How to Read a Factoring Contract, Clause by Clause

Before you start

Factoring agreements are written by the factor and are negotiable more often than owners assume, especially when you have competing offers. Read every schedule, exhibit and fee sheet, because the terms that hurt are often in the attachments.

This guide is general information, not legal advice. Laws vary by state and contracts vary by factor. For an agreement of any size, have a business lawyer in your state review it before you sign.

New to factoring? Start with how factoring works.

The purchase and assignment clause

This is the clause that makes the agreement a sale. It typically says you sell, assign and transfer to the factor all of your right, title and interest in the accounts listed on each schedule, along with related rights such as the right to collect.

What to check:

• What is being bought. Only the invoices you schedule, or all of your accounts, present and future? A clause that sweeps in all accounts makes it a whole-ledger agreement whatever the sales pitch said.
• Representations and warranties. You will be asked to promise that each invoice is genuine, for completed work, free of other liens and not subject to dispute or offset. Breaking these promises is usually what triggers a buyback, even under non-recourse terms.

The legal effect is real. Article 9 of the UCC covers sales of accounts, and UCC 9-318(a) provides that a business that has sold an account keeps no legal or equitable interest in it. Once an invoice is sold, the customer's payment belongs to the factor.

Advance rate

The advance rate is the percentage of each invoice's face value paid to you up front. Check whether it differs by customer and whether the factor can reduce it at its discretion. A clause allowing unilateral reductions means your cash flow can change without your agreement.

The discount fee

This is the factor's main charge, and its structure matters as much as its level.

• Flat fee. A single percentage for an invoice paid within a set period. Predictable, but check what happens after that period ends.
• Tiered or time-based fee. A starting percentage for an initial period plus an added increment for each further block of days. Cheap on fast payers, expensive on slow ones.
• Daily or prime-based fee. A charge that accrues daily on the advanced amount, sometimes tied to an index such as the prime rate plus a margin. Read whether it accrues on the advance or on the full face value, which can make a large difference.

Three questions resolve most of the ambiguity. Is the fee calculated on face value or on the amount advanced? How are partial periods counted, by the day or by rounding up to the whole block? And does the fee keep accruing after a customer is past due, or does the invoice get charged back first? Ask the factor to calculate the fee on one of your real invoices at 30, 45, 60 and 90 days. Our guide to freight factoring costs shows how flat and tiered structures compare in practice.

Reserve and rebate timing

The reserve is the share of each invoice the factor holds back. A FreightWaves explainer written for carriers describes reserves as often 5% to 20%. Look for:

• When it is paid out. Per invoice when the customer pays, or in a periodic settlement weekly or monthly.
• What can be deducted from it. Fees, short pays and chargebacks are normal. Broader language letting the factor apply the reserve to "any obligation" means one customer's problem can hold up rebates on unrelated invoices.
• Cross-collateralization. Whether the factor can hold back reserves until all open invoices are resolved, rather than releasing each one as paid.
• What happens at termination. How long the factor may hold the final reserve after the agreement ends.

Recourse period and chargebacks

In a recourse agreement, the factor can make you repurchase an invoice that is not paid within a set period after purchase or after the due date. Find the exact trigger: a number of days, a dispute, a customer bankruptcy, or anything the factor deems uncollectible. Check how a chargeback is collected: from the reserve, from your next advance, or by direct demand.

In a non-recourse agreement, find the definition of the covered credit event. Most cover only a customer's insolvency, not disputes or paperwork problems. Our recourse vs. non-recourse guide covers this in detail.

Minimum volume and shortfall fees

Many whole-ledger agreements require you to factor a minimum dollar amount each month, quarter or year. If you fall short, you pay a fee calculated as though you had factored the minimum. Check how the minimum is measured, whether a slow month can be offset by a strong one, and whether the minimum survives if a major customer leaves or your business shrinks. A minimum set near your average volume will cost you in every below-average month.

Term, auto-renewal and notice window

Most agreements run for a fixed initial term and then renew automatically for another term unless you give written notice within a set window before the renewal date. Notice windows can be narrow, and missing one can lock you in for another full term. Write the notice deadline in your calendar the day you sign. Check the required delivery method too.

Termination and early-exit fees

Look for what it costs to leave before the term ends. Early-termination fees may be a flat amount, a percentage of the facility limit or of average monthly volume, or the fees the factor would have earned for the rest of the term. FreightWaves cites fees such as 3% to 6% of the facility limit as a barrier to switching. Check whether the fee is waived if the factor raises its rates or breaches the agreement, and what you must do to obtain a payoff letter and a UCC-3 termination of the factor's filing. Our guide on how to switch factoring companies covers the exit process.

Scope of the UCC lien

Every factor files a UCC-1 financing statement. The question is what it covers. UCC 9-504 allows a financing statement to describe the collateral specifically or simply to say it covers "all assets." A filing against all assets gives the factor a claim on your equipment, inventory, bank accounts and other property, not just the invoices it buys. That can block a future equipment loan or bank line. Ask for the filing to be limited to accounts and related rights, and read the security agreement inside the contract, which may grant a broader interest than the filing describes. A UCC filing is generally effective for five years under UCC 9-515(a), so confirm the factor will file a termination promptly when you leave.

Personal guaranty

Most factoring agreements ask the owners to sign a personal guaranty. The scope varies greatly:

• A validity or performance guaranty covers fraud, misrepresentation and breaches of your warranties, such as selling an invoice for work not done. This is common and fairly narrow.
• A full payment guaranty makes you personally liable for every obligation under the agreement, including chargebacks, fees and early-termination charges.

Ask which one you are signing and whether it survives termination.

Verification and notification rights

Expect the factor to reserve the right to contact your customers to verify invoices and to notify them of the assignment. Under UCC 9-406(a), once a customer receives an authenticated notice of assignment, it can no longer discharge the debt by paying you. Under UCC 9-607(a)(1), a party with an interest in accounts may notify customers to pay it directly where the agreement allows it or after default. Ask whether you can approve the wording of customer contact.

Misdirected payments

Customers sometimes pay you instead of the factor. Most agreements require you to hold the payment in trust and turn it over within a short deadline the contract sets, and impose a fee for late turnover. Some treat a misdirected payment you keep as conversion or fraud and a default. Know the deadline and the fee, and set up a process so that factored payments reaching your account are forwarded immediately.

Confession-of-judgment clauses

A confession of judgment is a signed statement in which you agree in advance that the factor can obtain a court judgment against you, without a lawsuit, if you default. It lets a creditor freeze accounts quickly and leaves you to challenge the judgment afterward. Treat any such clause as a serious red flag and refuse it if you can.

Their use has been restricted, though not eliminated:

• New York. In 2019 New York enacted S6395, signed on August 30, 2019 as Chapter 214, which amended CPLR 3218. The current statute allows a confession of judgment to be filed only with the clerk of the county the debtor named as its residence in the affidavit, or where it resided at the time of filing, and says a business resides in any county where it has a place of business. The Senate sponsor's release described the purpose as restricting the use of confessions of judgment for out-of-state loans. In practice, a business with no New York residence or place of business can no longer have one entered against it in New York courts.
• Federal consumer rule. The FTC's Credit Practices Rule, 16 CFR 444.2(a)(1), bars lenders and retail installment sellers from taking a confession of judgment from consumers. It does not protect businesses, so do not assume a commercial agreement is covered.

Other states have their own rules, and they change, so have a lawyer in your state review any agreement that includes one.

Disputes, governing law and venue

Most agreements name the state whose law governs and the courts where disputes must be heard, usually the factor's home state. Some require arbitration, waive a jury trial or limit class actions. A distant venue makes any dispute more expensive for you. Check who pays attorneys' fees.

Disclosure laws that may apply

Some states require standardized cost disclosures. In New York, Financial Services Law section 806 requires a specific factoring offer to state the purchase price, finance charge, total payment and an estimated annual percentage rate; section 802 exempts financial institutions and individual transactions over $2.5 million, among others. Compare any disclosure you receive with the contract, and see our factoring vs. line of credit guide to annualize costs yourself.

Questions to ask before signing

1. What is the advance rate, and can you change it without my agreement?
2. Is the fee charged on face value or on the amount advanced, and what does it come to on one of my invoices at 30, 45, 60 and 90 days?
3. When and how is the reserve rebated, and what can be deducted from it?
4. Must I factor all my invoices, or only the ones I choose?
5. What triggers a chargeback, and how is it collected?
6. Is there a monthly or annual minimum, and how is a shortfall calculated?
7. How long is the initial term, how does it renew, and what is the exact notice deadline and method?
8. What does it cost to leave early, and is that fee waived if you change terms?
9. Does the UCC-1 cover only receivables, or all assets?
10. What exactly does the personal guaranty cover, and does it survive termination?
11. Does the agreement contain a confession of judgment, jury waiver or arbitration clause?

Red flags

Our guide to hidden fees in factoring goes deeper on the fee language to search for.

Frequently asked questions

Can I negotiate a factoring contract?

Often, yes. Terms such as the initial length, renewal notice window, minimum volume, early-exit fee, scope of the UCC filing and scope of the personal guaranty are commonly negotiated, particularly when you have offers from more than one factor.

What is the most important clause to read?

There is no single one, but the combination of term, auto-renewal, notice window and termination fee decides how hard the agreement is to leave. Read those together, then the fee calculation and the scope of the UCC lien.

Are confessions of judgment legal in factoring contracts?

It depends on the state. New York's 2019 amendment to CPLR 3218 limits where a confession can be filed, which in practice blocks entry in New York against businesses with no residence or place of business there. The FTC's ban on confessions of judgment applies only to consumer credit. Have a lawyer review any agreement that includes one.

Do I need a lawyer to review a factoring agreement?

For a small spot transaction you may decide not to, but for a whole-ledger agreement with a multi-month term, a personal guaranty or an all-assets lien, a review by a business lawyer in your state is worth the fee. This guide is general information, not legal advice.