Beyond the Balance Sheet: Factoring Facility Primer + First Brands Case Study

Welcome to the 156th Pari Passu newsletter.

In today’s edition, we’re looking at off-balance sheet factoring facilities, a financing tool that has become one of the most controversial and misunderstood credit mechanisms. While traditionally used as a working-capital bridge, factoring has evolved into a complex form of financing, altering the perception of leverage. 

If you read our newsletter, then chances are you’ve also seen the headlines around First Brands Group’s bankruptcy, which has been popularized not only by its $10bn+ of liabilities, but also its $2.3bn of factored receivables. Those receivables sit at the center of an investigation into First Brands, and may have a lasting impact on future factoring facilities. 

This writeup breaks down how factoring works, how GAAP and bankruptcy law define a true sale of receivables, and why companies use factoring and off-balance sheet structures. We’ll use hypothetical examples to show how factoring can meet working capital needs, improve perceived liquidity, and complicate creditor recoveries. We’ll end with live updates on the First Brands situation, which tests nearly every concept covered in this piece.

Before we get started, we launched the first Restructuring Competition, learn more here.

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Factoring Overview

Factoring is a form of financing that allows companies to convert their accounts receivable into immediate cash. Traditionally, when a company sells goods or services, it issues an invoice to its customer, which is often not paid for thirty, sixty, or even ninety days. Instead of waiting for the cash payment, some companies opt to sell the invoice to a third party, known as a “factor”, at a discount, typically around 95 to 98% of the  face value of the receivables (this discount represents the fee charged by the factor). Importantly, factors often won’t advance the entire cash balance upfront. Typically, 75% to 90% of the receivable’s face value is advanced upfront, and the remaining balance is transferred, less dilutive credits (as applicable) and the abovementioned discount, once customer accounts have been collected [1]. Dilutive credits refer to adjutments that reduce the collectible value of an invoice, such as returns or rebates. Therefore, once the customer has paid the invoice, the operating company will have collected the full receivables balance, less credits and the factoring fee. The Factor’s fee represents its earnings for providing upfront liquidity and assuming the risk that the customer may not pay on time, or at all. 

To numerically illustrate concepts in this primer, we’ll use ABC Co. as a hypothetical example. First, imagine ABC Co. sells $100k worth of goods to a customer on sixty-day terms. Instead of waiting two months to collect, ABC Co. sells the invoice to Factor Co. On the day of the sale, Factor Co. advances 85% of the invoice, or $85,000, to ABC Co. When the customer eventually pays the full $100,000 on day 60, Factor Co. sends the remaining $15,000 back to ABC Co., but subtracts its $3,000 factoring fee. In total, ABC Co. has collected $97,000, with $85,000 upfront and $12,000 later, with the $3,000 difference in cash collected and face value representing the cost of accelerating cash flow. 

Common Factoring Structures

Although the basic idea of factoring is simple, facilities can be structured in several different ways, depending on the borrower's needs and the factor’s risk tolerance:

Notification vs. Non-Notification:

First, a factoring arrangement can be a notification or non-notification agreement [1]. In a notification deal, the customer is explicitly informed that its invoice has been sold and is directed to pay the Factor rather than the operating entity. This makes receivable collection straightforward and reduces the risk of misdirected payments. In a non-notification deal, the customer is never told that the receivable has been factored and continues to pay the operating company as though nothing has changed. When customers pay the operating company, cash collected from factored invoices is typically held in segregated accounts before quickly being upstreamed to the factoring company. Tight cash management controls become extremely important down the line, when considering the accounting and legal treatment of factoring facilities. Non-notification structures are attractive to companies that want to keep their financing structures out of customer view, but they also expose the Factor to more risk since cash flows through the company before reaching them. Each structure carries its own benefits, and both are common, with notification factoring often being utilized by middle-market companies and non-notification being utilized by large or sponsor-backed companies.  

Regular vs. Spot:

Factoring can also be arranged on a regular or “spot” basis [1]. In a spot deal, like the ABC Co. example above, the company and Factor agree on a one-off transaction, selling a single receivable or a small batch. This might be done to address a one-off short-term liquidity pinch. Companies might also use spot arrangements when confidentiality or customer relationships are a concern. For example, a company that is limited to a notification structure might only factor receivables of select customers. On the other hand, a regular factoring deal functions more like a revolving credit facility. The company and Factor will maintain an ongoing relationship and have an approved limit, which can be drawn and repaid. Regular factoring programs are more common among all types of companies, as they are cheaper and more easily integrated over the longer term. Conversely, spot factoring may be a viable option for small businesses that need immediate cash against specific invoices (e.g., a $100k sale to Walmart that won’t pay for 60+ days). 

Recourse vs. Non-Recourse Factoring:

The last and most important distinction is whether the factoring agreement is recourse or non-recourse [1]. In a recourse arrangement, if the customer fails to pay the factor, the Factor may demand repayment from the operating company. Economically, that puts the customer’s credit risk back on the company, making the transaction seem more like an RCF or ABL facility. In contrast, the Factor bears this customer credit risk in a non-recourse deal, under which the Factor bears any loss from non-payment. Due to this shift in risk, non-recourse factoring arrangements almost always feature higher fees than recourse deals. Non-recourse deals are also much more likely to qualify as a “true sale”, which will become very important as we explain the implications of a true sale in a distressed context.

Accounting Treatment: On vs. Off Balance Sheet

Another important nuance of factoring facilities is how they show up in the financial statements. Since a company is “selling” its receivables, it initially makes sense that they should be derecognized (removed from the balance sheet). Under US GAAP, the Accounting Standards Codification (ASC) section 860 (Transfers and Servicing) governs the accounting treatment for transactions involving the transfer of financial assets, including factoring. Under ASC 860, three conditions must be met for the receivables to come off the balance sheet [2]. To eliminate any confusion, in the case of factoring, the transferor is the operating company, while the transferee is the factoring company.

1. Legal Isolation: “The transferred financial assets have been put presumptively beyond the reach of the transferor and its creditors, even in bankruptcy or other receivership.” This means the receivable must be legally separated so that even if the company files for Chapter 11, its creditors can not claim them.

2. Transferee’s Right to Pledge or Exchange: “Each transferee has the right to pledge or exchange the assets it received, and no condition both constrains the transferee from taking advantage of that right and provides more than a trivial benefit to the transferor.”  This test ensures that the Factor truly controls the receivables and isn’t limited to acting as a collection agent. In practical terms, a factoring agent should not be prohibited from reselling receivables to anyone, even competitors. Any restrictions placed on the Factor should provide no more than a “trivial benefit” to the operating company. For example, if a Factor is required to notify the operating company when it sells factored receivables, this restriction may be considered a trivial benefit as it doesn’t really limit the factor’s control. 

3. Surrender of Control: “The transferor does not maintain effective control over the transferred financial assets through (a) an agreement to repurchase or redeem them before maturity, or (b) the ability to cause the transferee to return specific assets.” This means the company can’t have any mechanism to call back or reclaim the receivables. 

Under GAAP, if these three criteria are met, the factoring is treated as a true sale, and the receivable is removed from the balance sheet, and no liability is recorded. If any three of the criteria are not met, the factoring is treated as a secured borrowing on the financial statements, meaning the factored receivable remains on the balance sheet at 100% of face value, and the company records a liability for the cash advance. Once the customer pays the factor, the receivables and associated liability come off the balance sheet. Let’s return to ABC Co. for a quick example. 

Consider two scenarios, in both of which ABC Co. once again sells its $100,000 invoice to Factor Co. on sixty-day terms at an 85% advance rate and 3% factoring fee. In the first scenario, the deal is structured as non-recourse, and Factor Co. assumes the risk of collection. The receivables are legally isolated in a separate SPV so ABC Co.'s creditors could not reach them (legal isolation). Factor Co. also obtains unrestricted rights to collect, pledge, or exchange the receivables (right to pledge or exchange). Lastly, ABC Co. has no contractual right or obligation to repurchase or substitute any receivables (surrender of control). In this case, ABC. Co.’s transfer of receivables to Factor Co. passes all three GAAP tests and thus is considered a true sale. Therefore, the receivables can be derecognized from the balance sheet. 

In the second scenario, assume the factoring arrangement is exactly the same, but this time it includes recourse. If customers fail to pay, ABC Co. must reimburse Factor Co. for any losses or substitute the delinquent receivables with new ones. Even though the receivables are legally isolated from ABC Co., and Factor Co. obtains the right to exchange or pledge, ABC Co. has retained effective control through its obligation to substitute or repurchase. In this case, since ABC Co. hasn’t fully surrendered control, the third criterion for derecognization has not been met, and the transaction is not considered a true sale. Therefore, ABC Co. must record a short-term liability secured by its receivables, which remain on the balance sheet. The figure below summarizes the balance sheet under each scenario: 

A couple of notes on the image above:

First, the “due from factor” arises in scenario one as ABC Co. is still entitled to funds remitted from Factor Co. following payment from the customer. Importantly, this represents ABC Co.’s residual interest in the transaction, not continued ownership or control of the receivables themselves. Under ASC 860, this due from Factor is treated much like a short-term receivable, as it represents cash that is almost certain to be collected within a few months  (unless Factor Co. defaults). On the other hand, in scenario 2, no due from Factor is recorded because, in GAAP terms, the receivables remain on ABC Co’s books as its own asset, and customer payments in excess of the cash advance and fee flow straight to ABC Co’s books rather than being routed through a Factor. 

Second, note how the leverage profile looks completely different in each case. In Scenario 1 (true sale), the company has no debt on its balance sheet, and reported leverage is effectively zero. In Scenario 2 (secured borrowing), leverage equals 85% of the receivables’ face value, mirroring the advance rate, which materially alters the company’s debt position. 

In summary, two transactions with identical cash economics can produce dramatically different financial statements. The GAAP treatment of factoring facilities becomes crucial for a company’s true liquidity position and leverage profile. 

Reasons for Factoring

To understand why companies use factoring facilities, we’ll return to ABC Co., covering two primary use cases. 

The first and more intuitive use case is working capital management. Imagine that ABC Co. is a middle-market supplier of specialty cleaning products, selling primarily into big box retail, with Walmart accounting for more than 50% of its sales. Like most large retailers, Walmart is able to leverage its scale and bargaining power to negotiate extended payment terms, often 90 days, leaving smaller vendors like ABC Co. waiting for months to collect cash. On the other hand, ABC Co. must pay its own suppliers within 30 days and cover payroll every two weeks. The result is cash flowing out faster than it comes in. By factoring its receivables, ABC Co. is able to accelerate cash receipts from its invoices upfront to cover current working capital needs. 

Why doesn’t ABC Co. just borrow on a revolving line of credit? The second use case relates to a company’s leverage optics. Even when a company has adequate liquidity, the accounting treatment of factoring can make it an appealing tool for managing leverage-related metrics. The clearest example of this is net debt-to-EBITDA. In a true sale arrangement, cash is received, but there is no corresponding liability recorded, representing a dollar-for-dollar decrease in net leverage and no change in total leverage. This creates a rare and interesting dynamic where a company can raise liquidity while simultaneously lowering reported net leverage, as the cash inflow from factoring is essentially treated as a cash flow from operations rather than financing. On the other hand, if the company were to borrow via an RCF, cash would increase, but so would debt, leaving net debt the same and increasing total debt.

To illustrate this dynamic, imagine ABC Co. now has a balance sheet with $150mm of outstanding receivables and a covenant limiting total debt to EBITDA of 4x. The company is facing a short-term working capital squeeze following a seasonal inventory build and delayed collections from its Walmart. To fund operations, management considers two options: drawing $30mm on its revolving credit facility or factoring $30mm of receivables under a non-recourse true-sale arrangement. ABC Co.’s pre-transaction balance sheet is presented below:

With $290mm of total debt, representing 3.6x EBITDA, ABC Co. sits just below its 4.0x maximum covenant threshold. With only $20mm of cash on hand, the company expects a temporary working-capital shortfall, as payables come due before collections from its major retail customers. 

Under the first option, which is detailed above, ABC Co. draws $30mm from its revolver to fund payables. While this immediately increases cash, it also raises total debt to $320mm, pushing leverage to its maximum limit of 4.0x. Any additional borrowing or decline in EBITDA would push leverage above its limit. While an RCF draw solves ABC Co.’s liquidity problem, it presents the new issue of lender scrutiny. 

Under the second option, which is also detailed above, ABC Co. instead factors $30mm of receivables under a non-recourse arrangement. Since the transfer qualifies as a true sale, the receivables are derecognized from the balance sheet. ABC Co. also records a $4mm due from Factor and $1mm loss on sale, recognizing the advance rate and factoring fees, respectively. Assuming a 90-day payment cycle, this represents an annualized Factoring cost of nearly 14% (1.033^4 - 1). Thus, a factoring arrangement is more expensive than an RCF draw, which would likely carry an all-in rate of 8-9% (SOFR + 3.00 / 4.00%), in today’s rate environment. This increased cost represents the transfer of risk from the operating company to the Factor. Importantly, under this arrangement, total debt remains unchanged, and ABC Co. remains at 3.6x leverage, despite having raised $25mm of immediate cash. 

Transactions like this highlight why factoring serves as both a viable funding and financial reporting strategy. By accelerating the conversion of receivables into cash without recording additional debt, companies can present a stronger liquidity position and lower leverage. However, when factoring is used too aggressively, it can mask excessive underlying leverage or recurring cash shortfalls.

Factoring via Special Purpose Vehicles

In practice, factoring doesn’t always involve a company selling receivables directly to a third-party finance company, especially for large or sponsor-backed companies. Instead, companies use SPVs to replicate the same economics and off-balance sheet treatment as traditional factoring. 

In a typical SPV factoring facility, the operating company first sells a pool of accounts receivable to a newly created SPV, usually a wholly owned subsidiary, with the Parent Co. still owning 100% of equity. The SPV has no other business operations, existing solely to purchase, hold, and finance receivables. Because it's a separate legal entity, often with independent directors, it is designed to be bankruptcy remote, achieving legal isolation. 

Importantly, these structures also rely on strict cash controls to preserve isolation. Customer payments are typically routed into controlled collection accounts held in the SPV’s name, rather than normal operating accounts. This prevents the operating company from commingling cash that technically belongs to the SPV. IF the parent were to collect into its own operating account first, it could blur the line of ownership and isolation. These segregated accounts may take multiple forms, each with varying risk profiles for the SPV/Factor. Here are some examples (from least to most risky) [10]:

• Fully segregated account in the name of the SPV/Factor

• Fully segregated account in the name of the operating company, but the SPV/Factor has continuous control or dominion

• A collection account that the operating company fully controls

Simultaneously, the SPV finances this purchase by selling undivided ownership interest (meaning investors don’t own specific identifiable receivables, but instead own a proportional slice of the entire pool) in the receivables pool or by borrowing against them. In practice, this financing is often structured as short-term notes backed by the expected cash collections on those receivables. Regardless of the financing method, they remain off the operating company's balance sheet. The SPV then transfers financing proceeds directly to the operating company, providing the same accelerated cash advance as traditional factoring with a third party.  

Legally, the SPV structure helps satisfy the legal isolation under both US GAAP and the true sale doctrine applied in bankruptcy courts. Because the SPV is a bankruptcy-remote entity, courts are more likely to find that the receivables have been put beyond the reach of the transferor, which satisfies the first requirement of ASC 860. 

Lastly, one risk of SPV structures that doesn’t come up in a traditional factoring model is that of substantive consolidation. As a reminder, substantive consolidation is a bankruptcy doctrine that allows a court to disregard the separate legal existence of related entities, combining their assets and liabilities into a single estate. However, substantive consolidation is rarely applied, especially in well-structured SPV securitization agreements like this. However, the risk still technically remains, and if applied, the SPV’s receivables could be pooled with the parent’s assets. If consolidated, the agreement would fail the legal isolation test, defeating the purpose of the bankruptcy-remote structure and diluting recoveries for SPV lenders as the receivables are pooled with the estate. 

In recent bankruptcies, SPV structures have been more prevalent than third-party factoring programs. However, the same questions and tests we’ve covered still apply. Courts will ask if the company genuinely transferred ownership and risk to the SPV, or if the SPV simply functioned as a conduit for secured borrowing. The answer to that question determines whether those receivables stay protected outside the state or are pulled back in if the company files for Chapter 11. 

Off-Balance Sheet Factoring Facilities in Bankruptcy

We’ve already covered the various structures, accounting treatment, and incentives for factoring, but we’ve yet to touch on the most controversial aspect: its treatment in bankruptcy. For all parties in a Chapter 11 involving factored receivables, the main question is whether the receivables sold truly sit beyond the reach of the company’s creditors, and thus are not part of the bankruptcy estate (in contrast to an ABL or RCF). This section examines how the true sale doctrine has held up in bankruptcy courts. 

True Sale Doctrine:

Section 541(a)(1) of the Bankruptcy Code states that a debtor’s estate includes “all legal or equitable interests of the debtor in property as of the commencement of the case”. This means that any assets owned by a debtor, whether legally or economically, get pulled into the estate. The true question for factored receivables is whether, following a sale, the debtor retains either interest. We’ll highlight two commonly cited cases that dealt with this. 

In Major’s Furniture Mart v. Castle Credit Corp. (1979), the 3rd Circuit examined a furniture retailer that had sold its installment receivables to a financing company. Although the transaction was labeled a sale, the factoring agreement required the operating company to repurchase defaulted contracts, classifying this as a recourse deal[4]. Economically, the operating entity retained nearly all of the nonpayment risk, while the buyer received a fixed yield, so despite being called a “sale”, this functioned more as a secured borrowing. The court found that the “risks of ownership remained with the transferor” and recharacterized the transaction as a secured loan [4]. The receivables were deemed property of the estate, and the finance company was treated as a secured creditor. Importantly, this case brought the accounting principle of “substance over form” into a legal setting, emphasizing the economic substance of transactions rather than their legal form. 

Two decades later, In re LTV Steel Co. (2001) came to the opposite conclusion. When LTV factored its receivables, it had transferred them to a bankruptcy-remote SPV under a non-recourse securitization program, meaning LTV Steel was not responsible for unpaid receivables. Under this agreement, the receivables were legally isolated, the SPV bore the credit risk of default, and LTV’s continuing obligations were limited to administrative servicing (collecting and forwarding cash to the SPV)[3]. The court held that the receivables were not property of the estate, finding both the legal title and economic risk had been fully transferred. Importantly, the court placed weight on a “true sale opinion”, differentiating it from the recourse-heavy factoring agreement in Major’s Furniture. For context, a true sale opinion is a formal legal opinion, typically written by a law firm, that states a transfer of financial assets should be treated as a sale rather than a secured loan under applicable law. While it is not a guarantee, it helps companies structure SPV facilities and provides a foundation for an argument if challenged. Since LTV Steel, most large receivables securitizations have been deliberately structured to meet this test, featuring legally isolated SPVs, non-recourse treatment, and a supporting true sale opinion. 

These two cases outline the practical test courts apply when deciding whether a factoring agreement qualifies as a true sale. What truly matters is risk and control. Similar to the GAAP standards, if the operating company bears meaningful exposure to customer defaults or retains the ability to manage the receivables, the transaction will almost always be recharacterized as a secured loan. On the other hand, if the Factor assumes the risk of nonpayment and the receivables are legally isolated, the receivables will typically be excluded from the debtor’s estate. 

Post-Petition Treatment:

The true sale status of a factoring facility also has numerous implications during the Chapter 11 process, especially for non-notification agreements in which the operating company continues collecting cash on behalf of the factor. To start, under section 363(c) of the Bankruptcy Code, a debtor cannot use cash collateral (cash subject to a creditor’s lien) without that creditor’s consent or court authorization [5]. As a reminder, under many factoring programs, especially SPV ones, the operating company continues to collect receivables before immediately transferring them to the factor. If a court finds the receivables were not truly sold, these cash proceeds from customer collections are considered the lender’s collateral, and their use is heavily restricted. This would lock the cash collections in the estate, even though they technically belong to Factor Co., as the cash proceeds are now part of lender collateral. Additionally, if the factoring facility is treated as secured debt, it is often rolled up into the DIP facility, as DIP lenders prefer a blanket collateral structure rather than a parallel factoring agreement. 

On the other hand, if receivables are deemed as truly sold, the cash belongs to the Factor (not the debtor’s estate). This creates a very interesting dynamic between the debtor, factor, and other creditors, as cash, which is likely quite scarce, flows into the debtor’s estate and then immediately out to the factoring company or SPV. However, in recent cases, courts have allowed companies with true-sale factoring agreements to continue them post-petition. Even when courts aren’t truly certain whether factored receivables are truly sold, as we’ll see with First Brands, they typically allow them to continue if they are deemed essential to operations.

Implications

As we’ve detailed above, the bankruptcy treatment of factoring facilities has direct implications for creditor recoveries. When receivables are treated as not truly sold, they remain within the debtor’s collateral pool, thereby increasing the asset base available to lenders and diluting the recoveries of the factoring company. Conversely, when receivables are treated as truly sold, they are excluded from the estate. In terms of recoveries, this can materially dilute the position of non-factoring creditors. In recent bankruptcies, particularly those of large retailers, factored facility classification can swing creditor recoveries by hundreds of millions of dollars. 

ABC Co. Example:

To illustrate this effect, we’ll return to ABC Co., which has now grown substantially but entered the Chapter 11 bankruptcy process after burning through nearly all the cash raised by its factoring facility. ABC Co. enters bankruptcy with $1.2bn OR $900mm of assets, depending on the treatment of $300mm of factored receivables. ABC Co. files with the capital structure below: 

Importantly, ABC Co.’s factoring facility is structured as a non-recourse sale to an SPV. However, instead of collecting cash in a controlled account before remitting it to the SPV, ABC Co. funneled customer collections through its operating account. An ad hoc group of first-lien credit facility holders has argued that ABC Co. has retained “effective control” of its receivables, and that the factoring agreement should be treated as secured debt, rather than a true sale. It is up to the court to interpret how the factoring facility should be classified, which will materially influence recoveries for secured creditors. 

To keep things simple, assume that before filing, ABC Co. factored $300 of its receivables for $255mm 30 days before filing for bankruptcy. In those 30 days, ABC Co. burned through all of the cash proceeds from factoring. However, the company has yet to collect any cash from customers on behalf of the factor. This means all of the receivables are still outstanding. 

To understand the impacts of recharacterization, we’ll examine two scenarios. In the first, ABC Co.’s factoring agreement will be treated as a true sale and remain off the balance sheet. In the second, it will be reclassified as secured debt.

Scenario 1 (true sale):

In the first scenario, assume the court rules that ABC Co.’s factoring agreement is treated as a true sale, meaning the receivables were in fact legally and economically isolated, and never became property of the bankruptcy estate. The $300mm in receivables sold to the Factor sit outside the pool of distributable assets, leaving only $900mm available in a liquidation. In this scenario, first lien lenders (RCF and TLB) recover 82% of their claims, while unsecured creditors recover nothing. This represents the worst outcome for secured creditors, as a large and liquid base of assets has been removed from the estate. We can also infer that as long as receivables accounts aren’t delinquent, the SPV/Factor will recover (collect) 100%. This scenario highlights why off-balance sheet factoring programs can be so controversial.

Scenario 2 (recharacterization to junior secured debt):

In the second scenario, the factoring program is recharacterized as secured debt, meaning the receivables become property of the bankruptcy estate and the Factor becomes a secured creditor, under most circumstances. However, if the Factor had never attempted to perfect its lien, securing its rights to collateral, in the first place, it may be treated as unsecured. In today’s world, though, most sophisticated factoring programs will file UCC-1 statements (the form to perfect a lien) anyway, just in case. They’ll also likely include precautionary language that publicly records their interest in the receivables. Importantly, these steps don’t jeopardize the off-balance sheet treatment, but simply act as “insurance” in the event of a recharacterization.

ABC Co. now has $1.2bn of distributable assets and a third senior claim. However, in nearly all cases, the reclassified factoring debt will sit junior to the pre-existing first-lien facilities. Because the company’s term loan and revolver were established long before the factoring program, their blanket liens take priority. At first, this seems counterintuitive. If the Factor has a direct lien on the receivables, why would the term loan take priority? The answer lies in the timing of the facilities and the “first-to-perfect” rule. 

Even if the factoring documents granted a “first-priority” lien on receivables, UCC § 9-322(a)(1) states that “conflicting perfected security interests rank according to priority in time of filing or perfection” [6]. This is commonly known as the first-to-perfect rule, and it ensures that older perfected liens take precedence. This means that the RCF and TLB, which held a first-priority lien on “substantially all assets” of ABC Co. and were established before the factoring program, will be paid out first. Importantly, this priority is not determined by when the factoring facility was established, but by when each receivable or pool of receivables was sold and the Factor’s lien was attached to it. In practice, this creates a dynamic where senior secured lenders will almost always be senior to the Factor in the event of a recharacterization. If, for some reason, a large, specific pool of factored receivables existed before the first-lien credit agreement, it may sit senior, but in reality, most first-lien credit agreements would require this factoring agreement to be terminated or subordinated prior to closing. 

As a result, the receivables collateral first flows to the $1.1bn of first-lien debt, allowing those lenders to recover 100%, while the Factor collects only the residual $100mm, roughly 39% of its $255mm claim.

As shown above, the classification of ABC Co.’s factoring facility represents a material 18% swing in recovery for first-lien debtholders. Additionally, since the factoring facility sits below first-lien lenders, factored debt recoveries vary by 61%. 

First Brands Investigation

The most recent case of off-balance sheet receivables financing is First Brands Group, a major US auto-parts supplier. First Brands is an evolving situation that we’ll cover in full in the future. For the purpose of this writeup, though, we will simply be applying the lessons we’ve learned, particularly around the true sale doctrine, and examining their potential impacts on this case. 

The company filed for Chapter 11 in late September 2025 after facing a serious tariff-induced liquidity crunch, reporting just $14mm of cash remaining in its DIP budget as of October 3, 2025. First Brands filed with $6.1bn of debt on its balance sheet, $2.3bn of off-balance sheet financing, $800mm of supply chain financing, AND $2.3bn of factored receivables. 

To quickly clarify, the $2.3bn in off-balance sheet financing is different from the $2.3bn factored receivables. The off-balance sheet financing likely reflects other SPV securitization programs designed to achieve “true sale” treatment, which may have also included other forms of collateral, such as inventory. Conversely, the reported $2.3bn of factored receivables appear to stem from direct operating company-level factoring agreements with third parties, such as Jefferies’ fund, Point Bonita (more on this later). Simply put, First Brands has total liabilities of roughly $11.5bn, and the treatment of $4.6bn of them is currently to be determined. 

Additionally, the $800mm of supply chain financing likely refers to a “reverse factoring” program [12]. In this structure, a third-party, usually a trade-finance fund, pays First Brands’ suppliers upfront, and First Brands repays the financer 60-90 days after the payment. This effectively converts a trade payable into an unsecured short-term borrowing. Reverse factoring is attractive to suppliers, who get paid faster, and First Brands, which is able to extend payment terms without upsetting vendors. However, under GAAP, while these programs must be disclosed (post-2022), they often remain classified as trade payables, and thus do not affect reported leverage [12]. 

The First Brands case has shocked many, as first-lien debt prices unexpectedly dropped from 95 cents to 30 cents in just a few weeks, as the company’s true liquidity position, a short position from Apollo, and off-balance sheet financing were revealed. First Brands provides a fascinating look at testing the concepts we’ve learned about so far. Some sources indicate that First Brands was channeling up to 70% of its revenue through factoring agreements [8]. 

First, let’s take a look at some language in the recent DIP order and tie it back to concepts we’ve covered. 

To start, the clause above effectively preserved any claim on the factored receivables until ownership is resolved. DIP lenders can’t count the receivables as collateral, and the factoring parties don’t get new protections either. This highlights the significant amount of uncertainty in this case, as even the courts aren’t sure what to do with the receivables yet. As a reminder, if those receivables are ultimately found to have been truly sold, they sit outside the estate. If not, they become part of the collateral pool. 

Additionally, as shown above, the court allowed ongoing factoring transactions as a part of ordinary operations, consistent with the post-petition treatment we overviewed above under Bankruptcy Treatment. Since factoring is essential to First Brand’s operations (considering it supposedly makes up 70% of revenue), the courts decided to let the program be until more information is revealed. 

First Brands has also appointed a special committee, advised by Alvarez & Marshal, to investigate multiple irregularities relating to their factoring and off-balance sheet financing programs. Each allegation directly tests one of the principles we’ve covered. 

Double-Factoring:

The first allegation is that certain invoices or receivables were factored more than once, meaning they were sold or pledged to multiple parties simultaneously [11]. If this were to be proven, the case would not only enter unprecedented territory but also clearly violate the legal isolation test. First Brands could not have truly sold the receivable to one Factor if it still had the ability to encumber or sell it to another (other than to do so fraudulently). For a receivable to be truly sold, the Factor must be able to prove that it alone has a legally isolated claim on the receivable. 

In plain terms, imagine First Brands sells a $100 receivable to a Factor that advances $80 upfront. Before the customer pays, it turns around and “sells” that same receivable again to another factor, who also advances $80. First Brands now has $160 of cash against a single $100 invoice. When the customer eventually pays, both parties believe they own the receivable, but only one can actually collect, meaning the other Factor gets shorted. If this were the case, the factoring would almost certainly get recharacterized so that First Brands remains on the hook to pay the remaining $60 owed to the Factor who didn’t collect. While a lot of details are left to be revealed, if First Brands knowingly sold or pledged the same receivable to multiple parties without disclosure, it would almost certainly constitute fraud, potentially triggering both civil and criminal liability. 

Commingling Collateral:

Another report is that roughly $376mm of collateral has been commingled among various borrowers under the First Brands umbrella [11]. According to in the first day declaration, this commingling stems from collateral that was pledged to Evolution Credit Partners, under an “uncommitted inventory finance agreement” [13]. This collateral “may have been commingled with collateral securing the ABL facility”, referencing Bank of America’s $250mm ABL [13]. Typically, an ABL facility would have a first-priority security interest in all eligible receivables and inventory (the borrowing base). It would be very unusual for a company to run an off-balance sheet program with the same collateral pledged to its ABL. One exception might be an intercreditor agreement with specific carve-outs for factoring or other off-balance sheet facilities. However, any evidence of an agreement has yet to be disclosed.

This raises red flags over whether certain collateral was properly segregated, and it could potentially undermine the silo of the company’s SPV structures, potentially creating arguments for substantive consolidation. As a reminder, substantive consolidation would collapse SPV-held assets back into the debtor’s estate, which would dilute SPV recoveries while likely improving general secured creditors’ recoveries.

Servicing & Control:

On October 8, Jefferies disclosed $715mm of exposure to First Brands’ factored receivables through its trade finance fund, Point Bonita. The $715mm figure includes invoices from retailers such as Walmart, Autozone, NAPA, and other auto-parts retailers [9]. In Jefferies’ filing, the firm disclosed that First Brands “stopped directing timely transfers of funds from the [retailers] on Point Bonita’s behalf” [9]. This means that when Walmart or AutoZone paid their invoices, the cash first went to First Brands’ own accounts (which is normal under a non-notification agreement). However, instead of immediately transferring those funds to the factor, First Brands allegedly withheld payments to preserve liquidity. As a reminder, under a true sale, First Brands should have no control over factored receivables or any influence over the cash flow from invoices. This influence over payments could be argued as “effective control” of receivables, potentially influencing a recharacterization to secured debt. 

Additionally, another fascinating development stemmed from the above correspondence between counsel on the First Brands case. 

In an October 2 exchange between Weil Gotshal and Orrick, Weil acknowledged that they did not know whether First Brands had ever actually received the roughly $1.9bn in factoring proceeds [10]. It’s not yet clear what’s driving this uncertainty, but there are several possible options. For example, it’s possible that the Factor never actually funded the advances. It’s also possible that the funds may have been netted against existing obligations or trapped in intermediate accounts before reaching the company. Regardless, the fact that neither counsel could trace the proceeds underscores a severe lapse in control. Additionally, they confirmed that the segregated collection accounts contained “$0” [10]. To understand why this is a red flag, recall that in a properly structured factoring program, cash management and segregation are extremely important. Under normal circumstances, cash should flow into segregated collection accounts, like the ones we listed above. Having $0 in a segregated account presents two possibilities: the factoring proceeds were never actually funded, or the proceeds were funded but were immediately commingled along with customer payments. We believe the latter scenario is more likely, as First Brands burned significant cash prior to filing, which must have come from some source. This is also consistent with the other widespread breakdown of control, making the factoring proceeds and customer collections indistinguishable from other liquidity sources. 

This admission reinforces the breakdown of cash management controls at First Brands, further weakening the true sale argument. If cash wasn’t properly isolated and upstreamed to the factor, First Brands' factoring facility would violate both the legal isolation and effective control principles. 

The most interesting point of this case to watch for is the findings of the investigative committee. The facts they uncover, whether double-factoring, comingling, or cash-flow control, could have a material influence on how First Brands’ factored receivables are treated, influencing creditor recoveries. In short, First Brands has become a live test for the true sale doctrine.

Key Takeaways

To recap what we’ve covered, factoring allows companies to convert receivables into immediate cash by selling them, sometimes entirely off the balance sheet under true-sale arrangements. Factoring is a great resource for companies with working capital mismatches, while also having a use case for masking true leverage. In theory, these transactions are simple; however, the dividing line between a true sale and secured borrowing complicates both the accounting and legal treatment of a factoring facility. GAAP’s criteria for derecognition test legal isolation, transferee rights, and effective control, all of which are considered by the courts when determining the treatment in bankruptcy. 

The First Brands bankruptcy will likely become the most popular modern example of how this dynamic plays out. With $2.3bn of off-balance sheet SPV financing and an additional $2.3bn of factored receivables, a true sale ruling could materially influence outcomes for creditors. The case also exemplifies the true ability of a factoring facility to mask leverage, as just over a month ago, First Brands’ debt appeared relatively healthy. 

First Brands will likely become a major reference point for how courts and creditors interpret true sale and control down the line. Importantly, the case as a whole is a great reminder that off-balance sheet financing doesn’t eliminate risk, it just changes where it shows up.

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