Reading and Understanding Legal Agreements

During my 15 years in banking I found it unusual for a loan customer to actually read and understand what all the legal documents were that I was putting in front of them to sign. While I trust most people who I sign agreements with, I also always make it a point to read, understand, and negotiate any points of the agreement I don’t like.

In the past 6 months, I have heard horror stories and read a few agreements that were in one word – terrible.

It’s important for you and your business that you not get stuck in an agreement that doesn’t work for you.

Recently I worked with a business that was using a very unscrupulous factoring company based in Eastern Washington State. When I asked the customer about the agreement they told me they signed it after having verbal representations of the company representative. They did not read it.

Business owners should not sign any agreement they don’t read and completely understand.

If they need to have their own counsel read the agreement to be sure they understand it that is money well spent. In the case of the company I am describing in this post, $300 to $400 in legal document review fees might have saved the company nearly $100,000 over the year contract.

When I read the agreement, proposal and all personal guarantees, I saw three big places that should have caused the customer to run away instead of entering into an agreement with this company.

Strike One: The first thing that raised a red flag for me was the difficulty I had in reading the contract to begin with. It wasn’t written in a format that most lay people could easily understand and the sections were not in logical order. I believe the company that wrote this agreement deliberately wrote it in such a way as to make it difficult to find the fees, and other onerous requirements of the agreement. A dumb attorney didn’t write this agreement; rather one who had been instructed to make it difficult to find all the “gottchas” in the agreement did.

Strike Two: Most factoring companies issue term sheets or proposals when they decide to work with you. Reputable factoring companies put both the positive terms and any potentially sensitive terms in the term sheet. In the term sheet for the company I am describing there was no mention of a minimum monthly funding requirement. In this case, the company wishing to be factored is a $12 million dollar a year business. The factoring company put in a requirement for the customer to finance a minimum of $750,000 a month each month for the year contract. Had the company read the contract and seen this provision, they clearly wouldn’t have signed it.

Strike Three: Many but not all factoring companies have an early termination fee. Reputable factors usually make this early termination fee a small percentage of the line of credit. In this company’s case, a 1 or 2% early termination fee on a $1 million line of credit might be reasonable, but deep in the contract in a long hard to read paragraph was the early termination fee. It read that if the customer wanted to terminate early they would have to pay the total of all unused months of the minimum monthly funding fees. In this company’s case that totals nearly $100,000.

It is important to know that while I am describing a real factoring company that is taking advantage of its customers, it could just as easily be any other company that you enter into an agreement with. It is important to trust but verify.

There are thousands of factoring companies in the United States and most of them are honorable good companies. There are a few like the one I describe here that give the rest a bad name. That is unfortunate because factoring can be a very viable solution for many businesses.

If you are in the market to find a factoring company I suggest you download a comparison sheet  I have prepared. Ask hard questions and get answers to each of the line items on the comparison sheet before you agree to do business with a factoring company. During the due diligence part of your search for a factor, ask for a sample set of documents you will be asked to sign. If they are unwilling to provide you a set, find someone else to do business with. Get answers to every question you have and reread the actual agreement. If you don’t understand provision, ask your attorney for help.

Lastly, don’t rely on verbal representations by lender representatives. In most states they don’t carry any weight. What is written in the contract is what matters.