Suppliers Beware: Are You Expanding Your Risk by Reverse Factoring?

Fennemore Craig Update

Suppliers Beware: Are You Expanding Your Risk by Reverse Factoring?

If you are a supplier, your buyer’s offer of quicker than normal payment can seem too good to be true and sometimes it is. It is important suppliers review the fine print before signing on the dotted line.

What is Reverse Factoring?

Reverse factoring is different than when a supplier who factors receivables and is usually available to suppliers with which a company has established a long-term trading relationship.  Reverse factoring involves the buyer, who goes to a credit intermediary and has it pay its payables to suppliers earlier. [1] For example, if the buyer has payment terms that stretch to 90 days, and the supplier’s typical payment terms are 30 days, the reverse factoring arrangement can allow the supplier to be paid by the finance company on the 30^th day, but then permit the buyer to pay the finance company on the 90^th day. In exchange, the supplier takes a small discount and the buyer pays an interest charge to the finance company. 

Who Typically Offers Reverse Factoring?

Reverse factoring for suppliers is usually offered by very large companies that are purchasing large volumes and who want to improve the cash flow situation for their suppliers. Most of them have extended payment terms to their suppliers beyond the typical 30 day cycle. Instead of shortening their payment terms, they enter into an agreement with a finance company to be the intermediary which includes  a considerable amount of factoring, an approach is not typically available to smaller companies.

Suppliers Must Read the Fine Print

The finance companies that enter into these agreements do not want to assume any risk and strive to establish a loan to your buyer to pay its payables, with the supplier accepting a slight discount in exchange for early payment.

In a proper reverse factoring arrangement, the supplier’s choice should be only whether or not to accept a discount for early payment. None of the other terms of the purchase and sale arrangement should change. However, the finance companies that provide these reverse factoring arrangements often have terms that go far beyond the normal purchase and sale risk that a supplier has negotiated with their buyers. These terms can expose the supplier to credit risk far beyond any normal payment terms or warranty periods.

In a normal purchase and sale, once the buyer has paid and the warranty period has passed, the seller is free to assume the payment is secure. This is not always true if the payment was received by a finance company in a reverse factoring arrangement.

The overly broad provisions of these reverse factoring arrangements can give the buyer the control to dispute the transaction “at any time” and force the supplier to repay the finance company the payments. The warranty periods and remedy limitations under normal sales contracts become meaningless.

What Should a Supplier Do?

First and always, read the fine print and confirm the agreement does not fundamental change the the terms of your purchase and sale agreement with your buyer.  It is important to consider the ramifications of payments from the finance company. What may happen if the buyer fails to pay the finance company? Can the finance company force you to repay the receivable? These reverse factoring arrangements can be a good thing for suppliers, but only if they do not alter normal course of sales with  your buyers.

In this case, it is not caveat emptor, it is caveat venditor!