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Factoring is the sale of a seller's accounts to its factor at a discount. Factoring differs from asset-based lending because the factor relies on the creditworthiness of the account debtor, not its seller, in deciding whether to purchase the accounts. Upon the purchase of the accounts receivable, the factor advances to its seller, a stated percentage of the face amount of the accounts (typically 75 percent-85 percent). The account debtors are required to pay the factor directly, so that the factor maintains dominion and control over the accounts.
Whether a sale of accounts represents a true sale or a disguised secured transaction is particularly important in the context of a seller's bankruptcy. If the transaction is determined by the bankruptcy court to be a true sale, and the factor is the owner of the accounts receivable, then the accounts will not be part of the bankruptcy proceeding. However, if the bankruptcy court determines that the "sale" of accounts is in fact a disguised secured transaction, then the accounts and proceeds are property of the estate under 11 U.S.C. §541, and subject to use, sale or lease by a debtor-in-possession under 11 U.S.C. §363(b)(1) in a Chapter 11 case, and a bankruptcy trustee in a Chapter 7 case.
This article will examine what elements are analyzed in determining whether an assignment of accounts, absolute on its face, may be recharacterized as a secured loan rather than a true sale.
Uniform Commercial Code (UCC) Article 9
Article 9 of the UCC governs, among other things, outright sales of accounts and loans secured by accounts. A purchaser of accounts is a "secured party" under UCC 9-102(a)(72)(D). Since Article 9 covers outright sales of accounts, by definition a factor has a security interest in the accounts it purchases.1 Therefore, regardless of whether the transaction is a sale of accounts by the seller to the factor, or a loan secured by accounts receivable, the factor must file a financing statement covering accounts and proceeds in order to protect and perfect its interest. UCC 9-§310; see also §9-102 Cmt. 5 ("Many categories of rights to payment that were classified as general intangibles under former Article 9 are accounts under this Article. Thus, if they are sold, a financing statement must...