Factoring: Liability for unpaid invoice and factoring: who’s eventually footing the bill?

While factoring looks like a handy service to generate instant cash from yet-to-be settled invoices, the final customer still has to pay the bill at some point. This can be decided from the start when choosing the factoring framework and product: some products will leave the business liable for unpaid invoices, some others transfer the liability to the factor. That is precisely the difference between recourse and non-recourse factoring. The somewhat confusing part is that both factoring and invoice discounting basic financing products can be either recourse or non-recourse.

Liability for unpaid invoices in the case of recourse and non-recourse invoice discounting

Although invoice discounting does not involve an actual transfer of ownership of the debt to the factor, and leaves debt collection to the business, the liability for unpaid invoice can be superseded by special arrangements.

Recourse invoice discounting

With recourse invoice discounting, businesses receive a quasi-credit facility from factoring services provides in exchange for unpaid invoices used as a collateral. The fact that this arrangement is “recourse” means that the liability for unpaid invoices always remains with the business using the invoice discounting financial service. If their client do not ultimately pay them, these businesses will have to pay back the funds released by the invoice discounter, to this invoice discounting company.

The special case of liability for unpaid invoices in non-recourse invoice discounting agreements

Technically, non-recourse invoice discounting does not actually transfer the liability for unpaid invoice to the invoice discounter, but the invoice discounter may include a bad debt protection service. This service is in fact a kind of credit insurance and involves the payment of insurance premiums by the business, and can cover a fraction, or the total amount of advanced funds. Businesses will not have to pay back these uncollected funds to the invoice discounter.

Liability in the case of recourse and non-recourse factoring

Very much like recourse and non-recourse invoice discounting, recourse and non-recourse factoring will ultimately leave the business respectively responsible, and not responsible for paying back uncollected invoices.

Recourse factoring

With recourse factoring, although the business sells its outstanding invoices to a specialised financial services provider, this business keeps total liability for unpaid invoices. If the final customer has not paid the invoices after a certain time, the business will have to pay back the funds received from the factor. Typically, factoring rates increase as time goes by with the invoice remaining unsettled, until a specified time when the invoice is considered lost for payment, and funds have to be paid back. The irony is that this still holds even when the factor is responsible for collecting the debt from the customer, so businesses had better make sure the collection services of their factors are effective!

Non-recourse factoring

With non-recourse factoring, liability for unpaid invoice is completely transferred to the factor, and businesses will not have to pay back unpaid invoices to the factor. As factors become liable for the risk of non-payment, access to this service is usually restricted to large corporations with a proven track-record of paid invoices over the years. The factor will adjust the pricing of factoring fees, and of the advance value - businesses may receive less than 80% of the invoice value - after reviewing support documents submitted by the business at the time of application.