Build with Bricks, Not Sticks: Helpful Provisions for Factoring Agreements
Ross Angus Williams and Scott R. Larson outline the most important provisions to include in a factoring agreement to ensure it holds up no matter which way the wind blows.
BY ROSS ANGUS WILLIAMS, ESQ., AND SCOTT R. LARSON, ESQ.
We all know the story of the three little pigs. Factors can think of the contracts they enter with their clients as the legal house they have built to protect against the day the big bad wolf — the client’s efforts to prevent or evade collection — comes to visit. Each clause is a piece of the building materials in that house. Based on experience, some of the important clauses that are left out or poorly drafted most often include those covering recovery of attorneys’ fees, forum selection, UCC filing authorizations and confidentiality. For factors who want to build their legal houses from bricks and not sticks, here are some helpful tips to follow.
ATTORNEYS’ FEE RECOVERY PROVISIONS
The ability to recover attorneys’ fees is often the key factor that determines whether a factor will pursue collection through litigation and from whom they will pursue collection. Including an attorneys’ fee recovery provision in a factor’s contract with the client and requiring client verification that the client’s own contracts with account debtors contain such a provision benefiting the client are important protections to maximize a factor’s ability to economically collect through litigation against as many potentially solvent parties as possible.
Under the “American” rule, a party can recover attorneys’ fees only if authorized to do so by contract or statute. The illustration of that rule in statutes differs from state to state. Some states, like Texas, have statutes that allow a person to recover attorneys’ fees from certain types of defendants (but not others), regardless of whether there is a fee recovery provision in the contract, on certain enumerated claims, such as: 1) rendered services, 2) performed labor, 3) furnished material or 4) an oral or written contract. Other jurisdictions, like Pennsylvania, provide that no fee recovery is available on contract claims absent an express provision in the contract. Other states have different statutory schemes that may be more or less restrictive. Including an attorneys’ fee provision in the pertinent contracts will likely improve the chances of recovery.
Regardless of the state a factor operates in, including well-crafted attorneys’ fee provisions in the factoring agreement is by far the best way for a factor to ensure that it can obtain attorneys’ fees in litigation against the client. Likewise, factors should include provisions that require their clients to have attorneys’ fee recovery provisions in their contracts with account debtors. This second step will increase the likelihood that the factor can viably pursue the account debtor in lieu of or in addition to the client if the account debtor hasn’t paid the client.
FORUM-SELECTION PROVISIONS
An enforceable forum-selection provision in a factoring agreement — often included in the “additional terms” tucked at the end of the agreement — may mean the difference between litigating a case in a factor’s “home court” or the obscure, far-flung and often unsympathetic hometown of a client or account debtor.
A forum-selection provision, when crafted correctly, 1) determines the venue where a case will be tried (such as courts within a specific city, county or state) and 2) provides courts in that venue with personal jurisdiction over the parties. Both points are important: Venue determines whether the case is being brought in the correct court and jurisdiction determines whether that court has the authority to rule over the defendant. Without both, a case may be subject to dismissal or transfer. Having a proper forum-selection clause allows the parties to decide up front where their disputes will be litigated, which can reduce costs. Having uniform, enforceable forum-selection clauses across all factoring agreements also can lead to greater predictability in dispute resolution and even greater cost reduction.
As opposed to permissive language, the forum-selection clause should provide for a mandatory and exclusive venue. Although specific magic words are not needed, the provision must make clear that the stated forum is the only venue for disputes and that the courts in that forum have exclusive jurisdiction over the parties’ disputes. Possible language could include stating that the parties must bring any lawsuits in the state venue, or that the stated forum is the exclusive venue for all disputes relating to the contract. Somewhat surprisingly, saying the venue “shall” lie in a certain venue has been interpreted as permissive, not exclusive. The wording of these provisions is a minefield.
Additionally, the parties should agree that they submit to the jurisdiction of the courts in the chosen venue and that those courts have jurisdiction over the parties. Finally, the clause should provide that the parties waive any challenge or objection to a lawsuit being brought in the chosen forum on grounds of lack of jurisdiction or improper or inconvenient venue.
UCC FILING PROVISIONS
Collateral often presents the best target for collecting on a client or account debtor’s receivables through litigation. Therefore, having effective provisions that protect a factor’s interest in that collateral is of paramount importance.
Security interests in most types of collateral are perfected by filing a financing statement, commonly in the form of a UCC-1. A factoring agreement should include certain provisions addressing such methods of perfection. A factor’s ability and authorization to file UCC-1 financing statements is an important step in putting the public on notice as to who owns the purchased accounts or other collateral in which the factor holds a security interest.
Key provisions to include in a factoring agreement include those that 1) expressly permit a factor to file UCC statements on a client’s collateral and the collateral of a client’s guarantor and 2) prohibit the filing or amending of UCC filing statements by the client or its guarantor without prior written consent of the factor.
The first type of provision is important because it gives a factor the express right to perfect its security interest in the collateral. This protects against claims that the factor’s security interest in certain collateral was not perfected merely because the filing of an otherwise valid financing statement was not authorized by the client or guarantor. The second type of provision guards against fraud and misappropriation and creates a further basis for a breach of contract claim if violated.
Fortunately, case law in some bellwether jurisdictions, such as the Southern District of New York, provides that the UCC-1 financing statement can be filed before these types of provisions are agreed to and be retroactively ratified so long as the agreements are signed before one tries to foreclose on the security interest. Inclusion of these provisions will at least minimize time spent dealing with specious arguments against collection.
CONFIDENTIALITY CLAUSES
Many factors can justifiably consider their pricing models confidential and proprietary business information. Factoring clients may, however, be tempted to shop around a factor’s pricing. Through confidentiality provisions, factors can (and should) seek to protect valuable pricing information in both the negotiation process and in a resulting factoring agreement.
At the start of the negotiation process, one important document to have in the factor’s toolkit is a concise and effective non-disclosure agreement (NDA) that protects the pricing information the factor discloses in the negotiation process as confidential and proprietary information.
NDA forms vary widely in complexity, length and scope. But an effective NDA will almost always:
Identify the parties to the agreement
Define what is deemed to be confidential in language clear enough for a stranger to the contract — like a juror or judge — to be able to tell what the confidentiality material comprises
Define the scope of the confidentiality obligation by the receiving party — what uses and disclosures are prohibited
List any exclusions from confidential treatment, such as for information obtained through a third party under no confidentiality obligation or for publicly available information
Define the term of the agreement — how long it will last.
Specific requirements may vary by jurisdiction. The NDA does not prevent the potential client from shopping around, but it can seek to obligate them to not disclose a factor’s pricing model as part of that process.
Once the deal is struck and memorialized in writing, a further confidentiality provision is advisable as a provision of the factoring agreement. While the building blocks of such a provision are typically virtually identical to those in the NDA, including such a provision in the factoring agreement allows its term to be extended on from the effective date of that agreement forward. It also makes sure that the confidentiality obligations continue past the merger and integration clause of the factoring agreement, which will otherwise cut off prior agreements between the parties unless specifically excepted.
CONCLUSION
Following these tips in consultation with counsel, or in review of one’s agreements, will help keep a factor’s legal house strong and, ultimately, increase the collectability of — or at least the options for collecting on — unpaid accounts despite huffing and puffing from the client or account debtor. •