Get Smart: How to Maintain Control Over Your Deals
In a perfect world, every factoring relationship would go smoothly without any real need for oversight or concern. In reality, due to the sometimes-risky nature of the industry, ensuring you have control over your deals is essential. Steven Kurtz outlines key actions and considerations to take to ensure you avoid chaos without needing to become a babysitter.
BY STEVEN N. KURTZ, ESQ., LEVINSON ARSHONSKY & KURTZ, LLP
As mentioned in prior articles, inspiration for this column comes from many sources. This one came from a conversation with an old friend whilst discussing a pressing question about the old TV show “Get Smart.” This classic show, which I used to watch in re-runs and which was also made into a funny movie, centered around the fictional spy agency known as Control and its battles against the bad guys known as KAOS. The factoring and asset-based lending business is often about maintaining control over chaotic clients and borrowers, and is not without comic relief. Hence, this article is about the need to always maintain control over your deals, with a focus on documents and common-sense rights.
It goes without saying that the factoring and ABL space is extremely risky. The typical factor client/ABL borrower comes with a story and is thus not able to obtain traditional bank financing. Most factor clients/ABL borrowers are good until they are not, and things can change quickly. Therefore, understanding your deal documents and knowing what external factors you can control, or at least be sensitive to, such as tax issues, corporate compliance and licensing problems, may be the difference between a loss and a close call.
It’s always advisable for you and everyone in your organization to review your suite of deal documents and come to your best understanding. As you continue to review your transaction documents, you should learn a little more about your deals and your rights every time. Here are a few things that you should understand to help you maintain control over your deals.
Information is Key
First, virtually all factors and most ABL lenders in the “IFA market space” have discretionary financing facilities, meaning you can fund or not fund for any reason. While you are obviously in the business of putting out money and earning returns via repayments, the fact that you don’t have to put out money gives you the opportunity to hit the pause button if necessary. For committed lenders, there will be details in your agreements that pertain to collateral eligible for borrowings and conditions for borrowing. This means, whether you have a discretionary or committed facility, if there is something that is out of sorts, you have the absolute right to stop and insist upon information. For example, if you are aware of potential negative information on an account debtor, or something seems off with the volume or size of the accounts you just funded, you may find that those gut feelings turn out to be real issues. Your documents also allow you to have the right to request information about virtually anything you can imagine. In many cases, you will be financing deals that are based upon written agreements. Since your rights as a secured party or owner of the account are always subject to the business deals your client has entered with account debtors, make sure to get copies of the actual contracts so you know what you are financing.
Your right to demand information extends to the things that your client/ABL borrower must do to stay compliant in its business. But first you need to understand the client/borrower’s business in order to know what to ask. For example, when financing freight brokers or freight forwarders, the client/borrower needs to be licensed with the FMCSA and maintain its surety bond. Freight brokers and forwarders can blow up on a moment’s notice when the actual carriers are not paid, so you need to ascertain who the carriers are and ensure they are paid in a timely manner for the actual jobs you’re financing, which should be done contemporaneously with the proceeds of your advance.
For those financing temporary staffing agencies, these types of clients/borrowers often get into trouble with their payroll taxes. Thus, you need the records and evidence that confirm that all payroll taxes are paid on time. You will also need confirmation that the temporary workers are paid. Unpaid workers mean that the account debtor fired the staffing company and withheld payments.
Many of your clients/borrowers are transacting business with account debtors with comprehensive online portals that reflect details of the transaction. These details often include order status, payment dates and even the factor/lender that is the assignee of the payment rights. This means you will need access and password information for all online portals so you can track your details in real time.
Those are just a few examples of things you want to look into to gain control, but primarily, you need to understand your client/borrower’s business and not be afraid to ask questions and dig deep.
State-By-State Concerns
While you certainly have the right to obtain whatever information you reasonably deem necessary to maintain control over the factor client/borrower, you can’t do everything and be a babysitter. There are many things that can happen under your nose that can lead to events of default that you won’t learn about until it is too late. For example, let’s say you have a contract that requires your client/borrower to be in good standing in its state of organization. The factor client/borrower could lose its good standing in its state by either not paying its annual fees, paying minimum taxes, maintaining licenses or filing tax returns. Many states will suspend the factor client/borrower for its failure to comply with such individual state requirements. In most states, once a corporation or LLC is suspended, it can no longer transact business until the problem is rectified. Depending on the reason for suspension, it can be a simple fix costing below $1,000 or a seven-figure tax problem.
In many jurisdictions, those doing business with your factor client/borrower (the account debtors) can have a defense to payment on your financed account for the sole reason that your factor client/borrower is no longer eligible to transact business in its state of organization. This can obviously turn into a big mess, as your collateral can also be in jeopardy and, in some instances, primed when your factor client/borrower is the subject of a judgment in litigation and the other side is levying on your collateral. (See, Lien Creditors and Other Predators in the IFA March/April 2016 issue of Commercial Factor).
Although these situations can be serious problems, evidence is often found in public records and just about every state will let you know if an LLC or corporation registered therein is in good standing. The same thing goes for tax liens and lawsuits/judgments. This simply means that you need to look for this information, at least once a quarter, by running online public record searches on your factor clients/borrowers. If this is not something you can do in-house, engage one of the commercial search firms to run those searches.
When a Deal Changes
Another area where you want to maintain control is when your deal changes, as you will want everything in writing in order to enforce the integrity of your deal documents. (See my article from this year’s May/June issue for a more complete analysis). Every amendment to your transaction should require a signed document that confirms the validity and enforceability of your deal and that, except for the modifications, everything else is enforceable according to the deal documents. This should be signed by the factor client/borrower and all guarantors.
In default situations, control is even more important. We have also discussed forbearance agreements in detail recently, so I’ll just reinforce the need for the acknowledgement of default, the outlining of how the default will be fixed, the confirmation that the deal documents are enforceable and that all collateral is properly perfected and the comprehensive one-way release in your favor. Often in default situations in which you are continuing to finance the deal, you will require a consultant. Control can be maintained when this occurs by having a stable of trusted people who can work for your factor client/borrower as their consultant. Your control is kept by giving your factor client/borrower a list of approved people and letting the other side pick the consultant.
Finally, many deals leave on good terms. When that happens, your final act of control is making sure that you receive the contractual one-way release you should have in your agreements in exchange for filing the UCC termination statement.
There is a fine line between maintaining control over the situation, which is good, versus controlling your factor client/borrower to the point where you’re running the business, which gets you into trouble. The key is maintaining the arm’s length dealings and formalities inherent in your transaction documents. Control is also about having situational awareness and keeping systems in place such as proactive searches. And as an aside, for those who appreciate old fashioned clean but silly comedy, check out “Get Smart” online before this cancelled show becomes cancelled for good.