Factoring agreements are very popular with subcontractors and suppliers in the construction industry, assisting cash-flow by providing a line of credit against accounts receivable. However, like any financial product, factoring agreements can also present unique complexities, pitfalls and at times surprises when pursuing debt recovery and enforcement action.
Illustrating some of the problems that can arise is the not uncommon scenario of a dispute in relation to an alleged oral contract for labour hire by a subcontractor that is factoring its debts. In this scenario:
- All of the subcontractor’s invoices in respect of the work performed pursuant to the alleged contract will likely note that the debt the subject of the invoice has been assigned to the factoring company (this is a standard requirement imposed under the factoring agreement).
- However, the line of credit under the factoring agreement will usually not extend to invoices where the debt is disputed or where there is no written contract, the factoring agreement instead providing for a “pay when paid” arrangement in such circumstances.
- Having not paid out on the invoices, the factoring company is therefore content to allow the subcontractor (at its own risk and cost) to pursue enforcement of the invoices itself, i.e. the factoring company’s account is simply a ‘post box’ for any payment that may be received.
- The subcontractor therefore proceeds, in its own name, to take steps to recover the debt, utilising security of payment or by court proceedings.
Unfortunately for the subcontractor, the assignment of the debt under the factoring agreement, perfected at law by the notification on its invoices, means that it does not have standing to bring the claim. This presents the debtor with a potential ‘knock out’ blow to any adjudication application or in court proceedings. Substituting the factoring company for the subcontractor would not be possible in the security of payment environment and although it may be an option in court proceedings, it is far from straightforward, particularly if the error has gone undetected for any length of time.
Consideration may be had to pursuing an alternative claim in quantum meruit, as claims in quantum meruit are not capable of assignment. But this is also not ideal, being more involved than debt recovery, as the entitlement is harder to prove, more complicated to quantify and its reception by the court much less certain. Further, quantum meruit is not addressed by security of payment legislation at all.
Another factoring related ‘complication’ relates to enforcement of debts through garnishee orders against a judgment debtor which is ‘factoring’. Garnishee orders are typically one of the most effective and commonly used enforcement tools available to judgment creditors (because they can be obtained quickly, for little cost and practically by stealth). Factoring can however throw a spanner in the works. If the judgment debtor is ‘factoring’ all or most of its debts, then the pool of its potential debtors who can be garnished shrinks dramatically. The debts are now owed to the financier, not your debtor. This can have the effect of frustrating or neutralising your garnishee orders.
A similar scenario played out recently in the Supreme Court decision in West Tankers2 where a prior assignment of a principal’s debt by a contractor to a financier (Scottish Pacific) under a factoring agreement was held to prevail against a claim in respect of the same debt made by a subcontractor utilising a withholding notice under the Building and Construction Industry Security of Payment Act 1999 (NSW) and then the Contractors Debts Act 1997 (NSW).
Finally, there is the potential for disputes in relation to factoring to be bogged down by arguments as to whether the assignment of debt under the factoring agreement has been perfected (by provision of appropriate notice of the assignment) or instead is merely an assignment in equity, meaning that factoring party (i.e. the subcontractor) retains the right to sue for the factored debt. These disputes can be quite complex and by simply being aired can cause additional cost, delay and uncertainty in what would otherwise be straightforward debt recovery.
The key ‘take-away’ is don’t lead with your chin, be informed about and mindful of the implications of both your own factoring and where-ever possible the factoring activities of those to whom you extend credit. Failure to do so can lead to your debt being left down for the count.