Receivables Financing - Advice for Insolvency Practitioners

In his latest Coffee Break Briefing webinar, Frettens’ own Insolvency Guru Malcolm Niekirk looked at receivables financing and how it works.

This is the summary of that briefing.

If you'd like to watch the webinar back, you can do so below, if not, read on for our summary...

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• The basic arrangements
  • How the facilities work
• Terminology
• Disclosed and non-disclosed arrangements
• Recourse and non-recourse agreements
• Debt collection and credit control
• Termination fees and charges

The basic arrangements

The basic arrangements for business financing are typically loans. These will usually be term loans or revolving credit.

A term loan is a straightforward advance of principal, a loan of money which is repaid with interest each term.

A revolving credit, e.g. an overdraft, is slightly more complicated as there is an agreed credit limit (the amount that the bank is prepared to lend at any one time). With revolving credit:

• Repayments create headroom for future advances
• The borrower draws on the facility according to their need

Will these loans be secured?

Both term loans and revolving credit can be secured, and usually will be.

These types of secured arrangements are ones where the borrower continues to own and possess the asset, while not in default, and has the right to sell it (but must repay the secured finance).

Sometimes the finance will be to fund the purchase, but it can also be unconnected, where the asset secures working capital for the business.

Asset finance

With asset finance, such as leasing and hire purchase, the financier owns the asset; rather than the borrower.

Here, rent represents payments of interest and principal.

And the borrower may or may not have the right to buy or sell the asset.

Debt finance arrangements

(e.g. factoring and invoice discounting)

These arrangements are not loans, instead they are a type of asset finance. They are arrangements by the trader to sell the debts that they create to get cash sooner.

For example:

1. A trader sells goods or services on credit (under 30 day terms) to create debts. The debts belong to the trader.
2. The trader sells these debts to the financier.
3. The financier immediately pays a discounted price to the trader.
4. The debtor later pays the full debt to the financier

Once the debts have been sold, they always belong to the financier; however, the trader may have a right to buy them back.

How the facilities work

The facilities are usually set up as a revolving facility, so when the financier takes on the trader as its customer:

• The financier will buy most of the debtor book at that date, and probably audit it to exclude old, bad and disputed debts
• The financier will then pay the agreed (discounted) price for the value of the book
  • Its customer (the trader) will probably have to pay set-up fees and expenses
• The financier will cap the value of the debts that is prepared to own, at any one time
• The debtors will be told they must pay what they owe (when it is due) to the financier

When a debtor pays their debt

The debtor will be given the financier’s bank details. When the debtor does pay, the financier may charge a processing fee and will adjust its record of the value of the debts it owns.

The financier may pay to its customer (the trader) a second instalment of the agreed price for the debt.

If the debtor fails to pay, the financier, having bought the debt, will probably ask for its money back from the trader.

When the trader completes work for a customer

The trader raises an invoice, which tells the customer to pay into the financier’s bank account. Furthermore, it will:

• Let the financier know it’s owed a new debt
• Probably ask the financier to buy the new debt
• And, if the financier agrees, the financier will pay to the trader the first instalment of the price for that debt

Most factoring and discounting agreements are ‘whole turnover’ agreements. This means that all debts that the trader creates are transferred to the financier, regardless of whether the financier is going to finance those debts or not.

Even the debts that the financier will not pay for are transferred to them anyway. For those, the trader does not receive an advance payment of the debts; they’ll have to wait until the customer pays the financier – then the financier will pay the purchase price for the debt at that time.

Opportunities for traders to misuse a debt finance facility

One of the features of these types of arrangements, is that there are plenty of opportunities for traders to misuse them.

It’s worth knowing a little about what these are, so you can pick out any potential misconduct for your D report on the directors.

These are some of them:

• ‘Anticipatory invoicing’
  • e.g. ‘the job will not be completed by the end of the month, but let’s invoice it this month. The financier will never know that we finished it a few days later’
• Deliberate overcharging
  • Misuse of credit notes (by delaying informing the financier about them).
• Credit notes
  • e.g. ‘We may as well invoice them now, before they instruct us, if they choose not to go ahead we’ll just issue a credit note next month’
• Imaginary customers
• Diverting funds
  • By telling customers to pay their debts into the trader’s bank account, rather than the financier’s.

The bottom two are essentially fraud.

What do the financier’s accounts need to show?

They need to show:

• The value of the good, approved debts it has bought (and now owns)
• The payments for the first and second instalments of the purchase price
  • And how much of that total has yet to be drawn by its customer
• The fees and expenses that they have charged, set off against the funds available to their customer

Terminology

There are many different names for arrangements of these sort, including invoice finance, receivables financing, invoice discounting, factoring and more.

There’s no single definition and some of these names are used interchangeably.

Each financier tends to have their name for their own products.

Disclosed and non-disclosed agreements

Some of the important terminology is the difference between disclosed and undisclosed agreements. Typically, confidential invoice discounting is used as the description for an undisclosed agreement, and factoring is usually used as the name for a disclosed agreement.

Undisclosed agreements

The trader’s customers are not told that the financier owns the debt. They are still given the financier’s bank account as the one they must pay their debts into.

Disclosed agreements

The trader’s customers are given notice of assignment (change of ownership), so they know they owe debt to the financier and not the trader.

Legally, they still owe it to the financier, even if they pay the trader. And, legally, the trader’s customers may lose the right to make deductions.

The notice of assignment doesn’t always work as some debts are non-assignable.

Recourse and non-recourse agreements

These are essentially about who takes the risk of bad debts.

Non-recourse agreements include credit insurance so, if a debt turns bad, the financier will claim on that insurance.

In recourse agreements, the financier will have recourse back to the trader if the debt turns bad. If the debt is not paid within the agreed time, typically 90-120 days, then the financier will have the right to ask the trader to repay the first installment of the price that the financier paid for it.

In circumstances such as the above, there are likely to be additional fees charged to the trader by the financier.

Debt collection and credit control

The arrangements for debt collection and credit control vary from financier to financier and product to product.

In some cases, the debt collection arrangements are outsourced from the trader to the financier. For many small businesses, having people chasing up debts can be very useful to have as part of the financing package.

Other finance agreements expect the trader themselves to operate their own credit control systems and procedures and enforce against late payers.

Regardless of what the arrangements are, when you come across an invoice discounting or factoring agreement, in the context of an insolvent business, the financier will almost certainly step in and collect the debts themselves – which they’re entitled to do!

The estimated outcome statement

When you’re putting together an estimated outcome statement and there’s a factoring or invoice discounting agreement in place – for practical purposes:

• The debtor book is shown as an asset
• The claims of the financier against it is shown as a fixed charge

This is the right way to show it on an estimated outcome statement and that is clear to creditors.

However, conceptually it is probably wrong as the finance agreement is actually a contract; so it will either have a positive value, in which case it should be shown as a single debtor, or a negative value which should be shown as a creditor.

The debtor book belongs to the financier, not the insolvent trader – so the book itself is actually not an asset of the company.

Backup debenture security

Many of these financiers take backup debentures and that gives them additional security over the insolvent trader’s assets if they are a net creditor.

That security is likely to be:

• (perhaps fixed charges over some of the trader’s assets and also)
• A floating charge over all the trader’s assets

It also gives them the right (as holder of a qualifying floating charge):

• To receive notice of intention to appoint an administrator
• To appoint an administrator (if they are a net creditor and can call in their debt)

Termination fees and charges

These are likely to bite hard when a trader becomes insolvent

For example, the agreement may be on a 12-month contract, but where the trader would have to give three months’ notice to end it - and perhaps can’t give notice validly if more than six months before the end.

The financier may claim the right to charge many other fees including:

• Discount fees (as a percentage, similar to interest, on the funds in use)
• Service charges
• Collect out fees (because the trader has ceased trading)
• Refactoring fees
• Collection expenses

It can be worth challenging these fees and charges. The financier should be able to show you which clauses in the contract authorise them to charge them and a rate sheet, to show how much each fee should be.

Presentation

You can download a copy of the presentation here.

Upcoming events

Thanks for reading this summary…

My next Coffee Break Briefing is coming up on 16^th January 2023, when I’ll be looking at Retention of Title claims. The link to book on will be sent out to the usual email list in due course.

If you’re not already, you can sign up to our email list here.

And Frettens’ Second Annual Insolvency Conference is set to be held on 12^th May 2023. Again, more details to follow.

Have an excellent Christmas, I’ll see you in the new year!

Specialist Insolvency Solicitors

If you have any questions after reading this article, please don’t hesitate to get in touch with our bright and experienced team.

Call us on 01202 499255, or fill out the form at the top of this page, for a free initial chat.