Article by Sidney Posel
Except at the retail level, most goods and services are distributed by sales made on open account. The short-term account receivable so created is one of the most liquid assets of the creditor enterprise. Representing a sale made in the ordinary course of business to a presumably creditworthy buyer, it is a value on the strength of which a financial institution will extend cash. In the United States today, such financing takes either the form of a loan secured by the account receivable or that of an outright purchase of the account. The first mode is with recourse to the client of the lender in case of the inability of the account debtor to pay the debt represented by the account. Often called "commercial financing" (of short term credits), the first mode is practiced both by specialized lenders, "commercial finance companies," and by commercial banks. The second mode, without recourse to the client of the financing institution in the stated contingency, is engaged in principally by specialized lenders called factors. In recent years, rapid growth and expansion among the several kinds of commercial financing institutions have blurred the two categories, although one may still find specialized divisions within a lending institution which engages in both.
In America, the demand for business credit is ever-growing, and there is a consequent need to mobilize assets considered as satisfactory collateral by prudent lenders. Accordingly, American law has moved away from its earlier emphasis on creditor equality, its suspicion of secret liens, and its fears of borrower oppression by a dominant creditor. It is no longer of importance that the account lacks authentic documentation. Ordinary business records are considered prima facie proof of transactions, and the records of institutional lenders (the only significant class) provide ample proof of payment for the assigned accounts. Only the simplest form of public notice of the financing relationship is required, so that maximum economy is achieved. As a result, the loan secured by the assignment of accounts receivable has received very strong protection under the Uniform Commercial Code (the U.C.C.).
Free from the restrictions and doubts which once surrounded its legal status, such a loan is no longer the expensive practice it was during and between the World Wars. Governed by article 9 (secured transactions), which specifically includes accounts as available collateral security, the security interest created by the assignment of an account receivable has acquired well-settled legal characteristics. During the same period, it has become more important as a source of short-term financing.
The outright sale and purchase of an account receivable would seem to fall into a different legal category, since no loan transaction is involved. Nevertheless, the transfer presents the same difficulties to third parties, since there is no indispensible tangible embodiment of the account receivable. Some efficacious method of public notice of the transaction is desirable to protect prudent persons from relying on previously sold accounts as collateral for a loan. For this reason, the U.C.C. includes the property interest of the buyer of accounts in the term "security interest," and has applied the rules of article 9 (secured transactions) to sales of accounts. At the cost of very few formalities, the business of the commercial factor, like that of the secured lender, has thereby been put upon a detailed statutory base, highly protected against unbargained-for risks. Furthermore, because these few formalities are the same for recourse and non-recourse financing, it is easier for the financing institution to choose either or both modes of financing with the same client.
More recently, with the enactment of the Bankruptcy Code, the application of the U.C.C. to a federal bankruptcy proceeding has been clarified. The financier's legal risks in the United States seem quite limited and the cost of legal compliance is low.
In recent years, Europe and other well-developed commercial areas have recognized the advantages of accounts receivable financing. American banks and commercial finance companies have brought these practices into their business abroad, and the foreign institutions have learned from them. Because of the diversity of legal concepts and cultural characteristics, things have been done somewhat differently in foreign countries. In one way or another, however, the financing of accounts has grown into a very large affair. In France, up to now, such development has largely taken the form of factoring, i.e., non-recourse financing. It is worthwhile to describe in some detail certain features of the French legal system in order to explain this course of development.
About the Author
Sidney Posel. Professor of Law, Rutgers, The State University School of Law, Newark, New Jersey.
Citation
57 Tul. L. Rev. 292 (1982)