In a market where asset based lending is growing in popularity, more and more funders are turning to invoice finance as a means of providing working capital solutions to their customers. As part of the funder due diligence process we are often asked whether a review of the key underlying debtor contracts is worth exploring. Time and fees are under constant scrutiny by customers, often leading to contract reviews being dismissed as an unnecessary cost or delay. So does the benefit of performing these contract reviews outweigh the burden of the extra fees and time spent?
From a funder's perspective, contract reviews can be as important as the other forms of due diligence and verification performed prior to an invoice finance facility going live. A focussed review of the underlying contract between a funder's customer and that customer's debtor is crucial to understand potential risks for a funder further down the line. Given the variety of possible customers using invoice finance, the underlying contracts will naturally vary in terms of content. Key issues we often see coming out of our contract reviews are as follows:
- unsigned or undated contracts – is there actually a binding contract in place between a customer and their debtor? This is important in allowing a funder to be confident that a debtor is bound to make payments of the debts purchased by that funder
- ban on assignment and/or creation of trusts – whilst the law has evolved in this area in recent times, such provisions can have implications as to the validity of the assignment of the debt between the customer and the funder
- set-off rights – where contractual set-off is authorised, the value of a debt payment coming to the funder may be considerably reduced if the debtor applies set-off against this payment
- rebates and discounts – how do these operate and how much warning will a funder get that credits, rebates or other discounts are being applied to the value of the debts the funder has purchased?
- termination rights – how do these impact on existing obligations of the customer and the debtor, and what is the time period for termination in different circumstances?
Following identification of any red flags within an underlying contract, a funder is able to apply mitigating steps. The ability to do this at documentation stage is crucial, allowing provisions to be captured within the facility documentation as necessary. Key mitigants might include:
- additional conditions precedent to the completion of a transaction, such as obtaining a signed and dated contract or a ban on assignment waiver from the relevant debtor(s)
- incorporating more stringent information requirements within the facility agreement, such as delivery of rebate information within a set time period
- amendments to the underlying contract, such as the disapplication of set-off rights
If you are a funder who regularly provides invoice finance to customers, we would encourage you to think about obtaining contract reviews for key debtor contracts. These are particularly important where you may be providing selective invoice finance facilities in respect of just one debtor, or only a small number of debtors.
We would be delighted to support you with your contract review requirements. The Asset Based Lending and Trade Finance team at Addleshaw Goddard have a wealth of experience in this area, regularly reviewing contracts for many of our funder clients and advising on next steps where issues have been identified.
