimums
Contracts typically stipulate minimum purchases. These thresholds consist of a minimum monthly volume of sales that the client agrees to factor.
After credit checks and analysis and based on debtors’ credit risk assessment, factors establish maximum purchase amounts and facility line limits. At its discretion, the factor can adjust these limits to support the client’s growing funding needs.
Costs of Invoice Factoring
Factors get commissions and fees in compensation for their invoice advance services. The costs of factoring usually consist of two types of charges, a discount fee based on the value of the invoices purchased and other miscellaneous fees to cover administrative expenses or as penalties for not reaching milestones or complying with obligations agreed on the contract.
These are the commissions that a client pays based on the face value of invoices sold. These factoring fees are calculated by applying a factoring rate (or discount rate) on either the purchase price or the amount advanced.
The discount rate definition varies from factor to factor. Here are some examples of factoring rate structures that you may find:
- A variable rate based on The Wall Street Journal’s published Prime Rate plus some additional discount is charged for every day the money is advanced.
- A fixed percentage is calculated on the invoice amount and charged every 30, 20, or 10 days or any other combination.
- In some specific cases, particularly in the transportation industry, some factors charge a fixed percentage of the invoice value, no matter the days it takes to collect the invoice (within some limits).
You can find detailed information about factoring rates and discount fees here.
Other Miscellaneous Fees
These fees vary widely from factor to factor, and you may find different names for similar types of costs.
Some factors tend to charge much higher factoring fees and discount rates (mentioned in the section above) and fewer miscellaneous fees. Others have lower factoring rates but more of these fees in their contracts. You need to make numbers considering all costs before deciding what deal is the best for your business.
Some fees cover administrative expenses and activities, like widespread processing, administration, set-up, wire, or facility fees.
Others, such as reserve shortage fees, misdirected payment, and termination fees, are penalties when the client doesn’t comply with some agreed terms.
Other Miscellaneous Receivable Factoring Terms
Receivables Purchase Agreement Initial Term and Renewals
All contracts include a clause defining the length of the initial term, and typically most also include auto-renewal provisions. It is common to require the clients to communicate by certified written notice, at least a month or two before the renewal date, that they don’t want to renew the service.
Some factoring companies deduct required reserve amounts and set-up fees from the initial funding.
Collections By Seller
Under a contract, sellers are not authorized to collect payments from debtors. If this happens, some clauses define the process the client must follow to send the amounts to the factor and penalties if the required steps are not obeyed.
All contracts have security agreement terms demanding collateral to secure the payment of amounts owed and compliance with other financial obligations by the seller.
The client has to agree to grant the factor the right to file a lien on the business assets. This lien is a first-priority security interest against losses and is formalized as a UCC Filing (Uniform Commercial Code). Business assets include, but are not limited to, accounts and current invoices, chattel paper, inventory, equipment, furniture, bank accounts, deposits, real estate, securities, contract rights, intellectual property, and other intangibles.
Most contracts include the obligation to notify debtors about the sale of the receivables. This notification is called a “Notice of Purchase” or a “Notice of Assignment.” You can find more information later in this document in the FAQ section.
Default and Remedies
All contracts include terms specifying remedies in the event of default. Default events may include but are not limited to:
- The client does intentional debt collections.
- Failure by the client to provide financial information when required.
- The seller becomes insolvent or files for bankruptcy.
- Any fraudulent activities performed by the client.
- Failure by the client to notify the factor about disputes with debtors.
- Client failure to pay taxes.
- Any other client failure regarding compliance with the obligations agreed.
- The client refuses to continue the relationship before the agreed initial or renewed period has passed.
Penalties in the Event of Default
In the event of default, the factor may choose to terminate the agreement and, in some situations, take other steps allowed by the contract to collect amounts owed.
When an agreement is terminated, the factor will try to collect all the fees and advanced amounts due. It will also charge a termination fee if the contract period has not expired or the client has not fulfilled other obligations.
All contracts include terms defining steps to follow in disputes between the parties, the State governing laws that apply, the courts to be used in case of a lawsuit, and who is required to pay for attorney fees.
Clauses Specific to Some Types of Factoring Contracts
Usually, terms vary depending on whether the service is provided on a full or non-recourse basis.
Accounts receivable factoring agreements with recourse contain clauses explaining what happens when the factor cannot collect purchased invoices within a defined period. In this situation, the client must pay back the invoice amount(usually a charge-back) and recourse fees.
Non-recourse factoring agreements may require the client to get credit insurance.
Seven Sample Business Factoring Agreements
As promised earlier, here are some real examples of factoring contracts. (Click to download PDF files)
If you want an example of our typical contract, don’t hesitate to contact us or call 1-855-424-2955.
Frequently Asked Questions
Are factoring agreements templates?
Even when some clauses are similar among factoring companies, the factoring industry does not have standard contracts. Each factor, with the help of corporate attorneys, develops its unique contract customized to its desired terms and conditions. These documents are usually modified to fit each client.
It’s improbable to find an invoice factoring agreement template used by more than one factoring company.
How to get out of a factoring contract?
Factoring arrangements include termination provisions, and you can terminate your contract anytime. But, before you do it, we recommend you consult your attorney and carefully read your termination rights and obligations.
As long as there are no disputes, you can usually exit the agreement when the initial period or renewal periods agreed have expired, all the factored accounts are collected, and all the owed fees are paid. At that time, the factor releases the balance of the reserve account.
Exit termination of a factoring agreement is not that simple if your agreed initial contract term or renewal time has not passed. In this case, you may typically have to pay administration fees and penalties, such as termination fees. You won’t easily be able to get out of a contract if any dispute exists or if there are unpaid invoices or due charges.
What happens with a factoring agreement in bankruptcy procedures?
The way bankruptcy affects a factoring arrangement depends on the time of the Chapter 11 filing.
If your company signed a factoring agreement before bankruptcy and has already been factoring invoices, the effects will depend on the terms defined in your contract:
- Some factors may agree to continue the relationship if you have creditworthy debtors, typically after collecting a DIP fee.
- If instead, the factor is convinced about your company or your debtors’ financial inability to pay, it may terminate the contract after collecting liquidation fees.
Suppose your company is ready to file for bankruptcy or is already in Chapter 11 when you are looking for factoring services. In that case, some companies like ours may be willing to offer to finance and will work with your counsel to arrange a DIP financing facility.
We provide debtor-in-possession factoring services to B2B companies in bankruptcy. Here you can find more information about DIP Financing.
What is a Notice of Assignment in a factoring arrangement?
An “NOA” or “Notice of Assignment” is a written communication sent to business owners (client’s debtors) informing them that the factoring company now owns the receivables. It also instructs the debtor to submit payments to the factor instead of the vendor.
What is the difference between factoring and invoice financing contracts?
Invoice finance is a loan that uses invoices as collateral. Invoice factoring is not a loan but the purchase of outstanding invoices at a discount. Because factoring is not lending, you won’t find the typical terms in loan contracts, such as origination fees and monthly or weekly repayment terms, in a factoring arrangement.
Do factoring companies charge origination fees?
No, origination fees are charged when loans are issued, and as explained in the previous question, invoice factoring is not a loan.
Would You Like Personalized Information?
If you would like to talk to our managing director about our receivables purchase services and get a proposal with customized business terms for your company, please call 1-855-424-2955. We serve a wide variety of industries.