FACTORING ACCOUNTS FROM EMPLOYMENT STAFFING COMPANIES: How to do it and the pitfalls

Transcription

1 FACTORING ACCOUNTS FROM EMPLOYMENT STAFFING COMPANIES: How to do it and the pitfalls Distinctive Solutions 8 th Annual Factoring Conference Memphis, Tennessee April 3 6, 2002 Publication Prepared By: Michael W. Ullman, Esq. John W. Kiefer, President Ullman Ullman & Vazquez, P.A. Capital Factors, Inc. 150 East Palmetto Park Road 120 East Palmetto Park Road Suite 650 Fifth Floor Boca Raton, Florida Boca Raton, Florida Telephone: (561) Telephone: (561) Facsimile: (561) Facsimile: (561) ullmanpa@msn.com jwkcapf1@aol.com All rights are reserved. These materials may not be produced in any way without the written permission of Ullman Ullman & Vazquez, P.A. This publication is designated to provide general information on the seminar topic presented.

2 I. THE EXPANDING MARKETPLACE: According to Training Magazine: 70 percent of the United States businesses use only contractors without any regular payroll employees. Employment staffing companies get hundreds of unsolicited resumes a week. As companies rebuild their work force, they increasingly turn to employment agencies for all skill level of employees including executives, computer technicians, accounting, clerical, and word processing. Some of the more important temporary employment agency job markets include nursing, housing construction, finance, and security. II. PROBLEM SCENARIOS: The taxes of interest are those employers are supposed to withhold from an employee s salary - - commonly referred to as trust-fund taxes. A. An Internal Revenue Service Problem Scenario: A client supplies employees to a manufacturing company and the client begins having problems meeting weekly payroll. The client provides you with a financial statement and summary of anticipated costs necessary to operate. The financial statement shows that the client has severe liquidity problems. As the factor, you agree to over-advance so that the client can pay its payroll. The client, without your knowledge, pays its employees but fails to pay the trust-fund portion owed to the government. Does the factor have any exposure to the IRS? [Scenario Insert available after lecture discussion] B. A Federal Department of Labor Problem Scenario: The client, an employment staffing company, provides home healthcare and health-related services to patients around the country. This company did business in a half dozen states around the country. The client s employees produce assessment and admission reports and skilled nurses notes and uses these records to produce invoices for billing purposes. Without your knowledge, the staffing company stopped paying the statutory wages to its employees as required under 6 and 7 of the Fair Labor Standards Act. The staffing company factors its accounts. You come to learn that the United States Secretary of Labor has just filed suit against your client to enforce provisions of 2

3 the FLSA that require payment of minimum and overtime wages to certain employees. More problematic is that the Secretary of Labor claims that the clinical patient records and billing information were produced in violation of the FLSA s wage provisions and seeks to enjoin or prevent you from shipping, selling, or transporting any of these clinical patient reports or billing documents to any treating physician, insurance carrier, or Medicare to get paid. Is your UCC lien going to prevail? 1 [Scenario Insert available after lecture discussion] C. A Real Estate Construction Problem Scenario: Your client, an employee staffing company, supplies laborers to a company that serves as a subcontractor on a construction job. The owner is not paying the subcontractors and that includes you, the factor. The real property is in the state of Florida and you have not been keeping track of construction lien issues. Where do you stand? 1. Presumably you were assigned the rights of the subcontractor who entered into the contract with the general contractor,... but... A. Did you get a copy of the contract between your client and the general contractor, or between the general contractor and the owner? B. Have you read the contract carefully? C. Can the subcontractor sue the contractor even if the owner has not paid the general contractor? D. Where does the subcontractor have the right to sue? E. Is there an arbitration provision in the contract between the factoring client s customer and the other contractor and, if so, how does that affect your filing a suit? F. Has your client got any lien rights and have they been perfected? G. Can you file a claim of lien on behalf of the client that supplied laborers to the jobsite? Do you want to? Do you risk being sued for a fraudulent lien? H. Has your client s debtor done everything required under the contract? I. Were all required notices timely served? J. Is the job bonded? K. If it is bonded, were proper notices issued to the bonding company? L. Who can issue a lien release? 1 29 U.S.C. 206 (minimum wage) and 206 (maximum hours and overtime). 3

4 III. BUSINESS/DUE DILIGENCE CONSIDERATIONS: 1. What is the nature of the Factoring Relationship when purchasing accounts from employment staffing companies? a. Factoring, asset-based lending, or a hybrid? 2. What are some of the due diligence considerations? a. Financial Evaluation. 1. Cash Flow Analysis A. Overhead B. Number of employees C. How are employees characterized for IRS purposes? 1. Employees/Independent Contractors D. Tax lien searches E. Auditor results 1. Tax problems and severity b. Management Integrity and Competency c. Operations 1. Placement issues/matching employee to employer s needs. 2. Type of placements Less skilled vs. more skilled (warehouse help, receptionists vs. Computer programmers, construction, consultants, clerical, legal assistants, etc.) 3. Are there any special documentation considerations? a. Factoring Agreement The IRS is likely to challenge any deduction of payments under Section 3505 or For example, the payment under Section 6672 is a penalty for which deduction is denied under Section 162(f). Therefore, your factoring agreement should provide the factor with rights of indemnification for any costs incurred by the factor to preserve collateral. Such contract rights may convert an otherwise nondeductible penalty into a deductible bad debt. b. Personal Guaranty c. UCC financing statements d. Joint letter to customers for payment instructions 4. Are there any special monitoring considerations? a. To permit or not to permit over-advances? 1. Reasons why a textile industry factoring client requires over-advances. A. Inventory 4

5 2. Reasons why a temporary placement personnel agency requires over-advances: A. Need for operating: insurance, payroll, etc. B. No inventory = no recoup. b. Require detailed accounts receivable ledgering c. Credit review and account debtor concentration 1. Under 5% d. Account debtor verification e. Requisite Invoice backup 1. Proof of service such as daily time sheets 2. Signed off on by an authorized representative of end user f. Tax Liability Exposure Considerations: 1. Options: A. Make full advance and obtain evidence of tax document filing B. Make partial advance and withhold and pay withholding, FICA, and workers compensation C. Require client to outsource (e.g. Paychex, ADP) payroll no payment at end of quarter. D. Require client to authorize Factor to outsource (e.g. Paychex, ADP) payroll no payment at end of quarter. 5

6 Scenario A Insert Material: The IRS Code section that we are most familiar with is section It imposes a 100% penalty on anyone required to account for, collect, and pay over trust-fund taxes but who willfully fails to do so. But this section usually results in exposure to corporate officers, directors, shareholders, and employees who are responsible for the company s payment of the unpaid taxes. The section that exposes the factor to liability is 3505, which the IRS uses to come after third parties for unpaid trust fund taxes of your clients and borrowers. 3505(a) is generally not a problem for the factor. Subsection (a) covers the scenario when someone other than the employer pays wages directly to the employees. Subsection (b) is the one to watch out for. This subsection generally applies to a factor or lender who supplies funds to the client to enable the client to pay wages. Liability for violating subsection (b) can be twenty-five (25%) percent of the funds advanced. This subsection imposes liability on a lender or factor who advances funds to a client for the purpose of meeting payroll expenses with notice or knowledge that without the advance the client is unable or notwithstanding the advance intends not to pay the trust-fund taxes. 26 U.S.C. 3505(b) reads: Personal liability where funds are supplied. If a lender, surety, or other person supplies funds to or for the account of an employer for the specific purpose of paying wages of the employees of such employer, with actual notice or knowledge (within the meaning of section 6323(i)(1)) that such employer does not intend to or will not be able to make timely payment or deposit of the amounts of tax required by this subtitle to be deducted and withheld by such employer from such wages, such lender, surety, or other person shall be liable in his own person and estate to the United States in a sum equal to the taxes (together with interest) which are not paid over to the United States by such employer with respect to such wages. However, the liability of such lender, surety, or other person shall be limited to an amount equal to 25 percent of the amount so supplied to or for the account of such employer for such purpose. 6

7 Query #1: When does the factor, under 26 U.S.C. 3505(b), have actual notice or knowledge that the client does not intend to or will not be able to make timely payment or deposit of the trust-fund taxes? Query #2: When will the factor be deemed, under 26 U.S.C. 6323(i)(1), to have actual notice or knowledge that the client does not intend to or will not be able to make timely payment or deposit of the trust-fund taxes? 26 U.S.C. 6323(i)(1) reads: Actual notice or knowledge. For purposes of this subchapter, an organization shall be deemed for purposes of a particular transaction to have actual notice or knowledge of any fact from the time such fact is brought to the attention of the individual conducting such transaction, and in any event from the time such fact would have been brought to such individual s attention if the organization had exercised due diligence. An organization exercises due diligence if it maintains reasonable routines for communicating significant information to the person conducting the transaction and there is reasonable compliance with the routine... (emphasis added). Is this section intended to limit, rather than expand, what the factor is deemed to know? Does this section impose an affirmative duty on the factor to get information from outside its own four walls meaning are you obligated to investigate the client s ability to pay its employment taxes, (i.e., can the factor bury its head in the sand)? The answers are: 1. Yes, 6323(i)(1) is intended to limit, rather than expand, what the factor is deemed to know, and 2. No, 6323(i)(1) does not impose an affirmative duty on the factor to get information from outside its own four walls unless the information within your 4 walls or already in your possession would lead a reasonably prudent person to suspect that employment taxes would not or could not be paid. 2 2 United States of America v. Swiftships, Inc., 76 A.F.T.R. 2d , 1995 SL (E.D. La.) and United States v. Coconut Grove Bank, 545 F.2d 502 (5 th Cir. 1977). 7

8 Planning Suggestions. 3 Strategies to consider in order to defend against an IRS claim for Section 3505 liability. (1). In the rare instance where you are paying your factoring client s wages, and this is section 3505(a) exposure, directly remit the trust-fund taxes for your client s employees to the IRS with Form 4219 by the due date of the employer/debtor's Federal employment tax return to eliminate or minimize the assessment of interest. (2). In those instances where there is Section 3505(b) exposure, confirm - - i.e., make sure you know - - that the client can or will pay its trust-fund taxes and avoid written agreements with the client that provide for the advance of funds for the specific purpose of paying net wages. 3 IRS Increases Reliance on Lender Liability Provision to Recover Trust-Fund Taxes, Howard L. Richshafffer. 8

9 Scenario B Insert Material: 29 U.S.C. 203(i) of the FLSA defines goods. It includes: 29 U.S.C. 215(a) makes it: Goods means goods... products, commodities, merchandise or articles or subjects of commerce or any character, or any part or ingredient thereof, but does not include goods after their delivery into the actual physical possession of the ultimate consumer thereof other than a producer or manufacturer. 4 [U]nlawful for any person (1) to transport, offer for transportation, ship, deliver, or sell in commerce... any goods in the production of which any employee was employed in violation of section 206 or section 207 of this title.... Query: Are the documents that the employee staffing company s employees prepared and that you need to ship around the country in order to collect your accounts available free and clear of the Department of Labor s FLSA claim? No. One court has held that the purpose of a Secretary of Labor s suit to enjoin or prevent hot goods from being transported is to prevent the unfair competition that results when products of underpaid workers enter the stream of interstate commerce. Is that what happens when your work papers for billing purposes are shipped out of state so that invoices or billing documents can get paid? Maybe not, but - - One court has ruled that the Secretary of Labor s action to prevent hot goods from being transported was to enforce the fair-labor servitude and that the secured creditor s rights are inferior. If you become subject to a FLSA claim, what do you do? The courts allow you to clear the tainted goods by paying not all, but only those employees who are covered by the FLSA. That is, the ones who did not get paid their minimum hourly wage or their 150% of their normal hourly wage for overtime. E:\wp51 99\990037\FactoringAcctsFromTempEmpAgencies(Memphis)(4-9-02).doc 4 See also 29 C.F.R (b). 9