20 May 2024
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Contract reviews – be forewarned, not surprised

To The Point
(4 min read)

Contract reviews are an important mechanism for identifying key risks to the value of debts purchased by funders who are asset based lenders or invoice financiers. Funders are at the mercy of the terms of the underlying contract between their customer and that customer's debtor, particularly with regards to the debtor's right to withhold payment, setting-off sums due to the customer and challenging the validity of the assignment of the debt to the funder. A targeted review of the underlying contract during the documentation stage of a transaction can enable a funder to be forewarned of any risks to the amount a debtor will pay in settlement of debt, reducing the risk of unwelcome surprises for the funder further down the line.

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.

Next steps

Please feel free to reach out to one of the key contacts or your usual contact within Addleshaw Goddard if you would like to discuss how we approach our contract reviews and the service we could offer to you for this due diligence process.

To the Point 

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