Picture it from your customer’s side. A letter arrives in plain first-class mail from an unrecognizable company. It spends two days sitting around the office, until it lands on the desk of an accounts payable clerk who is out of the office. The clerk returns, thinks it is a collection scam (because your customer is set up for ACH, and has just paid their invoice), and tosses it. Three more payments are sent, until your customer is sued on all four invoices. The bad news for that customer? Well, it still owes the money for the invoices. The even worse news? When it phones to say all future payments must go to the other company, you threaten to withhold deliveries, telling the customer that the other side is taking you for a ride on the late fees and attorneys and isn’t owed a dime more. How did this become your customer’s problem? Answer: The lien you signed.
More Diversion Notices
As more businesses feel the pressure, particularly those that discounted their receivables for fast cash with hard-money lenders, we are seeing more diversion notices issued by banks, factors and other lenders. If you accepted an advance against your receivables, and the funder has a lien on your receivables, it’s important to understand what the funder can do with the lien. Many merchants we meet at Delancey Street have signed a merchant cash advance contract without giving the UCC lien on it much thought. But a funder who files a financing statement and takes a security interest in your receivables, the funds your customers owe you, has some significant weapons under Article 9 of the Uniform Commercial Code. Here are 9 of them, and what each means for you.
First, it allows the funder to take the receivable even if your customer’s contract expressly prohibits it. Section 9-406(d) renders unenforceable any clause that forbids assignment, as well as any default that occurs as a result of violating that clause. The Code calls the funder an assignee, which means either a purchaser of the receivable or a secured party who has a security interest in the receivable.
Second, the funder can notify your customers directly. Section 9-406(b) allows the assignee to give the account debtor - your customer - a notification of the assignment (or pledge). It must be authenticated, which means signed (an electronic signature satisfies the requirement). You might not even realize it was sent.
Third, it can redirect your customers’ payments. A valid notice instructs the customer to make the payment to the funder, rather than to you. However, a notice is not effective to the extent that (1) the notice does not reasonably identify the rights assigned, or (2) the customer could treat the notice as not effective because it instructs the customer to make a payment to the funder in an amount that is less than the amount of an installment payment or other periodic payment.
Fourth, it can force your customers to pay twice. A customer that receives a valid notice can’t satisfy its obligation by paying you instead of the funder. It may be forced to pay a single invoice twice, unless it can get double payment out of you. For a customer whose accounts payable clerk threw the notice away, that is a nasty surprise.
Fifth, it can pursue your customers directly. The funder can compel payment directly from your customer - which could mean a lawsuit on invoices the customer thought it had paid. Imagine a customer that continues to pay you via ACH after the notice, and is then hit with a lawsuit on all those invoices.
Sixth, it must be able to show proof of the assignment upon request by your customer. Section 9-406(c) provides that your customer can ask the funder for “proof of the assignment,” for example, a copy of the signed agreement where you pledged the accounts. The filing of a financing statement alone does not suffice. If the funder does not provide proof seasonably (i.e., in a timely fashion), your customer can pay you without subjecting itself to the risk of having to pay twice. There is no specific time frame under the UCC. An official comment to Section 9-406 states that, if a customer requested reasonable evidence, it may pay you when payment is due, or even at some earlier time if reasonably necessary to avoid the risk of default. Nevertheless, if the customer pays you a significant time before the due date, that payment won’t discharge the obligation, unless the funder did not comply with its request for evidence in a timely manner.
Seventh, it can result in payments being frozen. A prudent customer who receives one of these notices will immediately notify their accounts payable group and stop sending payments to you to see if the amount the funder says is owed is accurate. They may advise you that a payment which is due will be slightly delayed due to its request for documentation.
Eighth, it can march in your shoes, but only your shoes. The funder does not obtain greater rights to payment than you possessed. Its rights, by Section 9-404, are subject to all the terms of your contract with the customer as well as any defense or claim against you arising from that transaction, and any other defense or claim the customer had against you that arose before it received the notice. The customer’s dispute about a billing, a payment of an invoice before the notice arrived, contras, set-offs and counterclaims survive.
Ninth, it can put your customers in the cross-hairs. If you challenge the funder’s right to get paid, your customer can call up its lawyer and have the lawyer tell it it can interplead the money by paying it to the court and letting the two of you battle it out.
A customer notice is not necessarily an indication that you are in distress with your funder, but it could be. If the business is desperate, and not able to pay employees or even keep the lights on, it may not deliver the goods or services owed to the customer. This will create a counterclaim that can be offset against the receivable, which is bad for the funder. Everyone has something to lose and something to gain.
The reason for this is that swift action to get a negotiated settlement, where each side gets less than they want, can prevent a worse outcome. We’re a business debt settlement company, not a law firm. At Delancey Street, our advisors negotiate with MCA funders for less than full balance, and we refer owners to an independent attorney when that’s needed. First consultation is free and confidential.
If your funder is contacting your customers, or you fear they will, call someone before the situation escalates. Delancey Street specializes in merchant cash advance debt, including stacked merchant cash advances. If we do not believe your case can be won, or that there is an alternative, less expensive solution to your issue, we will let you know this on the first phone call, and if we believe that bankruptcy is the best course of action, we will refer you to bankruptcy counsel. Our fee will be quoted in writing before we take on your case.
