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What Happens When Invoice Factoring Customers Refuse to Pay?

You may not be overly familiar with the term just yet, but if you want better cash flow for your business in the short term, you will undoubtedly find invoice factoring an interesting option.  This, the purchasing of your accounts receivable, can give you the cash up front to pay down debts, invest in new technology, or to avoid insolvency.  One of the first questions that arises, though, when companies are considering invoice factoring is what will happen if one or more of the customers refuses to pay.  After all, you don’t want to use the money you receive as a result of invoice factoring only to find that it will have to be repaid at a later date.  That could create serious financial difficulties within your company. 

Choosing the Invoices to Sell

You do not have to factor all of your invoices.  In some cases, a company only needs enough money upfront, so they sell only one or two of their accounts receivable.  In other situations, all of the invoices are sold to the factor.  Your monetary needs will likely dictate the best course of action for your company.

Agreeing to the Terms

Before anything else happens, the terms of the agreement will be explained, and you will have the right to accept or refuse the offer from the factor (the company buying the invoices).  Within this documentation, it should give a clear explanation of what will be expected from you in return for the upfront cash.  It should also discuss the percentage that will be withheld, which is, in essence, like the interest paid to the factor for paying the lump sum in advance.

Establishing Accounts and Getting Paid

Once you have decided on the invoices to be sold, an account will be established, through which you will be paid the agreed upon percentage of the value of invoices sold.  Typically, this amount will be 70-95% of the total value, but the actual figure will depend on many variables.  That money will be paid immediately, so you are not forced to wait for the customers to pay.  In some cases, these accounts remain open and active for a period of time, so that your company can continue to factor invoices at the agreed upon rate.

Billing the Customer

In most cases, the factor will require that you continue billing the customers as usual, but with the address of the factor listed as payment recipient.   In some situations, however, the company will request that you stop billing and the invoices will be sent directly from the factor to your customer.  This will be preceded by a letter to the customer explaining the payment arrangement and introducing the factor.  These letters are not sent to all of your customers, but are generally sent to all those for which you factored invoices. 

When the Customer Doesn’t Pay

There is always the chance that one or more of your customers won’t pay the factor.  It does happen.  Often many companies within the same industry will face financial hardship at the same time due to economic influences.  Your customers could be suffering financially.  Understanding what will happen should the customer default and fail to pay will depend on the terms in the invoice factoring agreement.  There are generally two types of accounts for invoice factoring – ‘recourse accounts’ and ‘non-recourse accounts’.

When the Customer Doesn’t Pay: Non-Recourse Account

If your agreement with the factor establishes a non-recourse account, then it will be the responsibility of the factoring company to seek payment on delinquent invoices. If the customer fails to pay, the factor company loses out, but your company will not be penalised.  Thus, you can feel free to spend all monies paid upfront by the factor without fear of being held accountable for your customers’ failure to pay.

When the Customer Doesn’t Pay: Recourse Account

If you have established a recourse account with the factor, you can be held accountable if the customer doesn’t pay on an outstanding invoice.  In some cases, this is the only type of agreement offered by a factor firm.  In other situations, the recourse account will pay a larger percentage of the value of the invoices because of the added security for the factor. 

Recourse Option: Buy Back the Invoice

It is important to realise that there is typically more than one form of payment on delinquent customer accounts.  You may buy the invoice back and seek payment directly from the customer.  There are several potential legal actions that can be taken when invoices are significantly overdue.

Recourse Option: Swapping Invoices

If you don’t have the funds available to buy a delinquent account, you may have the option to swap out invoices.  Essentially you are giving the factor another of your accounts receivable in return for that which has been ruled delinquent.

In Summary

  • Carefully consider your invoice factoring options
  • Establish a mutually pleasing agreement with the factor
  • Set up an account through which you will be paid
  • Be sure that you understand the type of agreement. If it is a recourse account, you will have to be more careful with the spending of the funds paid by the factor, especially if you have reason to believe a customer will not pay.