How to protect yourself as a contractor if invoice factoring unravels

We’ve already looked at the problems some recruitment agencies and other businesses in the contractual supply chain have been running into from relying too heavily on invoice factoring -- now let’s get hands-on to help contractors, writes Adam Home, senior credit manager at Safe Collections.

When invoice factoring goes bad

While factoring is supposed to help cash flow by providing an early payment finance option on outstanding invoices, problems quickly accelerate when invoices are not paid – a hallmark of this still ongoing third coronavirus lockdown.

In these non-payment situations, the factoring providers will take the value of any unpaid invoice out of the next payment due to the client (typically your agency, contractors), leaving the customer company short of the cash they were expecting for the month ahead.

We’ve seen several cases of late where this exact dynamic has been enough to push recruitment firms into insolvency. The risks which invoice factoring exposes recruitment agencies to has a knock-on effect for contractors. So what do contractors need to know about factoring (whether it’s an umbrella or agency who’s doing the factoring), and what can contractors do to mitigate the risks?

What are the risks of invoice factoring for contractors?

Contractors sit in a vulnerable position at the end of a value chain -- at the best of times.

Invoice factoring, in theory, should benefit contractors -- the agency gets equity tied up in invoices released early, meaning they should be able to pay contractors promptly. But all too often we see factoring being used to mask poor credit control practices, and in these situations, it actually leaves the contractor even more vulnerable.

For example, we see agencies that are using invoice factoring and still insisting on dreaded ‘pay when paid’ clauses. Why do they need to? If they are getting their invoices financed, why do they need to pass on the commercial risk of non-payment to the contractor?

Even with no pay when paid clause, be cautious, or concerned if unpaid

Even without pay when paid clauses, we advise contractors to be cautious about working with agencies that use invoice factoring, simply because it could make underlying cash flow issues worse.

Say a client you work for doesn’t pay its invoice one month. The agency will have already received 80-90% of the value of this invoice upfront from the factoring company, and presumably spent it. The factoring company will then take the full value of the outstanding invoice out of the next round of payments, meaning the agency actually loses money - 90% of the invoice value paid upfront, 100% taken back!

Will they be able to pay you what you are owed? How many non-payments or late payments will it take before the agency is in serious financial difficulty, potentially jeopardising all the outstanding invoices you have with them?

Let’s get practical: how to check if an agency uses invoice factoring

To any contractor working through an agency, our first piece of advice is always check whether the intermediary is using factoring or not. This is straightforward as the agreements signed to underpin a financing arrangement are recorded by Companies House.

Here’s a step-by-step guide on how to find out if an agency uses invoice factoring or not:

• Go to the Companies House website and look up the agency.
• Click on the ‘Filing History’ tab, which lists all the documents a company must legally file, along with records of company ownership and details of any charges. It’s these charge details you are looking for.
• Scroll down and look for any entry marked ‘Registration of charge’ - this indicates a ‘live’ charge against the company.
• Download the charge to see who the charging company is.
• A quick Google search of the company name will tell you if it is a factoring firm or not.
• Back on the Companies House site, look to see if there is a more recent ‘Satisfaction of charge’ entry listed above the ‘Registration of charge.’ If there is, check the details - it could be that the factoring arrangement is no longer in place. If not, then the factoring arrangement is ongoing.

Protecting yourself when working for an agency that uses factoring

Let’s be clear. We would not advise contractors NOT to work with an agency if it uses invoice factoring. Many do so with good reason and use it as part of a sound credit control strategy. It’s the ones that use factoring when their credit control practices are poor that mean you, the contractor, have to exercise caution.

By contrast, we would strongly advise contractors to refuse to agree to work under any ‘pay when paid’ clauses -- full stop. It’s a toxic form of credit control and passes all the commercial risk of non-payment onto you. As mentioned, if an agency is insisting on pay when paid arrangements, that should be a major red flag, irrespective of if they finance their invoices or not.

The reddest of red flags

Second, we recommend you insist on the shortest possible termination period. If an agency is getting its invoices financed and then for some reason doesn’t pay you on time, that’s the reddest of red flags that something is seriously wrong! You then need to be able to down tools and walk away as soon as possible.

All too often we see contractors locked into taking work from an agency they know is in financial trouble, racking up invoices worth thousands if not tens of thousands of pounds that may well never be paid! The safest way to avoid that is to refuse to work for anyone under a lengthy termination agreement, and be prepared to cut your losses and trigger it the moment you smell danger.

As an aside to this, a bit of a reminder. Contractors cannot simply assume that non or late payment constitutes a breach of contract which would allow you to walk away outside the agreed termination mechanism. In our experience, the law would say it isn’t, and it gives an agency a ready-made excuse not to pay you at all, by turning the tables to say that it is YOU who has breached the contract.

‘He or she who shouts loudest…’

Finally, swift action to recover an unpaid invoice is always recommended. But when you don’t get paid by a company that uses invoice financing, we would double-down on our advice for you to fast-forward and act quickly.

Remember, once a company that is reliant on finance starts getting into difficulties, their cashflow can deteriorate into insolvency very quickly. The general rule of thumb is that ‘they who shout loudest get paid first’ and if insolvency is looming, you want to be both the loudest of creditors and the first in the queue.