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David Jencks is a partner in the law firm of Jencks & Jencks, P.C. located in Madison, South Dakota. David's law practice
consists primarily of assisting small and medium sized factoring companies in structuring transactional documents, company set up, and contract litigation. David also represents regional lending institutions in
preparing loan documents, problem loans and foreclosure litigation. David can be reached by telephone at 605.256.0121 or via email at: davidjencks@hotmail.com.
Legal Considerations for the Small Factor
by David Jencks
I am pleased that Jeff Callender has asked me to write a short article dealing with the small factor, litigation and
litigation alternatives. A constant refrain heard from small Factors around the country is “my small claim isn’t worth litigating, I’ll spend more on legal fees than I’ll ever recover”. As an attorney who works
almost exclusively with the small factor, I sympathize with and understand that concern and position. This article will aim to look at a few issues you may not have considered with respect to litigation, as well as
some litigation alternatives that you may find cost effective.
While I think litigation is often times unfairly rebuked, and the negatives of litigation are often overblown, court
resolution of disputes between parties has increasingly been criticized. First, litigation is expensive. Not only can legal fees be astronomical, the costs of experts, data gathering, and other discovery processes
are also prohibitive. Second, litigation is time consuming. The large number of lawsuits and appeals in process cause long delays in resolving a dispute, often taking years to resolve. Finally, litigation can be
damaging to future business relations and frustrating to the parties. While these are the most common complaints and drawbacks of litigation, I think these issues can be avoided or mitigated in some of the following
ways.
First, Small Claims Courts exist in nearly every state. In some states, attorneys are not allowed to practice in courts of
small claims. This levels the playing field for the Small Factor acting pro se (for itself and without counsel) and gaining the appropriate judgment. Attorneys, by and large, do not like to practice in small claims
courts even when they can, and often encourage their clients to go at it without them in such courts. A court trial is usually held within a few months of gaining proper service on the named defendant(s). Gaining a
judgment against the defendant(s) will gain you leverage for both executing on the judgment as well as satisfying it by preventing your client from factoring or gaining other financing elsewhere. Furthermore, no
account debtor named in a lawsuit will want judgment taken against it. Naming an account debtor who has improperly paid or otherwise dishonored your assignment will facilitate settlement and judgment satisfaction.
Second, if you have been the victim of a fraudulent scheme, many states allow for the pleading and potential recovery of
punitive or exemplary damages. Punitive or exemplary damages are those damages awarded by the court in excess of actual damages, i.e., more than is required to compensate the factor for his/her actual contractually
sustained damages. Such damages are awarded to punish the defendant for committing fraudulent acts and to provide the Factor some solace for enduring the fraudulent act. Solace for the factor may also be inducement
for an attorney to take your case on a contingent fee or a hybrid fee agreement whereby you may have to pay a flat fee plus out of pocket costs to your attorney, but then share in the percentage award received from
the defendant. Fraudulent acts and exemplary damages awards can make pursing a $5,000.00 contract claim worth three, four or five times the amount of your actual damages. Thus, even if attorneys’ fees are
significant, the Factor may then be able to recover the base amount of its claim, pay its attorney, and even possibly recover more than the contract amount of the claim.
Third, it has been my experience that courts will award as a part of any judgment, whether punitive damages are pled or
awarded or not, reasonable attorneys fees if your factoring contract sets forth the right to claim and receive them in the course of its enforcement. Therefore, properly drafted attorneys fees provisions in your
contracts are essential and valuable. Attorney’s fees provisions alone may make it worthwhile for you to pursue a small deal that has gone bad and it may induce an attorney to take your small dollar amount case. You
should be aware, however, that if for some reason the court did not award attorneys fees, did not award the total amount of attorney’s fees presented to the court by your counsel, or if the attorney’s fees are not
collectible, you may still be responsible for the entire amount of your attorney’s bill. Often times, attorneys may compromise their bill depending on the award and subsequent collection of attorneys fees from a
defendant, but this is not always the case and you should be aware of and understand this issue prior to hiring an attorney or proceeding with a case.
If you have properly weighed the option of litigation and you and/or your attorney have decided it is not the most feasible
option for potential collection, you may want to consider a form of alternative dispute resolution. The two most common types of alternative dispute resolution ("ADR") tools are mediation and arbitration.
Mediation is a process by which participants, together with the assistance of a facilitator (i.e., mediator), systematically isolate disputed issues in order to develop options, consider alternatives, and reach a
consensual settlement that will offer a reconciliation. Arbitration is the submission by two consenting parties of their dispute to an impartial decision maker, usually for a binding determination.
Mediation, like all systems of dispute resolution, has its pros and cons. Mediation can leave both parties feeling shorted.
For instance, a mediator may work toward and push a settlement whereby the account debtor or seller of the account owes you the face amount of invoice(s), but will ask you to forgive all collection costs despite the
factoring contract indicating you are entitled to collect the same before you are required to legally release your client. Mediation is rarely binding in nature and can thus be costly and time consuming with no
final result. Mediation does not necessarily require the presence of attorneys. However, if no successful result is reached in mediation, the parties are not bound by it and are free to pursue another method of
resolving the dispute. Getting your opposing party to agree to undertake mediation when it is very likely they have either breached your contract or taken part in a fraudulent act is difficult to say the least.
Generally, I do not recommend mediation as a form of dispute resolution in commercial transactions such as factoring contracts. It is important, however, to know the various dispute resolution systems available to
you in the forum in which your claim will be heard, whether the claim is heard in the courts or through ADR.
Arbitration comes in a binding and non-binding forms. Most arbitration is binding in nature. The American Arbitration
Association (AAA), like many other arbitral forums, does not actually conduct arbitration hearings. Instead, it is an independent and non-governmental organization that supervises independent arbitrators in all
types of domestic and international disputes under its Rules of Commercial Arbitration.
Once a party requests arbitration, an arbitrator is selected as specified in its contract, or if the parties fail to specify
any method for appointing an arbitrator, the AAA provides the parties with a list of qualified persons from which an arbitrator is selected.
The parties will generally specify beforehand where arbitration is to take place and what rules of law will govern the
proceedings. In the absence of such an agreement, the AAA, rather than the arbitrator, determines the place of arbitration. A weakness of the AAA Rules is that they make no mention of what substantive or evidentiary
law should be applied in the absence of an agreement between the parties. The AAA Rules state that the arbitrator is the sole judge of what is relevant and admissible at the arbitration hearing.
The parties begin the hearing by making brief oral statements clarifying the issues in the case. Next, the parties present
their evidence. All witnesses are subject to cross-examination by both the arbitrator and the adverse party. Thus, the AAA encourages parties to be represented by counsel. The arbitrator then has 30 days to reach a
decision and render an award. All awards are final and may only be vacated by a court of law if corruption, fraud or a substantial abuse of discretion exists. Courts will not go behind the award to determine whether
the arbitrator made errors either in fact or law.
I believe a business that negotiates AAA arbitration in their contracts will find that it is an excellent arbitral forum. AAA
is particularly attractive to small and medium-sized businesses because its services are very reasonably priced. AAA arbitrators serve with minimal compensation except in protracted cases. The most attractive
feature of AAA arbitration is the speed with which it resolves disputes. Arbitration, particularly on a smaller scale, can also be conducted with lower legal expense, or even with the small factor representing
itself. I would absolutely not recommend the small factor representing itself in more complex or higher dollar amount arbitrations. However, when say $1,000 to $5,000.00 is at stake, the small factor may want to
perhaps make a cost/benefit decision and attempt the arbitration process pro se. Every factor has a fiscal, psychological and emotional tolerance level for loss. Deciding on whether to arbitrate a matter, and at
what dollar amount level to attempt arbitration pro se will of course vary from factor to factor and the decision to arbitrate, and especially arbitrate pro se, should only be made after careful consideration and
discussion with those who have been through the process and/or counsel. Some of the factors in such loss tolerance will of course be the size of your potential loss, the overall size of your business, whether you
want to pursue the default on principle, and the potential costs of collection in the various potential forums.
The ageless and simple dispute resolution system of negotiation should never be overlooked. If a factor is owed $1,700 on and
invoice that was improperly or not paid by a client or the account debtor, and both parties are refusing to properly pay you, it stands to reason you are of course better off accepting $500.00 from each party as a
negotiated settlement than having each party disappear without paying anything. This of course assumes you have not been the victim of client fraud with the defendant having absconded or you have no interest in
putting any money into collection.
The Uniform Commercial Code, Article 9, as adopted in most states, allows for non-judicial foreclosure (as well as judicial
foreclosure) of collateral in which a secured party has a perfected interest. It is important to establish what your non-judicial foreclosure rights are in the state in which you are located and the state in which
your collateral is located. If non-judicial foreclosure is allowed, you can avoid courts, arbitration, mediation, and even negotiation. Non-judicial foreclosure allows a party to take collateral without judicial
process, if that foreclosure proceeds without a breach of the peace. (UCC 9-609) The Uniform Commercial Code, Article 9, also provides for the disposition of the seized collateral so that the factor, as a secured
party, can turn property into cash. (UCC 9-610) There are certain requirements that must be followed when effectuating a foreclosure and disposing of collateral under the UCC. Time and space constraints prevent me
from elaborating in too much detail on non-judicial procedural requirements. You should consult your attorney for proper instruction on the foreclosure process before one is initiated, in particular, the notice
requirements required to foreclose. The non-judicial foreclosure process is one that is underrated and underutilized and I would encourage factors to consider this process in the event of a default. I would further
encourage each factor to make sure its contract carefully sets forth the right to non-judicial foreclosure in the event of default. In this author’s opinion, the UCC has created a strongly pro-creditor process in
the foreclosure provisions and it is an excellent way to limit legal expense and maximize returns in the event of a deal gone bad.
I would strongly suggest small factors spend the money and time to make sure its factoring agreement, power of attorney,
purchase agreement, and other related factoring documents are in proper order and are as comprehensive and effective as possible. This investment pays dividends and saves you money when a deal goes bad. The ability
to cite the provisions of your contracts that clearly and strongly delineate your rights as a factor to clients and account debtors alike, and the potential financial consequences to them in the event of their
breach and default, will foster compliance with its provisions or, at the very least, foster efficient settlement in negotiation in the event of a deal that has gone bad. Of course, comprehensive contracts promote
favorable results in any type of dispute resolution system. Comprehensive and well drafted factoring documents will also strengthen your position in recovering attorney fees if you do find it feasible and necessary
to commence litigation. Furthermore, a comprehensive and well drafted contract will give you the right, and subsequent protection, if you initiate any type of foreclosure pursuant to the Uniform Commercial Code.
Also, if arbitration is something that may be attractive to you after discussing it with counsel, your factoring contract
should be amended to add a provision whereby arbitration is a potential method of dispute resolution in your contract if you so elect exercise it.
Lastly, I would take this opportunity to say that the law and business of factoring and secured lending has become a very
unique and specialized business. I would encourage small factors to seek out the proper legal counsel as well as to discuss legal and business issues with your colleagues. I am continually impressed with the
collegiality and willingness of factors to help other factors improve and strengthen their respective businesses through shared experiences and ideas. There are obviously other methods of collection. This article is
meant to simply provide a taste of a few of them and some that I have found effective. Also, I’d be happy to elaborate or discuss in more detail any issues raised in this article. Feel free to email me at:
davidjencks@hotmail.com.
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