Factoring and Security Agreements

What the Factoring and Security Agreement Must Accomplish

The factoring and security agreement is the contract that every later recovery depends on. It should identify and transfer the purchased accounts, allocate credit and performance risk, and define the seller's obligations and the events that allow the factor to stop purchasing and enforce its rights. Where the program calls for additional security, it should include an enforceable collateral grant securing the seller's obligations, such as repurchase and turnover of collections. A broader collateral grant is a commercial choice, not a requirement of every accounts purchase.

Article 9 of the Uniform Commercial Code generally governs a sale of accounts under § 9-109(a)(3), adopted in Illinois at 810 ILCS 5/9-109(a)(3), subject to the exclusions in § 9-109(c) and (d). For the factor's interest to attach, § 9-203(b) requires that value be given, that the seller have rights in the accounts, and that the statutory agreement requirement be met. The agreement should be drafted with those requirements in mind.

Core Commercial Terms

The economic terms should be precise enough that the balance can be calculated from the agreement and the supporting transaction records.

• Purchase price, advance rate, and the treatment of the reserve or rebate held back from each purchase
• Fees, their accrual period, and how they are charged
• The allocation of nonpayment risk, including any repurchase or reimbursement obligations and the period after which they apply
• Eligibility criteria for accounts, including concentration limits by account debtor
• A clear, auditable payoff calculation that accounts for purchases, collections, reserves, credits, repurchases, and fees
• The offer, acceptance, and schedule process that documents which invoices were actually purchased

A payoff calculation is evidence, not a binding damages determination. Any demand or damages claim must account for purchases, collections, reserves, credits, repurchases, fees, and other adjustments permitted by the agreement and applicable law. The most important distinction in a later dispute is between a master agreement authorizing purchases and evidence that a particular account was actually purchased.

Warranties, Covenants, and Events of Default

Factoring losses can arise from credit risk, disputes, invoices that do not reflect completed work, duplicate financing, and diverted collections. The warranties and covenants allocate the non-credit risks to the seller by contract.

• Each invoice represents completed and accepted work or delivered goods and is owed without undisclosed offset or dispute
• No account has been sold, pledged, or assigned to any other party
• Collections received on purchased accounts will be handled and remitted as the agreement requires
• Remittance instructions to account debtors will not be changed without the factor's written consent
• The seller will give prompt notice of any dispute, credit, return, backcharge, or claim by an account debtor

The events of default should track those obligations directly, and may include diverted collections, invoices that do not reflect completed work, duplicate financing, insolvency, a change of control, and a guarantor default. The agreement should address the factor's collection rights under § 9-607, any required notices, and an express provision for reasonable attorneys' fees and enforcement expenses. Illinois courts read fee provisions according to their terms; in Negro Nest, LLC v. Mid-Northern Management, Inc., 362 Ill. App. 3d 640 (2005), a clause for "all collection costs" was held insufficient to support recovery of attorney fees.

Perfection: Filing the UCC-1 in the Correct State

A factor ordinarily perfects its interest in purchased commercial accounts by filing an effective financing statement under § 9-310. Section 9-309 provides automatic perfection for certain limited assignments and for sales of payment intangibles and promissory notes, so the method depends on the transaction and the collateral. A single UCC-1 should not be assumed to perfect every asset in a broader collateral package.

For ordinary accounts owned by a state-organized registered organization, the filing generally belongs in the seller's state of organization under §§ 9-301(1) and 9-307(e). A seller organized in Delaware or New York but operating in Illinois or California is generally filed against in its state of organization. The name must match the most recently filed or issued public organic record under § 9-503(a)(1). A debtor-name error can make the filing seriously misleading and ineffective under § 9-506. A search-logic safe harbor may apply under § 9-506(c), but the factor should not rely on it when preparing the filing.

Before the first funding, we run entity searches to confirm the state of organization and exact name, and UCC searches to identify prior filings by other funders or lenders. Where a prior lender claims accounts, review the actual collateral description, the secured obligations, any proceeds claims, the existing lender's consent, and the proposed priority arrangement; a financing statement alone does not establish the full scope of a competing creditor's rights. The filing generally lapses after five years under § 9-515 unless continued within the six months before lapse, and filing-office acceptance does not by itself confirm that the filing is effective.

Supporting Documents That Belong in Every File

The agreement should not stand alone. A strong onboarding file typically includes the following.

• Invoice-level purchase evidence: offers, acceptances, schedules, funding records, and eligibility confirmations
• Underlying contracts and performance evidence: purchase orders, master services agreements, delivery receipts, approved timesheets, and acceptance records
• A notice of assignment under UCC 9-406 for each account debtor, with evidence of delivery and receipt
• Personal guaranties signed in an individual capacity, with documented consideration
• Organizational documents, resolutions or consents, and evidence of signer authority
• The filed UCC-1, the pre-filing searches, and any payoff letters, releases, subordinations, or intercreditor agreements with prior lenders

When a program later goes into default, these records support the demand letters and, if necessary, the pleadings. A gap at onboarding often becomes a contested issue at enforcement. For how these documents are used in a default, see factoring collections and recovery.