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Assignment of Accounts Receivable: Meaning, Considerations

Adam Hayes, Ph.D., CFA, is a financial writer with 15+ years Wall Street experience as a derivatives trader. Besides his extensive derivative trading expertise, Adam is an expert in economics and behavioral finance. Adam received his master's in economics from The New School for Social Research and his Ph.D. from the University of Wisconsin-Madison in sociology. He is a CFA charterholder as well as holding FINRA Series 7, 55 & 63 licenses. He currently researches and teaches economic sociology and the social studies of finance at the Hebrew University in Jerusalem.

Charlene Rhinehart is a CPA , CFE, chair of an Illinois CPA Society committee, and has a degree in accounting and finance from DePaul University.

Investopedia / Jiaqi Zhou

What Is Assignment of Accounts Receivable?

Assignment of accounts receivable is a lending agreement whereby the borrower assigns accounts receivable to the lending institution. In exchange for this assignment of accounts receivable, the borrower receives a loan for a percentage, which could be as high as 100%, of the accounts receivable.

The borrower pays interest, a service charge on the loan, and the assigned receivables serve as collateral. If the borrower fails to repay the loan, the agreement allows the lender to collect the assigned receivables.

Key Takeaways

• Assignment of accounts receivable is a method of debt financing whereby the lender takes over the borrowing company's receivables.
• This form of alternative financing is often seen as less desirable, as it can be quite costly to the borrower, with APRs as high as 100% annualized.
• Usually, new and rapidly growing firms or those that cannot find traditional financing elsewhere will seek this method.
• Accounts receivable are considered to be liquid assets.
• If a borrower doesn't repay their loan, the assignment of accounts agreement protects the lender.

Understanding Assignment of Accounts Receivable

With an assignment of accounts receivable, the borrower retains ownership of the assigned receivables and therefore retains the risk that some accounts receivable will not be repaid. In this case, the lending institution may demand payment directly from the borrower. This arrangement is called an "assignment of accounts receivable with recourse." Assignment of accounts receivable should not be confused with pledging or with accounts receivable financing .

An assignment of accounts receivable has been typically more expensive than other forms of borrowing. Often, companies that use it are unable to obtain less costly options. Sometimes it is used by companies that are growing rapidly or otherwise have too little cash on hand to fund their operations.

New startups in Fintech, like C2FO, are addressing this segment of the supply chain finance by creating marketplaces for account receivables. Liduidx is another Fintech company providing solutions through digitization of this process and connecting funding providers.

Financiers may be willing to structure accounts receivable financing agreements in different ways with various potential provisions.​

Special Considerations

Accounts receivable (AR, or simply "receivables") refer to a firm's outstanding balances of invoices billed to customers that haven't been paid yet. Accounts receivables are reported on a company’s balance sheet as an asset, usually a current asset with invoice payments due within one year.

Accounts receivable are considered to be a relatively liquid asset . As such, these funds due are of potential value for lenders and financiers. Some companies may see their accounts receivable as a burden since they are expected to be paid but require collections and cannot be converted to cash immediately. As such, accounts receivable assignment may be attractive to certain firms.

The process of assignment of accounts receivable, along with other forms of financing, is often known as factoring, and the companies that focus on it may be called factoring companies. Factoring companies will usually focus substantially on the business of accounts receivable financing, but factoring, in general, a product of any financier.

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Assignment of accounts receivable is an agreement in which a business assigns its accounts receivable to a financing company in return for a loan. It is a way to finance cash flows for a business that otherwise finds it difficult to secure a loan, because the assigned receivables serve as collateral for the loan received.

By assignment of accounts receivable, the lender i.e. the financing company has the right to collect the receivables if the borrowing company i.e. actual owner of the receivables, fails to repay the loan in time. The financing company also receives finance charges / interest and service charges.

It is important to note that the receivables are not actually sold under an assignment agreement. If the ownership of the receivables is actually transferred, the agreement would be for sale / factoring of accounts receivable . Usually, the borrowing company would itself collect the assigned receivables and remit the loan amount as per agreement. It is only when the borrower fails to pay as per agreement, that the lender gets a right to collect the assigned receivables on its own.

The assignment of accounts receivable may be general or specific. A general assignment of accounts receivable entitles the lender to proceed to collect any accounts receivable of the borrowing company whereas in case of specific assignment of accounts receivable, the lender is only entitled to collect the accounts receivable specifically assigned to the lender.

The following example shows how to record transactions related to assignment of accounts receivable via journal entries:

On March 1, 20X6, Company A borrowed $50,000 from a bank and signed a 12% one month note payable. The bank charged 1% initial fee. Company A assigned $73,000 of its accounts receivable to the bank as a security. During March 20X6, the company collected $70,000 of the assigned accounts receivable and paid the principle and interest on note payable to the bank on April 1. $3,000 of the sales were returned by the customers.

Record the necessary journal entries by Company A.

Journal Entries on March 1

Initial fee = 0.01 × 50,000 = 500

Cash received = 50,000 – 500 = 49,500

The accounts receivable don't actually change ownership. But they may be to transferred to another account as shown the following journal entry. The impact on the balance sheet is only related to presentation, so this journal entry may not actually be passed. Usually, the fact that accounts receivable have been assigned, is stated in the notes to the financial statements.

Journal Entries on April 1

Interest expense = 50,000 × 12%/12 = 500

by Irfanullah Jan, ACCA and last modified on Oct 29, 2020

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Home > Accounts Receivable > Assignment of Accounts Receivable Journal Entries

Assignment of Accounts Receivable Journal Entries

The assignment of accounts receivable journal entries below act as a quick reference, and set out the most commonly encountered situations when dealing with the double entry posting of accounts receivable assignment.

The assignment of accounts receivable journal entries are based on the following information:

• Accounts receivable 50,000 on 45 days terms
• Assignment fee of 1% (500)
• Initial advance of 80% (40,000)
• Cash received from customers 6,000
• Interest on advances at 9%, outstanding on average for 40 days (40,000 x 9% x 40 / 365 = 395)

About the Author

Chartered accountant Michael Brown is the founder and CEO of Double Entry Bookkeeping. He has worked as an accountant and consultant for more than 25 years and has built financial models for all types of industries. He has been the CFO or controller of both small and medium sized companies and has run small businesses of his own. He has been a manager and an auditor with Deloitte, a big 4 accountancy firm, and holds a degree from Loughborough University.

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Receivables Finance And The Assignment Of Receivables

Tfg legal trade finance hub, receivables finance and the assignment of receivables.

A receivable represents money that is owed to a company and is expected to be paid in the future. Receivables finance, also known as accounts receivable financing, is a form of asset-based financing where a company leverages its outstanding receivables as collateral to secure short-term loans and obtain financing.

In case of default, the lender has a right to collect associated receivables from the company’s debtors. In brief, it is the process by which a company raises cash against its own book’s debts.

The company actually receives an amount equal to a reduced value of the pledged receivables, the age of the receivables impacting the amount of financing received. The company can get up to 90% of the amount of its receivables advanced.

This form of financing assists companies in unlocking funds that would otherwise remain tied up in accounts receivable, providing them with access to capital that is not immediately realised from outstanding debts.

FIG. 1: Accounts receivable financing operates by leveraging a company’s receivables to obtain financing.  Source: https://fhcadvisory.com/images/account-receivable-financing.jpg

Restrictions on the assignment of receivables – New legislation

Invoice  discounting  products under which a company assigns its receivables have been used by small and medium enterprises (SMEs) to raise capital. However, such products depend on the related receivables to be assignable at first.

Businesses have faced provisions that ban or restrict the assignment of receivables in commercial contracts by imposing a condition or other restrictions, which prevents them from being able to use their receivables to raise funds.

In 2015, the UK Government enacted the Small Business, Enterprise and Employment Act (SBEEA) by which raising finance on receivables is facilitated. Pursuant to this Act, regulations can be made to invalidate restrictions on the assignment of receivables in certain types of contract.

In other words, in certain circumstances, clauses which prevent assignment of a receivable in a contract between businesses is unenforceable. Especially, in its section 1(1), the Act provides that the authorised authority can, by regulations “make provision for the purpose of securing that any non-assignment of receivables term of a relevant contract:

• has no effect;
• has no effect in relation to persons of a prescribed description;
• has effect in relation to persons of a prescribed description only for such purposes as may be prescribed.”

The underlying aim is to enable SMEs to use their receivables as financing to raise capital, through the possibility of assigning such receivables to another entity.

The aforementioned regulations, which allow invalidations of such restrictions on the assignment of receivables, are contained in the Business Contract Terms (Assignment of Receivables) Regulations 2018, which will apply to any term in a contract entered into force on or after 31 December 2018.

By virtue of its section 2(1) “Subject to regulations 3 and 4, a term in a contract has no effect to the extent that it prohibits or imposes a condition, or other restriction, on the assignment of a receivable arising under that contract or any other contract between the same parties.”

Such regulations apply to contracts for the supply of goods, services or intangible assets under which the supplier is entitled to be paid money. However, there are several exclusions to this rule.

In section 3, an exception exists where the supplier is a large enterprise or a special purpose vehicle (SPV). In section 4, there are listed exclusions for various contracts such as “for, or entered into in connection with, prescribed financial services”, contracts “where one or more of the parties to the contract is acting for purposes which are outside a trade, business or profession” or contracts “where none of the parties to the contract has entered into it in the course of carrying on a business in the United Kingdom”. Also, specific exclusions relate to contracts in energy, land, share purchase and business purchase.

Effects of the 2018 Regulations

As mentioned above, any contract terms that prevent, set conditions for, or place restrictions on transferring a receivable are considered invalid and cannot be legally enforced.

In light of this, the assignment of the right to be paid under a contract for the supply of goods (receivables) cannot be restricted or prohibited. However, parties are not prevented from restricting other contracts rights.

Non-assignment clauses can have varying forms. Such clauses are covered by the regulations when terms prevent the assignee from determining the validity or value of the receivable or their ability to enforce it.

Overall, these legislations have had an important impact for businesses involved in the financing of receivables, by facilitating such processes for SMEs.

Digital platforms and fintech solutions: The assignment of receivables has been significantly impacted by the digitisation of financial services. Fintech platforms and online marketplaces have been developed to make the financing and assignment of receivables easier.

These platforms employ tech to assess debtor creditworthiness and provide efficient investor and seller matching, including data analytics and artificial intelligence. They provide businesses more autonomy, transparency, and access to a wider range of possible investors.

Securitisation is an essential part of receivables financing. Asset-backed securities (ABS), a type of financial instrument made up of receivables, are then sold to investors.

Businesses are able to turn their receivables into fast cash by transferring the credit risk and cash flow rights to investors. Investors gain from diversification and potentially greater yields through securitisation, while businesses profit from increased liquidity and risk-reduction capabilities.

References:

https://www.tradefinanceglobal.com/finance-products/accounts-receivables-finance/  – 28/10/2018

https://www.legislation.gov.uk/ukpga/2015/26/section/1/enacted  – 28/10/2018

https://www.legislation.gov.uk/ukdsi/2018/9780111171080  – 28/10/2018

https://www.bis.org/publ/bppdf/bispap117.pdf  – Accessed 14/06/2023

https://www.investopedia.com/terms/a/asset-backedsecurity.asp  – Accessed 14/06/2023

https://www.imf.org/external/pubs/ft/fandd/2008/09/pdf/basics.pdf  – Accessed 14/06/2023

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Assignment of Accounts Receivable – Trap for the Unwary

By  Steven A. Jacobson

Most businesses are familiar with the mechanics of an assignment of accounts receivable. A party seeking capital assigns its accounts receivable to a financing or factoring company that advances that party a stipulated percentage of the face amount of the receivables.

The factoring company, in turn, sends a notice of assignment of accounts receivable to the party obligated to pay the factoring company’s assignee, i.e. the account debtor. While fairly straightforward, this three-party arrangement has one potential trap for account debtors.

Most account debtors know that once they receive a notice of assignment of accounts receivable, they are obligated to commence payments to the factoring company. Continued payments to the assignee do not relieve the account debtor from its obligation to pay the factoring company.

It is not uncommon for a notice of assignment of accounts receivable to contain seemingly innocuous and boilerplate language along the following lines:

Please make the proper notations on your ledger and acknowledge this letter and that invoices are not subject to any claims or defenses you may have against the assignee.

Typically, the notice of assignment of accounts receivable is directed to an accounting department and is signed, acknowledged and returned to the factoring company without consideration of the waiver of defenses languages.

Even though a party may have a valid defense to payment to its assignee, it still must pay the face amount of the receivable to the factoring company if it has signed a waiver. In many cases, this will result in a party paying twice – once to the factoring company and once to have, for example, shoddy workmanship repaired or defective goods replaced. Despite the harsh result caused by an oftentimes inadvertent waiver agreement, the Uniform Commercial Code validates these provisions with limited exceptions. Accordingly, some procedures should be put in place to require a review of any notice of assignment of accounts receivable to make sure that an account debtor preserves its rights and defenses.

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Assignment of Accounts Receivable

The financial accounting term assignment of accounts receivable refers to the process whereby a company borrows cash from a lender, and uses the receivable as collateral on the loan. When accounts receivable is assigned, the terms of the agreement should be noted in the company's financial statements.

Explanation

In the normal course of business, customers are constantly making purchases on credit and remitting payments. Transferring receivables to another party allows companies to reduce the sales to cash revenue cycle time. Also known as pledging, assignment of accounts receivable is one of two ways companies dispose of receivables, the other being factoring.

The assignment process involves an agreement with a lending institution, and the creation of a promissory note that pledges a portion of the company's accounts receivable as collateral on the loan. If the company does not fulfill its obligation under the agreement, the lender has a right to collect the receivables. There are two ways this can be accomplished:

General Assignment : a portion of, or all, receivables owned by the company are pledged as collateral. The only transaction recorded by the company is a credit to cash and a debit to notes payable. If material, the terms of the agreement should also appear in the notes to the company's financial statements.

Specific Assignment : the lender and borrower enter into an agreement that identifies specific accounts to be used as collateral. The two parties will also outline who will attempt to collect the receivable, and whether or not the debtor will be notified.

In the case of specific assignment, if the company and lender agree the lending institution will collect the receivables, the debtor will be instructed to remit payment directly to the lender.

The journal entries for general assignments are fairly straightforward. In the example below, Company A records the receipt of a $100,000 loan collateralized using accounts receivable, and the creation of notes payable for $100,000.

In specific assignments, the entries are more complex since the receivable includes accounts that are explicitly identified. In this case, Company A has pledged $200,000 of accounts in exchange for a loan of $100,000.

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The Difference Between Assignment of Receivables & Factoring of Receivables

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You can raise cash fast by assigning your business accounts receivables or factoring your receivables. Assigning and factoring accounts receivables are popular because they provide off-balance sheet financing. The transaction normally does not appear in your financial statements and your customers may never know their accounts were assigned or factored. However, the differences between assigning and factoring receivables can impact your future cash flows and profits.

How Receivables Assignment Works

Assigning your accounts receivables means that you use them as collateral for a secured loan. The financial institution, such as a bank or loan company, analyzes the accounts receivable aging report. For each invoice that qualifies, you will likely receive 70 to 90 percent of the outstanding balance in cash, according to All Business . Depending on the lender, you may have to assign all your receivables or specific receivables to secure the loan. Once you have repaid the loan, you can use the accounts as collateral for a new loan.

Assignment Strengths and Weaknesses

Using your receivables as collateral lets you retain ownership of the accounts as long as you make your payments on time, says Accounting Coach. Since the lender deals directly with you, your customers never know that you have borrowed against their outstanding accounts. However, lenders charge high fees and interest on an assignment of accounts receivable loan. A loan made with recourse means that you still are responsible for repaying the loan if your customer defaults on their payments. You will lose ownership of your accounts if you do not repay the loan per the agreement terms.

How Factoring Receivables Works

When you factor your accounts receivable, you sell them to a financial institution or a company that specializes in purchasing accounts receivables. The factor analyzes your accounts receivable aging report to see which accounts meet their purchase criteria. Some factors will not purchase receivables that are delinquent 45 days or longer. Factors pay anywhere from 65 percent to 90 percent of an invoice’s value. Once you factor an account, the factor takes ownership of the invoices.

Factoring Strengths and Weaknesses

Factoring your accounts receivables gives you instant cash and puts the burden of collecting payment from slow or non-paying customers on the factor. If you sell the accounts without recourse, the factor cannot look to you for payment should your former customers default on the payments. On the other hand, factoring your receivables could result in your losing customers if they assume you sold their accounts because of financial problems. In addition, factoring receivables is expensive. Factors charge high fees and may retain recourse rights while paying you a fraction of your receivables' full value.

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Notice of Assignment of Accounts Receivable Under the PPSA: What Every Factor Should Know

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INTRODUCTION

Factoring is the legal relationship between a financial institution (the “Factor”) and a business (the “Client”) selling goods or providing services to a trade customer (the “Customer”), pursuant to which the Factor purchases the accounts receivable owing to the Client by its Customer. The Courts in Ontario have determined that a factoring agreement creates a security interest and, as such, is subject to the provisions of the Ontario Personal Property Security Act R.S.O. 1990 c.P.10 (the “PPSA”). This means, among other things, that the Factor must register a financing statement against the Client under the PPSA claiming a security interest in the Client’s accounts receivable. A factoring agreement may be on a notification or a non-notification basis.

A factoring agreement on a notification basis requires that the Client’s Customer be notified regarding the purchase of the accounts receivable by the Factor and the assignment of the accounts receivable by the Client to the Factor. One purpose of notifying the Customer is to require the Customer to make payment on the accounts receivable directly to the Factor, instead of to the Client.

A notice of assignment is governed by Section 40(2) of the PPSA, which states that an account debtor (i.e., the Customer) may pay the assignor (i.e., the Client) until the Customer receives notice, reasonably identifying the relevant rights, that the accounts receivable have been assigned. If requested by the Customer, the Factor is required, within a reasonable period of time, to furnish proof of the assignment and, if the Factor fails to do so, the Customer may pay the Client.

What constitutes adequate notice of an assignment of accounts receivable? The PPSA does not set out a statutory form of notice of assignment. In RPG Receivables Purchase Group Inc. v. Krones Machinery Co. Limited , 2010 ONSC 2372, C. W. Hourigan J. of the Ontario Superior Court of Justice was required to review a notification of assignment and to determine whether it was adequate. The Court’s decision is an important guide to the essential elements that should be included in the notice of assignment.

The facts were as follows:

1. On July 14, 2005, RPG Receivables Purchase Group Inc. (“RPG”) entered into a factoring agreement with its client Kennedy Automation Limited (“Kennedy”), pursuant to which RPG agreed to purchase certain of Kennedy’s accounts receivable, including accounts receivable due from its customer Krones Machinery Co. Limited (“Krones”).

2. On July 14, 2005, Kennedy faxed a notification of assignment to Krones, which read as follows:

“NOTIFICATION OF ASSIGNMENT

In order to grow and serve you better, we have retained the services of RPG Receivables Purchase Group Inc. to accelerate and stabilize our cash flow. Through their accounts receivable program, RPG has purchased and we have assigned to them all of our right, title and interest in all currently outstanding as well as all future accounts receivable from your company.

We request that all payments be made payable and mailed directly to:

RPG Receivables Purchase Group Inc. (“RPG”)

Suite 300, 221 Lakeshore Road East

Oakville, ON L6J 1H7

Tel (905) 338-8777 (800) 837-0265

Fax (905) 842-0242

This notice of assignment and payment instructions will remain in full force and effect until RPG advises you otherwise in writing. Please note that their receipt of payment is the only valid discharge of the debt and that RPG’s interest has been registered under the Personal Property Security Act of the Province of Ontario.

Although this notification is effective upon receipt by you, in order to complete RPG’s records, we would appreciate your acknowledgement of this notification and your confirmation that:

• the invoices on the attached statement are for goods and/ or services completed to your satisfaction (please note any exceptions or simply provide a listing from your accounts payable); and
• that payments will be scheduled in accordance with the invoice terms and that your accounts payable records have been modified to ensure payment of the full invoice amounts directly to RPG or you will notify RPG of any disputes or potential chargebacks in a timely manner.

Please fax and mail the signed copy of this letter to RPG Receivables Purchase Group Inc., who shall be entitled to rely upon your notification and confirmation as a separate agreement made between you and them. Thanks for your help and cooperation. We look forward to serving you in the future.”

3. On August 5, 2006, Krones executed the notification of assignment and returned the executed copy to RPG.

4. In 2007, Kennedy entered into agreements with Krones for the supply of services and materials to Krones in relation to various projects including projects in Etobicoke, Edmonton, and Moncton.

5. Before Kennedy submitted its invoices to Krones, Kennedy provided the invoices to RPG and RPG stamped each invoice as follows:

“NOTICE OF ASSIGNMENT All payments hereunder have been assigned and are to be made directly to:

RPG RECEIVABLES PURCHASE GROUP INC.

221 Lakeshore Road East, Suite 300

Any offsets or claims should be reported to:

(905) 338-8777 Ontario

(800) 837-0265

Fax (905) 842-0242”

6. Krones paid 13 of the 16 invoices issued by Kennedy. RPG did not receive any notice from Krones regarding any disputes, off-sets, chargebacks or claims arising out of the Edmonton or Etobicoke projects.

7. At or about the time that the three unpaid invoices were rendered, Kennedy began to experience difficulty in paying its subcontractors on the Moncton project.

8. When the Moncton project ran into difficulty, Krones stopped making payments on the Edmonton and Etobicoke invoices in a timely fashion.

9. RPG commenced an action against Krones in respect of the unpaid invoices for the Moncton project that RPG had factored.

10. Krones also commenced an action for damages against Kennedy relating to the Moncton project.

11. Krones denied liability in respect of the unpaid invoices on the grounds that it had a right to set- off due to alleged overpayments, chargebacks, and damages relating to the Moncton project. It also raised issues with respect to the validity of the assignment of the invoices by Kennedy to RPG and the validity of the invoices.

12. The Court decided in favour of RPG and granted it summary judgment in the amount of $183,172.61, plus interest, for payment of the three outstanding invoices.

THE DEFENCE OF SET-OFF

The primary defence of Krones was that it had a valid defence of set- off. In reviewing this defence, the Court referred to the legal principle of “mutuality”. In order to establish a valid claim of legal set-off, there must be mutuality which requires that the debts be between the same parties and that the debts be in the same right. The Court stated that this mutuality is lost where the debt has been assigned to another party (i.e., the Factor), unless the rights to set-off have accrued between the debtor (i.e., the Customer) and the original creditor (i.e., the Client) prior to receipt of the notice of assignment by the debtor. At the time that the accounts receivable owing by Krones to Kennedy were assigned to RPG, no right of set- off had accrued in respect of the alleged overpayments, chargebacks, and damages relating to the Moncton property. Therefore, Krones had no legal right to set-off, because the mutuality required for this defence was lost when the accounts receivable were assigned by Kennedy to RPG.

The Court also reviewed the purchase order for the Moncton project to see whether it contained a contractual right of set-off. The Court rejected this claim by Krones and found that there was no contractual right of set-off.

Finally, the Court considered the issue of equitable set-off and concluded that it was not available to Krones.

OTHER DEFENCES

In its other defences, Krones took issue with the validity of the invoices and the validity of the assignment by Kennedy to RPG. Krones argued that the notification of the assignment was limited to the invoice attached to the notification of assignment. The Court rejected this argument for three reasons:

1. This argument ignored the clear statement in the notice of assignment that “RPG has purchased and we have assigned to them all of our right, title and interest in all currently outstanding as well all future accounts receivable from your company”.

2. Each of the disputed invoices contained a stamped notification of assignment; and

3. Krones paid RPG directly for 13 of the 16 invoices. The Court also rejected a number of other arguments raised by Krones in its defence relating to the validity of the invoices.

CONCLUSIONS

In a notification factoring arrangement, a Factor needs to protect its interest in the purchased accounts receivable by giving written notice of the assignment to the Client’s Customer. According to Section 40(2) of the PPSA, the Customer may continue to pay the Client until the Customer receives notice that the accounts receivable have been assigned to the Factor. However, the PPSA does not set out a statutory form of notice, nor does the PPSA deal with any right of set- off that the Customer may claim with respect to the purchased accounts receivable. In general, a Factor can only “step into the shoes” of his Client and assert the same right that his Client has against the Customer. This means that, if the Customer has any right to claim a set-off against the accounts receivable owing to the Client, then the Factor is required to accept the reduction in payment as a result of any legitimate claim asserted by the Customer.

In order to protect its interest in the purchased accounts receivable, the Factor should send a notice of assignment, which when signed by the Customer, should accomplish the following purposes:

1. it should require the Customer to make payment on the purchased invoices directly to the Factor, instead of to the Client;

2. it should request the Customer to verify the accuracy of the purchased invoices;

3. it should eliminate the Customer’s right to claim any set-off or reduction in the amount payable on the accounts receivable in respect of the Client’s obligations arising after the delivery of the notice; and

4. It should create an enforceable direct contract between the Factor and the Customer.

Since the notification of assignment in the RPG case has been given the “judicial seal of approval”, it is recommended that this form be used by a Factor in Ontario. It is also recommended that the Factor follow the procedure referred to in the RPG case pursuant to which the Customer is requested to acknowledge and confirm the terms of the notification of assignment and return a signed copy to the Factor.

The Court in RPG also referred to the “stamped notification of assignment” on each of the disputed invoices as one of the reasons for rejecting the Customer’s defences. For this reason, it is recommended that this form of stamp also be used by a Factor in Ontario on each factored invoice before the invoice is submitted to the Customer.

If a Factor follows the above procedures, then the Factor should be able to collect from the Customer on the invoice, regardless of what issues arise between the Client and the Customer subsequent to the delivery of the notice of assignment. If the Customer refuses to acknowledge and sign the notice of assignment, then the Factor will have limited recourse against the Customer and will have to make a business decision regarding the risk involved in funding the invoice. Even if the Customer acknowledges and signs the notice of assignment, the Factor will still have to be on the alert for any future disputes between the Client and the Customer. For example, the form of notification used in the RPG case requires the Customer to notify the Factor of “any disputes or potential chargebacks” and the stamp on the invoices in this case requires the Customer to report “any offsets or claims”. If the Customer notifies the Factor about any such disputes, chargebacks, offsets, or claims, then the Factor will also have to evaluate the funding of the invoice.

A properly drafted notice of assignment will put the Factor in a stronger position to resist any reduction in payment claimed by the Customer. As a practical matter, however, the Factor should also try to confirm with the Customer prior to funding an invoice that there are no disputes between the Customer and the Client. This extra step could avoid the time and expense of litigation over the purchased accounts receivable.

Jeffrey Alpert

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Receivables Finance: the prohibition on assignment is now in force

18th January 2019

The Business Contract Terms (Assignment of Receivables) Regulations 2018 came into force on 31 December 2018 meaning that parties to a contract in the UK may no longer be able to prohibit the assignment of receivables arising in respect of supplies made under it, even if it is a long term supply contract providing for multiple deliveries.

As we reported in December 2017 , draft regulations were laid before Parliament in September of that year which proposed to make any term in a business contract that prohibited or restricted the assignment of receivables automatically ineffective. Those draft regulations were subsequently withdrawn amid concerns that they would create uncertainty in the finance markets.

The main areas of concern were that:

• the legislation appeared to be retrospective therefore catching contracts that were already in place;
• the types of assignment which fell within the regulations were not described sufficiently well enough to create certainty; and
• there was no protection for the debtor who may have stipulated for a non-assignment clause in the expectation that its rights of set off would be preserved.

However, the government has since revisited the legislation and on 24 November 2018 the Business Contract Terms (Assignment of Receivables) Regulations 2018 (the Regulations ) came into force. The Regulations apply to contracts (with a few exceptions described below) created after 31 December 2018 and mean that parties will no longer be able to prohibit the assignment of receivables in the UK. The Regulations make it clear that the prohibition is not retrospective and so the Regulations only apply to new contracts. In effect, this means that one party to a contract cannot prevent the other party from choosing who should receive payments under a contract for the supply of goods, services or intangible assets.

The Regulations also render unenforceable any terms which prevent a person who has been assigned the receivable from being able to enforce the contract, or determine its validity or value (for example by preventing the disclosure of the information required to commence court proceedings for its collection).

The Regulations are aimed at improving access to invoice financing for small and medium-sized enterprises and the government speculates that this will provide a £1 billion, long-term, boost to the economy. Invoice financing allows businesses to assign their right to be paid by a customer to a finance provider. In return the finance provider provides the business with up-front funds, thereby speeding up the business’ working capital cycle (provided the debtor ultimately pays the assigned invoice). Before 1 January 2019, smaller businesses would usually be forced to engage with larger customers on those customers’ standard terms, which often contained non-assignment clauses. As a result, some smaller businesses were restricted from engaging with invoice financing opportunities. This should now change.

The Regulations apply to contracts for the supply of goods, services or intangible assets where the supplier has the right to be paid under the contract. There are, however, a number of exceptions including:

• a large enterprise or part of a large group (as defined by the Companies Act 2006); or
• a special purpose vehicle, set up to hold assets or finance commercial transactions involving it incurring a liability under an agreement of £10 million or more.
• The Regulations also do not apply to services of a financial nature. The definition of ‘financial nature’ is construed widely and includes, amongst other things, leasing, loan relationships and all types of securitisation and derivative transactions.
• The Regulations do not apply to contracts which have as their purpose the acquiring, disposing or transferring of ownership in a firm (as defined in the Companies Act 2006) whether incorporated or established, or of a business or undertaking. However, for this exemption to apply, the contract must include a statement to that effect.
• The Regulations generally do not apply to contracts that relate to non-UK businesses. However, parties cannot contract out of the Regulations by changing the contract’s governing law, if the only reason for doing so is to circumvent the regulations.
• There are also a number of other types of contracts which the Regulations do not apply to, including consumer contracts, real estate contracts, public-private partnership contracts and rental contracts. Interestingly, the Regulations will apply to building contracts which, up to now have been impossible to finance, in practice, through an invoice discounting arrangement.

Practical application

The Regulations will lead to the need for certain changes to the drafting and implementation of commercial contracts:

• No assignment clauses –  An eligible supplier will be able to assign their receivables to a debt purchaser without having to seek their customers’ prior consent. This means a blanket non-assignment clause will no longer work for on its own to preserve rights of set off;
• Confidentiality provisions –  Confidentiality obligations can still be imposed on suppliers, except for any “essential information” that enables the identification of the receivables following assignment. This means information that enables the identification of receivables (so as to facilitate their collection) may be disclosed by a supplier to a third party purchaser for the purpose of receivables assignment or transfer without constituting a breach of confidentiality.
• Set-off –  The Explanatory Note to the Regulations clarifies that a contractual right to set-off is not considered as a restriction on transfer of receivables for the purpose of the Regulations. Although the right to set-off is maintained, businesses may want to consider the practical impact of the Regulations on the mechanism to exercise the right to set-off, such as how cash flow will be affected if you are no longer able to consolidate future transactions to set-off against one original invoice that has already been assigned to a third party.

Many commercial arrangements will be unaffected by this change in legislation. However this will depend, in relation to contracts entered into this year and beyond, on the terms of the contract and the nature of what is being supplied under it. A key point to note is that the Regulations will not nullify the contract as a whole or, indeed, the whole of the clause restricting assignment, but only to the extent applicable to receivables.

Providers of invoice finance will still need to carry out due diligence, at least for now, on taking on any new invoice discounting client to ascertain the extent to which the debtor book may still contain debts which are subject to restrictions on assignment or are otherwise subject to rights of set off.

Small and medium sized companies seeking to avail themselves of the new rules should seek advice before doing so. Invoice discounting products can be an extremely effective way of assisting a growing business meet its working capital needs. However, lumpy cash flow, or bad debt experience (including habitual slow payers in the customer base) can lead to disaster if not properly managed.

If you need advice on how the Regulations may affect your business please get in touch.

In the realm of trade credit security, factoring, forfaiting, and assignment of receivables share a common thread – they all revolve around the utilization of receivables as financial instruments. However, it is crucial to recognize that while they may seem similar due to their reliance on receivables, they differ fundamentally in their use and application. Let's explore how these financial strategies, though linked by receivables, serve distinct purposes in the world of trade credit security.

Factoring and Forfaiting:

Factoring involves the sale of a business's accounts receivable to a specialized financial entity, known as a factor, at a discounted rate. The factor takes on the responsibility of collecting customer payments, offering rapid access to cash flow and bolstering liquidity.

Principal Difference: Transfer of Ownership

The fundamental distinction lies in the transfer of ownership. In factoring, the trade creditor relinquishes ownership of the accounts receivable to the factor. This means the factor or forfaiter becomes the new legal owner of the receivables and directly manages the collection process. The trade creditor essentially converts future payments into immediate capital.

Assignment of Receivables:

Assignment of receivables, on the other hand, is a process where the rights and benefits of a receivable are transferred from one party (assignor) to another (assignee). It serves as a tool for credit risk management, allowing businesses to transfer the risk of non-payment or default to the assignee while stabilizing cash flow.

Principal Difference: Retention of Ownership

In contrast to factoring, in the assignment of receivables, ownership of the receivables remains with the assignor. The assignee, while assuming responsibility for collecting payments, does not become the new legal owner of the receivables. Instead, they act on behalf of the assignor to ensure payment collection.

In essence, while both factoring and assignment of receivables offer solutions for managing credit risk and enhancing cash flow, their fundamental difference lies in the ownership structure. Factoring involves the sale and transfer of ownership of accounts receivable to a factor, while assignment of receivables retains ownership with the assignor, with the assignee acting as a collector.

Businesses evaluating these trade credit security options should carefully consider their preferences, goals, and impact on customer relationships to determine which approach best aligns with their financial strategies.

#credit #creditmanagement #creditrisk #creditworthiness #creditengineering

Contract for the assignment of receivables

A receivable assignment agreement is an agreement by which a creditor – the “assignor” – assigns to another person – the “assignee” – a receivable it holds against a third person – the “assigned debtor”. The assigned debtor is not a party to the assignment agreement. The mere exchange of consents between the assignor and the assignee is sufficient to give rise to the contract for the assignment of the receivable, the consent of the debtor not being necessary for its performance.

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3 November 2017

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Assignment of Receivables

The draft Business Contract Terms (Assignment of Receivables) Regulations 2017 (the “ Draft Regulations ”) are currently before Parliament. If approved, these would contain provisions to nullify contract terms which attempt to restrict the ability of a party to assign a receivable.

In December 2014, the Department for Business, Innovation & Skills (BIS) consulted on an earlier version of the Draft Regulations. These earlier regulations contained a provision that allowed a party to rely on a confidentiality clause to prevent assignment of a receivable. This was included in the event that a debtor is unwilling for a receivable to be assigned because the disclosure of the debt to a third party compromises the debtor’s confidentiality. In August 2015, BIS published a response to the consultation.

Businesses often have to wait for a considerable length of time to be paid, which can cause cash flow issues. As a way of raising finance, a business may choose to assign an unpaid invoice to a third party, such as an invoice finance provider. This works by the finance provider lending the money to the business on the basis that the invoice is assigned to the finance provider. The finance provider will then pursue the debtor for the unpaid amount which will cover the earlier loans to the business.

Most contracts contain boilerplate provisions preventing the assignment of any rights under the contract unless the other party consents. A receivable is a right to be paid and a boilerplate non-assignment clause is broad enough to prevent invoices from being assigned.

Certain contracts are excluded from these rules. These include contracts for: an interest in land; for financial services; consumers where one or more of the parties is acting for purposes which are outside a trade, business or profession; for national security; and for certain energy and petroleum contracts.

Noticeably, the Draft Regulations do not include the confidentiality clause that was included in the earlier version.

Controversially, “assignment” is not defined. It is clear that this law would apply to outright assignments of receivables, but it is unclear the extent which it will apply to security interests. On the face of it, the new law will extend to security assignments but not charges or trusts. This may have the result that the parties cannot prevent a security assignment but can prevent a lesser interest such as a charge.

One of the reasons why restrictions on assignment are included in contracts is to protect the payer from having to pay more to an assignee than it would have to pay to the assignor. However, there is nothing in the Draft Regulations to protect the payer. It can only rely on its rights under the general law, which are extensive but not as good as an effective prohibition on assignment.

If approved, the Draft Regulations will not only apply to small companies. It will also read so that it covers all contracts, including those in existence at the time the new law comes into effect, which is expected to be in November or December 2017.

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About the Author

Tim littler, senior legal counsel.

Tim Littler is a Cheltenham solicitor , specialising in banking and finance .

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