Why the Quality of Your Verifications Determines the Strength of Your Receivables — Part 1
Written by: Scot Pierce, Esq., Partner, Whitaker Chalk Swindle & Schwartz PLLC
In recent years, I have encountered problems with clients either not verifying accounts receivable properly or not verifying them at all. This issue is particularly common with new factors, many of whom do not fully appreciate the importance of verification. The reasons vary. Some tell me that, in the rush for speed, they simply do not have time to verify. Others say they use alternative metrics to assess risk or have agreed to be non-notification factors to stay competitive. And some believe they are verifying adequately until a problem arises and they discover their foundation is not as solid as they believed.
Often, collections proceed normally until, without warning, an account debtor refuses to pay several invoices after discovering discrepancies in billing or problems with the work performed. Account debtors may suspend all payments while they conduct a full-scale audit, which can take months to resolve. If you have not verified the accounts properly before purchasing them, you are often at the mercy of your client’s ability to prove the receivables are fully collectible. That rarely ends well. Many clients are small companies without adequate documentation or leverage to persuade a stubborn account debtor that they are wrong. Even when backup exists, account debtors tend to be skeptical in the early stages of a dispute and take their time to ensure they are not being misled.
You can invoke your recourse provisions and charge the reserve, but you may be under-reserved, and your clients may not have the financial capacity to make you whole. Small and mid-sized businesses, which frequently rely on factoring, are often unable to absorb the loss of a larger nonpaying account debtor. In contrast, account debtors are typically larger, well-capitalized companies with stronger balance sheets. It is, therefore, far more practical to rely on the enforceability of the receivable against the account debtor than on your client’s uncertain ability to cover losses. Verification procedures are the mechanism that secures this protection.
At a top level, verification procedures such as confirming the existence of the debt, ensuring that goods or services were delivered satisfactorily, and validating the account debtor’s intent and ability to pay create the foundation for confidence in the legitimacy of the receivables. Without careful verification, you risk acquiring receivables that are fraudulent, already paid, disputed, or otherwise uncollectible.
At a deeper level, good verifications give you leverage, and leverage is crucial for persuading an account debtor to pay. The irony of lawsuits is that the ability to present a strong case is often what prevents you from needing to file a lawsuit. Effective verifications can lead to quicker and less costly resolutions. Still, keep in mind the perceived unfairness of your case. You are arguing that you are entitled to be paid even if the goods were defective, nonconforming, or not delivered at all. A judge’s initial reaction is likely going to that the account debtor should not have to pay in that situation. How, then, do you overcome that?
If you do not have a good verification from the account debtor, you are at the mercy of your client. You are left arguing that the account debtor breached its promise to pay under either the master agreement or normal trade terms (if no master contract exists). You will need to establish that the receivable is valid and owed by relying on your client’s backup documentation like contracts, invoices, delivery confirmations, bills of lading, and similar records. The problem is that a well-drafted master contract gives the account debtor a “home-field advantage.” It establishes the rules, typically in the account debtor’s favor, and provides broad defenses to payment. These may include claims of defective goods, billing errors, or audits. In short, you must prove that your client is right, and the account debtor is wrong which is often difficult.
However, if you have a good verification from the account debtor, your position and your lawsuit has more teeth. You are still asserting that the account debtor broke its promise to pay, but you can also argue that the account debtor, intentionally or not, misrepresented the validity of the receivable. The account debtor confirmed that the invoice was valid and would be paid in the normal course of business. You relied on that confirmation when deciding to advance funds. If the account debtor later refuses to pay, you can argue that it does not matter whether the goods were defective or whether the account debtor has defenses against your client. What matters is that the account debtor was negligent and misled you. The account debtor was in the best position to identify problems before verification and failed to do so. That failure caused your loss. The account debtor can still dispute performance with your client, but it should first honor the obligation it confirmed to you.
Of course, this argument is not bulletproof. Pushback usually centers on who made the verification and what exactly was said. Account debtors often claim that the employee who verified the account lacked authority to speak for the company. For instance, they may that an accounts payable clerk confirmed the invoices when approval was required from a supervisor or project manager. The resolution depends on the facts, but the best practice is to send the verification to the person designated by the account debtor, not by your client.
Another common defense is that the verification merely confirmed the existence of the account, not that it was valid or approved for payment. In other words, the debtor characterizes the verification as a routine administrative acknowledgment that the account was “set up” or “ready to be billed,” not that it was ready to be paid. This is why the language of your verification is critical. The clearer the language, the stronger your position will be.
With that background, what makes a good verification?
That is the subject of the second part of this article. For now, understand that verifications are not just a procedural step. They are a tool for mitigating and managing risk. Proper verification can help protect you from relying solely on your client’s documents and representations and shifts the focus to the account debtors’ mistakes. It strengthens your position transforming what might otherwise be a weak dispute into a case of reliance and accountability. The time you invest in thorough, well-documented verifications pays dividends in reduced losses, faster resolutions, and greater confidence in the integrity of your portfolio. Strong verification practices are essential to mitigating risk.
About Scot Pierce
Scot Pierce is a proud Fort Worth native and an experienced commercial litigator, corporate finance, and bankruptcy attorney. A large part of his practice is dedicated to representing contractors, businesses, financial entities and secured creditors.
Before returning to Fort Worth in 2002, Scot worked as a Dallas County Assistant District Attorney where he tried over 60 jury trials and numerous bench trials. He has been voted one of the Top Attorneys in Fort Worth by Fort Worth, Texas Magazine and 360 West Magazine for several years. Scot is also listed as an AM Best “recommended Insurance Attorney.” A prolific writer and speaker, Scot received an award in 2010 from the State Bar of Texas for Best Series of Articles – Substantive Law for his articles on creditor rights. For his insurance clients, Scot is also set up for billing both under Legal Software Systems, Inc. billing system (LSS) and Legal Express billing system (LegalEx).
Scot has extensive experience in single-family, multi-family and commercial construction cases representing both general contractors and subcontractors in litigation and arbitration around the state of Texas.
The views expressed in the Commercial Factor website are those of the authors and do not necessarily represent the views of, and should not be attributed to, the International Factoring Association.