We covered invoice factoring – the good, the bad, and the predatory – in a previous blog. Below, we’ll look at one of the rare cases involving invoice factoring to make it to the high courts, the 2024 South Carolina Court of Appeals case Associated Receivables Funding, Inc. vs. Classic Industrial Services, Inc. (find it here, PDF).
Businesses who work with factors should be aware of this case because it answered two questions:
- Does an invoice have to be paid once it’s certified? and
- Is the customer bound by all the terms of the factoring agreement between the factor and the vendor?
Let’s dive in.
Background: The Associated Receivables Funding Case
As a quick reminder, in invoice factoring, there are three parties:
- The customer who obtains products or services from the vendor
- The vendor who provides products or services to the customer and creates an invoice, which it then sells to the factor
- The factor who buys the unpaid invoice (receivable) from the vendor and collects payment from the customer
In this case, the parties are:
- The customer: Classic Industrial Services (Classic)
- The vendor: Dunlap, Inc. (Dunlap)
- The factor: Associated Receivables Funding, Inc. (ARF)
ARF had an agreement (the Factoring Agreement) executed under South Carolina law with Dunlap in which ARF would provide Dunlap funding in exchange for receivables. Starting in spring 2014, ARF began purchasing receivables in which Classic, who had hired Dunlap as a subcontractor, was the customer.
For the next two years, the arrangement worked as it should. Classic paid ARF on at least 40 Dunlap invoices totaling over $1 million without issue. When Classic received a Dunlap invoice, it completed ARF’s “Work Completion Form” and certified the invoices with language indicating the work had been complete and the invoice was ready to be paid.
Then Classic Stopped Paying
But Classic stopped paying the Dunlap invoices starting in March 2016, believing Dunlap had not paid some of its suppliers. Classic was rightly concerned, because Dunlap’s failure to pay its own subcontractors or suppliers could lead to a mechanic’s lien that could become a big problem for Classic.
Despite knowing this was going on, Classic continued to assure ARF that everything was fine, so ARF continued advancing funds to Dunlap on new receivables. Classic also continued to certify the Dunlap invoices as before.
ARF finally learned in July 2016 that Classic was not going to pay the remaining Dunlap invoices. By the time of the trial, ARF’s outstanding invoices totaled $323,718.31.
ARF sued for repayment.
Yes, Certified Invoices Must Be Paid
In a nonjury trial, the circuit court agreed with ARF, finding Classic liable for payment under three theories:
- Under South Carolina Code § 36-9-607 and § 36-9-404, an “account debtor” (Classic) must pay the “assignee/secured party” (ARF) once it receives notice that the “assignor/debtor” (Dunlap) has assigned the right to payment. Classic had an obligation to pay the amount owed under its contract with Dunlap – not under the terms of the Factoring Agreement between Dunlap and ARF. And because Classic certified the invoices as valid and payable, it could not then withhold payment, even for a valid reason.
- Under the common law theory of negligent misrepresentation, the court found Classic liable because it knowingly made false statements to ARF, representing that the Dunlap invoices were valid and payable, and ARF relied on this information to continue advancing money to Dunlap.
- Similarly, under the theory of promissory estoppel, ARF relied on the false information Classic provided to continue advancing funds to Dunlap.
The appeals court agreed with the circuit court on the first and second points, declining to discuss the issue of promissory estoppel because it was not necessary.
No, the Customer Is Not Bound by All the Terms of the Factoring Agreement
Importantly, the appeals court disagreed with the circuit court on one issue: the rate of interest applied to the outstanding amount.
The circuit court had imposed a rate of 24.64%, as specified in the Factoring Agreement – but Classic was not a party to that agreement. While Classic was bound to the assignment of the right to pay in the Factoring Agreement, it was not bound to the rest of its terms. The appeals court directed the lower court to calculate the money owed with the statutory interest rate of 8.75%, rather than the higher rate of 24.64% that Classic was not bound to.
After the decision, both the Respondent (ARF) and the Appellant (Classic) requested a rehearing but were denied by the South Carolina Court of Appeals in September 2024.
A Sidebar: “Should” You Pay the Invoice?
The appeals court takes a moment to discuss the meaning of the word “should” in the context of contract language. When Classic certified the Dunlap invoices, it stated that “complete payment should be processed.” (Emphasis added)
Does “should” carry the connotation of obligation or discretion in this context? Classic argued that there was disagreement over whether the word “carries the force of a mandate.”
South Carolina courts have not yet ruled on this, notes the appeals court, but cites the Fourth Circuit’s interpretation that “should” on its own “can express the notion of requirement or obligation.”
“We find it problematic to construe ‘should’ as discretionary in the context of processing a payment for work certified to be complete and payable in the course of an ongoing business relationship,” writes the appeals court. “Instead, it seems logical to construe ‘should’ as a requirement or obligation in such a contractual context.”
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