The practice of providing funding using accounts receivables as collateral is primarily based on the securitization of the actual accounts. It is one of the first issues in due diligence that must be investigated when considering invoice factoring. What entity might already consider the accounts to be collateral?
Usually the case is a bank has provided a small line of credit to a business using All Business Assets as the collateral for the loan. This is colloquially called a “blanket lien” in the industry as it covers anything of value related to the business. Included in the loan documents is a condition called dilution of assets – meaning, it is important that the company does not sell off parts of the assets without the bank’s knowledge. By diluting the assets a company can find themselves in default of their loan agreement.
So what to do? The best remedy and typically the most difficult would be to get the bank to subordinate their position on the collateral to the factor. In other words, the factor will become the first lien holder on the accounts before the bank. You can see why the bank might not consider this arrangement.
There are certain instances though that this might work in the best interest of the bank. Depending on the relationship, it might have run its course and the bank now has the loan in workout and is very interested in having the company exit completely from the loan. By securing invoice factoring and guaranteeing an accelerated pay off there might be some cooperation.
But no matter what the circumstances, in order for a factor to finance accounts any existing lien holders would have to subordinate their position on those accounts in order to move forward.