It’s the first thing most lawyers drill into their factoring clients: send the authenticated notice of assignment to the account debtor before the ink fully dries on the factoring agreement. Of course, some factors don’t want the account debtor to know they’re involved for a myriad of reasons. Perhaps their client’s relationship with the account debtor would be harmed if they knew a factor was involved. Perhaps the factor has a good enough relationship with their client that they trust the client to remit funds to them. Or perhaps the factor simply doesn’t want the industry to know they’re entering the space. Regardless, factors sometimes choose to forgo sending an authenticated notice of assignment. This is a mistake that can prove extremely costly in litigation.
There are two key reasons why. The first, and the one most factors know, is that once the account debtor receives an authenticated notice of assignment, the account debtor is obligated to pay the factor, not the client. The second reason is less known to factors, but is absolutely essential to prevail in factoring litigation. Once the account debtor receives the authenticated notice of assignment, any claim for setoff is cut off.
Let’s start with the first reason. Just because you’ve executed a factoring agreement with your client doesn’t mean the money starts flowing to you right away. Rather, payment obligations are governed by the Uniform Commercial Code § 9-406. Under Section 9-406(a), unless and until the account debtor receives the authenticated notice of assignment from the factor, the account debtor has no obligation to pay the factor directly. They can instead pay your client and satisfy its obligations. It should be readily apparent why that is undesirable for a factor. The client can abscond with the money, declare bankruptcy, or otherwise fail to remit payment to you. Without an authenticated notice of assignment, the factor has no recourse against the account debtor. This changes if the factor sends an authenticated notice of assignment.
Once the account debtor receives the authenticated notice of assignment, it can only discharge its obligation by paying the factor. As most experienced factors know, account debtors will still try to pay the factoring client instead, sometimes at the direction of the client. But, if it does so, the account debtor has “paid over notice” and remains obligated to pay the factor. While this will almost certainly result in litigation, it is one the factor should ultimately win.
But sending an authenticated notice of assignment does not just protect a factor’s right to payment. It also preserves the value of the accounts receivable collateral. This is because an account debtor’s right to setoff is extinguished after it receives an authenticated notice of assignment. UCC § 9-404(a)(2). This is crucial, because even if a factor has a right to payment, that right to payment can be significantly reduced by the sums the client owes to the account debtor.
A few hypotheticals help illustrate this:
Hypothetical A:
Factor is assigned $100,000 in staffing accounts receivables from Client and sends an authenticated notice of assignment on January 1, 2025, to the Account Debtor. On December 31, 2024, the Client hit Account Debtor’s truck with their forklift, causing $20,000 in damages.
Here, setoff is easily applied. The Client owes the Account Debtor $20,000 for an incident that was not part of the contract and it accrued before the authenticated notice of assignment was received. Thus, the Account Debtor can offset the $100,000 owed to Factor by $20,000, leaving Factor only receiving $80,000.
Hypothetical B:
The same facts as Hypothetical A, but now the Client hits the Account Debtor’s truck with its forklift on January 2, 2025. Now, the Account Debtor has no right to setoff against Factor, it will owe Factor the full $100,000 and will have to sue the Client separately for the $20,000 in damages.
These hypotheticals illustrate why the authenticated notice of assignment should be sent immediately, even if the factor has other compelling reasons for not wanting to send one. The amount of money at stake is simply too much to place at risk.
However, a factor should be aware that an authenticated notice of assignment does not stop all attempts from a factor trying to reduce its obligations or even recover from the factor. The account debtor still has a right to seek set-off against the factor if it has a claim directly against the factor. It could also seek recoupment from the factor under UCC Section 9-404(a)(1) for debts arising out of the same transaction as the debt itself. Finally, an account debtor could try to tie the factor and its client together as joint venturers, which could make the factor liable for its client’s debts. But these claims are significantly more difficult for an account debtor to prevail on, forcing them to incur large costs in litigation.
A hypothetical can help illustrate recoupment:
Hypothetical C:
The Factor is assigned $100,000 in accounts receivables from a construction contract and sends an authenticated notice of assignment on January 1, 2025. On March 1, 2025, the Account Debtor discovers that the Client has performed deficient work, costing Account Debtor $20,000 to fix and repair.
Here, the Account Debtor is not entitled to setoff, because the damage spawns from the failure to perform the contract itself, not from outside the contract. But the Account Debtor is entitled to recoupment, even though the damage arose after the authenticated notice of assignment. Thus, the Factor will only recover $80,000.
Finally, you might have noticed that we used “authenticated” throughout this article. This is because a notice of assignment is more than just a document that can be slapped together by ChatGPT. It has specific requirements to be legally enforceable. To be authenticated and binding, the notice of assignment must identify the rights assigned and signed by the factor. This last part seems small but more than a few factors have been burned by not adding a simple electronic signature to make the notice of assignment authenticated.
To recap, most factors already sent authenticated notices of assignment to account debtors. But a small subset do not, or delay in doing so. This places the factor at significant risk of losing its right to payment and or lowering the amount it ultimately recovers in litigation. So factors, as part of your post-execution process, make sure an authenticated notice of assignment is sent right away to the account debtor.
If you are a factor in need of experienced factoring counsel, please contact Robby Dube or Daniel Cragg at Eckland & Blando LLP