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Factoring Cases from the Second Half of 2022

I have written short summaries of selected factoring cases from the second half of 2022. Part of what I want to provide is insight about how courts make decisions. Factoring issues can look very different to judges who do not routinely deal with these issues. I am providing these summaries to give you some context. The cases relate to the following issues:

(i) whether a factor can be enjoined because it has allegedly damaged a broker’s goodwill;

(ii) does the earmarking doctrine provide a defense for a factor being taken out by another factor that acquires fraudulent invoices;

(iii) can a particular estoppel letter be enforced against an account debtor;

(iv) will a reassignment of invoices from a factor back to its client support the client having standing to file a lawsuit against an account debtor if the reassignment was made after the client had already filed the lawsuit.

Be aware that these cases are from courts around the nation and may not be predictive of how a court may rule in the jurisdiction where you are operating. Also, some of the cases may still be reversed on appeal.

  1. Total Quality Logistics, LLC v. Tucker, Albin, and Assocs.[i] (from the Ohio Court of Appeals).

Question:  A carrier and broker had an agreement where the broker was solely responsible for paying the carrier’s bills. A dispute occurred between the carrier and broker over a certain shipment, and the broker refused to pay the carrier’s bill leaving an account receivable on the carrier’s books. The carrier sold this account receivable to a factor who then contacted the customer to collect. The customer purportedly assumed this meant that the broker did not pay its bills. The customer contacted the broker who then asked the factor to cease and desist from contacting the customer. Next, the broker filed a lawsuit asserting several causes of action and requesting that the factor be enjoined from contacting the customer because the factor was damaging the broker’s goodwill. Was this enough to warrant the court enjoining the factor from continuing to contact the customer?

Answer: No. The broker only made self-serving statements that its goodwill was damaged and never quantified how much it was damaged or provided proof of actual damages. The court recognized that it is common sense that an allegation like this could hurt a business arrangement. It also recognized that it is incredibly difficult to show how any single allegation contributes to a loss of goodwill. Nonetheless, the broker still needed to provide some evidence of the specific amount of damage caused to its goodwill. Since it did not do that, it was not entitled to a preliminary injunction against the factor. The broker may still recover damages for loss of goodwill at trial, but there was no evidence at this early stage of the litigation to support granting a preliminary injunction.

Comment: Parties often allege that they have lost goodwill meaning their business reputation has been hurt. But proving and quantifying how a defendant’s statements or actions actually damaged a plaintiff’s goodwill can be very difficult and often is just speculation which is not enough.

  1. Mann v. LSQ Funding Group[ii] (from the United States District Court for the Eastern District of Wisconsin).

Question: Earmarking is a doctrine that can protect a payment from being subject to being avoidable in bankruptcy court. It is a legal principle that when a new lender makes a loan to a debtor for the specific purpose of paying off a former lender, the debtor has not made a transfer of its own property because the debtor still owes the same sum, only to a different creditor. When one factor takes out another factor by paying off any obligations owed by the debtor to the original factor and later learns that the debtor’s invoices were almost all fraudulent, is that payment protected from being a preferential or fraudulent transfer under the bankruptcy code by the earmarking doctrine?

Answer: Yes. The debtor never had an interest in the underlying payoff, it had no control over the payoff, and the payoff did not reduce the overall amount owed by the bankruptcy estate, so the fraudulent conduct was irrelevant for purposes of analyzing the avoidance claims against the factor. Likewise, the earmarking doctrine applies in factoring arrangements even though the arrangement is not a conventional loan. Since one factor is taking out another factor, the earmarking doctrine applies, and there was no preferential or fraudulent transfer.

  1. Amerifactors Fin. Grp., LLC v. Univ. of Chicago[iii] (from the United States District Court for the Northern District of Illinois).

Question: A contractor entered into an agreement to design and build a new campus building for the University of Chicago. The contractor hired subcontractors to work on the project. The work was completed in June and July, and the invoices were issued and sold to a factor. On August 27, the university emailed a signed estoppel letter to the factor stating that it would pay the factor without claiming any disputes, offsets, credits owed, prior payments, discounts, or claiming any other matters reducing the obligation owed. The factor also sent notices of assignment and purchased additional invoices over the next few weeks. Despite the estoppel letter, the university refused to pay the factor for two of the invoices. Was the estoppel letter enforceable to compel payment from the university?

Answer: No. Courts have taken different approaches to enforceability of estoppel letters, and I am including this case to show an approach that some courts take. This court decided that there was no consideration for the bargained for exchange. It was not persuaded by the factor’s argument that the benefit to the university was the contractor being able to continue working on the project since the contractor had already contracted and agreed to do the work. I have seen cases where this argument has worked, and others like this case where it has not. The court also rejected the factor’s argument that the estoppel letter should be enforceable because the factor suffered a detriment since it would not have purchased this account receivable without this letter. The court held that the factor should have disclosed this fact to the university somewhere in the letter. Since it did not, it cannot be considered part of the bargained for exchange. As a result, the court declined to enforce the estoppel letter.

Comment: Reading between the lines, I suspect that one of the underlying issues that troubled the court about the factor’s argument was fairness. The factor’s client was a contractor, but most of the amounts owed on the two invoices was for work performed by subcontractors. The University paid subcontractors directly on one of the two invoices which is what the university was entitled to do under its contract with the contractor. Subcontractors were also owed most of the remaining amount owed on the unpaid invoice. The factor filed its lawsuit to collect the full amount of the invoices which included the subcontractors’ portion. The court seemed to imply that was “unfair” to the university. My experience is judges want to use their discretion to find a way to do what they perceive is fair. Unfortunately, the fairness of some of the policies underlying the UCC is sometimes not obvious to courts which can create obstacles for factors.

  1. C-Spine Orthopedics, PLLC v. Progressive Mich. Ins. Co.[iv] (from the Michigan Court of Appeals).

Question: A health care provider provided treatment of personal injury claims. It was entitled to seek reimbursement of insurance benefits for these treatments. The health care provider sold certain of its invoices to a factor. It then filed a lawsuit against an insurance company for payment of these assigned invoices. After filing the lawsuit, the factor reassigned the receivables to the health care company which vested it with the right to bring a lawsuit seeking payment of the outstanding balances. Did the health care provider have the legal standing and capacity to file a lawsuit against the insurer even though at the time the lawsuit was filed, the health care provider had transferred its interests in the invoices to the factor?

Answer: Yes. The health care provider had a statutory right to file a lawsuit regardless of the reassignment. Also, the court held that a reassignment to the health care provider after the lawsuit was filed was enough to confer standing on the health care provider. It would, of course, have been better to make the assignment before filing a lawsuit although it worked out in the end.

Comment: This case illustrates the need to ensure your paperwork is in order when filing a lawsuit to avoid having to litigate over tangential issues like “standing” which could have dire consequences. This case was decided by a three-judge panel. The factor only won support of two of the judges. The third judge filed a sharp dissent that was much longer than the actual opinion. Not only would the dissenting judge have ruled that the health care provider lacked standing, but the judge was also very critical of the “messy” facts and the confusing documentation.

Scot Pierce, Esq. is a trial lawyer and transactional attorney.  Click on his picture for his profile page.

Disclaimer: This post contains general opinions and analysis, is solely for educational purposes, and should not be treated as advice for any specific case.

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[i] 2022 Ohio App. LEXIS 1666 (Ohio Ct. App. 2022).

[ii] 71 F.4th 640 (7th Cir. 2022).

[iii] 619 F. Supp. 3d 842 (N.D. Ill. 2022).

[iv] 2022 Mich. App. LEXIS 7057 (Mich. Ct. App. 2022).

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