Factoring Fraud

Factoring fraud is an increasingly common fraud affecting companies that outsource their invoicing to factoring agencies.

Small and medium-sized enterprises account for approximately 90% of factoring agencies’ customers and the use of factoring agencies is on the rise. The EU Federation calculated that factoring agencies’ client turnover was €1.5 trillion in Europe in 2016.

What is factoring?

Factoring is when customers forward their sales invoices to a factoring agency for collection. The agency pays the business immediately and then recovers the funds from the business’ customers. They withhold a portion of the invoice to make the service profitable.

Factoring agencies are active for clients in a range of sectors, from construction to publishing. They are sought after for a number of reasons, such as to even out volatile cash flow, overcome the financial burden of slow paying customers, or simply to act as a steady supply of working capital that allows customers to meet their day-to-day business expenses. For smaller companies, outsourcing collection to a factoring agency may be more cost-effective than an in-house credit control function.

Customers often turn to factoring agents when their applications for bank funding have been declined. Factoring agencies often take a charge against their client’s assets to protect their debt in the event that they cannot recover the amounts due from the client’s customers.

How do people commit factoring fraud?

Factoring agencies are vulnerable to rogue businesses that seek to defraud them. Factoring fraud occurs when a customer submits false invoices to its debt factoring company. These invoice amounts are promptly paid to the defrauding companies but prove irrecoverable for the factoring agencies.

In October, the Insolvency Service banned an individual from acting as the director of a finance company for the next ten years. David Marsden instructed his customers to prepare false invoices. He then submitted them to his company’s factoring agency to secure £4m of illegal funding.

What happens after the fraud?

What happens when the debt factoring agencies go back to the customer and say that the debt was irrecoverable? Defrauding customers often explain away the problem by issuing credit notes and amended invoices to conceal the true nature of the transaction.

Factoring agencies often request a personal guarantee from their customers. If the customer defaults, the customer will have to repay the sum specified by the guarantee. If it emerges that a factoring fraud has occurred, individuals can be personally liable, even though they themselves did not commit the fraud.

An additional measure taken by factoring agencies is to issue a debenture. This normally entails taking security over assets of the business. In the event of the customer’s liquidation, the factoring agency will have first rights over the company’s assets. However, it often emerges in factoring fraud cases that the defrauding company may not have sufficient assets to ensure repayment in full, and so the lender is left out of pocket.

If you have any questions or if you would like to discuss any concerns you have around factoring fraud in more detail, please contact our Forensic team on 01903 234094.

A version of this blog originally appeared on the blog of MHA member firm, Tait Walker

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