What Is a Factoring Agreement?
A factoring agreement is a method of financing a business. Under a factoring contract, the factoring company (called the ‘factor’) will temporarily purchase certain business assets and provide the business owner some money that they can use to fund and finance the business in the short term. The assets that are generally used in such agreements are the accounts receivable of the business.
The company and the factor enter into an agreement in which the factor purchases the company’s accounts receivable (such purchased accounts are called factored accounts), collects on the factored accounts and then pays the purchase price of the accounts to the company. The agreement that records the details of such a deal between the company and the factor is known as a factoring contract.
When Do You Need a Factoring Agreement
A factoring contract is required when a company wants to raise money for the operation of its business. Many small companies have regular sales or payments coming in, which they invoice their customers for. A factoring company will ‘purchase’ the rights to the accounts receivable in exchange for providing the business owner some short-term capital. The purpose of a factoring contract is to help the company raise capital by ‘selling’ its accounts receivables to a third-party factoring company.
Inclusions in a Factoring Agreement
The agreement must clearly state the names of the parties between whom the agreement is entered into. This will include the ‘Company’ and the ‘Factor’. The date on which the agreement is entered into must also be mentioned along with the territory in which the agreement is enforceable.
The agreement should clearly mention the terms and conditions for the sale of the account’s receivables and the factoring fee to be paid to the factoring company. The amount to be payable on transfer on the invoice and the invoicing schedules must also be laid out.
Apart from this, the agreement must clearly mention under which law it will be governed and how the agreement shall be terminated. The manner in which the agreement is to be modified should also be described.
How to Draft a Factoring Agreement
The following are the steps to follow while drafting a factoring contract:
- Decide the type of factoring that best suits the company’s needs.
- Decide which factoring company to enter into this arrangement with.
- Decide the commissions, fees and expenses payable to the factor.
- The agreement must mention what all accounts receivables are included under it.
- Make sure to include all important details such as purchase price, invoicing schedules, advances etc.
Benefits of a Factoring Agreement
- The company receives advances from the factoring company, which helps it meet short term requirements.
- It is one of the easiest ways to raise capital for a company.
- The company receives security through this arrangement while the factoring company has the opportunity to make a profit while collecting the accounts receivables.
- The company can set up an efficient payment cycle, which makes its cash flows stronger.
- This arrangement can reduce the credit losses of the company.
- It reduces the credit and collection expenses of the company.
Types of Factoring Agreements
There are mainly two types of factoring agreements:
- Recourse factoring: This is the most common type of factoring. The factor advances the company around 80% of the invoice value. However, if the customer does not pay the invoice within a certain period, the advance must be returned to the factor.
- Non- recourse factoring: This type of factoring is also similar to recourse factoring in most aspects. The only major difference is that even if the customer does not pay the invoice, the company gets to keep the advance. This helps to protect the company from non-payment.
Key Clauses in a Factoring Agreement
The following are the key terms of a factoring contract:
- Sale and purchase of accounts receivables and purchase method
- Purchase price and advanced purchase price
- Invoicing and assignment schedules
- Credit approvals and withdrawals
- Commissions and fees
- Payment of the purchase price of an account
- Obligations and interest
- Conditions precedent to all purchases
- Representations and warranties of the company
- Representations and warranties of the factor
- Events of default
- Security interests and remedies
- Term of the agreement
- Limitation of liability
- Indemnification and damages
- Modification of the agreement
- Governing law and jurisdiction
- Termination of the agreement
What Happens in Case of Violation?
Generally, factoring contracts have a clause that talks about the actions to be taken when a party to the agreement breaches the clauses of the said agreement. An arbitration clause is present in most agreements and states that if a clause of the agreement is breached or if any dispute arises with respect to the terms of the agreement, the matter will be resolved by arbitration. The clause mentions where the arbitration proceedings will take place i.e. seat of arbitration, the language in which the proceedings shall be conducted and the manner in which the arbitrators shall be appointed.
Alternatively, any other form of dispute resolution such as mediation may also be mentioned in the agreement.
The agreement can also mention that all disputes arising out of the agreement will be subject to the exclusive jurisdiction of a specified court.
Sample Factoring Agreement
If you require a factoring agreement sample, you can download a factoring agreement template here.