Introduction
Invoice factoring — the purchase of accounts receivable at a discount — is one of the most accounts-receivable-intensive forms of commercial finance, and it depends entirely on a clean, perfected first-priority security interest in the client's receivables. A factoring company that fails to properly perfect its interest in accounts receivable — or that factors receivables already pledged to another lender — faces the risk of paying for assets it cannot actually collect.
This guide covers the UCC filing requirements, due diligence steps, and portfolio management practices specific to factoring companies.
The UCC Framework for Accounts Receivable Factoring
Under Article 9, the purchase of accounts receivable is treated as a secured transaction for filing purposes — even though the transaction is structured as a sale rather than a loan. This means factoring companies must file a UCC-1 Financing Statement to perfect their interest in the receivables they purchase, just as a lender perfects a security interest in collateral.
Failure to file leaves the factor's interest unperfected, which means it can be avoided by a bankruptcy trustee and is subordinate to any perfected security interest held by another creditor.
Pre-Purchase Due Diligence: The UCC Search
Before entering into a factoring relationship with a new client, run a certified UCC search in the client's state of organization. The two most critical things to look for:
- Blanket all-assets liens filed by a bank or other lender — these almost certainly cover the client's accounts receivable and will be senior to your interest unless released or subordinated.
- Specific accounts receivable liens filed by another factor or asset-based lender — a direct conflict with your proposed purchase.
A blanket lien filed by a commercial bank is the most common obstacle in factoring due diligence. Many small businesses seeking factoring have an existing revolving line of credit with their bank, secured by a blanket all-assets lien. Before you can factor their receivables on a first-priority basis, that bank lien must be released (the bank pays off and terminates) or subordinated to your factoring lien.
Never fund against receivables until you have confirmed (a) a clean UCC search showing no competing liens on the accounts, or (b) a fully executed subordination agreement from any senior lienholder, and (c) your own UCC-1 has been filed and confirmed as indexed.
Filing Your UCC-1 as a Factor
The UCC-1 for a factoring relationship should cover the full scope of receivables you will be purchasing. Best practice collateral language for factoring:
"All accounts, accounts receivable, contract rights, chattel paper, instruments, and general intangibles of Debtor/Client, now existing or hereafter arising or acquired, together with all collections, proceeds, books and records, and supporting obligations relating thereto."
Key elements to include:
- 'Now existing or hereafter arising' — covers receivables the client generates in the future, not just those at the time of the agreement.
- 'Collections and proceeds' — ensures your interest follows the cash when receivables are paid.
- 'Books and records' — useful for enforcement; covers the client's records of the receivables.
- 'Supporting obligations' — covers guaranties and other credit support related to the receivables.
Notification Requirements: Notified vs. Non-Notified Factoring
Factoring can be structured as notified (disclosed) or non-notified (confidential):
| Type | How It Works | UCC Considerations |
|---|---|---|
| Notified Factoring | Account debtors (the client's customers who owe the invoices) are notified that the receivable has been assigned to the factor and instructed to pay the factor directly. | Article 9 requires that account debtors receive notification before they are obligated to pay the factor directly. Without proper notification, an account debtor who pays the original client is discharged even if the factor has a perfected security interest. |
| Non-Notified Factoring | Account debtors are not informed of the factoring arrangement and continue to pay the client, who remits funds to the factor. | Your UCC-1 still needs to be filed to perfect your interest. However, you rely on the client to remit collections — a higher operational risk. |
Competing with a Bank's Blanket Lien: The Subordination Negotiation
The most common scenario in factoring due diligence is discovering a bank blanket lien. The standard solution is negotiating a Receivables Subordination Agreement (sometimes called a "blocked account" or "dominion" agreement) with the bank, in which the bank agrees that:
- Its lien on accounts receivable is subordinated to your factoring lien for the duration of the factoring relationship.
- The bank will not exercise its rights against the receivables while the factoring agreement is in place.
- In exchange, the factor may agree to maintain a minimum reserve, provide the bank with borrowing base reports, or restrict the client from drawing on the revolving credit facility.
Banks are often willing to negotiate these agreements because the factoring arrangement provides the client with working capital that ultimately supports loan repayment. The key is to get the subordination agreement in writing and fully executed before funding any receivables.
Portfolio Management for Factoring Companies
| Portfolio Event | Required Action |
|---|---|
| New client onboarding | UCC search → resolve competing liens → file UCC-1 → confirm indexing before first funding. |
| Client changes legal name | File UCC-3 Amendment within 4 months. |
| Factoring agreement assigned to another factor (portfolio sale) | File UCC-3 Assignment to update secured party of record. |
| Client terminates factoring relationship | File UCC-3 Termination once all purchased receivables are collected and account is settled. |
| Approaching 5-year lapse date | File UCC-3 Continuation within 6-month window. |
| Client files bankruptcy | Confirm your UCC-1 is active and correctly indexed. Your perfected interest in purchased receivables should be protected. |
Key Takeaways for Factoring Companies
- Article 9 requires factoring companies to file a UCC-1 to perfect their interest in purchased receivables — the purchase/sale structure does not exempt you from filing.
- Run a certified UCC search before funding any new client. Competing blanket liens must be resolved before you fund.
- Use broad, future-receivables language in your collateral description to cover the full flow of the factoring relationship.
- Notify account debtors per Article 9 requirements to ensure they are obligated to pay you directly.
- Negotiate a Receivables Subordination Agreement with any senior lienholder before committing to the relationship.