Recharacterizing Contracts: The Sale-versus-Loan Problem of Receivables Financing

Our article addresses a complex and critically important issue that lies at the intersection of contract, property, commercial, and bankruptcy law and is crucial to corporate wealth production: what constitutes the sale of intangible rights to payment, or ‘receivables.’ Courts often recharacterize contracts that purport to sell such rights if, notwithstanding being designated a sale, some of the substantive terms of the transfer are indicative of a loan.

As a highly simplified example, assume that Party A (the transferor/purported seller) contracts to sell $1,000 of receivables to Party B (the transferee/purported buyer) for $950. If the collections on the receivables are less than $975, or if collections are made later than 180 days (when expected), the contract requires Party A to compensate Party B for the loss or delay. If the collections are more than $985, the contract requires Party B to turn over the surplus collections to Party A. As a business matter, this sales contract is sensible because it voluntarily and deliberately allocates the transaction’s risk of loss and the time value of money between (typically) sophisticated business parties. Even for this simple example, however, judges struggle whether the recourse of Party B, the transferee, against Party A, the transferor, coupled with the transferor’s right to any surplus collections, permits or even constrains them to recharacterize the contract as creating a loan secured by, as opposed to a sale of, the receivables. Furthermore, most receivables-sale contracts are much more complicated.

The jurisprudence on this sale-versus-loan problem is muddled and inconsistent. The confusion is compounded by the intangibility of receivables, subverting the old adage that ‘possession is nine-tenths of the law.’ About the only well-established legal principle is that a court may sometimes, though it is unclear when, recharacterize a transaction that parties deem a sale to be a secured loan.

The resulting uncertainty has serious real-world consequences. A recharacterization means that a purported buyer would not own, but merely would have a security interest in, the receivables and their collections, with the relatively limited rights and remedies associated with that interest. The risk of recharacterization thereby impairs receivables financing as a tool to unlock the growing segment of the world’s money—currently estimated at trillions of dollars—and, in developed countries, the bulk of corporate wealth that is locked up in receivables. 

To reduce that uncertainty and mitigate its costs, our article seeks to build a rational, consistent, and cost-effective legal framework for resolving the sale-versus-loan problem. To that end, the article seeks to reduce, if not eliminate, the confusion and uncertainties associated with that problem, including correcting certain misunderstandings and anachronisms contained in a widely cited 1991 law review article. Since then, there have been major changes in the economy and financing landscape, including significant increases in the volume of receivables financing and the growth of securitization. Judges, lawyers, investors, and scholars alike need a fresh perspective.

The authors’ article can be found here. 

A version of this post originally appeared in the Harvard Law School Bankruptcy Roundtable (see Recharacterizing Contracts: The Sale-versus-Loan Problem of Receivables Financing).

Steven L. Schwarcz is the Stanley A. Star Distinguished Professor of Law & Business, Duke University School of Law; Senior Fellow, the Centre for International Governance Innovation (CIGI); and Founding Director, Duke Global Financial Markets Center.

Isabelle Stewart is a J.D. Class of 2026 candidate at Duke University School of Law.