Factor Beware: How MSAs Can Deprive You of Recovery
Written by: Robby Dube, Esq. and Daniel J. Cragg, Esq.
A few months ago we explained why a Notice of Assignment does not protect factors as much as they may think because the Uniform Commercial Code still allows for a defense to the assignee’s claim called “claim in recoupment,” even after a Notice of Assignment. In this article, we follow up, explaining what really constitutes a claim in recoupment and explain why a crucial part of any factor’s due diligence is discovering, before funding, whether the factoring client is under a Master Services Agreement with the account debtor and where the various work sites are.
A quick recap: A factor’s right to the collateral is subject to the Uniform Commercial Code Section 9-404. Section 9-404(a)(1) provides that a factor’s rights are subject to “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.” UCC § 9-404(a)(1). This is recoupment: the ability to offset recovery by the damages owed to the account debtor under the transaction itself.
This leads to a crucial question: what is the “transaction that gave rise to the contract?” Is it just the account that’s being purchased, or is it the entire contractual relationship between the factoring client and the account debtor? As with many things in the law, it depends.
“There are two primary approaches in determining whether an obligation meets the ‘same transaction’ requirement” for recoupment. William L. Norton, Bankruptcy Law and Practice § 73:2 (3d ed. 2025). The first is known as the “logical relationship approach,” and the second is the “single integrated transaction approach.” Id.
For quick reference, here are the jurisdictions that seem to adopt the (worse for factors) logical connection test vs. the (better for factors) single integrated approach:
The 5th Circuit (Texas, Louisiana, and Mississippi) does not follow a set rule.
The Logical Relationship Approach
The logical relationship approach is illustrated by In re TLC Hosps., Inc., 224 F.3d 1008, 1012 (9th Cir. 2000):
We have held that the crucial factor in determining whether two events are part of the same transaction is the “logical relationship” between the two. Thus, a “transaction” may include “a series of many occurrences, depending not so much upon the immediateness of their connection as upon their logical relationship.
Newbery Corp v. Fireman’s Fund Ins. Co. provides a good example of an application of the logical relationship test in the construction context. See generally 95 F.3d 1392 (9th Cir. 1996). In Newbery, an electric company, sued its former surety, Fireman’s Fund, for unpaid equipment rentals. In response, Fireman’s Fund filed for recoupment based on an unfulfilled claim for indemnification in a different contract. Id. at 1402. Newbery objected, arguing that the contract which covered indemnification and the contract which covered the equipment rentals were two separate transactions and therefore recoupment was improper. Id. at 1401–02. The 9th Circuit, applying the “logical relationship test,” disagreed, finding that the two agreements—though separate contracts—were the same transaction. Id.
Single Integrated Transaction Approach
The other approach courts have used has been called the “single integrated transaction approach”:
For the purposes of recoupment, a mere logical relationship is not enough: the fact that the same two parties are involved, and that a similar subject matter gave rise to both claims . . . does not mean that the two arose from the same transaction. Rather, both debts must arise out of a single integrated transaction so that it would be inequitable for the debtor to enjoy the benefits of that transaction without also meeting its obligations.
In re Univ. Med. Ctr., 973 F.2d 1065, 1081 (3d Cir. 1992) (citations and internal quotations omitted). “When the circumstances that gave rise to the credit and those giving rise to the creditor’s obligation to the debtor do not result from a set of reciprocal contractual obligations or from the same set of facts, they are not part of the same transaction.” In re Malinowski, 156 F.3d 131, 134 (2d Cir. 1998).
In In re Univ. Med. Ctr., UMC determined it had been overpaid by Medicare, and based on that overpayment, HHS withheld reimbursement for services after UMC filed a petition in bankruptcy. Id. HHS argued this recoupment was proper, pointing to the statutory reimbursement relationship between UMC and HHS, and also pointing out that their contract had expressly contemplated potential overpayments like this. Id. at 1080. Nonetheless, the 3rd Circuit said recoupment was not allowed because this was not a “single integrated transaction.” Id. at 1081. The Court found that the payments at issue “were independently determinable and were due for services completely distinct” from those that had been overpaid. Id. Transactions, for purposes of recoupment, began with the services rendered, included the payment for those services, and concluded with recovery of any overpayment. Id. at 1081–82.
What Steps Should a Factor Take to Protect Against the Defense of Recoupment?
So what does this mean for factors? Your purchased account may ultimately be worth nothing if the factoring client failed in other parts of the contractual relationship.
This can be seen most prevalently in construction or transportation factoring. For example, the factoring client has an MSA with the account debtor to perform construction services in California, Alabama, and Maine. It receives discrete SOWs for each project, and bills separately on each project.
The factor may only be funding invoices for the California project, but if the client fails to perform in Alabama, that MSA would permit the account debtor to use recoupment as a defense to payments due under that contract from the California invoice, even when the California work was performed perfectly. Thus, a project the factor potentially had no knowledge of, or perhaps wrongfully assumed would not affect the California invoice it purchased, has now deprived the factor of recovery from the account debtor (possibly after lengthy litigation).
Because of this uncertainty regarding recoupment, factors must know whether there is an MSA (or other similar overarching contract) that governs the factoring client’s relationship with the account debtor.
If there is, the factor needs full visibility into that entire relationship before it advances funds. To do otherwise means a failure of the factoring client to perform on one project could wipe away the factor’s recovery on accounts that would seem to be totally disconnected. An additional way to mitigate this risk is to obtain an estoppel agreement with the account debtor, a practice we wrote about in this article last January.
About Daniel Cragg, Esq., Partner, Eckland & Blando LLP
Daniel J. Cragg’s practice focuses on complex personal injury matters, commercial litigation, labor & employment law, factoring and asset-based lending, admiralty and maritime law, and procedurally complex cases, including cases against the government. Daniel has represented clients in State and Federal trial court and in administrative proceedings at the Federal, State and local levels. He has also argued before the U.S. Court of Appeals for the Eighth Circuit, the Minnesota Supreme Court, and the Minnesota Court of Appeals.
Daniel is a cum laude graduate of William Mitchell College of Law. He received his B.A. in history and international studies from the Virginia Military Institute.
Daniel is also a Rule 114 qualified civil adjudicative neutral and available to arbitrate complex civil matters.
About Robby Dube, Esq., Senior Associate, Eckland & Blando LLP
Robert “Robby” Dube grew up working in his family’s small business and ranch, so he understands the needs of businesses and works tirelessly to advocate for them in a cost-effective manner. He is a zealous litigator, having briefed, argued, and won numerous motions before both state and federal courts across the country, including maritime and admiralty cases, and has won cases in every stage of the litigation process, including trial. Robby also has deep experience with the factoring industry and the customs industry, litigating for and advising clients across the country.
Robby is deeply experienced with pursuing claims against all levels of government, including bid protests, municipal litigation, challenging terminations for cause, drafting requests for equitable adjustments, and producing government contract compliance guides for businesses. He has engaged in significant Administrative Procedures Act challenges against states and the federal government at the district courts and Circuit courts, winning unanimous decisions.