1 HOW FACTORING FAIRED IN COURTS International Factoring Association 13th Annual Conference Sheraton New Orleans New Orleans, LA April 27, 2007 Robert A. Zadek Of Counsel
2 Anglo-Dutch Petroleum International, Inc., et al v. John Haskell, et al Court of Appeals of Texas, First District, Houston 193 S.W. 3d 87; 2006 Tex. App. LEXIS 1779 Facts Anglo Dutch needed money to fund a major lawsuit against Halliburton, and raised funds by selling investments in the suit, with the return based on a percentage of recovery. When it won it sought to have the investments set aside as void as against public policy and usurious. Court found for the investors. Significant Holdings and Legal Goodies 1. Contingency factor in usury analysis - A factor that courts consider when determining usury is whether repayment was based on a contingency. Catalina, 881 S.W.2d at 297. This factor is important because it helps a court in determining whether a transaction was a loan or a business investment. Id.; If the agreements did not constitute a loan, if the agreements did not create an absolute obligation to repay, or if the agreements did not charge usurious interest, If Anglo-Dutch recovered nothing or an insufficient amount of damages, then according to the plain terms of the agreements, Anglo-Dutch had no obligation to reimburse appellees for the principal amounts invested, much less pay appellees any return on their investments. Thus, as a matter of law, the agreements cannot be usurious. 2. Van Dyke s testimony that he explained to appellees that there was no risk and that he was confident that Anglo-Dutch would collect enough money to repay appellees because Anglo- Dutch s interest in the oil and gas field lost as a result of Halliburton s and Ramco s actions was valued in the hundreds of millions of dollars, is also insufficient to create a fact issue concerning Anglo- Dutch s usury defense. These statements merely constituted Van Dyke s personal expectations on the success of the Halliburton lawsuit, and the fact that he communicated his personal expectations to appellees is of no consequence; Van Dyke s confidence in the outcome of the lawsuit did not dissolve the very real contingency that existed in the agreements themselves. Similarly, Van Dyke s testimony that appellees communicated to him that they did not consider their investments to be speculative, that some appellees stated that they believed that success in the Halliburton lawsuit was certain, that one appellee told Van Dyke that he could not afford to lose his money, and that multiple appellees stated that there must be no risk whatsoever because of Anglo-Dutch s trial counsel also constitute nothing more than appellees personal expectations on the success of the Halliburton lawsuit. As such, it does not erase the contingency in the agreements. Significantly, despite Van Dyke s testimony concerning his and appellees confidence in the outcome of the lawsuit, the very real contingency contained in the agreements is illustrated by the fact that the amount of the judgment that Anglo- Dutch ultimately received in the Halliburton lawsuit was significantly lower than what it had anticipated and, importantly, what it had represented to appellees that it would receive at the end of the case. Anglo-Dutch argues that an illusory contingency will not remove a transaction from the scope of the usury laws-at least not as a matter of law. Anglo-Dutch cites the following illustration offered by the Restatement (First) of Contracts:
3 Important Issues and Lessons 1) Usury is sometimes raised in factoring transactions. 2) If it is raised in non-recourse transactions, one of the defenses offered by a factor is the contingency nature of the purchase (i.e. the factor may not be paid back) making this not a loan. 3) The contingency must be real, and cannot be illusory. Litigation Funding Issues 1) In Echeverria, the New York Superior Court held that a litigation funding agreement that provided for a lender s right of recovery only in the event the plaintiff received a judgment in his favor charged usurious interest. However, the court noted that because the underlying case was a strict liability labor law case there was a very low probability that judgment would not be in favor of the plaintiff and, in fact, later characterized the probable success of the lawsuit a sure thing.
4 Wells Fargo Century Inc. v. Peter Brown, et al 2007 US Dist LEXIS Facts 1) On March 13, 2003, Wells Fargo entered into Factoring Agreement with RBS Holdings, Inc. ( RBS ). On the Same day, guarantors signed an Unlimited Personal Guaranty (the Guaranty, The guaranty provided THE UNDERSIGNED EXPRESSLY SUBMITS AND CONSENTS TO THE JURISDICTION OF THE SUPREME COURT OF THE STATE OF NEW YORK, IN THE COUNTY OF NEW YORK, WITH RESPECT TO ANY CLAIM OR DEMAND UPON THE UNDERSIGNED BASED UPON THIS INSTRUMENT OF GUARANTY OR ANY AMENDMENT OR SUPPLEMENT THERETO 2) The guarantor attacked the forum selection clause. Significant Holdings and Legal Goodies 1) There exists a strong presumption favoring enforcement of freely negotiated choice of forum provisions. A party seeking to prevent the enforcement of a forum selection clause bear[s] the heavy burden of making a strong showing in order to overcome the presumption of validity. Such clauses should be enforced unless it is clearly shown that enforcement would be unreasonable and unjust or that the clause was obtained through fraud or overreaching. 2) The unreasonable exception is interpreted narrowly. It renders forum selection clause unenforceable in the following circumstances: (1) if its incorporation into the agreement was the result of fraud or overreaching; (2) if the complaining party will for all practical purposes be deprived of his day in court due to the grave inconvenience or unfairness of the selected forum; (3) if the fundamental unfairness of the chosen law may deprive the plaintiff of a remedy; or (4) if the clauses contravene a strong public policy of the forum state. 3) Identification of the jurisdiction more narrowly drawn to refer to a specific court pursuant to a restrictive contractual agreement dictates where the matter may be settled. Important Issues and Lessons 1. Although factors rarely find it necessary to sue guarantors, sometimes they do. 2. It is often important to be able to sue in the jurisdiction of your choice. 3. A forum selection clause is one where both sides agree on the forum (i.e. the place where litigation will take place). 4. A specific court should be named as the forum to be used.
5 Facts GREENFIELD COMMERCIAL CREDIT, L.L.C. VERSUS CATLETTSBURG REFINING, L.L.C., ET AL. CIVIL ACTION NO SECTION K (2) UNITED STATES DISTRICT COURT FOR THE EASTERN DISTRICT OF LOUISIANA 2007 U.S. Dist. LEXIS 1936 January 9, 2007, Decided 1) On May 15, 2003, Pipeworks entered into a factoring agreement with Greenfield Commercial Credit, L.L.C. ( Greenfield ) by which Pipeworks Inc. assigned its accounts receivable to Greenfield. 2) The notification sent by the factor identified the assignor as Pipeworks Reserve, Inc., not Pipeworks, Inc. 3) The client asked that the account debtor paid it directly (i.e. not pay the factor) and the account debtor complied. 4) The factor sued the account debtor for payment after notification. 5) Catlettsburg and Jacobs sole challenge to the validity of the assignment is that Greenfield s notice of assignment failed to reasonable identify the rights assigned by identifying the assignor as Pipeworks Reserve, Inc., with which defendants had no contractual relationship, rather than Pipeworks, Inc. and by failing to identify the invoices assigned to Greenfield. 6) Catlettsburg and Jacobs contend that the notice was deficient because it failed to indicate what project account (Catlettsburg or Valero) the notice applied to, and if it applied to a Catlettsburg project, which of several Catlettsburg projects was involved. Significant Holdings and Legal Goodies 1) The assignee bears the burden of proving that the account debtor received proper notice of the assignment. 2) A notice of assignment must reasonable identify the rights assigned. If an account debtor had doubt as to the adequacy of a notification, it may not be safe in disregarding the notification unless it notifies the assignee with reasonable promptness as to the respects in which the account debtor considers the notification defective.
6 3) Uniform Commercial Code Comment 3, Comment 3 makes it clear that when an account debtor, such as Jacobs, doubts the adequacy of the notice of assignment, the onus is on it to contact the assignee not the assignor concerning the alleged insufficiency of the notice. Additionally, Greenfield s notice letter specifically invited Jacobs to contact it [i]f you have any questions concerning this account 4) The notice provided by Greenfield states that the assignment applies to our accounts. Important Issues and Lessons 1) Although the notice of assignment must be carefully drawn, the UCC is quite protective of factors, and states that the account debtor has a duty of inquiry if it is not sure what the notice is all about. 2) Be sure that the notice states that the factor is the assignee of all present and future accounts. 3) Note, under the UCC, if the account debtor asks for proof of assignment, the factor must promptly provide it or else lose the benefits of the notification.
7 DESSERT BEAUTY, INC., Plaintiff, - against PLATINUM FUNDING CORP., Defendant. PLATINUM FUNDING CORP., Third Party Plaintiff, - against NEIL SHINDER; RANDI SHINDER, and DESSERT BEAUTY HOLDINGS, INC., Third Party Defendants. Facts 06 Civ (SAS) UNITED STATES DISTRICT COURT FOR THE SOUTHERN DISTRICT OF NEW YORK 2006 U.S. Dist. LEXIS December 26, 2006, Decided December 26, 2006, Filed 1) Dessert Beauty, Inc. a Barbados corporation, is a manufacturer of cosmetics. Platinum Funding Corp. ( Platinum ), is a New Jersey financing company. 2) Platinum has a very complex minimum monthly fee clause, which is cleverly drawn and quite onerous. 3) When the client discovered how expensive the minimum fee clause was, they tried to get out of the contract, claiming that they were induced into signing the contract based on misrepresentations. 4) Platinum sought to dismiss the complaint. 5) Specifically, DBI claims that at the time the parties entered into the agreement, Platinum knew that the representation contained in paragraph 9... was false because, as a practical matter, Platinum knows what it does and does not require of its customers and that in fact the Fee and Reimbursement Schedule that was made part of the Factoring Agreement is the same fee schedule Platinum incorporates into all of its contacts. 6) The clause: Seller expressly acknowledges that Platinum has agreed thereto in reliance upon Seller s agreement during each Term Semi-Annual to deliver at least the Semi-Annual to deliver at least the Semi-Annual Base Sales Amount and that Platinum requires an increased fee in the event that [*10] a lesser volume of approved Accounts Receivable is agreed upon in any Term Semi-Annual. Consequently, if the aggregate amount of approved Accounts Receivable delivered by the Seller to Platinum during any Term Semi-Annual, whether by reason of Seller s premature termination, reduced level of salves, or otherwise, shall
8 be less than the Semi-Annual Base Sales Amount, then Seller shall pay to Platinum an adjustment fee on account of such Term Semi-Annual. The adjustment fee is arrived at by dividing the amount of fees earned by Platinum on the accounts receivable sold by DBI in the Term Semi-Annual, by the aggregate amount of accounts receivable delivered by DBI during the term. This quotient is multiplied by the Semi-Annual Base Sales Amount, and the amount of fees earned by Platinum on the accounts receivable purchased is subtracted from that total. Thus, the adjustment fee is roughly equivalent to a weighted average discount rate for the term, applied to the Semi-Annual Base Sales Amount, less the aggregate fees already collected during that term by Platinum. Significant Holdings and Legal Goodies 1) Under New Jersey law, there are five elements to a claim of fraudulent inducement: (1) a material misrepresentation of a presently existing or past fact; (2) knowledge or belief by the defendant of its falsity; (3) an intention that the other person rely on it; (4) reasonable reliance thereon; and (5) resulting damages. Fraud in the inducement occurs when the victim[ s] consent to [a] bargain is obtained by lies or half-truths. n81 It is a misrepresentation as to the terms, [*22] quality or other aspects of a contractual relation... that leads a person to agree to enter into the transaction with a false impression or understanding of the risks, duties or obligations she has undertaken. 2) Only matters of act can be misrepresented. Furthermore, statements as to future or contingent events, to expectations or to probabilities, or as to what will or will not be done in the future, do not constitute misrepresentations, even though they may turn out to be wrong. 3) Client asserted enough to survive motion to dismiss. 4) The client s request for a jury trial was made too late. Important Issues and Lessons 1) Monthly minimums and early termination clauses are quite contentious. 2) This was only a motion to dismiss, so it is impossible to determine how this will turn out.
9 Facts SBN-DVI, LLC vs. WALTER F. CROWDER, ET AL. CIVIL ACTION NO. G UNITED STATES DISTRICT COURT FOR THE SOUTHERN DISTRICT OF TEXAS, GALVESTON DIVISION 2006 U.S. Dist. LEXIS November 1, 2006, Decided November 1, 2006, Filed 1) Crowder was mistreated by DVI, which did all sorts of bad things and violated Medicare rules. 2) DVI went into a bankruptcy proceeding, and sold assets to SBN free and clear of claims. 3) SBN asserted claims against Crowder Significant Holdings and Legal Goodies 1) This case presents a sad example of a legally directed result which appears, under any notion of fair play, to be simply unjust. For almost four years the lecherous predecessors of Plaintiff s interests sucked increasingly larger amounts of unearned monies from the Defendants Medicare receivables pursuant to contracts establishing what has not been shown to be illegal and unenforceable factoring arrangements. Important Issues and Lessons This case is presented just to show how angry a court could get at a factor.
10 Facts Re: Securities and Exchange Commission v. U.S. Funding Corp., et al. Civ. No (WJM) UNITED STATES DISTRICT COURT FOR THE DISTRICT OF NEW JERSEY 2006 U.S. Dist. LEXIS April 11, 2006, Decided 1) Gwinnett, a New Jersey resident, was the president, founder and sole owner of defendants U.S. Funding Company and U.S. Funding Corporation (collectively, Gwinnett formed U.S. Funding Company in New Jersey in October (Id. at P3). She formed U.S. Funding Corporation, a New Jersey based corporation in December (Id. at P4). 2) Gwinnett s capital contribution of $39, constituted most of U.S. Funding s startup capital. 3) When Gwinnett started U.S. Funding, she had no prior experience in the factoring business other than performing bookkeeping for two companies that used factoring services and personally funding a one-time factoring transaction for a friend. 4) She hired a telemarketer to help her raise funds from investors. 5) The Investment Materials misrepresented and committed many key facts about U.S. Funding. For instance, the Investment Materials misrepresented: (1) that as of September 30, 2001, U.S. Funding had over $2.2 million in assets; (2) that U.S. Funding serviced thirteen industries, such as food, telemarketing, and transportation, even though it had not engaged in any such business prior to this date; (3) that U.S. Funding was a privately-funded business that had operated since 1998; (4) that U.S. Funding owned a substantial portfolio of accounts receivable; [*7] (5) that investments in U.S. Funding would be used solely to acquire new accounts receivable; and (6) that U.S. Funding would secure UCC-1 filings to protect the interests of investors. 6) The SEC contents that Gwinnett, individually and as the principal of U.S. Funding, [*21] received at least $636, in profits through violating the securities laws. According to the SEC, this amount consists of; (1) $435, in net salary and distributions, $25, from investors deposited directly into her personal bank account, $26, in cash withdrawals for Gwinnett s benefit from U.S. Funding s account by her personal assistant, and $50, in payments by U.S. Funding for Gwinnett s gambling bills and her purchases at various department stores, minus her initial capital contributions by her of $39,526.00; plus (2) payment by U.S. Funding of $138, in total salaries for the benefit of Gwinnett and related persons.
11 Important Issues and Lessons 1) This case shows you what you are up against from a public relations standpoint as factors.
12 ORIX FINANCIAL SERVICES, INC., Plaintiff v. INTERSTATE CAPITAL CORP., Defendant Case No. 3: UNITED STATES DISTRICT COURT FOR THE MIDDLE DISTRICT OF TENNESSEE, NASHVILLE DIVISION 2006 U.S. Dist. LEXIS 5685 January 27, 2006, Filed Facts 1) Rich Transport Inc., a Waynesboro, Tennessee trucking company, became indebted to Orix pursuant to leases and notes made and entered into between Orix and Rich Transport relating to the lease of tractors and trailers. To secure the indebtedness, Rich Transport granted to Orix security interests in Rich Transport s accounts receivable. 2) After Orix had perfected its security interests in Rich Transport s accounts receivable, Rich Transport entered into a factoring agreement with Interstate Capital Corp. 3) Interstate collected accounts. 4) Orix contends that the agreement between Rich Transport and Interstate is junior to the interest it has in Rich Transport s accounts receivable and consequently sues Interstate in this Court for conversion. 5) The statute of limitations had run in Tennessee and Oriz asked for a voluntary dismissal so it could sue in New Mexico which had a longer statute. Important Issues and Lessons This case was included to remind factors that equipment lessors often take a blanket lien to secure rental obligations or installment sales contracts on equipment. Care must be taken in doing a search and reading the fine print of attached leases.
13 DONALD M. LAUGHLIN Debtor(s). RMJ LEASING INC., Plaintiff(s) vs. DONALD M. LAUGHLIN, Defendant(s) Bankruptcy No , Chapter 7, Adversary No Facts 1) RMJ Leasing is an invoice factoring company. 2) Debtor operated a business known as ATA, Inc. ( ATA ). Debtor was the President of ATA. ATA employed drivers to haul automobiles by truck from a point of origin, [*3] such as a manufacturing plant, to their final destination, such as a sales lot. Debtor s business was growing and many of his clients were slow in paying their invoices. Thus he sought an agreement with RMJ Leasing to factor the invoices so he would have sufficient cash to cover payroll, gas, and the other costs of operating his business. 3) RMJ Leasing would receive an initial invoice for a specific amount due. It would pay ATA the discounted rate on that invoice. Subsequently, an amended invoice would be received for the same transaction which was reduced by various amounts. 4) Other times, after having purchased invoices and submitting them for payment, RMJ Leasing was informed that ATA owed more money to the payor than the invoice reflected. In other words, the company owing money on the invoice would use the amount of the invoice to setoff an indebtedness already owed to them by ATA. Additionally, several of the invoices were reduced upon presentation because the contracted number of automobiles were not actually hauled. 5) During Miller s (the owner of RJM)vacation week, Mr. Miller wires money to the various clients based upon this communication. However, he does not physically see the invoices until he gets back from vacation. 6) The revised invoices, which were at Mr. Miller s business when he returned from vacation, were all less than the amount discussed on the telephone while Mr. Miller was on vacation. 7) RMJ Leasing is not seeking denial of discharge on all of the deficiency but only on the 33 invoices which the company asserts are the product of fraud. 8) Mr. Miller testified that the company bases its fraud allegations on the fact that initial invoices should have been accurate and collectable when received. None of these invoices was final. All were inaccurate or subject to later modification in some respect. Mr. Miller testified that every invoice was submitted with a dollar figure which was subsequently modified downward. He felt that it was suspicious that not one of these invoices ever generated more money than the face value of the initial invoice. 9) Debtor explained that initially, Mr. Miller only agreed to factor invoices for completed jobs. This arrangement is reflected in the factoring contract between the parties.
14 However Debtor stated that over time, this arrangement became unfeasible due to his cash flow problems. Debtor testified that he discussed his problem with Mr. Miller. He stated that Mr. Miller agreed to begin factoring invoices ahead of time, but only if the invoiced load was actually on the truck, ready to be hauled. Debtor added that over time, with Mr. Miller s knowledge, he would prepare and submit invoices for contracted jobs that were a day or more away from being completed. Debtor used the term prefactoring for this business arrangement. Mr. Miller stated that while he has never heard the term prefactoring, it was the parties eventual understanding that invoices were submitted for work to be completed within a reasonable length of time. 10) Debtor testified that the fact that certain misstated invoices came in during RMJ s vacation period was merely coincidental. 11) In order to comply with RMJ s method of factoring, Debtor divided the total contract price into fixed invoice amounts. In actuality, sometimes the manufacturer would state that it had a load ready for delivery and have fewer cars ready for transport than Debtor s invoice had indicated. Manufacturers would often demand that the load leave immediately and, therefore, the revised invoice would reflect a lesser amount. Significant Holdings and Legal Goodies 1) Discharge opposed based on Bankruptcy Code 523(a)(2) (fraud or false pretenses). Through its denial of discharge claim, RMJ Leasing essentially asks the Court to disregard the corporate form and find that the debt is owed by Mr. Laughlin, the individual debtor in this case, rather than ATA. 2) As the primary goal of the Bankruptcy Code is to provide honest debtors with a fresh start, exceptions to discharge are generally construed narrowly against the creditor and liberally for the debtor. These considerations, however, are applicable only to honest debtors. 3) The Court finds RMJ Leasing has established by a preponderance of the evidence that the invoices purport to represent the existence of debt owed to ATA by its customers. 4) Additionally, the Court finds that the representations made by the Debtor were not true. 5) Debtor provided purchase summaries to RMJ Leasing that asserted that ATA agrees these invoices are true and correct as defined in the Factoring Contract with RMJ Leasing, Inc. 6) The factoring contract required each invoice to be unconditionally owed and... due without defenses, disputes, offsets, counterclaims or rights of return or cancellation. 7) Debtor s own testimony establishes that at the time he submitted the invoices, he knew they were untrue for various reasons,
15 8) The Court finds that Debtor knew his representations were false when made. 9) RMJ Leasing has failed to establish that Debtor presented inaccurate invoices with an intent to deceive the company. 10) While Debtor s representations were clearly inaccurate, testimony presented by the parties establishes that Debtor and his employee Delores Johnson took measures to ensure that RMJ Leasing was aware of the prefactoring practice. Significantly, Johnson testified that she was in contact almost daily with Mr. Miller. 11) Mr. Miller substantiated the testimony of Debtor and Johnson, stating that he knew invoices were submitted for uncompleted work that was to be finished within a reasonable length of time. 12) It has failed to establish justifiable reliance on Debtor s misrepresentations. 13) The evidence is overwhelming that RMJ Leasing was intimately familiar with Debtor s business. 14) Mr. Miller was in almost constant contact with Debtor s employees and even made phone calls directly to Debtor s customers when he felt it was necessary to confirm the existence of a job. 15) The Court finds that RMJ Leasing purchased each of the invoices in dispute after it had become aware of Debtor s prefactoring practice. Important Issues and Lessons 1) This case is a reminder that the seeking to have a debt declared non-dischargeable is difficult. Also, it is sometimes hard to find a benefit to support the effort, and expense. Benefits might include (i) debtor s often settle non-dischargeability litigations, (ii) enforce non-discharged judgment against post-bankruptcy assets or earnings.
16 In re Jessee, Carolyn K. Factoring of Oklahoma, LLC v. Carolyn K. Jessee United States Bankruptcy Court for the Northern District of Oklahoma 2006 Bankr. LEXIS 2685 October 5, 2006, Decided Facts 1) Debtor and her son worked for her company, Pounds & Francs, Inc. which factored its accounts with Factoring of Oklahoma, LLC 2) The factor claims that it was defrauded by the client, through the actions of Jessee and her son Means. 3) Jessee and her son were persuaded to sign a consent judgment wherein they admitted to the fraud. 4) Neither Jessee nor Means consulted an attorney prior to executing the documents and they did not answer the state court action. Significant Holdings and Legal Goodies 1) The doctrine of issue preclusion applies in bankruptcy dischargeability proceedings. While a bankruptcy court ultimately determines whether a debt is nondischargeable under 523, a state court judgment may preclude the relitigation of settled facts under the collateral estoppel doctrine. 2) When an issue of fact or law is actually litigated and determined by a valid and final judgment, and the determination is essential to the judgment, the determination is conclusive in a subsequent action between the parties, whether on the same or a different claim. 3) Thus, under Oklahoma law, the party relying on the doctrine of issue preclusion must establish: (1) a final judgment on the merits in prior litigation; (2) the issue sought to be precluded is identical to one previously litigated; (3) the issue was actually litigated and necessarily determined in the prior proceeding; and (4) the party against whom estoppel is asserted had a full and fair opportunity to litigate the issue in the previous forum. 4) When a judgment is entered by consent, none of the issues is actually litigated. However, issue preclusion may still be applicable if it is clear that the parties intended that the issues addressed in the consent judgment could not be relitigated in a subsequent action between the parties. 5) Generally, consent judgments should not be given preclusive effect unless it is clear that the parties intended the judgment to have such preclusive effect.
17 6) Neither the Agreed Judgment nor the Stand Still Agreement contain express language that Jessee would be precluded form relitigating such issues in a subsequent proceeding or that Jessee s debt to Factoring would not be dischargeable in a bankruptcy proceeding. Important Issues and Lessons 1) The court did not address the issue of the breaching of the corporate veil to get to the individuals. 2) This case teaches us the use of consent judgments and their value (except not here) in a subsequent bankruptcy case.
18 LeChase Data/Telecom Services, LLC, on Behalf of Itself and All Others Similarly Situated, Appellant, v. Daniel Goebert et al., Defendants, and Business Funding Group, Inc., Respondent. (Action No. 1.) COURT OF APPEALS OF NEW YORK 6 N.Y.3d 281; 844 N.E.2d 771; 811 N.Y.S.2d 317; 2006 N.Y. LEXIS 198; 2006 NY Slip Op 1247 January 10, 2006, Argued February 21, 2006, Decided Facts 1) Plaintiff LeChase Data/Telecom Services, LLC is a specialty contractor that furnishes and installs telecommunications and data transmission facilities in new and existing buildings. 2) Defendant Business Funding Group, Inc. is a factor, a company that lends money to others on the security of their accounts receivable. 3) Light House entered into an Outside Plant Engineering and Project Management Agreement with WorldCom for the design, engineering, project management, procurement, construction, operation, maintenance, relocation and replacement of various telecommunications network projects within the United States. 4) Light House also entered into an Accounts Receivable Purchase Agreement with Business Funding on January 31, ) On February 4, 2000, Light House instructed WorldCom to pay all invoices directly to Business Funding. 6) Business Funding did not, however, file a notice of assignment (Lien Law 15) or a notice of lending (Lien Law 73). 7) Light House testified that, on occasion, it would request an advance for less than the face value of an invoice. Business Funding would advance funds in the amount requested, and would divide that amount by 0.8 to create a fictitious face value to be used for purposes of calculating the rebate and factor s fee. 8) Light House subcontracted out to LeChase part of two projects for the design. 9) Le Chase sued Light House and its principals and controller for breach of contract, and also asserted claims against these parties and WorldCom and Business Funding for diversion of statutory trust funds in violation of article 3-A of the Lien Law. 10) LeChase filed mechanic s liens for the sums remaining due from Light House on the Monroe County projects. 11) After learning that Light House had entered into the factoring agreement prior to Business Funding s incorporation, LeChase commenced a second action in May 2002
19 against Mark Burgholzer, doing business as Business Funding Group, again alleging diversion of statutory trust funds. Significant Holdings and Legal Goodies 1) Business Funding has the means to protect its interests by filing a notice of assignment [*288] complying with Lien Law 15, or a notice of lending complying with Lien Law 73 (see also Lien Law 73  [d] [deeming a properly filed notice of assignment which meets the requirements of Lien Law 15 to be a notice of lending]), but neglected to do so. 2) Article 3-A of the Lien Law impresses with a trust any funds paid or payable to a contractor under or in connection with a contract for an improvement of real property (Lien Law 70 ). 3) Section 77 authorizes a trust beneficiary to recover trust assets from anyone to whom they have been diverted with notice of their trust status. 4) The only contested issues are what type of notice would disqualify Business Funding from the benefit of the exception to liability under article 3-A for a good-faith purchaser; and whether there are triable issues of fact regarding the requisite notice. 5) UCC (25) supplies the proper standard of notice in this case, and that actual knowledge is not prerequisite to depriving Business Funding of the protection of the exception in Lien Law 72 (1) for a good-faith purchaser. 6) Factors may readily avoid the risk of loss, however, by filing proper Lien Law notices and screening accounts receivable. 7) LeChase maintains that Business Funding has failed to raise a triable issue of fact regarding its notice of the trust and the diversion, and we agree. 8) The master agreement n4 included construction among these services, and the work orders detailed the construction work. 9) According to Burgholzer, Business Funding did not receive a copy of the master agreement. Under the factoring agreement, however, Business Funding had the right to the original and one copy of each invoice submitted for its possible purchase as well as a copy of the bill of lading, proof of delivery, contract or purchase order, and other documents satisfactory to Factor. 10) Business Funding s files contain a list of WorldCom s construction managers and their telephone numbers, and there are various s and notes that refer to approval of Light House s invoices by WorldCom s construction managers.
20 Important Issues and Lessons Statutes NY Lien Law 1) Not that the factor had to dummy up invoices in order to work around the accounting software. This is never a good idea. Courts and juries pick up on and never understand things like dummy invoices and they make a factor look slippery. 2) The NY Lien Law allows a factor to avoid the adverse effects of mechanics liens. Here it appears that the factor was unaware of this provision. Note that mechanics lien laws are decidedly not uniform, and someone factoring construction receivables would be well advised to learn the law in the appropriate jurisdiction. 3) The court was not sympathetic to the factor s claim that they did not know these were construction invoices. 15. Assignments of contracts and orders to be filed 1. No assignment of one or more contracts for the performance of labor or the furnishing of materials for the improvement of real property shall operate to reduce the lien of a subcontractor, laborer or materialman,... nor shall any such assignment or order be valid for any purpose, unless a "Notice of Assignment" meeting the requirements of subdivision two of this section....or a statement containing the substance thereof and such assignment... be filed within ten days after the date of such assignment... in the office of the county clerk... and such assignment or order shall have effect and be enforceable from the time of such filing, and no such assignment or order shall have any validity until the same shall have been so filed, and every such assignment or order, not filed shall be absolutely void as against a subsequent assignee in good faith and for valuable consideration, whose assignment or order is first duly filed. 72. Diversion of trust funds 1. Any transaction by which any trust asset is paid, transferred or applied for any purpose other than a purpose of the trust as stated in subdivision one or subdivision two of section seventy-one, before payment or discharge of all trust claims with respect to the trust, is a diversion of trust assets, whether or not there are trust claims in existence at the time of the transaction, and if the diversion occurs by the voluntary act of the trustee or by his consent such act or consent is a breach of trust. Nothing in this article affects the rights of a holder in due course of a negotiable instrument or of a purchaser in good faith for value and without notice that a transfer to him is a diversion of trust assets. 77. Action to enforce trust 1. A trust arising under this article may be enforced by the holder of any trust claim, including any person subrogated to the right of a beneficiary of the trust holding a trust claim, in a representative action brought for the benefit of all beneficiaries of the trust. An action to enforce the trust may also be maintained by the trustee. In any such action, except as otherwise provided in this article, the practice,