I. Introduction
Factoring Business defined under The Factoring Regulation (Amendment) Act, 2021:
“factoring business” means the business of acquisition by way of assignment of receivables of assignor for a consideration for the purpose of collection of such receivables or for financing, whether by way of making loans or advances or otherwise, against such assignment but does not include— (i) credit facilities provided by a bank in its ordinary course of business against security of receivables; (ii) any activity as commission agent or otherwise for sale of agricultural produce or goods of any kind whatsoever or any activity relating to the production, storage, supply, distribution, acquisition or control of such produce or goods or provision of any services.
Receivables defined under The Factoring Regulation (Amendment) Act, 2021:
“receivables” means the money owed by a debtor and not yet paid to the assignor for goods or services and includes payment of any sum, by whatever name called, required to be paid for the toll or for the use of any infrastructure facility or services.
It may however be noted that the credit facilities provided by banks in the ordinary course of business against security of receivables and any activity undertaken as a commission agent or otherwise for sale of agricultural produce or goods of any kind whatsoever and related activities are expressly excluded from the definition of Factoring Business. The Factoring Act has laid the basic legal framework for factoring in India.
II. Types of Factoring Business in India
Invoice Factoring: Invoice factoring is a type of financing facility in which the company sells some of its outstanding invoices to the factoring company. The factoring company, in turn, pays around 80-90% of the invoice amount immediately. The rest is paid when customers make the actual payment to the factoring company. The factoring company will deduct its fee when making the balance payment.Recourse Factoring: A company that factors with recourse is one that works with a Factor that lends against the accounts receivable using them as collateral to advance funds. Typically, recourse factoring requires the personal guaranteeof management or the owners because the owners must maintain liquidity to purchase back any non-performing accounts receivable taken as collateral by the Factor.The company is still ultimately liable for the invoices if they remain unpaid past their due date. Any invoice that is non-collectible or in dispute is sold back to the company. Recourse Factors can offer higher advances and lower factor fees when purchasing the invoices under recourse factoring facilities.Non-Recourse Factoring: A Factor that executes an invoice purchase agreement with a company without asking the company to repurchase unpaid or past due accounts receivable is automatically non-recourse. In a non-recourse arrangement, the Factor assumes the credit risk and liability of non-payment on a factored invoice. Non-Recourse Factors are often compensated differently for taking the credit risk away from the company. Advance rates may be lower and factor fees may be higher when compared to recourse factoring. Since the Factor is taking on more risk in a non-recourse transaction, to qualify the company’s customer, they must have an extensive history of prompt on-time payments and meet the credit requirements of the Factor.Reverse Factoring: Reverse factoring is a type of supplier finance solution that companies can use to offer early payments to their suppliers based on approved invoices. Suppliers participating in a reverse factoring program can request early payment on invoices from the bank or other finance provider, with the buyer sending payment to the financial institution on the invoice maturity date. By giving suppliers access to reverse factoring, buyers can reduce the risk of disruption in their supply chains and strengthen their supplier relationships, while also improving their own working capital position.
III. Factoring Business Process
There are three parties involved in this process:
Assignor/Company- Owner of the receivable.Factor- NBFC or Bank where:50% or more of its income and financial assets must be attributed to factoring business.Certificate of registration need to obtained by it from RBI.
(After the proposed amendment Bill, 2020- all NBFCs will be permitted to do factoring. Banks can do factoring without prior approval of RBI.)
Debtor- Person liable to the assignor to pay any receivable or discharge an obligation in respect of the receivable.
(The nature of receivable could be existing, accruing, future, conditional or contingent.)
Process:
As depicted in the image above, the process involved in the factoring business in India is as follows:
Step 1 – A company sells good on credit to its debtor.Step 2 – The company, in order to get quick term short financing and mitigate the risk associated with the payment delays and defaults by the buyer assigns the receivables to a factor.Step 3 – A factor makes payment to the company at a discount.Step 4 – On the expiry of credit period, the debtor of the company will make full payment to the factor, not to the company.Step 5 – The difference between full payment received by the factor and discounted payment made to the company is the profit for the factor.
IV.Benefits of Factoring
Factoring provides a quick boost to cashflow. This may be very valuable for businesses that are short of working capital.It can be a cost-effective way of outsourcing the company’s sales ledger while freeing up the company’s time to manage the business.It assists smoother cashflow and financial planning.Some customers may respect factors and pay more quickly.Factors may give you useful information about the credit standing of your customers and they can help you to negotiate better terms with your suppliers.Factors can prove an excellent strategic – as well as financial – resource when planning business growth.The company will be protected from bad debts if they choose non-recourse factoring.Cash is released as soon as orders are invoiced and is available for capital investment and funding of the next orders.Factors will credit check the customers and can help the business trade with better quality customers.
V. Registration of a Factor
Registration of Factor NBFCs and Companies are mandatorily required to obtain a registration certificate from the RBI to carry on the factoring business as per the regulations issued by the said authority. Further, the Banks and Statutory Corporations that act as a Factor are required to follow the rules and regulations and directions or guidelines issued by RBI. The registration of Companies and NBFCs intending to undertake factoring business are required to obtain registration under the Master Direction – Non-Banking Financial Company –Non-Systemically Important Non-Deposit taking Company (Reserve Bank) Directions, 2016.
VI.Rights and Duties of Parties
Debtor
The debtor has the right to get a notice from the assignee.The debtor has obligation to pay the receivables as per the original contract to the assignee and such payments will fully discharge the debtor from associated liability there under the original contract.
Assignee/Factor
The assignee has the right to collect the payment from Debtor.The assignee has the obligation to give notice to the debtor for the payment.The assignee has an obligation not to demand the debtor for the payment of receivables without giving prior notice.
Assignor/Company
The obligation of the Assignor is to pay the assignee when the receivables are paid to the assignor by the debtor.
If the amount payable by the debtor is delayed and the business is the micro or small MSME. Then the assignee needs to receive interest for the delayed period as per the provisions of the Micro, Small, and Medium Enterprises Development Act, 2006 (27 of 2006).
VII. Legislations involved
The Factoring Regulation Act,2011
This act provides procedure for the registration of assignments of receivables. It sets out the rights and obligations of parties to an assignment contract and covers matters connected with the assignment itself or incidental thereto.
The Factoring Regulation (Amendment)Act, 2021
This act has bought some amendments to the presiding law for more effectiveness of the law and procedure.
Micro Small and Medium Enterprise Development Act, 2006
This law relates to facilitating the growth and development of micro, small, and medium-sized businesses, increasing their competitiveness, and addressing issues related to or incidental to those developments.
VII.Latest Amendments
Trade Receivables Discounting System has been introduced in The Factoring Regulation (Amendment) Act, 2021.
TReDS is an electronic platform that helps businesses get financing for their trade receivables. This can be done through several lenders, which makes it a convenient way to get loans for small businesses. To improve operational efficiency, the Trade Receivables Discounting System (TReDS) is authorized by the Act to report the specifics of receivables assignment transactions to the Central Registry on behalf of the Factors. The Act also gives the Reserve Bank of India the authority to issue regulations that specify how certificates of registration are granted and how TReDS must file assignments of receivables transactions on behalf of the Factors.
Registration of Factors Regulations, 2022
There was a notification that came up on January 14th, 2022, from RBI regarding the process of granting certificates to factoring businesses.
Registration of assignment of receivables Regulations, 2022
Later there was another notification came up on January 17th from The Reserve Bank of India, hereunder issuing regulations that govern the filing of particulars of transactions with the Central Registry on behalf of Factors by a Trade Receivable Discounting System (TReDS).
Author: Abhishek Gupta, Senior Associate.
Disclaimer: The content of this article is intended to provide a general guide to the subject matter and that the same shall not be treated as legal advice. For any queries, the author can be reached at abhishek@samistilegal.in.
