Factoring
A financing arrangement in which a business sells its accounts receivable to a third party (the factor) at a discount in exchange for immediate cash. Distinct from a loan secured by receivables, the factor purchases ownership of the receivables. Under Texas UCC Article 9, sale of accounts is treated as a secured transaction for filing purposes. May be recourse (seller bears collection risk) or non-recourse (factor bears collection risk).
Factoring is a financing arrangement in which a business (the seller, often called the "client") sells its accounts receivable to a third party (the "factor") at a discount in exchange for immediate cash. Factoring is distinct from a traditional loan secured by receivables: the factor purchases ownership of the accounts, not merely a security interest. Despite the technical sale characterization, Texas UCC Article 9 treats the sale of accounts as a secured transaction for purposes of filing, perfection, and priority, collapsing many of the distinctions that exist in other commercial contexts.
Sale-versus-loan characterization
The threshold legal question in any factoring transaction is whether the arrangement constitutes a true sale of receivables or a loan secured by receivables. The distinction matters for (1) usury, a true sale is generally outside Texas usury limits, while a loan dressed as a sale may be subject to the ceilings in Tex. Fin. Code chs. 302, 303 and 306; (2) bankruptcy, true-sale receivables are not property of the seller's bankruptcy estate, while loan-collateral receivables are; (3) accounting, which applies its own derecognition test and may not follow the legal characterization. Factors that support true-sale characterization: (a) the factor pays a fixed purchase price that does not depend on later collections; (b) factor's recourse rights are limited; (c) seller's recourse exposure is bounded; (d) the transaction documents consistently use sale terminology. Factors against true-sale: (a) full recourse to seller for non-collection; (b) seller's right to "buy back" the receivables; (c) factor's right to a fixed rate of return regardless of collection performance.
Recourse vs. non-recourse factoring
Recourse factoring: the seller remains liable to the factor if an account debtor fails to pay. The factor's risk is essentially limited to collection mechanics; the seller bears the underlying credit risk. Recourse factoring is generally cheaper but provides less risk transfer. Non-recourse factoring: the factor bears the credit risk on approved accounts. Non-recourse factoring is more expensive but transfers the risk of account debtor insolvency on approved accounts. Many commercial factoring arrangements are partial recourse, recourse for disputes, returns, and short-pays, but non-recourse for pure credit losses.
Notification and perfection
The factor's interest is perfected by filing a UCC-1 financing statement under § 9.310(a), unless the assignment does not transfer a significant part of the seller's accounts (§ 9.309(2)). Notifying account debtors under § 9.406 is not a perfection step. It controls whom the account debtor must pay. Notification directs account debtors to pay the factor directly rather than the seller. Account debtors who pay the seller after receiving valid notification are not discharged; account debtors who pay the seller before receiving notification are discharged. Section 9.406(d) makes most contractual anti-assignment terms ineffective against an assignment of accounts, subject to the exceptions in § 9.406 itself (for example, health-care-insurance receivables under § 9.406(i)) and to federal law.
Verification and dilution
Most factoring agreements include verification provisions, the factor's right to confirm with account debtors that the goods or services have been delivered, the invoice is correct, and no offsets are claimed. "Dilution" refers to reductions in collectible amount through returns, allowances, disputes, short-pays, or offsets. Most factoring agreements adjust the advance rate based on dilution history; high-dilution sellers receive lower advance rates or pay higher fees. Disputed invoices ("disputed receivables") are typically chargeable back to the seller regardless of recourse vs. non-recourse posture.
Texas-specific considerations
Texas factoring transactions benefit from a clear statutory framework under UCC Article 9 and case law holding that usury requires a loan and an absolute obligation to repay, which a true sale lacks. Two practical considerations: (1) oilfield-services factoring, large industry segment in Texas with specialized factors and unique receivable characteristics; (2) healthcare factoring, subject to additional federal and state regulatory overlays (Medicare/Medicaid receivables, anti-assignment rules in some payor contexts).
For Texas SMBs, factoring is most attractive when (1) the business is too young or too leveraged to qualify for traditional bank financing; (2) the business has working-capital intensive growth and slow-paying customers; (3) the business is willing to trade margin (factoring discount) for cash-flow predictability and growth capital. The principal trade-off: factoring is more expensive than bank lines but easier to obtain and scales with sales. The terms that matter most in a factoring agreement are true-sale characterization, recourse scope, dilution definitions, advance rates, and termination and exit provisions.