Every factor has experienced the frustration of the account debtor refusing to pay the factor on the grounds that the assignor’s performance was deficient.[1] To combat this, factors have turned to a powerful tool: the Estoppel Agreement. An Estoppel Agreement is a direct contract between the factor and the account debtor, which obligates the account debtor to pay even if the assignor has failed to perform. Unsurprisingly, despite agreeing to the Estoppel Agreement, account debtors may try to wiggle out of their obligations, often by claiming the Estoppel Agreement is not a valid contract for lack of consideration. Recently, we here at Eckland & Blando won a unanimous Minnesota Court of Appeals case, Dynamic Energy Solutions, LLC v. Danna, LLC, 2023 WL2763191 (Minn. App. 2023), confirming the validity of consideration for Estoppel Agreements and adding Minnesota to a growing number of states around the country.[2] In this Slingshot, we will explain the basics of an Estoppel Agreement, why they are good for business, and why they do not fail for lack of consideration.
The contours of a factoring agreement are familiar to any factor, but for the uninitiated, a factoring agreement is a contract between the factor (“Factor”) and another company (“Assignor”), whereby the Factor purchases the Assignor’s accounts receivable, owed by the Account Debtor, who is not usually a party to the factoring agreement. A Factor profits from this arrangement by paying less than one hundred (100) cents on the dollar. The Assignor benefits by having immediate working capital. And the Account Debtor usually does not care who its paying so long as the work is performed. If things go as planned, the Factor advances funds to the Assignor, the Assignor completes the contracted job, and the Account Debtor pays the accounts receivable to the Factor. However, Factors know things rarely go to plan, which is why Estoppel Agreements are crucial.
In the context of factoring, an Estoppel Agreement is formed when the Account Debtor promises to pay the Factor directly as an inducement to fund the its vendor, the Assignor. If the Factor decides to advance the monies to the Assignor, it is doing so based on reliance of the promise of payment made by the Account Debtor.
The reason the Estoppel Agreement is so powerful is because it is enforceable regardless of whether the Assignor performed, meaning it is enforceable even if the accounts receivable are worthless. This is because the Account Debtor separately promised to pay the Factor, and the Factor relied on that promise when it made the decision to forward funds to the Assignor. It should be apparent why Account Debtors fight the Estoppel Agreement so aggressively: they are paying the Factor even though the Assignor failed to perform, leaving the Account Debtor holding the bag. But, if Account Debtors wished to avoid this situation, they simply should not have signed the Estoppel Agreement. Nonetheless, Account Debtors inevitably waste time and resources trying to fight enforcement of the Estoppel Agreement, claiming lack of consideration. These arguments are grounded in a misunderstanding of centuries of basic contract law.
Every contract requires, inter alia, three essential elements to be valid: offer, acceptance, and consideration.[3] Consideration exists “if the promisee, being induced by the agreement, does anything legal which he is not bound to do. . . [.] [I]t is sufficient that something valuable flows from him, or that he suffers some prejudice or inconvenience, and that the agreement is the inducement to the transaction.”[4] Some attorneys mistakenly believe consideration has to mean a benefit and, they argue, because the Account Debtor did not receive a benefit, there is no consideration. But this ignores centuries of Minnesota (and other jurisdictions) basic contract law: Consideration does not have to be something of value conferred; the suffering of a detriment is sufficient consideration.[5] Furthermore, it is not necessary that the detriment is suffered by the promisee – the only requirement for proper consideration is that a detriment is suffered by some party to the agreement.[6] Unfortunately, this bedrock principle of consideration is often overlooked by attorneys, when in-fact it has been upheld by the Minnesota Supreme Court since at least the 1890s.[7]
Why does this matter? Because consideration as detriment is exactly the form of consideration that undergirds Estoppel Agreements. The advancing of monies (detriment) from the Factor to the Assignor, induced by a promise from the Account Debtor entirely separate from the factoring agreement, that the Factor was not obligated to pay. In fact, when considering challenges to consideration for estoppel agreements, federal courts have repeatedly upheld the validity of detriment as consideration.[8] For example, in Hunts Point Co-op. Market, Inc., the Third Circuit held that the factor “suffered a considerable detriment in advancing large sums of money. . .” and therefore there was sufficient consideration to support a contract between the Factor and Account Debtor.[9] Again in LSQ Funding Group, L.C. v. EDS Field Services, the Middle District of Florida found that the Factor “suffered a detriment by extending funds” and thus a valid contract existed between the Factor and the Account Debtor.[10] Thus, as should be clear, an estoppel agreement has valid consideration based upon the detriment suffered by the Factor in advancing funds to an Assignor due to the inducement of promises made by the Account Debtor.[11]
There are two other potential theories that a factor could advance to ensure payment by the Account Debtor. First, that there actually was a benefit incurred by the Account Debtor based on the Factor’s advancement of funds, and second, that a benefit was given to a third party. In the first theory, the Account Debtor does receive a benefit because the Assignor will be able to complete the project, thus allowing the Account Debtor to retain its contracts.[12] However, this raises concerns about past consideration, making it a less attractive theory to rely on.[13]
In the second theory, the Assignor becomes the third party on whom the benefit is conveyed. For consideration “can be directed to a party other than the party to the agreement.”[14] So, through the Estoppel Agreement, a benefit is actually being conferred on the Assignor in the form of an advancement of cash and continued ability to work on the project.[15] However, this theory has not been extensively tried in courts, and should not be the sole theory relied on in defending an estoppel agreement.
If practical for your factoring business, you should strongly consider using Estoppel Agreements in your practice. Such an agreement helps better ensure compensation should Assignor fail to produce viable accounts receivable. Further, there is language that can be incorporated to better ensure the enforceability of an estoppel agreement.
If you would like help drafting an Estoppel Agreement or are seeking to enforce a Factoring Agreement or Estoppel Agreement, please contact the experienced factoring attorneys at Eckland and Blando.
[1] Co-authored by Daniel Cragg, partner at Eckland & Blando. Research; research and drafting assistance provided by John Pouchot, former summer associate at Eckland & Blando.
[2] Dynamic Energy Solutions, LLC v. Danna, LLC, 2023 WL2763191 (Minn. App. 2023).
[3] Commercial Associates, Inc. v. Work Connection, Inc., 712 N.W.2d 772, 782 (Minn. App. 2006).
[4] Home Supply Co. v. Ostrom, 164 Minn. 99, 204 N.W. 647 (1925).
[5] Id.
[6] Estrada v. Hanson, 10 N.W.2d 223, 225 (Minn. 1943)(noting a tendency to emphasize the detriment to the promisee).
[7] See Grant v. Duluth, M. & N. Ry. Co., 63 N.W. 1026, 1027 (Minn. 1895); see also Anderson v. Nystrom, 114 N.W. 742, 744 (Minn. 1908); Johnson v. Kruse, 285 N.W. 715, 717 (Minn. 1939); Nybladh v. Peoples State Bank of Warren, 76 N.W.2d 492, 498-99 (Minn. 1956); Cederstrand v. Lutheran Bhd., 117 N.W.2d 213, 222-23 (Minn. 1962);
[8] Hunts Point Co-op. Market, Inc v. Madison Financial LLC, 421 Fed. App’x 153, 162 (3d Cir. 2009); see also Brookridge Funding Corp. v. Northwestern Human Services, Inc., 326 Fed. App’x 10, 11 (2d Cir. 2009); LSQ Funding Group, L.C. v. EDS Field Services, 879 F.Supp.2d 1320, 1329 (M.D. Fla. 2012).
[9] Fed. App’x 153, 162 (3d Cir. 2009); see also Brookridge Funding Corp. v. Northwestern Human Services, Inc., 326 Fed. App’x 10, 11 (2d Cir. 2009).
[10] 879 F.Supp.2d 1320, 1329 (M.D. Fla. 2012).
[11] Id.
[12] CJM Financial, Inc. v. Leebcor Services, LLC, No. 4:20-CV-35, 2021 WL 1256906 at *1 (E.D. Va. April 5, 2021).
[13] Factor King, LLC v. Zenith Tech, Inc., No. 62-CV-19-2706, 2020 WL 4012715 at *5 (Minn. Dist. Ct. Feb. 24, 2020).
[14] Dynamic Energy Solutions, LLC v. Danna, LLC, 2023 WL2763191 (Minn. App. 2023).
[15] Id.