Fraud in invoice financing

The use of invoice financing is now widespread and enables companies to free up working capital sooner by receiving advances against the value of invoices which are assigned to an invoice discounter when raised rather than waiting for customers to make payment.

However, due to the nature of invoice financing, unfortunately this is an area which is susceptible to fraud.

Fresh air invoicing happens when a company has issued an invoice to a customer and then draws monies from the finance company under the terms of the Invoice finance agreement prior to the delivery of the goods or services. This is done with the knowledge that the company has not fully completed all or part of its contractual obligations to the customer.

Alternatively, invoices can be issued fraudulently, purely to raise finance from a finance company when there is no underlying transaction or value attached to it and no real debt exists that is capable of being validly assigned. However, it isn’t just factoring companies which can suffer from abuses of invoice practices.

Ghost invoicing happens when a fraudster creates invoices purporting to be for legitimate goods or services which are sent to companies in the hope that they will ‘slip through the net’ and be paid without question. This is more common in large organisations with several different divisions where ghost invoices can simply be processed as valid normally by an employee involved in the fraud.

Whilst Invoice finance agreements usually include a provision which classifies fraud as an event of default meaning the funding is to be repaid, in the above situation funds are invariably unavailable for repayment. The company and its directors (if involved in the fraud) will likely have moved funds outside the reach of the invoice finance company and possibly put the company into a form of insolvency.

Invoice finance agreements are therefore often supplemented with personal guarantees given by the directors of the company receiving the funding. In some cases, the personal guarantee may be limited to a specific figure; however the terms of the personal guarantee may be such that the fraud invalidates the limited nature of the guarantee and widens the scope allowing all funding obtained by fraudulent means to be recoverable.

It is important to ensure that the terms of the Invoice financing agreement and any personal guarantees are carefully drafted to cover all eventualities including fraud. However, what happens in the circumstances where there is no personal guarantee? How can a finance company go about recovering the funding which was predicated on an underlying fraud? In such situations, there are various causes of action available against fraudsters and such causes of action fall under the general umbrella of fraud.

Possible claims against directors could be based on the following causes of action:

• Deceit – this arises from a false statement of fact made by one person, knowingly or recklessly, with the intent that it shall be acted on by another, who suffers damages as a result.

  Raising fraudulent invoices which are to be acted upon by the finance company in terms of paying out on the invoices could clearly fall within deceit and damages could be recoverable as a result.

• Conspiracy - arises where there is a combination or agreement between two or more legal persons (including corporate bodies) to take action that results in damage being caused to another person.

  The conspiracy in the present case would be between the company in whose name the invoices have been raised and the fraudster(s) who have created fraudulent invoices.

• Procuring breach of contract – this arises where a person intentionally induces or procures the breach of a contract between two parties without reasonable justification and loss is suffered as a result.

  The fraudster who procures that the company breached its invoice finance agreement by submitting fraudulent invoices could be liable under this particular cause of action.

Payments by a customer to the company itself instead of the invoice finance company are held on trust for the invoice finance company. If individuals within the company have diverted those customer payments for their own personal benefit rather than paying them to the finance company, they may also be liable for knowing receipt or dishonest assistance.

• Knowing receipt - Refers to the personal liability of non-trustees for losses arising to trusts. Liability arises where the non-trustee receives trust property (or continues to hold trust property) in the knowledge that it is in breach of trust.

  Whilst the company itself holds the funds received from customers on trust for the finance company, the director personally cannot be classed as a trustee. However, where the director receives such funds from the company and knows that such has been procured by way of breach of trust, knowing receipt provides a useful remedy.

• Dishonest assistance – again, this is where a non-trustee becomes personally liable for breaches of trust committed by one or more trustees. Liability arises where the non-trustee is an accessory to the breach of trust (whether by inducing or assisting in the breach) and has acted dishonestly. Liability is imposed if the accessory has not acted as an honest person would, in the circumstances, have acted.

  A director authorising and approving fictitious invoices could be classed as an accessory to the company and, in doing so, has clearly not acted as an honest person would. The director could therefore fall foul of the dishonest assistance offence.

Therefore whilst the ability to rely on documents such as the Invoice Finance Agreement and Personal Guarantees will inevitably provide protection, a claim based on one of the causes of action summarised above may enable a successful claim to be pursued and proper justice to be served.