The product is very popular when dealing with cross border business, where for example credit knowledge of a buyer may be harder for the Seller to ascertain.
As with Recourse Factoring, the Factor purchases the open account sales invoices of the Seller, provides them with up front funds and collects payment from the Buyers when the debt falls due. The Factor maintains the sales ledger by chasing debtors, sending regular statements of account, allocating received payments and reporting transaction histories and balances.
Non-Recourse factoring arrangements also are usually operated on a disclosed basis, so the Buyers are aware of the Factor’s involvement. A Notice of Assignment is placed on the Seller’s sales invoice instructing customers to make payment directly to the Factor.
The major difference is that in Non-Recourse Factoring, the Factor also takes the credit default risk of the Seller’s Buyers failing and (subject to pre-agreed limits) provides cover for any bad debts which are incurred.
Each existing and new Buyer will be vetted by the Factor and a specific ‘debtor limit’ is set on a case by case basis. Subject to their verification and confirmation, the Factor will consider invoices up to this limit as being ‘approved’ for funding. Any trading over the limit is usually at the Seller’s risk and, although it may be financed, is not insurance covered.
But Invoices within the agreed debtor limit are covered, which means that any bad debt loss is absorbed by the Factor rather than the Seller.
It’s important to note that the cover only relates to credit default non-payment and not to disputes or any other reason for refusal to pay. Just as with Recourse Factoring, in the event of a non-credit default, the Seller is required to repurchase the invoice from the Factor.
For this reason, some people choose to describe the product as Factoring with Credit Protection. It’s generally a little more expensive than Recourse Factoring, but the cost of the insurance is usually much lower than it would be for the Seller if sourced by themselves.