Factoring Companies Guidebook
Contra Trading
This is where a customer of a Client is also a supplier i.e. the same entity will appear on both the Sales and Purchase ledger.
Alternative Terms: "Two Way Trading" and "Reciprocal Trading".
Concerns
Where contra trading exists, the customer may well have established the right to offset amounts due to them against amounts due to the Client. In the event of us attempting to collect the debt, the customer may well attempt to exercise that right. Although it has been proved in court that such offset is not enforceable, it will at least cause difficulties and delays.
Identification
Make enquiries with the Client as to whether they purchase from any of their customers. Compare the Debtors listings with the Creditors listings to establish common names and list balances due, where found (being mindful of any group structures/relationships).
Assess the accuracy of the Purchase Ledger through comparison of supplier statements, as well as reviewing bank reconciliations and accruals listings.
Enquire with the Client as to whether they are able to produce a 'common customer' report, which if available will ease the identification of potential contras for us.
We should continue to review the ledgers independently for any noticeable omissions.
Treatment
We should, at least monthly, obtain a copy of the both the Clients Sales and Purchase ledgers to identify common customers. A reserve should be set up to the value of the potential offset i.e. the lower of the Sales and Purchase ledger balances. Where the potential set-off is considerable or regular, consideration should be given to excluding the debtor altogether. If we are confident about the stability of the needed reserve, we could also insert a blanket amount to cover us, as long as this is reviewed regularly to ensure this still fits the purpose.
With a disclosed facility the customers are aware of our right to the proceeds of the debt and the prohibition on any right of offset, through the notice of assignment. Once the customer has paid, they are deemed to have accepted the notice of assignment and the cancellation of any right of set-off, although they may potentially challenge it at a later date if they are experiencing difficulty obtaining payment from the Client. At the very least they may endeavour to delay payments until they have been paid.
We should be particularly aware of the potential security erosion through such trading, where there are Going Concern problems. Not only is the potential offset by the Client's suppliers greater at these times, but restricted lines of credit may lead the Client to alternative suppliers, who are also customers, but have not previously been identified on the Purchase ledger.