The Factor Guru

Tips on accounts receivable financing and business practices.

Archive for category Underwriting

What do you mean everything on the Internet is not real?

Dec 28

Posted by Gen Merritt in Underwriting | No Comments

Yes, I know it has been way too long since the last post. I was actually thinking of taking this website down since I do not have that much time lately and seem to also be experiencing writer’s block. Well, I guess not everyone liked that idea. So, for now, we’ll keep writing… for a little while.

As the end of the year nears and a new one begins, here are some tips that some of you have provided to share with our readers, all of which relate to fraud prevention. Thank you for your comments and emails.

What if you suspect a fraud? Have you ever considered taking a portion of the verbiage on an invoice and entering that into a search engine on the internet? This may sound really crazy, but recently someone I know did this as the items being billed for on the invoice looked “off” and the descriptions were extremely long. As it turned out, the exact verbiage was found on the marketing products page for a completely different company.  The prospective client had copied and pasted the verbiage from a site in their haste to prepare invoices. What did the factor say, “Plagiarism is not limited to college or high school term papers anymore.”

With technology today, it has become increasingly easy to create, edit and submit invoices, purchase orders, and even billing documentation. You can find a lot on the Internet, and there are several tools that allow for editing PDF files and other documents that now exist. Just think of all the tools you have access to in your daily work.

Even more so, what about those prospective clients or clients who have also created account debtors? Yes, this can be done and is done. You can check credit agencies, secretary of state websites, and perform Internet searches on the customers. Sometimes a simple credit report is not sufficient. Plus, it is important to know which credit reporting agencies take reporting from the company being reported on (self reporting) versus accepting credit reporting only by third parties. If you are not sure, find out before you rely on simply one credit agency.

All of this is time consuming for the prospective client and for the factor to research, but it can be done. More importantly, it has been done and is being done today. When money is involved, people looking to initiate a fraud will go to great lengths to convince you to send them money. Creating the story and covering their tracks is what they do all day, every day.

When someone who commits fraud goes so far as to set up fraudulent debtors with websites and state registered companies, even if you cross check a phone number or address on the Internet, your independent research will reveal matching results with what your prospective client has provided to you, the factor.

One way to attempt to catch this is to check out the domain name for the debtor; this also works on email addresses as well. Watch for discreet domain ownership as this type of service can be used to hide a potential fraud.

On another note but along the same lines, have you ever had verification calls that went too smoothly? This with forwarded phone calls, Internet phone services, prepaid cell phones and other methods of hiding the true person you are contacting will also help a company commit fraud. If the company is valid, there should be a land line that can be identified with that company.

Well, that should be enough fraud facts for now. Thank you for your comments and tips. Please keep them coming.

Wishing you continued success. The Factor Guru.

Tags: , , ,

The Sixth C: Common Sense

Jul 16

Posted by Gen Merritt in Underwriting | 2 Comments

Always remember your six C’s of credit, even if the C’s don’t always seem to be the same for everyone. For some, the sixth C is Common Sense. And, when something does not quite ‘fit’ in the story, that is when it is time to dig a little deeper…

A few weeks ago, an underwriter contacted me about her process in reviewing a new deal. She also wanted to share some Red Flags that arose in her process.

The prospect had been owned by one party, but all correspondence had been through another individual. We’ll call him Joe. The underwriter on the deal felt that Joe, although stating he was forthcoming, continued to omit pieces of information. She went through her six C’s of credit ultimately concluding to decline the deal.

But, let’s start at the beginning, the credit.

The debtor credit was insufficient for the amount being requested; the credit department was looking for additional history to support the request. In the interim, the underwriter requested copies of invoices. Joe said they did not invoice the debtor. Instead, they provided handwritten backup to the debtor and the debtor invoiced the client. The underwriter never did receive a report or copy of these debtor invoices.

Speaking of credit, the application noted another person owning the business, not Joe. The owner’s personal credit and background appeared good. However, the documentation on who actually owned the company legally did not link back to this person. Moreover, Joe had been the one to provide all correspondence, since he was who was running the daily operations. Since Joe did not own the business, he also would not sign an application for credit or background checks, nor would he sign any type of guaranty. After all, he was just helping out the owner to start the business.

The underwriter then decided to start searching – the Internet – there were just too many pieces that did not add up in the story. After trying different search phrases, there it was… Joe was no stranger to factoring. In fact, he had defrauded other factors in other states using the same strategy. Unfortunately for him, one of those times, he had the business in his name.

But, it was the Common Sense part of the underwriting process that led the underwriter to search a little bit more on the Internet, where she ultimately found these articles. Afterwards, she prepared some Red Flags to think about when going through this process:

Red Flag # 1:

“This prospect was almost overly friendly, likable, and eager to help. Fraudsters know that they need to become your friend first in order to drop the wall of skepticism between you. Typically prospects will get exasperated with the front end factoring process at some point in time, but this prospect was always making reassuring statements such as ‘we will get whatever report you need, and I will make sure that it has every piece of information you need is on it’.  He also didn’t even hesitate when I asked to speak directly to the debtor at an early stage in the underwriting process which would typically be a good sign.”

Please note that the reports were never received; the conversation with the debtor was never had.

Red Flag # 2:

“Double Talk. After going through a few questions on the underwriting call, specifically Joe’s background and experience, I felt as though we had talked for over 20 minutes regarding his background yet I couldn’t tell you one thing about him. Keep in mind that he wasn’t the owner of the business, but was acting more as an advisor and therefore we didn’t have any information on him (application info, background/credit information, driver’s license, financials, etc.). I pressed a bit further and nicely let him know that I still really didn’t understand what his experience or background was and that this is an important piece given the fact that it is a start-up operation. At this point, he finally realized he would have to give something concrete and told me that he used to work in the sporting goods industry (still not much). As we know, when answers are vague, that is when you need to keep pressing for better answers.”

This is another tactic fraudsters will use (see How to Smell a Rat).

Red Flag # 3:

“Physical signs of discomfort. When pressing the individual for a background report, I not only got an excuse as to why that wouldn’t be necessary, but he also mentioned his age along with the a reference as to his great character accompanied by a sort of numerous small coughs that had not been there previously. When attending the IFA’s fraud seminar this past year, a former FBI agent spoke to the group regarding various physical signs of distress. This was clearly a sign of distress as he had never done that in our previous conversations, going back to what the agent called ‘knowing your prospect’s baseline’.”

Thank you for sharing your experience with our readers.

Wishing you all continued success. The Factor Guru.

Tags: , , , , ,

Case Law Updates, a guest blog by Scot Pierce

May 17

Posted by admin in Underwriting | 2 Comments

In late 2010, a new Yale Factors’ opinion was published that I thought was worth discussing, as many may still not be familiar with the case or the opinion. Because this dispute has been around so long, we really need to start at the beginning to understand what happened.

Facts of the Case

In 2002, Jersey Tractor Trailer Training, Inc. entered into a loan agreement with Wawel Savings Bank for $315,000.  To secure the loan, Wawel took a blanket security agreement against all assets including inventory, equipment, accounts, instruments, documents, chattel paper and other rights to payment including general intangibles.  Wawel filed a UCC-1 on May 24, 2002.  Wawel put no restrictions on Jersey’s use of its accounts and the proceeds unless there was a default on the loan.

In 2003, Jersey entered into an agreement to factor its receivables with Yale Factors NJ, LLC.  According to the court, Yale never asked Jersey about any prior encumbrances and never reviewed Jersey’s books or records.  Dun and Bradstreet ran a lien search for Yale, but instead of using Jersey’s exact legal name, they left off “Inc.”  Because of this, Dun and Bradstreet did not find Wawel’s senior lien.  And, of course, the client concealed Wawel’s loan from Yale and concealed Yale’s factoring agreement from Wawel.  Yale filed their UCC-1 against all present and after acquired accounts in 2003.

Jersey continued having cash flow problems.  In December 2005, Wawel and Yale finally learned about each other and began litigation.  By April 2006, Jersey Tractor declared bankruptcy.  Yale and Wawel promptly filed an adversary proceeding in the bankruptcy court to determine who is entitled to the proceeds of all of Jersey’s accounts.  Yale argued that this case was an exception to first to file priority rule and that it should win over Wawel.

2007 Opinion

In 2007, after a two day trial, the bankruptcy court held that Wawel wins.  Yale argued that under New Jersey’s version of UCC 3-302, 9-330 and 9-331, it should have priority over Wawel to the proceeds because it was a holder in due course and purchaser for value of invoices.  For Yale to qualify for protection under either of these statutes, the court must find that the invoices are “instruments.”  The court must also find that Yale took the instruments in “good faith” which means that Yale observed “reasonable commercial standards of fair dealing.”  Although the court held that the invoices are instruments, the court denied Yale relief because Yale did not observe “reasonable commercial standards of fair dealing” when it entered into the factoring agreement because its due diligence was lacking and because it did not run the lien search using the exact corporate name of the debtor.

2008 Opinion

Yale appealed to the district court.  In 2008, the district court issued an opinion upholding the lower court’s ruling.  Wawel wins again.

2009 Opinion

Yale then appealed to the Third Circuit Court of Appeals.  In 2009, the Third Circuit affirmed most of the district court’s decision, but found that the bankruptcy court could not conclude that Yale’s lien search was commercially unreasonable as a matter of law just because it omitted “Inc.” from the name.  In fact, the Third Circuit Court seems to believe Yale’s search was commercially reasonable.  But instead of reversing the bankruptcy court, the Third Circuit sent the case back to the bankruptcy court to redetermine commercial reasonableness.  No one wins, but Yale gets another chance.

2010 Opinion

This year, the bankruptcy court issued a ruling in favor of Wawel . . . but for a different reason.  The bankruptcy court reconsidered the issue of whether an invoice is an “instrument” for purposes of 3-302, 9-330 and 9-331.  The court concluded that an invoice is merely a record of a transaction and not an instrument.  Yale Factors, therefore, cannot avail itself of any of the holder in due course or purchaser for value protections regardless of whether it acted with commercial reasonableness.  Yale attempts to argue that it was not just invoices, but also checks from account debtors that it purchased, therefore, the court should analyze whether these checks are instruments.  At trial, however, Yale never introduced any checks into evidence.  Without these checks, the bankruptcy court held that it cannot even begin to consider this issue.  Wawel wins again.

So what should we learn?  There are lots of lessons, but I want you to consider how much time and money these parties have spent litigating this issue.  Better due diligence and lien searches could have saved everyone a lot of time and money.  Or, to say it another way, an ounce of prevention is worth a pound of cure.

About the author:

Scot Pierce is a partner with the lawfirm of Bracket & Ellis, P.C. located in Fort Worth, Texas.  He has represented a number of factors with commercial litigation and bankruptcy issues.  He also regularly writes articles and presents speeches on creditor issues and has been a speaker with the International Factoring Association.  He can be reached at 817/339-2474 or spierce@belaw.com.

Wishing you continued success. The Factor Guru.

 

Tags: , , , , , , , ,

Understanding the Story… “What If” a guest blog by Darla Auchinachie

Jul 9

Posted by Darla in Underwriting | 1 Comment

I recently became involved in underwriting an application for a factoring facility that brought me back to a session I co-instructed at the 2004 IFA Annual Factoring Conference. The title for that session: “Understanding the Paper you are Buying.” One of the ideas presented focused on how cutting corners in the due diligence process may lead to disastrous results. That was true five years ago, and it is even more so today.

It’s been said that it is very difficult to correct a bad underwriting decision, and anyone that has been tasked with a client “work-out” can echo that sentiment. The role of a factoring credit underwriter is to try to accurately predict that if a prospect is accepted for financing then that relationship will perform as expected – and to structure the facility in such a way that monitoring that performance can be effective. After the underwriter has recommended the prospect for financing, it becomes operation’s responsibility to employ the necessary procedures to protect and preserve the factor’s capital.

When you think about it, initial underwriting is a really tough job; even after you get past all the obstacles we understand academically, you still have to rely upon what your intuition tells you. And, after that, you have to determine if you are being too conservative or not conservative enough.

So, back to my original story about this application package, it was neat… too neat. Robust financials, plausible agings, strong guarantors, dare I say it – a factor’s dream. Of course there were issues a seasoned factor would spot such as the nature of the receivables having a “little hair on them” and the customers, while nicely spread out and quasi-governmental, still thin on the credit side. Of particular interest was the volume – it was substantial for the small non-traditional market. Who wouldn’t love funding a new prospect with a receivable base of several million, especially if it could be done for a desirable rate?

Personally, I wasn’t comfortable with the deal. It wasn’t necessarily the receivables themselves; it was more about the “Conditions” of the deal – Conditions is one of those “C’s” of credit we should never forget when underwriting. You see, the company had experienced tremendous growth in the past fiscal year, and by tremendous growth, I mean well over a 150% increase in revenues. But wait…

In this economy today, what industry could possibly support that kind of growth? I’m not talking about a startup company whose revenues might be expected to grow at a steep pace. This was a company that had been around for decades and had never experienced such a sharp increase in sales.

Another interesting Condition was that the prospect already had a factor funding their receivables. Usually this is not a cause for concern. In fact, it’s quite common to see an applicant who is already factoring. As part of the initial qualifying stage, the business development officer contacted the current factor and was given a glowing recommendation: the factor loved their client, had experienced zero dilution over the course of a multi-year relationship and wished they could keep funding the client. It was the client’s growth that had outstripped the factor’s ability to fund.

However, here is where the story becomes a little more interesting… 442f0b535d06bd4e2

The prospect urged the incoming factor to “rush” funding. They needed the capital to continue operating during this explosive growth cycle. One should ask, “Why?”

Well, common sense and experience were telling me something was not quite right: the recent growth, the current factor volunteering there had never been any dilution over the course of a long funding relationship, and now the company needed to rush the initial funding for a payoff. Why was a participation arrangement not being considered or requested?

I know many factoring companies and believe that most have very capable and honest folks, but this factor in particular was relatively new to the industry and now had a several million dollar deal that had outgrown them. I’d never met this factor at any industry event; I even called other factors to see if they had any experience or knowledge of this financial source – no one did. Because of this, I recommended that my client (remember the one who originally engaged me to review the application) fully and strongly verify the receivable base before getting too far down the road. My client asked me, “Why shouldn’t we rely upon the existing factor’s story and records?”. And, this is what brought me back to that class in 2004…

It was after that session when a factor approached me stating they wished they would have attended this course before taking on a rather large client. They had relied upon another factor’s story, similar to the one described above. To their detriment, they funded the prospect’s receivables. You see, the incoming factor didn’t have a large enough staff to fully verify the invoices, and the payoff was also a “rush” situation. As it turned out, there was not enough true collateral. The incoming factor had wanted to appease the client and get the deal done. They had “assumed” the information received from the prior factor was accurate. Therefore, the incoming factor only made a few random calls instead of following their normal procedure of verifying a large percentage of the collateral.

I know several factors who would say they would never do such a thing: fund a large client without full verification – but what about those newer factoring companies? We’ve seen the number of factors steadily increasing over the years, and yet many of these businesses may not survive. I think this story provides a good reason why newer factoring companies tend to fail. They do not understand (or believe) that fraud exists, that there are people waiting for opportunities to intentionally defraud factors or lenders out of their capital. Further, they believe they can correct their cutting corners on the initial funding by performing post funding verifications. Really? I think if this is the plan, you will just know sooner that you have a fraud. Once the money is sent… it may really be gone.

Yes, it is important to talk to the prior factor and hear their story. However, you should not solely rely on what they say… especially where your interests are not the same. Perform your own due diligence.

Newer factors might not have experienced a fraud; they may assume the current factor has strong procedures in place that mirror their own. But, what if the current factor hasn’t figured out what they have on the books isn’t any good? Or, what if the current factor knows but is hoping someone takes them out of the deal? And then, what if the incoming factor just doesn’t have sufficient resources or time to verify the accounts? Well, that sounds like just too many “What if’s?”

Be aware of what your intuition tells you. Or as my friends in Texas say, “Go with your gut feel.” Business is tough for everyone, and we all want to fund new deals. But, just because you catch a nice fish on your line doesn’t mean you should take it home and fry it up – sometimes catch and release may be better off for the longevity of your factoring company.

Oh, and just in case you were wondering about that deal I was engaged to review… the factor did start calling to verify invoices before they funded even with the glowing recommendation from the prior factor. The result: Declined. While I won’t go into great detail, remember that a factor’s best friend can be the Internet and that searches and reverse phone number searches on customers can be easily checked.

Until the next time…

Tags: , , , , , ,

A Good Deal for Factoring

Dec 2

Posted by Gen Merritt in Underwriting | No Comments

As someone who has specialized in credit and operations, I do have to on occasion empathize with the business development team. Once in awhile, a deal comes along that you know is a good deal. Don’t let me confuse you though. I don’t mean a deal that is a good ‘factoring’ deal… I just mean a good deal. You know the one: the company that is profitable and has strong customers; the owner(s) have good personal history and experience in the business along with great personal credit… oh, and the product has ‘mostly’ been delivered.

Wait, that’s it: “mostly” delivered. That’s the word that factors have a hard time with… mostly.  The fundamentals of factoring rely on delivered products and services performed in full. Nothing remains to be done. The sale is final. The invoice will be paid.

With the word “mostly,” however, the product is not definably delivered, today. Many technology and consulting businesses have services predicated on something else occurring. The services are not yet finished. They may need something else to happen for payment, or they may not. It just depends, right? The invoice, therefore, may at the end of the day still be disputed. So, what do you do?

Well, the best thing would then be to get a confirmation from the customer that the invoice will be paid in full, without offset, without dispute, and, hopefully, the factor is ensuring the payment is going to them pursuant to Article 9 of the Uniform Commercial Code, as outlined under the notification of assignment letter that is sent to the customer (account debtor). If you have never heard of a ‘no offset’ letter or an ‘estoppel’ letter, then call your legal counsel. Check out the International Factoring Association for legal counsel, if you don’t already have someone to prepare one for you.

Now, as a business development person, try telling this to the client. The company may not  understand. They have never had someone not pay; it just hasn’t happened to them. It’s only happened to other people. So, why do ‘you’ need this letter (the factor – the independent third party)?

This type of transaction may have been structured and approved under the ‘we did it before, so why don’t we do it now’ mandate. Remember, however, that was when working capital was at a surplus, when factors and lenders were aggressively competing in the financial marketplace.

So, after you see a deal like this, talk to them, maintain a good relationship with them, get prompt and accurate information from them, it is definitely hard to then say, “No, we cannot do your deal (the way you would ideally like),” or however you approve a transaction with certain requirements that the client ultimately then says no.  

When it is all said and done, sometimes you have to step back and say, “Can I get out of their transaction tomorrow?” That’s my motto, right? So, why is it so hard when you are so close to the client and the owners… just after a few phone calls and an in-person meeting? Well, because the answer to your own question was, “No,” even after all that.

So, once again, that is what I have to remember: honesty and candidacy is the best policy. You have to explain how a deal needs to be structured and also monitored. You have to tell this to the prospective client. You have to further explain and describe why this is the only way you or your company can approve their request. If their request to approve the transaction cannot be done, then it just can’t…or it can’t be done by your company. Maybe they can find financing elsewhere; however, with the current credit environment, I have to say there are slimmer pickings.

At the end of the day, a factoring company has to ask themselves, “Can I get out tomorrow?” They have to have an exit strategy. If the answer that comes back is anything less than a “Yes” then maybe the transaction is not meant for factoring. Sometimes, you really do have to say, “No,” even when you want to say, “Yes.”

Wishing you success, without regrets. The Factor Guru.

Tags: , , , , ,

Lost in the Internet

Nov 11

Posted by Gen Merritt in Underwriting | No Comments

So much information is available on the Internet. You can look up just about anything… or find out just about anything. One step I always take during due diligence for underwriting new prospective clients is ‘Googling’ them. Can we use that term or do we have to say “search the Internet?”

Anyhow, remember that just typing in the name of the company or the name of the guarantor may not be sufficient. Your search terms may be lost in all the information that may be available. You can’t really find out easily the information you are seeking. Try your own name as an example, just to see what comes up when you search yourself.

Sometimes, I find it helpful to insert quotes or add an ‘and’ or ‘minus’ to filter my results. After all, who wants to look through 20 pages of results? I don’t know if anyone even makes it beyond page two.

You may be asking, “What are you talking about?” If you are, then keep reading. If you are not and are now saying to yourself, “Who doesn’t know that,” then stop. No need to read any further; you probably already do these searches all the time if for no other reason than you cannot help it.

Lately, though, I have been amazed that more people don’t do any search or don’t know how to narrow their search criteria;  they don’t know about filtering or narrowing searches or modifying search phrases. So, for those who are not doing this already, here is a process you can try. I’d love to use a real example; however, I think I would be revealing information that should be kept to a private posting and not available for the world to see (at least not through this posting).

Therefore, searching your prospects is all up to you.

If you type [company name] by itself, you will receive a list of various Internet resources that have this name together or that have these names anywhere within the search results you find (meaning, the words searched are not all together as one phrase). By inserting quotes [“company name” or “guarantor name”], the search results become more narrowed. You are now only searching by the specific phrase listed in the quotes.

From here, you can narrow the results even further by adding an ‘and’ such as [“company name” and “Florida”] or other criteria you choose. Take this concept if you have results you don’t want and then insert a [minus ‘thing you don’t want’] and look again. This even works for factoring. Tired of seeing results that retrieve information on factoring polynomials? Just enter [factoring minus math] to narrow the results.

Eventually, depending on the transaction you are reviewing, you may find more information that you thought possible. Some of this data will just help you bring together all the information you already knew… or didn’t know but ultimately helped create a fuller picture. You will realize over time when you have searched too much (or over researched) as all the results will be the same.

However, in some cases, it may ‘pay off’ and you may have saved yourself from doing a deal that would have resulted in a loss. You may find out about prior frauds, tax liens, customer disputes or billing concerns, other charges, related entities, common ownership among customers, and more. You may no longer feel ’lost’ when you enter into a new transaction. And just think, it would all be through a free search… just your time and prudent due diligence.   

NEW: since this post, I did find an example that may help illustrate the importance of searching the Internet:

[Bob Pearson] was the contact for a prospective client on an insurance type of prospect, where receivables would be paid by the insurance or other commercial entity to the factor. Go ahead, search just the name without quotes.

Although a ‘one off’ deal, during the due diligence process, the factoring company also searched ["Bob Pearson" and "Dallas"]… do your own search with quotes to see what information was found…

Wishing you success. The Factor Guru

Tags: , , , ,

The Swiss Cheese Theory

Nov 4

Posted by Gen Merritt in Underwriting | Comments off

Why do some deals make it and others don’t, even when they have similar characteristics? Even when you go through the company background, the receivable base and performance, financial trends and sometimes the background and credit of the guarantor, in some cases, a prospect may not fit into your box. Why?

Well, this can be attributed to just a deal that doesn’t fit within a factoring company’s target client profile. It may, however, be perfect for another factoring company based upon their niche, risk profile, or other criteria.

One other reason may be because too many holes exist. What does this mean?

Someone (I believe it was Michael Haddad, Core Business Credit) told me once that when you mitigate too many risks in a transaction… it’s like a block of Swiss cheese. There are too many holes without enough cheese holding it all together. I know… sounds weird but the analogy stuck.

Since factoring is more of an art, I think this Swiss cheese theory helps explain why.

So, what are the holes? Many look at the six Cs of credit when reviewing a prospective client transaction. I tend to break it down to four key areas instead (as I can never remember the other two as everyone seems to have a different other two): Character, Collateral, and Credit, along with Common Sense of course.

You may ask why Character first? The person running the business who has the relationship with the customers can be critical when reviewing a new transaction. How they manage their personal finances may be indicative of how they manage their business and, ultimately, how they may work with their factor or lender during challenging financial times.

Collateral remains the foundation of factoring. Some important questions to think about: Who does the company sell to (what types of customers)? How is the customer credit? What type of industry does the company operate in and what current trends are ongoing in that industry that may affect the collateral? Do concentrations exist? What does the aging reflect about aged invoices or credits? How does the company bill? When is an invoice considered accepted by the company’s customers?

The third element, Credit, can include customer credit; however, what about the credit of the company? What do their financial statements show? What is going on in the business? What is their margin and does it support the factoring expense? Are there any entries or trends that require additional explanation? Remember, reviewing one period of time only provides a snapshot; however, having prior financial statements to compare against may help show trends in the business.

Finally, Common Sense is a must. This is the key element that brings all the other pieces together. Does the information reviewed correspond to the discussions held to date? Are there any areas that remain unclear or are conflicting with the information reviewed? Have the holes been mitigated in a way that would result in a successful collection, should the need arise? Is there enough cheese… or, are there too many holes?

Wishing you success. The Factor Guru

Tags: , , , , ,