Photo of Cameron MacCarthyBy Cameron MacCarthyNovember 12 2015
Business Law

Finding Financing in Difficult Capital Markets: Factoring and Receivables-Based Lending

Sustained periods of low oil prices and reduced economic activity have significantly impacted the cash-flow of many energy and non-energy businesses in Western Canada.  Over the past fifteen months, the collection period for many accounts receivable have aged-out, thereby exacerbating the pressure from decreased sales, leaving many businesses facing acute working capital deficiencies or insufficient cash flow to fund operating costs.  Moreover, weak cash flow may also result in a borrower being in technical default on the maintenance covenants of existing loan facilities.   This default may jeopardize the renewal of senior loan facilities or, worse yet, result in the senior lender enforcing repayment obligations.

Factoring and other forms of receivables-based lending (collectively, "Receivables Financing") provide an alternative structure for businesses to raise capital against the strength of their accounts receivable.  These strategies can be particularly effective when businesses lack the asset coverage necessary to support traditional bank loans, face other impediments to obtaining credit or require additional working capital to finance rapid growth that may result from abnormally large purchase orders. In addition, Receivables Financing can promote greater alignment between debt service obligations and a business' cash flow when compared to term-loans or revolving lines of credit with monthly interest expenses.

What is Factoring and Receivables Based Lending?

Receivables Financing can be broadly divided into two categories:

1. Factoring:

In a factoring arrangement a factoring company will purchase one or more of an operating business' accounts receivable at a discount to the invoice value based on the quality of the receivable and immediately pay these funds to the operating business.  Once payment of the accounts receivable is made, the factoring company will receive payment equal to the purchase price paid for the discounted receivable plus applicable fees, which are designed to serve as a proxy for interest expenses.  The operating business will, in turn, be entitled to receive any spread between the purchase price and fees charged by the factoring company and the total value realized on the receivable.  The purchase of accounts receivable by a factoring company may be limited to a single transaction, such as a large purchase order where an operating business requires immediate working capital or a more long-term relationship where receivables are purchased on an ongoing basis.

A factoring arrangement can be either with recourse or without recourse.  If a factoring arrangement is with recourse, the factoring company will have a right that, if exercised, requires the operating business to repurchase the receivable and pay applicable fees if payment is not received in respect of the receivable by a pre-determined future date.  The presence or absence of such a recourse right will materially impact the fees charged and the discount taken upon the purchase of a receivable.  When the factoring company obtains a recourse right against the operating business, the factoring company will normally obtain a general security interest in the assets of the operating business to secure the recourse obligations.

2. Receivables-Based Lending:

Unlike factoring, which involves an absolute assignment of a receivable, receivables-based lending is similar to a conventional loan. However, with receivables based lending, the lender will advance funds against security granted in the borrower's receivables and will often align the debtor's payment obligations to correspond with receipt of the receivable.  In this manner, receivables-based lending may provide greater flexibility than traditional term loans or revolving lines of credit, which are neutral with respect to the cyclicality of a debtor's cash flow.

As the lender in receivables-based lending does not purchase title to the receivables, receivables-based lending may involve fewer transactional complexities and presents less risk for existing debt covenants, which generally preclude the sale of receivables on the basis that such a transfer is not a sale in the ordinary course of business.

Both factoring and receivables-based lending can be structured as either a with-notice or without-notice assignment.  When a receivable is assigned or otherwise pledged to a factoring company or creditor with-notice, the factoring company or creditor will provide notice of the assignment of the account to the account debtors and direct that all payments in respect of the account receivable be made to the factoring company or creditor. This structure provides a greater level of security for the factoring company or creditor and may reduce the administrative burden for the operating business. Alternatively, a factoring company or receivables based lender may require that any amounts paid in respect of assigned or pledged receivables be paid into a blocked bank account, thereby limiting the ability of the borrower to transfer or otherwise utilize the funds for an unauthorized purpose.

When is Receivables Financing a Potentially Favourable Credit Product?

Receivables Financing may be a favourable credit product for businesses with highly credit worthy account debtors but long payment periods.  These extended payment periods often result in cyclical periods of low cash flow.  In this manner, Receivables Financing helps smooth a business' cash flow thereby enabling it to fund its interim operating expenses. However, as Receivables Financing agreements typically ensure that the operating business shares in the collection risk associated with an account receivable, Receivables Financing should not be regarded as a mechanism for insuring against non-payment risk by an account debtor.

Receivables Financing may also be a favourable credit product for businesses with limited access to traditional bank loans or those who are facing pressure by banks seeking to reduce their credit exposure in down markets.  This may be the case for businesses that have obtained financing from a senior lender that now seeks to reduce their available credit or remove products such as a revolving line of credit that is, or was once, heavily relied upon.  

When a borrower has existing lenders, the borrower and its legal counsel will typically have to negotiate a restructuring of the borrower's secured debt so as to facilitate the security required for the new Receivables Financing.  Consequently, a consolidation of debt may be required to facilitate Receivables Financing when a business has multiple creditors.

As with any form of alternative lending, providers of Receivables Financing typically charge a premium rate compared to bank debt so as to account for the increased credit exposure of lending against the creditworthiness of both the immediate borrower as well as the account debtor.  In this manner, Receivables Financing should be regarded alongside other non-bank financing options available to a debtor.

Our Business Law group acts for both borrowers and lenders on a variety of conventional and non-conventional financing arrangements.  Given the complexity and non-conventional nature of Receivables Financing arrangements, it is important that businesses obtain appropriate legal advice from a knowledgeable legal practitioner when negotiating and structuring these financing facilities.

Invitation for Discussion:

If you would like to discuss this blog in greater detail, or any other business law matter, please do not hesitate to contact one of the lawyers in the Business Law group at Nerland Lindsey LLP.


Note that the foregoing is for general discussion purposes only and should not be construed as legal advice to any one person or company. If the issues discussed herein affect you or your company, you are encouraged to seek proper legal advice.

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