How Factoring Companies Deal With Existing Liens on Accounts Receivable

When a business owner wishes to engage in an invoice factoring relationship, the factoring company performs due diligence to insure that the potential client is a good fit. One facet of this process is a lien search, which gives the factor adequate assurances that they will have clear title to the client’s receivables. This is critical, as the factoring company will be advancing sizable funds to the client.

The reason a clear title to the pool of receivables is important is illustrated by the following example: Let’s say the factoring company has advanced 80% of the face amount of invoices totaling $100,000. The client’s customers typically pay within 45 days and payments are made to the factor’s lockbox. Between the time the funds are advanced and payments are made by the customers, the factoring client has defaulted on a term loan with a local bank. Among the assets pledged to secure the loan is the company’s receivables. In other words, the bank, at the time the loan was granted, made a UCC filing on all the assets used for collateral. This would typically include the receivables, so they have a secured interest in this asset. When the company defaulted on the loan, the bank took control of the assets, which included payments on all the receivables on the books. Had the factoring company not done a lien search that exposed the UCC filed by the bank, they would be greatly exposed and lost the $80,000 advanced to the client.

Another example of a lien filed against receivables is when the company has neglected to pay federal payroll taxes withheld from employee’s paychecks and their share of FICA and Medicare taxes. After several notices have been mailed to the company, the IRS will eventually “play hardball” and file a lien against the company’s assets. Needless to say, the same type of exposure would exist for the factor.

The above scenarios occur all the time, so it’s important to those considering the use of accounts receivable factoring to understand that there are ways of dealing with the situation. In the case of a lien filed by the bank, the factor will often analyze the proportionate amount of the receivables to the total collateral base so they can get an idea of what the bank might accept as payment to release the lien on that particular asset. Some banks are stubborn and won’t do a partial release, but those that realize that invoice factoring will help the client increase their working capital base will be willing to work out a deal. They will often agree to accept a percentage of the initial advances until the agreed-upon paydown of the loan is made. That lessens their exposure and allows their client to take utilize the advantages that invoice factoring has to offer. In addition, the company has less of a debt load to contend with.

In the case of a lien filed by the IRS for non-payment of payroll taxes, a similar agreement is made. Typically, a subordination agreement. With this legal document, the IRS agrees to allow the funding source to have a senior position on the lien so they will be willing to continue the factoring relationship. In return, the agreement states that a certain amount of the advances will be made to pay off the delinquent payroll taxes.

Whether the lien on receivables is held by a bank, private investor, or the IRS, the lien holder should be flexible and open-minded in working with clients who wish to factor invoices.