Recourse Factoring

Companies working with factors are soon finding out that not all agreements are built the same. As with most financial transactions these days, things can get complicated in a hurry. One question that often comes up is “What is the difference between recourse and non-recourse factoring?” This hub will briefly explain what factoring is, what the difference between non-recourse and recourse is, and the impact of choosing one over the other.

For those of you who are just starting to hear about invoice factoring (also known as accounts receivable factoring and invoice discounting) then this next paragraph will bring you up to speed on our discussion. If you want to know more, then you should visit this page on receivables financing.

Factoring is different than a normal loan for a couple of reasons: (1) it isn’t a loan, it is a sale and (2) there are three parties involved. The three parties involved include the receivable factoring company, your company, and your customers. Your customers make sales to you on credit. These credit sales become accounts receivable for your company. Your company then sells these receivables to the factor at a discounted price of course. Note that this is different than using invoice discounting services where your invoices are simply used as collateral and they are not sold.

In these factoring arrangements a lot of questions start to surface. One of the main questions asked is “What happens if my customers fail to pay the factor?” This is an excellent question, and as with most excellent questions, the answer is it depends. It depends on your contract with the factor as well as whether you are in a nonrecourse or recourse factoring agreement.

A recourse factoring agreement means that if your customers don’t make payment then your company is held liable to the factor (the factor can come after you and force you to pay). In a nonrecourse arrangement the factor has no recourse against your company and cannot force you to make payments if your customers do not. All things being equal it would appear that a nonrecourse agreement is much better, but again that really depends on the situation your company is in.

One major advantage of a nonrecourse agreement is that you sell the receivable and you are done. That’s it, nothing more to it. It is up to the factor to collect from your customers, and if they don’t get the money, it should have no impact on your organization. However, this advantage comes with disadvantages.

One of the disadvantages of a nonrecourse arrangement is that your company no longer has any control over how the factor treats your customers. Because your company has no recourse and you have sold the receivable, all of the rights have transferred to the factor. There have been horror stories in the past about factors treating customers extremely harsh (you can see why they would want to under a no recourse agreement—if they don’t get paid they lose all of the money).

One major advantage of a recourse factoring agreement is that they are often less expensive. They are less expensive because the factor doesn’t bare as much risk. For the same reason these arrangements are often easier to find.

Another advantage of a recourse agreement is that factors tend to treat your customers a little nicer. They know that they will be paid, either by you or your customers, so they don’t feel the need to send the thugs out to collect.

One drawback of a recourse agreement is that the factor may not pursue collections aggressively enough. They may find it easier to just force you to pay if the customer doesn’t (instead of calling customers and asking them to pay).

This Hub doesn’t begin to explain the plethora of ways that factoring contracts can be construed. However it does give you insight into one of the key issues in these agreements. Best of luck as your company decides between nonrecourse and recourse factoring.