Collection Account: a Worked Example

Security over receivables has a built-in weakness. The asset changes form when the customer pays. An invoice is a claim the lender can identify; the same value in the operating account is money that can be spent on wages by Friday. A financier that takes security over the invoices and then lets the receipts fall into general funds has security over something that keeps dissolving.

The account closes that gap, for invoice discounting and factoring, for asset-based lending under cash dominion, and for a trade loan, where the proceeds of one sale repay one advance. Terms differ. In disclosed factoring the customers are told to pay the factor. In confidential discounting, the account usually stands in the client's name with the financier in control of it, so that customers see nothing unusual on the invoice.

The sweep is often daily, and the agreement usually makes the client trustee of any money reaching the wrong account, to be passed on promptly. The legal effect differs by market. In the UK, where debts are charged rather than sold, the House of Lords held in 2005 that a charge over book debts was floating where the company was free to use the proceeds, and that an account must be operated as blocked in fact for a fixed charge to stand ([2005] UKHL 41). In Australia a transfer of receivables is itself a security interest under the Personal Property Securities Act 2009, whether or not it secures an obligation, and only the bank at which a deposit account is held has control of that account for perfection. New Zealand's Act also reaches transfers of receivables but has no perfection by control of a bank account, so priority there turns on registration and the Act's ordinary rules.

A maker of commercial roller shutters, constructed for this page like every figure in it, has a confidential invoice discounting facility advancing 80% of a ledger of US$9.00m, so US$7.20m is drawn at the start of the month. Over the month it invoices US$3.20m and issues US$0.10m of credit notes. Customers pay US$3.40m. Of that, US$2.78m lands in the trust account. Pressed for cash, the finance director has told two large customers to pay the old operating account, and US$0.62m reaches it and is spent. Only the US$2.78m is recorded on the ledger sent to the financier.

Nothing on the certificate looks wrong. The advance rate is met, the ledger has grown, and receipts on the ledger agree with the trust account, because the diverted money did not go on the ledger. But US$0.62m of debts that have already been paid are still on the ledger as if collectable, and the financier has lent against them. It would find this in a debtor verification call, in an audit that reads the operating account beside the sales ledger, or when an old invoice is queried and the customer says it was paid in June. Each of those takes time, and the amount grows the longer it runs. Had the customers simply paid the wrong account by mistake, and the cash been passed on within a day or two, the figures would have been identical on both sides. The difference is in the conduct.

A collection account is a route for incoming cash and the balance is meant to clear. A debt service reserve is a balance meant to stay. An operating account is the business's own to spend from, even if the bank holds security over it. An escrow account holds money for release on an event between two parties. Virtual accounts are a way of identifying which customer paid and can sit on top of a collection account without replacing it.

DEFINED IN ONE PARAGRAPH → · INVOICE FINANCE, THE PRODUCT FILE → · CASH DOMINION →

Before drawdown the question is whether the arrangement exists in practice. Does the invoice show the collection account, and have the customers who matter actually been told? Is any large customer in the habit of paying elsewhere, or netting off what it is owed? The trade loan file calls this the leaked collection account: the client tells the buyer to pay as usual, often innocently, and the self-liquidating loan loses the thing that liquidated it.

After drawdown the question is the trend. Receipts into the account that run below ledger receipts, money arriving from accounts the financier does not recognise, and a client slow to send statements are all early signs, and a confidential facility can move to disclosure or to tighter controls when they appear. The controls cost the client little when the business is healthy, and that is when they are easiest to agree. The moment a financier most wants them is the moment a client finds them hardest to accept.