Should You Consider “Factoring” Your HOA’s Delinquencies?

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Is your HOA board getting contacted by companies offering to purchase your association’s accounts receivable? It’s called “factoring,” and there’s a ready market if you’re interested. When might that be worth considering instead of hiring a collection agency to collect your HOA’s debt? Rarely, say our experts.

The Basics of Factoring

Factoring, most simply defined, means selling your accounts receivable in exchange for a fee, whether it’s an immediate fee or a fee paid if the purchaser eventually collects the debt.

In some states, laws may limit your ability to enter into a factoring agreement. “I don’t hear about factoring too much,” says James R. McCormick Jr., a partner at Peters & Freedman LLP in Encinitas, Calif., who represents associations. “Some associations do assign their debt to a collection agency. However, a California statute precludes associations from assigning their delinquencies unless it’s the account of a prior owner. That covers the vast majority of delinquencies, which are usually current owners.”

It’s also not common in Massachusetts because of a statute that makes it unnecessary. “It’s not something we see in Massachusetts,” says Robert Galvin, a partner at Davis, Malm & D’Agostine PC in Boston who specializes in representing condos and co-ops. “We have very powerful superlien law that gives condos a lien for six months of condo expenses that even comes before first mortgages. So if your association filed the collection lawsuit today, your lien would encompass the six months immediately before today and would take priority even over the first mortgage. Therefore, there’s no reason to factor your accounts receivable or borrow against them because you’re all but certain to get paid.

Galvin explains how that law typically shakes out. “There’s a requirement in Massachusetts that 30 days before you sue, you have to send a letter to the mortgage holder,” he says. “When they get that letter, most banks just ordinarily pay the delinquency. The unit is often owned by somebody current on the mortgage but who hasn’t paid the condo fees. The bank just pays the amount and then adds it to the mortgage amount because they know that if the association does sue, the association’s debt come before the mortgage.”

Less Common Today

Factoring is permissible in Florida but less common than in the past. “I don’t think it’s as prevalent as it once was,” contends Christopher J. Shields, a partner at Pavese Law Firm in Ft. Myers, Fla., who’s represented associations for decades. “We were pretty much ground zero in the recession. When there was the substantial downturn and we had selling prices 30 percent of what they were at the high tide, we had communities inundated with delinquent accounts. Any time you have an environment like that, you have companies with a business model saying, ‘We can solve your problem for you,’ and some of those are factoring companies.

“Basically what they’re doing is if there are 100 cents owed on the account, they’re buying it for a very discounted price and the association is basically assigning and selling that account to a third party,” explains Shields. He had a number of clients “in the depths of the real estate meltdown” several years ago that sold their accounts for $.50 on the dollar.

But that is only part of the revenue that the association foregoes, Shields adds. “The real profit center for factoring companies is that they now own the account and can exact further profits by charging and collecting late fees equal to 5 percent of each installment past due on top of 18 percent interest. If the association simply kept these accounts, the associations would have received the late fees and interest.”

Shields concludes, “Like it or not, there are some ethical issues and some realistic issues.” Here are some of the concerns:

  • It can damage goodwill in the community. “Associations are communities made up of people who are unit owners,” says Shields. “Some people have had a hard time—maybe they bought off more than they could chew—and when you assign that account to third party, you’re throwing your delinquent owners to the wolves.”
  • Fees charged to your owners may not be fair. “The prospect for abuse is rampant because the factoring company can asses and charge late fees and charge exorbitant legal fees,” says Shields. “People fall behind and owe $500 or $5,000, and then they get a delinquency notice from the company that now owns that account. It’s paid pennies on the dollar, but now it’s seeking to recover exorbitant late fees, attorney’s fees, and interest. “One large issue is the attorney’s fees,” Shields explains. “Typically, under Florida law, an association is entitled to recover reasonable attorney’s fees and costs expended in collections. That implies the association has received and approved a bill for an attorney’s work and actually paid the bill. But sometimes the relationship between the factoring company and the law firm that’s doing the collections work isn’t at arm’s length. What happens all too often is that the factoring companies show a bill as being charged or incurred, but whether that’s the actual legal responsibility of that factoring company to pay is a different story. There is abuse in the industry.”
  • The company often wants your best—meaning collectible—accounts. “The factoring company is often going to cherry pick those accounts it purchases,” says Shields. “And all too often, the factoring agreement basically allows the company to reassign and sell back to the association the worst accounts. So in cases where the homeowners later file for bankruptcy, the factoring company will reassign those accounts back to the association.”

Ultimately, Shields says factoring is rarely a good choice for an association. “Associations should factor only in extremely limited cases,” he says. “And when they do so, they should understand it’s a business relationship they’re entering into only because they’re cash poor and getting fast income.”

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