The Truth About Non-Recourse Factoring
One of the most common questions we are asked is if our factoring agreements are recourse factoring or non-recourse factoring. As we’ve answered this question, it’s become clear that there is a common misunderstanding about how factoring works.
Many years ago, factoring meant that the factoring company was accepting the risk of non-payment on an invoice. Today, this is rarely true. When addressing non-payment of invoices purchased by the invoice factoring company, there are two types of factoring contracts: recourse factoring and non-recourse factoring.
Recourse in Factoring Defined
Every factoring company will have a slightly different definition of recourse. In invoice factoring, recourse covers what happens if the factoring company purchases an invoice from its client and then the invoice is not paid by the factoring client’s customer, also known as the account debtor. This will cover a time period; typically from 60 to 90 days, but we have seen anywhere from 45 to 180 days in extreme cases.
If an invoice is not paid in that pre-defined time period, the factoring company will “recourse”, or ask its client to repurchase, the invoice. This repurchase can happen in a variety of ways including:
- providing the factor with a different invoice that the factor can use as collateral, or
- deducting cash from the reserve account.
What is Non-Recourse Factoring?
Non-recourse factoring is when a factoring company offers to purchase some, or all, of its clients accounts receivable “without recourse”. In theory, a non-recourse factoring contract means if an account debtor does not pay an invoice, that the factoring company will take the loss on that invoice, not the factoring client.
This means that the factoring company is essentially insuring those receivables for the factoring client. Non-recourse factoring contracts are typically more expensive than a similar contract where the factoring company has recourse, or “charge back”, to the factoring client on unpaid invoices.
What Does “Non-Recourse” Factoring Really Mean?
The problem with non-recourse factoring contracts is that the non-recourse provision is typically very narrow. Most non-recourse contracts only protect the factoring client from recourse only when its customer files for bankruptcy or becomes insolvent. This is often called a “credit problem” by the factoring company.
To reduce the factoring company’s exposure on a non-recourse factoring contract, the factoring company will also provide a very narrow list of customers that meet the factor’s criteria of acceptable customers.
What Isn’t Covered by Non-Recourse Factoring
Invoices are commonly not paid by account debtors for many reasons beyond going out of business. The typical non-recourse factoring contract does not cover:
- invoices disputed, regardless of the reason
- invoices where the client has breached its agreement with the factor
- invoices when the factoring client has made the “credit problem” worse
- invoices that are offset by other amounts due to the account debtor
- invoices where the client has sent the invoice to the customer instead the factoring company sending the invoice
Anyone in search of non-recourse factoring contracts should look at why they have lost money on past sales. Then, review a copy of the proposed factoring contract early on in the sales process. Look for the sections that deal with recourse. They may have headings or definitions like “recourse”, “credit problem”, or “credit event”. Are the reasons that money has been lost by the factoring client covered under the factoring contract? Or is the factor still able to charge back invoices to the client in those circumstances under its non-recourse provision?
Disadvantages of Non-Recourse Factoring
Because non-recourse factoring means the factoring company is taking on additional risk, it not typically as flexible as recourse factoring. When compared with a typical recourse factoring agreement, a non-recourse factoring contract may have:
- highly conservative credit limits for account debtors, potentially limiting the factoring client’s sales to certain key accounts and limiting its access to working capital
- limits on the factoring client’s concentration of sales with its customers
- higher factoring fees when compared with a recourse factoring agreement
- a more intrusive relationship by the factoring company with a business’s customers
- higher required monthly minimum fees (aka “volume commitments”) by the factoring company
When Is Non-Recourse Factoring A Good Option?
Non-recourse factoring is not a terrible product. It can be a good option for certain businesses, especially larger businesses with a broad customer base. A business may be looking clean up their balance sheet by offload their receivables near quarter-end or year-end. In exchange for being free of any obligations to the factoring company if their customers become insolvent, the company may be willing to pay extra to a factoring company for this privilege. If the factoring client can break even at the factoring company’s advance rate, then this may be a good option.
Non-Recourse Factoring For Small Trucking Companies
Non-recourse factoring for truckers has become a popular alternative to recourse factoring in recent years. Truckers, long at the bottom of the food chain, are being sold that non-recourse provides them with financial security when it comes to getting paid on loads. However, as discussed above, the most frequent reason a load is not paid is because of a claim or dispute, which isn’t covered by non-recourse factoring agreements. So, with a 40–80% price premium over recourse factoring agreements, it hardly seems worth it to pay the extra fees for non-recourse factoring with so little benefit to the trucker.
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