Invoice factoring could be next big thing for fraud scam, predicts lawyer

Shaw Capital Management and Financing offer a complete line of factoring services, purchase order funding, asset based financing, accounts receivable management, and other related financial services.

One of the biggest challenges facing businesses in the current economic climate is getting invoices

paid and the use of invoice factoring could become a significant area for fraud, according specialist

fraud lawyer Arun Chauhan of Midlands firm Challinors.

“In the current economic climate the use of factoring is becoming more prevalent,” says Arun, a

Partner at Challinors and head of its Fraud & Asset Recovery department. “The problem of getting

invoices paid is a growing problem and an increase in fraud in Factoring is an area that will not be

immune from this threat.”

The issue of invoice payment is not unique to the economic climate but one that is encountered by

all businesses and in particular start up businesses. Factoring is the selling of a company’s

invoices, at a discount, to a ‘Factor’ - typically a financial institution - which then assumes the

credit risk of the account debtors and receives cash as the debtors settle their accounts. The

company then receives the value of the invoice less a percentage retained by the company as their

fee for the factoring service.

“The Factor will typically obtain a personal guarantee or some form of security from a director of a

company before commencement of any agreement,” explains Arun.

There are two specific types of factoring - Open and Hidden factoring. In Open Factoring the

company does not mind if its customers know if they are using a Factor. The debtor is sent

invoices by the Factor to recover the face value of the invoices.

If a company has decided to Factor invoices to improve cash flow, it may wish to keep this from its

customers. In these circumstances the practice of ‘Closed Factoring’ is used, which involves the

debtor being invoiced by the company not the Factor, who is sent the invoice and then pays a

percentage. When the debtor pays the invoice the sum due to the Factor is then paid.

“The process of factoring is susceptible to fraudulent activity, if there are not sufficient controls in

place within a business,” says Arun. “A Managing Director may not be aware that those dealing with the raising of invoices for the company may well be devising a fraudulent scheme by creation location of businesses: “The fact that the postcode of a company is the same or in a similar geographical location to the debtor is one warning sign to look for. Another is the existence of large invoice amounts relative to the average for that debtor.”

The fraud is sometimes not internal but purely perpetrated to cause loss to the Factor. “One

example of this was uncovered in 2008 where the Directors of a Manchester based computer firm,

Ravelle, were convicted in a £3.25 million fraud upon its creditors. The fraud was centred on the

creation of false sales documents and a complex web of inter-company transactions designed to

deceive Factoring companies into providing finance to the Ravelle Group. This is a prime example

of collusion, which is one pre-requisite for factoring fraud.

“Many types of fraud are only possible if collusion between parties exists. In the Ravelle case, the

collusion between the directors enabled the company to create ‘fresh air’ invoices and more

importantly partake in ‘circular trading’, the point of which is to create a complex set of trading

requirements which allow a systematic deception of the factoring company. The schemes that

keep companies running could not have been implemented without the continued input of the

parties at Ravelle, and one of the Directors was a qualified accountant.”