Texas is a Haven for Full Recourse Factoring
Jason Medley of Clark Hill explains how Texas has become the preferred state for full recourse factoring and outlines how it stands out as a particularly favorable place to do business.
BY JASON MEDLEY, ESQ., ATTORNEY, CLARK HILL
Among the many reasons Texas is special is that it embraces full recourse factoring. Most other states view full recourse factoring as a fatal flaw that can lead to a reclassification of the factoring agreement into a secured loan, which in turn imparts usury ceilings and changes the accounts receivable from a factor’s property to a factor’s collateral. In such instances, in a bankruptcy of a factoring customer, a factor could be deemed a secured creditor and the automatic stay would apply to cease collection of the accounts. In some states, usury ceilings are far lower than the effective yield on factoring deals, so usury is a real concern.
In Texas (as well as Louisiana, see La. Stat. Ann. § 10:9-109(e)), full recourse factoring is protected by statute, not once but twice (arguably, three times). While politicians can be redundant, it is rare for redundant laws to be passed. You might expect repugnancy from the legislature but not redundancy. In this case, Texas has protected full recourse factoring in multiple statutes. First, Section 306.001 of the Texas Finance Code defines factoring as a sale of accounts even if the factoring customer has a repurchase obligation. In addition, Section 306.103 of the Texas Finance Code goes on to say that factoring fees are not interest (and therefore not subject to usury limitations), and the only requirement for an agreement to be classified as a factoring arrangement is for the parties to call it factoring, as long as fraud is absent, of course. You could not be cute and take a promissory note or loan agreement and simply change the title to “factoring agreement” and then charge usurious rates.
Not to be content with those two statutory provisions, Texas went on to create its own special non-uniform provision of the otherwise uniform UCC with Section 9.109(e). Other states stop at (d), but (e) provides that, absent fraud, the parties’ characterization of a deal as factoring and not as a loan is “conclusive,” even if there is full recourse to the factoring customer to repurchase the invoices. Courts have protected full recourse factoring in light of this, too (e.g. Express Working Capital, LLC v. Starving Students, Inc. and Korrody v. Miller).
The catch here is that the factoring agreement must be subject to Texas law (or Louisiana’s equivalent protections). In order for any contract to invoke and be governed and construed by Texas law, there must be a reasonable relationship to Texas. In commercial transactions, parties are generally free to choose the state law to apply as long as there is a reasonable (as opposed to a substantial) connection to that state. The easiest way to accomplish this for Texas law is for the factor to be a Texas entity, or to have a substantial physical presence in Texas (or better yet, both). I have helped many factors and other businesses relocate and domesticate in Texas over the past few years to take advantage of these favorable factoring laws, as well as the lower business tax rates and the general business-friendly environment and lower cost of living for employees. I recently gave a speech to the Houston chapter of the Italian Chamber of Commerce on the benefits of doing business in Texas; the attendance was almost double my expectations.
But what happens when you end up in another state court or in federal court or bankruptcy court in another state? I have stood before many judges, hungry opposing counsel and trustees with blood in their eyes, all of whom at first wrongly assumed that a factoring agreement is not valid and should be reclassified as a loan. To prove otherwise requires a reeducation process and artful advocacy, but to have success, the factoring agreements need to be properly drafted (citing the Texas statutes is a good starting point), and the behind-the-scenes facts that support Texas jurisdiction must be sufficient (i.e., the factor must be a Texas entity or have a bustling office there).
There are new laws emerging from the legislative chambers in New York (1), California (2) and Maryland (3) that will impact commercial finance in terms of disclosure requirements or with regard to merchant cash advances (4). With the advent of these new state laws that require disclosure of ‘interest rates,’ or laws that misdirect anger at factors under the guise of protecting small businesses from predatory finance, and with the out-of-state case law so unfavorable to full recourse factoring, the option to seek shelter under Texas’ pro-factor climate should be considered. Cases such as Reaves Brokerage Co., Inc. v. Sunbelt Fruit & Vegetable Co., Inc. and Major's Furniture Mart, Inc. v. Castle Credit Corp., Inc. illustrate this point.
To that end, if you are considering relocating to or adding a branch in Texas, you would be in good company. Tech giants like Tesla and HP have recently made the move from Silicon Valley to the Lone Star State, citing the financial incentives and employee preferences concerning the “future of work” as reasons for the big move (5). More simply, Texas is a place that people want to live and work, and large corporations are more than happy to take advantage of the financial benefits of doing business in Texas. In fact, in light of this anticipated growth in business for 2021, we are launching a Texas Chapter of the International Factoring Association. Contact me for more details if you are interested in participating.
If you are considering making the move to Texas yourself, you should seek legal counsel to make sure you are doing all you can to meet the substantial nexus test, and you should have your factoring agreements reviewed annually regardless to make sure they are up to date and in compliance with true sale rules. If you are considering a full recourse product offering, you should consider domesticating in Texas. Besides, as Tommy Tune said, “Texans have more fun than the rest of the world.”
Footnotes
NY LEGIS 369 (2020), 2020 Sess. Law News of N.Y. Ch. 369 (S. 5470-B) (McKinney’s).
Cal. Fin. Code § D. 9.5, Refs & Annos (West) which was added by Stats.2018, c. 1011 (S.B.1235), § 2, eff. Jan. 1, 2019.
MD HB1478.
The newly enacted Small Business Truth-In-Lending Law in California requires non-bank lenders and other such finance companies to provide consumer-style written disclosures for certain commercial transactions. The full text can be accessed here. New York passed its Senate Bill requiring Truth-In-Lending style disclosure requirements on factors and commercial lenders. For more information on the New York bill click here. The Maryland Bill focuses more narrowly on merchant cash advance companies. The full text of the proposed Maryland bill can be accessed here.
“Hewlett Packard Enterprise to move headquarters to Texas,” Associated Press, Dec. 2, 2020, and O.Aldridge, “Story to Watch in 2021: Tesla’s Gigafactory Set for Completion By Year’s End,” Community Impact Newsletter, Jan. 18, 2021.
Jason Medley, Esq., loves every state in America; not just Texas. He is a member of the national law firm Clark Hill, PLC, with multiple offices in Texas and from coast to coast, as well as in Mexico City and Ireland. Over the past 20 plus years, he has helped factors across the country with a multitude of matters. He is a preferred attorney vendor with the IFA. You can contact him at JMedley@ClarkHill.com or via phone at (281) 352-6032.
Disclaimer: This article is not legal advice. Readers should seek legal counsel for specific help. No attorney-client relationship is created by the dissemination of this article.