Question

Vêtements, Inc. Inc. is a technology company that designs, manufactures, and ships clothing to retail store, Belle Boutique, on credit terms pursuant to which Belle Boutique has 180 days after delivery of the clothing to pay the purchase price.   Not surprisingly, Vêtements, Inc. often has cash-flow problems.

On February 1, Vêtements, Inc. entered into a transaction with MoneyCentre, a Finance Company,

pursuant to which Vêtements, Inc. sold to the Finance Company all of Vêtements, Inc.’s

outstanding rights to be paid by Belle Boutique for clothing. The transaction was

memorialized in a signed writing that described in detail the payment rights that were

being sold.  The Finance Company paid Vêtements, Inc. the agreed price for these rights

that day but did not file a financing statement.

On March 15, Vêtements, Inc. borrowed money from First Commercial Bank, a Bank.  Pursuant to the terms of the loan agreement, which was signed by both parties, Vêtements, Inc. granted the Bank a security interest in all of Vêtements, Inc.’s “present and future accounts” to secure  

Vêtements, Inc.’s obligation to repay the loan. On the same day, the Bank filed a properly

completed financing statement in the appropriate filing office. The financing statement

listed Vêtements, Inc. as debtor and the Bank as secured party. The collateral was

indicated as “all of Vêtements, Inc.’s present and future accounts.”

There are no other filed financing statements that list Vêtements, Inc. as debtor.

On May 25, Vêtements, Inc. defaulted on its repayment obligation to the Bank. Shortly

thereafter, the Bank sent a signed letter to Belle Boutique to which

Vêtements, Inc. sold clothing on credit.  The letter instructed Bell Boutique to pay to the

Bank any amounts that the store owed to Vêtements, Inc. for clothing purchased on

credit. The letter explained that Vêtements, Inc. had defaulted on its obligation to the

Bank and that the Bank was exercising its rights as a secured party.

The Finance Company recently learned about the Bank’s actions. The Finance Company

informed the Bank that the Finance Company had purchased some of the rights to payment

being claimed by the Bank. The Finance Company demanded that the Bank cease its efforts

to collect on those rights to payment.

Meanwhile, Belle Boutique responded to the Bank’s letters by refusing to pay the

Bank. The store contend that it has no obligations to the Bank and that payment to

Vêtements, Inc. will discharge their payment obligations.

1. As between the Bank, First Commercial Bank,  and the Finance Company, MoneyCentre, which (if either) has a superior right to the claims against the  Belle Boutique  for the money the  Belle Boutique  owe  Vêtements, Inc. for clothing they bought on credit before February 1?  Explain.

2.  Is Belle Boutique correct that it has no obligations to the Bank and that paying Vêtements, Inc. will discharge their payment obligations?  Explain

BUSINESS LAW SUBJECT

Answer 1

1) Factoring is a legal relationship which exists between a financial institution, who is the factor, and the client who is the business selling goods or providing services to its consumers. For a transaction which involves factoring, the major factors which decide the extent of right that a factor can exercise, are the legal characteristics of the transaction, based on the agreement signed to seal the transaction and terms and conditions governing it. Ecourt will generally consider evidence indicating transfer of ownership of the receivables including the risk and rewards. An option for right to recourse, whether applicable to the financer and to what extent the financer his having a right to recall other than a default in payment. The receivables purchase agreement between the parties should initiate a clear objective and intent to enable legal action on the basis of the relationship created by such agreement. Also another major actor governing rights of a financer in such a transaction is the treatment of the financed amount in the balance sheet of the client. This becomes important as an off balance sheet treatment does not present the liability to the financer, treating it instead as cash inflow from the receivables account. This can greatly reduce the rights of the financier, as also present a much healthier picture of the balance sheet than is true, allowing the client to leverage further financing on its basis. Factoring, is generally, the sale of the receivables and mostly all associated and inherent risks and gains pass on to the factor.

Line of credit which is secured by accounts receivable is simply an asset-based loan which is secured against the accounts receivable of a company. This is considered as a secured loan as the lender can utilise an alternative source for recovering the loan amount in case of default by the customer. In such a case, the lender analyses the financial statements of the applicant in order to verify that the business is healthy and profitable with sufficient future earning potential, therefore an investment of capital shall result in increased returns. The transaction is protected by a legally binding agreement which clearly enunciates the exclusive rights of the lender over all the mentioned accounts receivables. This agreement is necessarily registered with the required filing offices to ensure that one security is not pledged to multiple beneficiaries, creating overlapping rights.

Therefore, it is very clear that the First Commercial Bank has a superior right to the claims against the Belle boutique, as it has its right secured by a legal agreement filed with the required authority clearly stating that the receivables were a security afforded to the bank for sanction of the loan to Vetements. Money centre was not in a position to exercise its rates as it did not have the support of a legal document which was authenticated profiling with the required filing offices, rendering the agreement itself as incomplete and therefore, invalid for enforcement by law. Also, Vetements being secured creditor ranks first and above Money Centre.

2) Belle Boutique is correct in stating that it has no obligations to the bank and that paying Vetements Inc. will discharge their payment obligations, as receivable secured loan can be made on a notification basis or non notification basis. The difference is essentially that on notification basis the bank notifies the customer is receivable has been pledged and requests for the remittances to be directly made to the lender, in this case, the bank. If the agreement mentions the basis to be known notification, the customers I am not informed that there accounts have been placed in order to secure a loan and they continue to pay the supplier as usual who,in turn, is required to pay to the bank. In this arrangement it is difficult for the lender to keep track of the receivables and risk the borrower withholding some payments. In case of this non notification which was the method adopted by the bank, enforcement of security is affected and becomes difficult as it does not get direct rights over the clients of the defaulter, as all rights of extracting the deuce remain with the supplier, in this case, Vetements Inc.