Diverted payments: how they happen and how to spot them

A factoring facility rests on one simple arrangement: when a customer pays a financed invoice, the money reaches an account the lender controls. Under notification factoring, the customer has received a notice of assignment and pays the factor’s lockbox. Under a non-notification arrangement, customers pay a blocked or controlled account the lender sweeps.

A diverted payment breaks that arrangement. The customer pays, but into an account the client controls on its own. The client has the cash, the lender still carries the receivable as open, and the collateral is now worth less than the borrowing base says.

How diversion happens

Not every diverted payment is fraud. Customers make mistakes, especially in non-notification deals where they don’t know a lender is involved.

• Old remit-to details. A customer keeps paying the client’s old account out of habit, or because its vendor master file was never updated.
• Changed remit-to details. The client tells customers to pay a new account. In a non-notification deal, that request looks routine to the customer.
• Card and ACH payments. Smaller customers pay by card or ACH straight into the client’s operating account.
• Deliberate redirection. The client deposits some collections in its own account and leaves the invoices open on the aging, often while drawing more against them.

The first three are usually honest errors that a client should correct and turn over immediately. The fourth is fraud, and it tends to grow: once a client keeps one payment, it needs the next to cover the gap.

The signs on your side

Diversion leaves traces in the lender’s own records long before a field exam.

A healthy customer who stops paying. When a customer that has always paid within terms suddenly goes quiet, ask why. If it is doing well and has raised no dispute, the money may be going elsewhere.

Remittances that don’t match receipts. A remittance listing invoices that never cleared your lockbox is the clearest sign there is. Keep remittances and compare them with what actually arrived.

Partial payments that don’t add up. A customer paying round amounts that never match invoice values may be splitting payments between two accounts.

Collections falling while sales hold up. If the client’s sales are steady but lockbox receipts drop, the difference has to be going somewhere.

Customer receipts in the operating account. Ask for the client’s operating account statements as well. Deposits from financed customers there are the most direct evidence you will find.

The checks that find it

Verify with customers. A customer confirming that an invoice was paid on a date you have no record of tells you exactly what happened. Use contact details you found yourself, never ones the client supplies.

Read the client’s bank statements. At each field exam, and whenever there’s a concern, look for deposits from financed customers. Match each one to a later remittance of the same amount to the lender. A deposit with no matching remittance is a misdirected payment until proven otherwise.

Watch batched remittances. Clients who forward diverted money in round batches make matching harder, not impossible. Total the customer deposits for the period and compare them with what was turned over.

Check the notice of assignment. A customer who says it never received a notice, or received different remit-to instructions, needs a new notice right away.

A remittance listing invoices you never received money for is not a cash application problem. It is the clearest evidence of diversion you will see.

A note for non-notification deals

Diversion is harder to see when customers have never received a notice of assignment, because the lender never speaks to them as itself. That makes the client’s bank statements and customer remittances more important, not less. Ask for both as a matter of routine, not only when something looks wrong: a client that sends them every month without being asked is rarely the one you need to worry about.

What to do when you find one

Record the facts: the customer, the amount, the date, the account it reached and how you found it. Then follow your lender’s procedure. Usually that means a written demand that the client turn the funds over immediately, and tighter control of customer contact. A single honest error, corrected the same day, is a note in the file. A pattern, or a client who can’t explain the deposits, goes to your manager and may lead to stepping up to notification or collecting out the portfolio.

What you should never do is accept the client’s explanation without the bank statement to back it up. The whole value of the check is that it doesn’t depend on anyone’s word.

The fraud library’s Diverted Payments and Concealment courses work through these checks with a fictional client’s lockbox reports, bank statements and remittances, and its case scenarios show how a small diversion grows when nobody looks.