Understanding UCC 9-404: how it pertains to claims and the right to offset

If you've ever worked with/for a factoring company at any capacity, you may have heard a hot headed portfolio manager throw out the term "UCC 9-404 - No right to offset." All to often this portion of the Uniform Commercial Code is loosely interpreted incorrectly, and used to protect poor verification and lazy due diligence on the part of the accounts receivable factoring company.

Usually, 9-404 is wrongly interpreted to mean that if a factor verifies an invoice with a debtor and specifically inquires about any exisiting claims regarding this specific invoice - anything that could potentially offset the payment back to the factor - and they are told there are no claims, then the invoice verified is free and clear of any claims that the debtor may have on file. This is close - but also dangerously far away.

Here is the actual UCC 9-404.

9-404. RIGHTS ACQUIRED BY ASSIGNEE; CLAIMS AND DEFENSES AGAINST ASSIGNEE.

(a) [Assignee's rights subject to terms, claims, and defenses; exceptions.]

Unless an account debtor has made an enforceable agreement not to assert defenses or claims, and subject to subsections (b) through (e), the rights of an assignee are subject to:

(1) all terms of the agreement between the account debtor and assignor and any defense or claim in recoupment arising from the transaction that gave rise to the contract; and

(2) any other defense or claim of the account debtor against the assignor which accrues before the account debtor receives a notification of the assignment authenticated by the assignor or the assignee.

The portion that most concerns us in this case is section (a). The attourney for my
former factoring company explained this to me to mean that the verification regarding claims must be done at the time the debtor is first notified of the assignment. This means that unless during the first call the factor makes to the debtor, he asks an authorized employee regarding any existing claims, that debtor will always have the right to offset factored invoices for any previously existing claims. Whether the claims pertain to factored invoices or not.

Currently Reading: The Law of Contracts and the Uniform Commercial Code 

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Buyout Process - What Each Factor is Up To

Once you've notified your current factoring that are planning to leave for another factor, a new and sudden game plan shifts into gear. We'll start by going over what actions your current factor is going to take. 

After they receive your written notice to terminate - either 90 Days or Early Termination - your current factor will probably be interested in finding out why you want to leave. Possibly, they may try to negotiate new terms with you or meet any needs that weren't previously being met. Assuming they fail, they will begin calculating the buyout figure.

You may have to provide the current factor with a letter authorizing them to release details about your account (i.e. aging reports) to the new factor. With a fresh accounts receivable aging report in their hands, the new factor will begin verifying all the open invoices on your account. Typically, this is done by physically calling the accounts payable department for each of your customers to check each and every invoice. Along with this, they will also contact the buyers, brokers, claims departments, etc. This will help verify that there is no fraud or history/ongoing issues with claims and your business.

I have worked through many buyouts on both sides of the business and can tell you that it is extremely important for the above steps to be taken by the new factor. I once had a factoring company request an aging report that had at least 30 different debtors (your customers) and 5 to 10 open invoices each. By the next morning, they were already wiring us the buyout money. Over the year that followed, I was constantly being contacted by my old client, the new factor, and the customers, who were all so confused about who to pay, where did check number such-and-such go, and how come I didn't get any reserve after the buyout?

Be sure to follow up with the new factor to be sure they are doing their DUE DILIGENCE. In the next post, we'll explain just where this buyout money comes from and just how much you should pay in early termination fees.

Buyout Process - how to calculate the buyout figure

Are you moving from factoring company to another? If so, you may find you and your business may be caught up in the tedious process of a Buyout. A buyout occurs whenever one company has a balance owed on accounts receivables they purchased and are the current UCC-1 lien holder on the business in question. There are many steps involved and over the next few weeks, we'll take a look at them all. This week, we'll discuss how to calculate the buyout figure.

Simply put, the buyout figure is the total amount owed to the UCC-1 lien holder. Here's how that is reached:

Unpaid Invoices + Fees Owed - Reserves = Buyout Figure

Still unclear? Understandably so. Let's work it out with an assumed fee structure and totals.

Lets say that your fee structure is a 90% advance with a flat 5% fee for invoices factored month to month. Your current outstanding balance in accounts receivables factored for the month total $85,000.

1. Total A/R - $85,000

5% of  $85,000 is $4,250. This would be your fees owed. If you did not give written notice prior to leaving, you may also owe Early Termination fees, so check with your factor.

2. Total Fees Owed - $4,250

Your reserves - which should be roughly 5% of your total open balance depending on how your factor releases reserves - can vary greatly based on many variables, lets just say you have $5,000 in reserves.

3. Total Reserves $5,000

The final result would look something like this:

$85,000 A/R
$4,250 Fees
(5,000) Reserves

Buyout Figure = 84,250.00

In the next week of this series, we'll look at how the new factoring company verifies the already outstanding invoices and reach this buyout figure for your business.