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The Buyout
Issues to Consider on Both Sides of the Buyout Transaction
By David Jencks
David Jencks is an attorney who specializes on legal issues for small and medium-sized factors. He is a frequent contributor
to FactorTips. His web site is www.jenckslaw.com.
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Most of you that have been in the business of buying accounts receivable for some period of time have completed more buyouts
than you can remember; both when taking over a new client from a competitor or being bought out by a competitor. My impression is that most Small Factors do not place much emphasis on the details of a proper buyout
and the potential risks involved in one. The Small Factor should work to negotiate provisions in each buyout agreement to protect its security interest, priority in collateral, and to limit its potential liability,
whether to the Client or the other Factor involved in the buyout.
The Incoming Factor
When effectuating a Buyout as the Incoming Factor, the most obvious issue is making sure that all account debtors are aware
(proper notice) that you are the entity that now needs to be paid on all current and future accounts. Therefore, your buyout contract should require that either the Outgoing Factor must provide notice to all of the
Client’s account debtors that you are now the Factor that must be paid on all existing accounts. Your contract should require that the Outgoing Factor provide this notice in no less than three business days. The
other option, and one that I advocate my clients employ, is that the Incoming Factor require that the Outgoing Factor provide it with a signed letter prepared to send to all account debtors advising that the
Incoming Factor is now the proper payee on all of Client’s accounts. I prefer this method because then you, as the Incoming Factor, have the assurance that the notice of the change in Factors has been properly and
timely provided along with any of your own notice and assignment documents are tendered to the account debtors.
When acting as the Incoming Factor, your buyout contract should also allow you to file UCC termination documents terminating
the Outgoing Factor’s UCC filings. This will avoid the scenario of the Outgoing Factor, who may not be happy about being taken out, taking its time, or simply failing to file a UCC termination statement.
Your buyout contract should also require the Outgoing Factor to pay to you any subsequent remittances made to it by account
debtors that were properly payable to you as Incoming Factor but mistakenly paid to the Outgoing Factor.
I also recommend that when operating as the Incoming Factor, your new Client should either sign an indemnity agreement
agreeing to indemnify you for any payments you make to the Outgoing Factor for invoices that do not end up being paid, or that are not paid to you.
To simplify and reduce documentation, I advise my clients to simply make the Buyout Agreement a Three Party Contract between
you as the Incoming Factor, the Outgoing Factor, and your new Client.
Lastly, I would advise that your Incoming Buyout Agreement require that both your new Client and the Outgoing Factor hold you
harmless and indemnify you from any losses that in any way could be construed as caused by the Buyout transaction, including but not limited to dishonored checks incurred while the Buyout and related invoices settle.
The Outgoing Factor
If you are the Outgoing Factor in a Buyout, there are certain contractual provisions that you should seek to negotiate and
institute in a Buyout Contract.
First and foremost, your contract should, obviously, set for the exact amount of funds due on or before a certain date to
satisfy the obligations owed by the Client. The Buyout Contract should also set forth an exact per diem adjustment amount due on the obligation for each day thereafter payment is received.
The Outgoing Factor should also require that the Incoming Factor agree to pay you the full amount of any check previously
credited by you to the obligations of the client which is returned to you unpaid not more than thirty days from the date your provide notice thereof to the Incoming Factor.
The Outgoing factor should also negotiate that any expenses incurred by it in the course of notifying account debtors of the
assignment to the Incoming Factor must be paid before a UCC-1 termination will be effectuated. In all practicality, it is more cost efficient for the Outgoing Factor to prepare the notice of assignment to the
account debtors, forward the same to the Incoming Factor, and have your Buyout Agreement require the Incoming Factor to then actually provide the Account Debtors the notice.
Lastly, when in the role of Outgoing Factor, require that the Incoming Factor indemnify you and hold you harmless for any
claim asserted against you arising out of your making payment to the Incoming Factor. This provision will likely insulate you from a suit brought by your soon to be ex-Client, and/or others, against any claims that
you should not have paid or forwarded a misdirected check or other similar payment to the Incoming Factor.
The Outgoing Factor will benefit from a provision in its factoring documents indicating that it is not required to terminate
its UCC-1 lien until the soon to be former client executes a general release. The Outgoing Factor will then have twice the peace of mind and assurances that it will be protected from claims brought by the Incoming
Factor and the ex-Client.
The Outgoing Factor will also benefit, if it so chooses, from a strong contractual provision stating the monetary penalty for
any termination suffered as a result of a buyout, or for any other reason.
Misrepresenting Accounts
The last issue when involved in a buyout is the issue of misrepresentation or fraud. When in the position of the Outgoing
Factor, you must be very careful to not misrepresent or commit fraud by making statements that are false concerning the Client’s history with you and the performance and/or quality of the Client’s account debtors.
As an Outgoing Factor, even if you have secured the proper hold harmless, indemnification and general release agreements, it
is incumbent upon you to be honest with inquiries from the Incoming Factor about client performance and account debtor quality and performance. The Outgoing Factor should adopt one of two policies on inquiries on
account quality inquiries from the Incoming Factor. The first option is to essentially be accurate and honest with the Incoming Factor about account quality. If the Outgoing Factor knows that 40% of the Client’s
accounts won’t pay or are a monumental struggle to get to pay, you should advise the Incoming Factor that approximately 40% of the Client’s accounts are difficult or problematic accounts. The second option an
Outgoing Factor has is to respond to account quality inquiries from the Incoming Factor that your office has a policy of making no warranties, representations or other statements about the quality of the Client or
the account debtors of the Client. If the Incoming Factor chooses this option, it should incorporate a short and conspicuous statement in its Buyout Agreement indicating that it does not do so.
Please review your Factoring Agreement and your Current Buyout Agreements with your Counsel to make sure you address and
understand the issues raised in this article. The Buyout Agreement does not have to be, nor should it be particularly difficult or lengthy. But the issues raised in this article are important to your protection.
Furthermore, these issues are ones I have seen litigated and that have thus become a time and expense drain on the Small Factor.
Please feel free to contact me at davidjencks@hotmail.com or 605.256.0121 if you have any questions about the Buyout transaction or its supporting documentation.
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