AR Factoring as DIP Financing in Subchapter V Chapter 11 Cases

What AR factoring is and why debtors pursue it as DIP financing

Accounts receivable factoring converts unpaid invoices into cash. The factor advances a percentage of the invoice face, commonly in the range of 75 to 90 percent, collects from the debtor's customers, and remits the balance less its fee once the customer pays. Used as debtor-in-possession financing, it gives the estate working capital during the case without a bank's commitment to a full DIP facility.

For a Subchapter V debtor, a conventional DIP loan is often unavailable. Banks rarely lend to a small business in distress, particularly when its assets are already encumbered. The factor underwrites the debtor's customers rather than the debtor, which makes an advance possible even for a company with negative net worth.

Consider a hypothetical Sub V debtor with $3 million in annual revenue and $400,000 in outstanding receivables. A factor advancing 80 percent provides roughly $320,000 of liquidity, enough to cover payroll, rent, and critical vendors through the first weeks of the case. Without it, the debtor may run out of cash before the meeting of creditors.

Why factoring fits the Subchapter V structure

Subchapter V is built for speed: the plan is due within 90 days of the order for relief under § 1189(b), and the debt cap, $3,424,000 for cases filed on or after April 1, 2025, keeps the cases small.^{1 2} Factoring fits that structure for three reasons.

First, the documents are simpler than a bank credit agreement. A factoring agreement, a security agreement, a UCC financing statement, and notices to account debtors cover most of it. Second, the facility repays itself from collections rather than from a separate amortization line in the budget, which simplifies the cash forecast. Third, once the court approves it, funding can begin within days.

Post-petition factoring is still financing, and it still requires court approval. Obtaining credit outside the ordinary course, or granting a lien on estate property to secure it, needs authorization under § 364(b) or (c), and a lien that primes an existing lienholder needs § 364(d) and adequate protection.³ The motion practice is lighter than a large DIP, not absent.

The risk on the other side is a financing source that takes a first-position lien and then stops funding. Trade press has described the pattern in small business cases as "DIP 'em and dump 'em."⁴ Negotiate notice periods and cure rights into the factoring agreement so the facility cannot be withdrawn without warning.

How factoring shows up in the 13-week forecast

A 13-week cash flow forecast is standard practice in a chapter 11 case and is frequently required by the cash collateral or DIP order. Factoring changes its shape by converting a receivable into cash on a predictable schedule.

The table assumes a hypothetical debtor whose factor advances 80 percent within two business days of invoice submission. Without factoring the debtor waits 30 to 60 days for customers to pay; with it, cash arrives on submission, and the customer's later payment settles the factor's balance rather than landing in the debtor's account.

The forecast must show the arrangement explicitly: the advance as a receipt, the factor's fee as a disbursement, the reserve the factor holds back against disputes as its own line, and the customer collections that go to the factor rather than to the debtor. The U.S. Trustee and the Subchapter V trustee will check whether the advance rate in the forecast matches the agreement and whether the projected advances match the factor's actual pattern once reports come in.

UCC Article 9 perfection

The factor perfects its interest in the receivables by filing a UCC-1 financing statement in the debtor's state of organization, describing the collateral as accounts and their proceeds. The order approving the facility should authorize the filing.

Timing and priority are the issue. If a pre-petition lender holds a blanket lien on accounts, the factor's interest in post-petition accounts may be junior unless the lender subordinates or the court grants a priming lien under § 364(d) with adequate protection.³ In most Subchapter V cases the pre-petition lender does hold that blanket lien, so the motion has to address it: consent and a subordination agreement, or a priming request with the evidence to support it.

Run a UCC search on the debtor before the motion is filed so every existing filing against accounts is known and addressed in the papers.

Pre-petition receivables and avoidance exposure

Keep the facility to post-petition receivables where possible. A factor that buys receivables generated after the petition date is providing new value against post-petition assets, and the transaction is squarely within the order that approves it.

Pre-petition receivables are different. They are property of the estate, they are usually collateral for the pre-petition lender, and a sale of them is a use of estate property outside the ordinary course that needs its own authorization under § 363(b) and the lender's consent or adequate protection. If the debtor needs to factor pre-petition receivables, say so in the motion, identify them separately, and ask for the authority expressly rather than folding them into the post-petition facility.

For a hypothetical debtor with $200,000 of pre-petition receivables and $300,000 of post-petition receivables, factoring only the post-petition pool keeps the arrangement clean. Factoring both requires the motion to disclose the pre-petition component and seek the additional relief.

Matching factoring to the plan timeline

Subchapter V compresses the calendar. With the plan due within 90 days of the order for relief and confirmation often following within months, the factoring facility has to run through the effective date and, if the plan relies on it, beyond.¹

The cost matters to feasibility. A factor charging 1.5 percent per 30 days on a $500,000 receivable pool costs $7,500 a month, and that cost belongs in the plan projections as a line item. If the factor's fees consume the margin the plan payments were supposed to come from, the plan is not feasible, and the trustee will say so.

Confirm that the factor's commitment extends past confirmation, and read the termination provisions against the plan's payment schedule. A facility that ends before the effective date leaves the plan with a funding gap at the moment it is supposed to start performing.

What the U.S. Trustee looks for

The U.S. Trustee's review of a factoring-based DIP centers on three questions.

Is the arrangement fully disclosed? The agreement should be attached to the motion, and the motion should describe the advance rate, the fee structure, the reserve, and the termination terms in plain language. Undisclosed fees or a variable advance rate that could be cut without notice draw objections.

Does the estate benefit? Granting a lien on receivables gives up the estate's ability to use them for anything else. The motion should show that the liquidity obtained outweighs the cost and the lien.

Is the forecast honest? A forecast in which factoring proceeds cover most of the operating expenses is a forecast of a business that cannot sustain itself. The U.S. Trustee reads factoring as a bridge, not as revenue, and will object to a forecast that treats it otherwise.

Coordinating with the Subchapter V trustee

The Subchapter V trustee monitors the debtor's operations and reports to the court on progress toward confirmation. The trustee will review the factoring arrangement as part of that role, and the trustee's concern is whether the facility's cost impairs the debtor's ability to make plan payments.

Give the trustee a monthly reconciliation: advances taken, collections applied, fees charged, reserve held, tied to the 13-week forecast and to the monthly operating report. On Form 425C, factoring advances are receipts on Exhibit C and factoring fees are disbursements on Exhibit D, and the "Yes" on line 15, borrowing or payments made on the debtor's behalf, needs an Exhibit B explanation each month.⁵ The trustee will compare the report to the factor's statements. Make sure they agree before the report is filed.

Your next step

Look at the Subchapter V cases where the debtor has meaningful receivables and no financing. If the customers are creditworthy and the receivables are not fully spoken for by a pre-petition lien, factoring may be the fastest route to the liquidity the case needs. If you want the motion exhibit and the forecast prepared so the trustee sees one set of numbers, contact us.