Factoring in the Details:
Navigating Receivables Financings
in Loan Agreements
April 2026
For highly leveraged companies, liquidity is often paramount. In the face of macroeconomic headwinds, borrowers may look to their balance sheets to unlock capital and restore cash flow.
The sale of accounts receivable to a third party (also known as “factoring”) offers one avenue for liquidity relief. However, a thorough understanding of transaction mechanics and negative covenant interplay is essential for both borrowers and lenders, especially in light of the recent plight of First Brands.
Leveraged loan agreements often diverge in their treatment of these transactions (which often fly under the radar) and the covenants can misalign with factoring transactions, impeding efforts to obtain liquidity.
In this article, we provide a brief overview of a typical factoring transaction, and we then explore the ramifications under a typical set of leveraged loan covenants.
An Overview of Factoring Mechanics
In a traditional factoring arrangement, a company sells its outstanding accounts receivable to a financial institution (also known as the “factor”) at a discount.
- The seller receives an upfront cash advance (e.g., 70-90% of invoice value).
- Upon customer payment, the company receives the remaining balance minus the factor’s fee (e.g., 1-5%).
- Depending on the scope of the factoring program, the company may also agree to fund a reserve account for the benefit of the factor.
In many respects, a factoring program represents an alternative to borrowing money secured by receivables. However, the factor can replace the credit risk of the highly levered company with that of its account debtors, which often unlocks access to liquidity. On the other hand, lenders may find themselves without collateral that has effectively been transferred to other financing sources.
An Overview of Factoring Mechanics
In a traditional factoring arrangement, a company sells its outstanding accounts receivable to a financial institution (also known as the “factor”) at a discount.
- The seller receives an upfront cash advance (e.g., 70-90% of invoice value).
- Upon customer payment, the company receives the remaining balance minus the factor’s fee (e.g., 1-5%).
- Depending on the scope of the factoring program, the company may also agree to fund a reserve account for the benefit of the factor.
In many respects, a factoring program represents an alternative to borrowing money secured by receivables. However, the factor can replace the credit risk of the highly levered company with that of its account debtors, which often unlocks access to liquidity. On the other hand, lenders may find themselves without collateral that has effectively been transferred to other financing sources.
From that overall structure, there are several key variations:
Recourse vs. Non-Recourse (Risk Allocation):
Factoring arrangements may either be recourse, in which the company must buy back or replace the receivable if the underlying account debtor fails to pay, or non-recourse (in which the factor accepts the loss of any receivables that remain unpaid, subject to certain exceptions (e.g., commercial disputes, missing documentation, unauthorized deductions, invoices exceeding credit limits, fraud, etc.).
Recourse factoring typically offers lower fees, as sellers retain this risk of nonpayment. Non-recourse factoring provides greater protection to the seller at a higher cost, reflecting the factor's assumption of the credit risk of the underlying receivables.
Key Structuring Choices:
Recourse and Non-Recourse
|
Feature |
Recourse |
Non-recourse |
|---|---|---|
|
Non-payment risk |
Company must buy back or replace the receivable if the account debtor fails to pay |
Factor accepts the risk of non-payment, subject to agreed exceptions |
|
Cost |
Typically lower fees |
Typically higher fees |
|
Seller protection |
Lower |
Greater protection for the seller |
|
Commercial effect |
Company retains more risk |
Factor assumes more credit risk |
Disclosed vs. Undisclosed:
In disclosed factoring, the factor may take over the administration and collection of receivables, ensuring invoices are paid on time and collecting directly from the account debtor. The account debtor is notified that their debt has been assigned to a factor and that the account debtor must pay the factor directly. This approach improves transparency for the factor but can result in more operational friction and higher fees for the company.
In undisclosed factoring, the company may continue to manage the collection of receivables and the customer may have no knowledge of the factoring arrangement. The company instead handles the transfer of funds to the factor upon receipt of payment from the account debtor. For the company, this approach has the advantage of maintaining customer relationships, but it can also lead to less transparency for lenders (and in extreme cases, make it more difficult to catch receivables fraud).
Eligibility & Limits:
The factor will conduct detailed diligence on the nature of the receivables. Based on its diligence, the factoring program will limit the aggregate amount advanced and exclude certain receivables (e.g., based on customer creditworthiness, invoice age, industry sector, etc.).
The company may have its own reasons for also limiting the scope of a factoring program – there may be certain customers that it does not want subject to a disclosed factoring program.
Factoring Adjacent Transactions
While frequently grouped with traditional factoring, the following alternative structures utilize fundamentally different mechanics:
Reverse Factoring (Supply Chain Financing):
Reverse factoring describes a situation where a company (often investment-grade) arranges for a financial institution to pay its suppliers early at a discount. The company then pays the financial institution the full invoice amount on an extended due date.
By doing so, the company effectively extends payment terms for its own accounts payable by relying on a third party. The economic profile though is closer to a typical unsecured financing, including recourse to the company.
Size of the Global
Reverse Factoring Market
Hover to find out more
Source: SNS Insider
Securitization Programs:
Securitization programs are a more complex factoring structure where receivables are transferred to a bankruptcy-remote special purpose vehicle. The SPV bundles the receivables into a pool used as collateral to issue securities to capital markets investors, often resulting in a lower cost of capital’. However, these programs often require a larger pool of receivables and more upfront work to set up the securitization vehicles.
Sale-Leaseback Transactions:
Companies can also engage in sale-leasebacks, where the company sells an asset to a third-party and then leases the asset back for use in its own business. Such assets often include real property or intellectual property, which lend themselves to long-term capital leases. These transactions are typically treated as secured debt under loan agreements and, as a practical matter, can raise many of the same issues as a factoring program (depending on the nature of the sold asset).
Reverse Factoring (Supply Chain Financing):
Reverse factoring describes a situation where a company (often investment-grade) arranges for a financial institution to pay its suppliers early at a discount. The company then pays the financial institution the full invoice amount on an extended due date.
By doing so, the company effectively extends payment terms for its own accounts payable by relying on a third party. The economic profile though is closer to a typical unsecured financing, including recourse to the company.
Size of the Global Reverse Factoring Market
Click to find out more
Source: SNS Insider
Securitization Programs:
Securitization programs are a more complex factoring structure where receivables are transferred to a bankruptcy-remote special purpose vehicle. The SPV bundles the receivables into a pool used as collateral to issue securities to capital markets investors, often resulting in lower cost of capital. However, these programs often require a larger pool of receivables and more upfront work to set up the securitization vehicles.
Sale-Leaseback Transactions:
Companies can also engage in sale-leasebacks, where the company sells an asset to a third-party and then leases the asset back for use in its own business. Such assets often include real property or intellectual property, which lend themselves to long-term capital leases. These transactions are typically treated as secured debt under loan agreements and, as a practical matter, can raise many of the same issues as a factoring program (depending on the nature of the sold asset).
Factoring Provisions in Leveraged Loan Agreements
For highly levered companies, loan agreements will typically restrict incurrences of debt, liens, and asset sales, among other transactions. Companies will also need to pledge substantially all of their assets, including any receivables.
These restrictions come with a broad slate of exceptions that can dovetail in unexpected fashion in permitting a factoring program.
Factoring Provisions in Leveraged Loan Agreements
For highly levered companies, loan agreements will typically restrict incurrences of debt, liens, and asset sales, among other transactions. Companies will also need to pledge substantially all of their assets, including any receivables.
These restrictions come with a broad slate of exceptions that can dovetail in unexpected fashion in permitting a factoring program.
Specific Provision:
The first step is to determine whether the Loan Agreement already has special dispensation for factoring programs. For example, certain Loan Agreements may specifically call out factoring transactions in the definition of “Indebtedness”, even if the actual transaction does not involve an actual borrowing of money.
If so, the analysis is typically simplified – the Loan Agreement should contain express requirements for any factoring program and include specific covenant baskets (e.g., in the list of permitted debt and liens). Conditions include requiring arrangements to be in the ordinary course of business, consistent with past practice, on an arm’s-length basis, on market terms, and/or on a non-recourse basis, with customary exceptions.
The question often then turns to whether the provisions exclusively constrain all factoring programs or whether the company may use other baskets to also incur factoring obligations.
Factoring Programs as Asset Sales:
If there is no specific treatment for factoring programs, then the next question is whether the factoring program will represent a true sale of receivables.
A non-recourse factoring program may qualify as a true asset sale. In that case, the factoring program may not implicate the debt and liens covenants but only require capacity under the asset sale covenant.
Careful attention will need to be paid to the definition of an asset sale and the list of exceptions in the covenant. In general, leveraged loan agreements exclude ordinary course asset sales from the covenant, but a factoring program is unlikely to be ordinary course.
While there is often a broad basket for non-ordinary course asset sales subject to receipt of fair market value and a minimum percentage of cash consideration, that basket may not work in practice though for the constant flow that occurs in a large-scale factoring program – the sale of receivables could trigger a mandatory prepayment (or reinvestment) obligation.
Factoring Programs as Secured Debt:
The factoring program may not qualify though as an asset sale, particularly if the factor retains recourse against the company and never assumes the credit risk of the account debtor underlying the receivables.
In that event, the advance could constitute debt secured by the receivables – a company may then be hard-pressed to find sufficient basket capacity under their debt and lien covenants.
Even if the factoring program does fit into a secured debt basket, the underlying receivables may not have an exclusion from the collateral pledge. In that event, the lenders under the loan agreement could still claim a first priority secured claim ahead of the factor, which may make those receivables unsuitable for factoring.
Specific Provision:
The first step is to determine whether the Loan Agreement already has special dispensation for factoring programs. For example, certain Loan Agreements may specifically call out factoring transactions in the definition of “Indebtedness”, even if the actual transaction does not involve an actual borrowing of money.
If so, the analysis is typically simplified – the Loan Agreement should contain express requirements for any factoring program and include specific covenant baskets (e.g., in the list of permitted debt and liens). Conditions include requiring arrangements to be in the ordinary course of business, consistent with past practice, on an arm’s-length basis, on market terms, and/or on a non-recourse basis, with customary exceptions.
The question often then turns to whether the provisions exclusively constrain all factoring programs or whether the company may use other baskets to also incur factoring obligations.
Factoring Programs as Asset Sales:
If there is no specific treatment for factoring programs, then the next question is whether the factoring program will represent a true sale of receivables.
A non-recourse factoring program may qualify as a true asset sale. In that case, the factoring program may not implicate the debt and liens covenants but only require capacity under the asset sale covenant.
Careful attention will need to be paid to the definition of an asset sale and the list of exceptions in the covenant. In general, leveraged loan agreements exclude ordinary course asset sales from the covenant, but a factoring program is unlikely to be ordinary course.
While there is often a broad basket for non-ordinary course asset sales subject to receipt of fair market value and a minimum percentage of cash consideration, that basket may not work in practice though for the constant flow that occurs in a large-scale factoring program – the sale of receivables could trigger a mandatory prepayment (or reinvestment) obligation.
Factoring Programs as Secured Debt:
The factoring program may not qualify though as an asset sale, particularly if the factor retains recourse against the company and never assumes the credit risk of the account debtor underlying the receivables.
In that event, the advance could constitute debt secured by the receivables – a company may then be hard-pressed to find sufficient basket capacity under their debt and lien covenants.
Even if the factoring program does fit into a secured debt basket, the underlying receivables may not have an exclusion from the collateral pledge. In that event, the lenders under the loan agreement could still claim a first priority secured claim ahead of the factor, which may make those receivables unsuitable for factoring.
Key Takeaways
As any credit cycle winds down and liquidity becomes increasingly constrained, borrowers will seek creative avenues to source liquidity in their balance sheets. However, the recent controversies observed in the First Brands situation serve as a stark reminder of the severe risks associated with aggressively structured or opaque receivables programs.
For market participants navigating these transactions, key takeaways include:
- For borrowers: Proactive covenant analysis is critical. The threshold determination of whether a program constitutes a true asset sale or secured debt will dictate the viability of the transaction under existing debt, lien, and asset sale constraints.
- For lenders: Heightened diligence is required to ensure that factoring arrangements do not inadvertently prime existing secured claims, quietly dilute collateral bases, or obscure the borrower's true financial leverage.
Navigating the intersection of complex factoring mechanics and restrictive leveraged loan covenants requires precise structuring. Should you have any questions or require assistance analyzing these provisions within your own capital structures, the debt finance team at Cleary Gottlieb is available to provide tailored guidance.
Key Takeaways
As any credit cycle winds down and liquidity becomes increasingly constrained, borrowers will seek creative avenues to source liquidity in their balance sheets. However, the recent controversies observed in the First Brands situation serve as a stark reminder of the severe risks associated with aggressively structured or opaque receivables programs.
For market participants navigating these transactions, key takeaways include:
- For borrowers: Proactive covenant analysis is critical. The threshold determination of whether a program constitutes a true asset sale or secured debt will dictate the viability of the transaction under existing debt, lien, and asset sale constraints.
- For lenders: Heightened diligence is required to ensure that factoring arrangements do not inadvertently prime existing secured claims, quietly dilute collateral bases, or obscure the borrower's true financial leverage.
Navigating the intersection of complex factoring mechanics and restrictive leveraged loan covenants requires precise structuring. Should you have any questions or require assistance analyzing these provisions within your own capital structures, the debt finance team at Cleary Gottlieb is available to provide tailored guidance.
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