Introduction to factoring, history, introduction to act, important features of the act, rights, obligation, responsibility, penality, shortcomings of the act.

1. FACTORING REGULATION
ACT, 2011

2. Factoring is a financial transaction whereby a business
sells its accounts receivable i.e. invoices to a third party
called a factor at a discount in exchange for immediate
money with which to finance continued business
Factoring differs from a bank loan in three main ways:
First, the emphasis is on the value of the receivables
(essentially a financial asset), not the firm’s credit
worthiness
Secondly, factoring is not a loan - It is the purchase
of a financial asset(the receivable). Finally a bank loan
involves two parties whereas factoring involves three.
FACTORING

3.  In this example, a factoring client has a ₹1,00,000 invoice
that they need to finance. This invoice is from a pre-
approved customer who has great credit and often pays in
30 days or less.
 The client gets the following terms from the factoring
company:
 Advance rate: 85%
 Fees: 2 % per 30 days
EXAMPLE

4. Mechanics of factoring

5. ▪ Through the use of factoring receivables are instantly converted
into cash leading to improved cash flows that can help funding of
future growth
▪ It facilitate an efficient follow up of payments from buyers, which
is made possible through relationships developed by factors with
client buyers
▪ Factoring provides credit protection for export sales which
enables to do business with buyers who are unwilling to open
letters of credit
▪ Factoring also provides other peripheral services such as advisory
services, credit assessment.
Why use factoring?

6. ▪ There are basically two types of factoring arrangements:
▪ Domestic factoring –If you are selling in India.
▪ The factoring arrangement where all the three –the factor, the
seller & the buyer are in the same country subject to the
same laws.
▪ International factoring - If you are exporting from India.
The factoring arrangement where the seller & the buyer are in
two different countries involving co-operation between two
factoring companies, one in the seller’s country (export factor)
and other in the buyers country (import factor).
What are the types of factoring
arrangement?

7. Recourse factoring
 In this type of factoring arrangement, the factor provides all
types of facilities except debt protection. In other words, the
client is responsible for any bad debts incurred.
 Invoice discounting-in this type of factoring arrangement only
finance is provided and no other service is offered.
 Up to 75% to 85% of the invoices receivable is factored.
 Interest is charged from the date of advance to the date of
collection.
 Factor purchases Receivables on the condition that loss
arising on account of non-recovery will be borne by the client.
 Credit Risk is with the Client.
 Factor does not participate in the credit sanction process.
 In India, factoring is done with Recourse.
DOMESTIC FACTORING

8. Non-Recourse factoring- It is the most
comprehensive type of factoring arrangement offering all
types of services namely:
 Finance
 Sales ledger administration
 Collection
 Debt protection
 Advisory services
It gives protection against bad debts to the client. In
other words, in case the customer fails to pay, the factor
will have “no recourse” to the client and will have to
absorb the bad debts himself.
DOMESTIC FACTORING

9. INTERNATIONAL FACTORING
1. Single / Direct Factoring System-In this system, a special
agreement is signed between two Factoring companies for single
Factoring. Whereas in Two Factor System, credit is provided by import
Factor and pre-payment, book keeping and collection responsibilities
remain with export Factor.
For this system to be effective there should be strong co-ordination and co-
operation between two Factoring companies. Pricing is lower when
compared to Two Factor System.
2. Direct Export Factoring-Here only one Factoring company is
involved, i.e., export Factor, which provides all services including finance to
the exporter.

10. 3. Direct Import Factoring-Under this system, the
seller chooses to work directly with Factor of the importing
country. The Factoring agreement is executed between the
exporter and the import Factor. The import Factor is
responsible for sales ledger administration, collection of debts
and providing bad debt protection up to the agreed level of
risk cover.
4. Back to Back Factoring-It is a very specialized form
of International Factoring, used when suppliers are selling
large volumes to a few debtors for which it is difficult to cover
the credit risk in International Factoring.
In this case, International Factor can sign a domestic
Factoring agreement with the debtor whereby it will be getting
the receivables as security for the credit risk taken in favor of
Export Factor.
INTERNATIONAL FACTORING

11. ▪ The factor does not follow up or collect payments from the
customer. The customer may not be aware of the factoring
arrangement and pays the client directly. The factor receives
payment of invoices through the client.
Factoring charges
▪ Finance charge-it represents the interest on funds made
available to the client by way of prepayment against purchase
of approved invoices.
▪ Service charge-the charge levied for rendering non-funding
services such as collection, sales ledger maintenance & other
advisory services.
How much advance client can get?
Advances are made as a % of invoice value based on
criteria, such as, quality of receivables no. & quality of buyers &
clients requirements. Typically 80 % of invoice value is
advanced.
Undisclosed factoring or open
account receivables

12. To the client:
 Competitive credit terms
 Accelerate the production cycle
 Free from tensions
 Efficient working capital management
 Assessing quality of debtors
 Expansion of business
To the buyers:
 Adequate credit facilities
 Getting periodical statement from the factor
 No effect on quality of goods, contractual obligations
etc.
Advantages

13. a) Where large volume of cash sales takes place
b) Engaged in speculative business
c) Selling highly specialized capital equipment's or made to order
goods
d) Where credit period offered to the buyers is more than 180 days
e) Where there is consignment sales or sale or return
arrangements.
f) Where sales are to the sister/associated companies.
g) Where sales are to the public at large,etc.
factoring is not suitable under
following cases:

14. There are three elements of factoring costs:
Service fee
Discount charge
One time setup fee
What is disclosed and undisclosed factoring?
In disclose factoring, the debtor is informed of the assignment of debts
to the factor. Alternatively, under undisclosed factoring, the debtor is
not informed of the agreement entered into between the seller and the
factor. Most of the cases disclosed factoring is happening
where
CB is the cash balance
nCF is the average negative cash flow in a given period
i is the [discount rate] that cover the factoring costs
r is the rate of return on the firm's assets.
COST INVOLVED IN FACTORING

15.  Though both factoring and bill discounting provides short term
finance, however in bill discounting the drawer undertakes the
responsibility of collecting the bills and pay the proceeds while in
factoring it is the factor that usually undertakes the responsibility of
collecting the bills. Given below are some more differences between
the two.
 Bill discounting is always of recourse type while factoring can be
either with or without recourse. In case of recourse the factor does
not assume the credit risk and it is the company which assumes the
credit risk
 Factoring is an off balance sheet entry in the sense that both amount
of receivables and bank credit are not shown in the balance sheet
which is not the case with the bill discounting which is shown in the
balance sheet.
DIFFERENCE BETWEEN FACTORING
& BILL DISCOUNTING

16.  In bill discounting there is only provision of finance while in
factoring factor provides in addition to finance facility other
facilities like sales ledger maintenance, collection etc.
 Discounted bills may be re-discounted several times before
they mature for payment which is not the case with
factoring.
DIFFERENCE BETWEEN FACTORING &
BILL DISCOUNTING

17.  Almost since the dawn of civilization ,there has been factoring
 Mesopotamians used factoring in their business dealings
 The ancient Romans used a form of factoring by selling promissory
notes on a secondary market at a discount
 The Code of Hammurabi is a code of laws set down by the 6th
Babylonian King, Hammurabi in 18th BCE. It is one of the 1st
preserved written records that mentions factoring type
transactions.
As civilization developed, other forms of financing began to form.
However, factoring remained a major funding option. Ancient
Roman merchants used agents to guarantee trade credits .
These agents came to be known as factors.
 Factoring gained true popularity in trade between their American
colonists & their European buyers.
THE HISTORY OF FACTORING

18. ● Prior to American Revolution , merchants in colonies sent raw materials to
British merchants, however sending goods over long distances could get
expensive & waiting for payment to come back caused delays in processing
new orders. In order to get around these problems European merchants paid
in advance so that they can continue their operations.
● Factoring became a prominent practice in Elizabethan England, as the British
Empire sought to colonize the New World. The East India Company and The
Hudson Bay Trading Company both used invoice factoring as they
established their dominant commercial empire during the Age of Discovery.
● The Massachusetts Bay Colony operated with a team of factors that made
other colonial trading companies realize the benefits of factoring. With the rise
of the textile industry in the 1800s, factoring became a popular method of
domestic financing as well.

19. • With Industrial Revolution the focus of factoring changed
•
Credit became more important to factoring
•
The credit of company was itself not as important as credit of its
clients.
Factors helped companies figure out which companies were the
most creditworthy. This way factors could help companies keep their
cash flow moving
•
Before 1930’s most popular industries for factoring were garment &
Textile Industries. These industries rely on raw materials. Here
factoring was used so that companies could continue to buy raw
materials to produce textiles
•
After WWII , it became evident that factoring could work effectively
for any business that invoiced others.

20. The United Nations Convention on the Assignment of
Receivables in International Trade was adopted to
facilitated availability of credit and capital. Article 2 of the
Convention defines Assignment as –
“Assignment” means the transfer by agreement from one
person (“assignor”) to another person (“assignee”) of all or
part of or an undivided interest in the assignor’s
contractual right to payment of a monetary sum
(“receivable”) from a
third person (“the debtor”). The creation of rights in
receivables as security for indebtedness or other obligation
is deemed to be a transfer
INTERNATIONAL MODEL LAW
(UNCITRAL)

21. The Convention generally does not apply to domestic assignments of
domestic receivables, but some of the clauses as stated are relevant
adaption and include
the following:
● Notice of assignment of receivables is required to be given to the
debtor and is effective when received by the debtor. An assignment
does not affect the rights and obligations of the debtor, without the
consent of the debtor
● The assignee may not retain more than the value of its rights in the
receivables
● The assignor makes representation that the debtor shall not have the
right of setoff
● The law of the State in which the assignor is located governs the
priority of the right of an assignee in the assigned receivable over the
right of a competing claimant.

22. Factoring is of recent origin in Indian context
Factoring activities, like other modes of financing, had to
operate within the existing laws such as the Indian
Contract Act, the Indian Sale of Goods Act, the Transfer
of Property Act etc.
The Committee appointed by the Government for
reviewing the working of the monetary system(1986),Vaghul
Committee on Money Market Reforms (1987) all
highlighted the need for factoring laws.
The Reserve Bank of India (RBI) constituted a Study Group in
1988 under the chairmanship of Shri C.S. Kalyansundaram,
former Managing Director, State Bank of India for
examining the feasibility and mechanics of starting
factoring organisations in the country and making
recommendations regarding its theory, constitution,
organisational set up, scope of activities and other
related matters.
FACTORING IN INDEPENDENT INDIA

23. ● Banking Regulation Act, 1949, was amended in 1991 for banks setting up
factoring services.RBI has permitted banks to undertake factoring
services through subsidiaries.SBI/Canara Bank have set up their
factoring subsidiaries :-
SBI Factors ltd. (April 1991)
Can Bank factors ltd. (August 1991)
● Apart from the two companies mentioned above, a few players have also
entered into the field of factoring viz.,
Export Credit Guarantee Corporation of India Ltd.,
IFCI Factors Ltd.,
Small Industries Development Bank of India,
Standard Chartered Bank,
The Hongkong and Shanghai Banking Corporation Ltd Non-
Banking Financial Companies (NBFCs)
● A special law, viz Interest on Delayed Payments to Small Scale and
Ancillary Industrial Undertakings Act, was enacted in 1993, which was
later incorporated into the Micro Small and Medium Enterprises Act,
2006. But in practice, these legislations did not improve the position of
MSEs because of their dependence on large businesses for continued
business.

24. ● The report of the S.P. Gupta Group (Study Group on Development of
Small Enterprises, 2000) recommended that in order to mitigate
the post sale problems of SSI there is a need to encourage bills
culture without recourse to SSI
● Report of the National Commission on Enterprises in
Unorganised Sector, 2009 recommended that Innovative
financing instruments such as factoring, venture capital, credit
rating, and a single multipurpose Swarojgar Credit Card for the
unorganised sector on the pattern of Kisan Credit Card with a limit of
up to Rs. 10 lakh may be introduced

25. ▪ No of factoring companies -08
▪ From domestic factoring turnover- 1450(million euros)
▪ From international factoring turnover- 175 million euros
▪ From total factoring turnover-1625 million euros.
▪ Large no of industries :
▪ Covered under factoring, including automobiles,
pharmaceuticals, textile, garment & engineering.
▪ In addition to the manufacturing sector, the services
sector industries, such as, travelling,
telecommunications, software services etc. are suitable
for factoring services.
Factoring profile India

26. ● As per FCI, the Global turnover of factored debt i.e. the value of
sales invoices factored /funded in 2013 was Euro 2.2 Trillion. One
would feel that a large country like India would have a significant
share of this. Unfortunately that has not been the case as factoring
business over the last decade or so has failed to take off in India. As
per reported data, India’s factoring turnover in 2013 was Euro 5240
Million i.e. 0.23 % share! Always compared with China in many
fields, we were way behind China’s turnover of Euro 378,128 Million
i.e. China’s turnover was 72 times more!! Even Taiwan and
Singapore are way ahead
● India still has limited no of players engaged in providing factoring
services. Problems facing the sector are :
 Mis-selling
 Wrong Market Segmentation
 Weak Legal System for Recoveries
 Rampant Fraud and Collusion
 Excessive Transactional Documentation

27.  An act to provide for and regulate assignment of receivables
by making provisions for registration therefor and rights and
obligations of parties to contract for assignment of
receivables and for matters connected therewith or incidental
thereto.
 The Act has 7 Chapters and 35 Sections
ACT EXPLAINED
Chapter 1 Preliminary
Chapter 2 Registration of Factors
Chapter 3 Assignment of Receivables
Chapter 4 Rights and Obligations
Chapter 5 Registration of Assignments
Chapter 6 Offence and Penalties
Chapter 7 Miscellaneous

28. ● Any company can commence Factoring by obtaining registration from
the RBI as a non-banking finance company. Such registration shall be
governed by the existing law applicable to NBFCs (Chapter IIIB of the
RBI Act, 1934) as well as the new Factoring Regulation Act, 2011.
● Banks or corporations established under an Act of Parliament can
also undertake factoring without being required to obtain registration
from RBI. Thus, organisations like NHB, SIDBI, EXIM Bank can also
undertake factoring.
● Definition of factoring also includes assignment of export receivables
and thus includes 'forfaiting', subject to the requirements of the
Foreign Exchange Management Act.
● Term receivables are widely defined to include toll or any other
charges payable for use of infrastructure facilities. However, bank
loans are excluded from the definition of receivables.

29.  The law applies to all business entities i.e. large, medium,
small and micro entities, whether engaged in any
manufacturing activity or trading or providing any services or
in any other business activity. Applicability of the new law is,
therefore, much wider and even large industrial houses and
multinational corporations can avail factoring services
 The definition of 'factoring' covers both, with recourse and
without recourse factoring
 The law requires that all transactions of assignment of
receivables in favour of Factors shall be registered with the
Central Registry established under the SARFAESI Act, 2002.
The registry record shall be available for search by the public
 Factors are declared to be credit institutions for the purposes
of Credit Information Companies (Regulation) Act, 2005 and
can have access to credit information relating to firms
availing factoring services

30.  Factors are not financial institutions for the purposes
of SARFAESI Act and hence will not have rights of
enforcement without the intervention of courts. But
provisions of the Code of Civil Procedure, 1908
regarding summary suits are made applicable to
claims of Factors to facilitate speedy recovery of
receivables
 The most important provision in the Act is insertion of
section 8D in the Indian Stamp Act, 1899, granting
exemption from stamp duty on documents executed for
the purpose of assignment of receivables in favour of
Factors notwithstanding anything to the contrary
contained in any other law in force. In view of such
exemption, assignment of receivables in favour of
Factors becomes a viable proposition and is expected
to give a boost to factoring

31.  While the intent of the Bill may be to stimulate the growth of
factoring business in India,but a close look at the Bill does not
enumerate so. The Act is a regulation Act, but the
much need is for a Bill to promote factoring and not so much
to regulate
 Section 2 (a) of the Bill defines assignment means ” transfer
by agreement, of undivided interest of any assignor in any
receivables due from any debtor.The definition talks about
undivided interest to be assigned only and does not consider
assignment of fractional interest within its ambit. This would
mean that any assignment of fractional interest would not be
covered under this definition.Further whether the assignment
could be in terms of money, in terms of time or rate of interest
is not clear from the definition.
ANALYSIS

32. ● Section 3(1) of the Bill says –“No Factor shall commence or carry on
the factoring business unless it obtains a certificate of registration
from the Reserve Bank to commence or carry on the factoring
business under this Act.”
The definition should have said no ‘person’ shall commence or carry
on the factoring business rather than using the term factor. A person
shall only become a factor after obtaining a certificate of registration
from the Reserve Bank as the section suggests. However the section
already terms such person as factor, making the definition circular.
● Section 3(3) of the Bill states every company carrying or
commencing factoring business to be registered with RBI, and such
companies would be classified as NBFCs and all the provisions
applicable to NBFCs would be applicable here as
well. Section 3(4) requires existing NBFCs to take a fresh certificate
of registration, if they are principally engaged in the business of
factoring. However the question to be considered is whether
companies carrying out the business of factoring can be classified as
NBFCs as per the definition provided in Section 45I(c) and Section
45I (f) of the Reserve Bank of India Act, 1934.

33. ● Section 7(3) states that in case the receivables are encumbered to any
creditor, the assignee shall pay the consideration for such assignment
to the creditor to whom the receivables have been encumbered. In
case of fixed charge created over assets, the provisions of this section
are well thought, as, if the consideration was paid to the assignor, it
would have resulted in double funding. However in case of floating
charges, this would render several difficulties for the assignor
● Section 8 of the Bill requires the notice of assignment to be given to
the debtor, without which the assignee shall not be entitled to demand
payment of the receivables from the debtor. However Section 7(2) of
the Act, makes Section 8 redundant, as it states that on execution of
agreement in writing for assignment of receivables, the assignee shall
have ‘absolute right to recover such receivable and exercise all the
rights and remedies of the assignor whether by way of damages or
otherwise, or whether notice of assignment as provided in sub-section
(1) of section 8 is given or not.’

34. ● Import factoring is not permitted as per Section 31(1) of the Act
Further recourse to the assignor is not permitted under the Act
● The Act is silent about non recourse factoring
● The need was to bring in a set of rules which would promote
Factoring and make Factors co-exist with banks and share the risks
and security available. The law explicitly requires Factors to seek
borrower’s existing banks’ consent before lending against receivables
assigned to it. With banks in no mood to lose any business, this has
been a non starter in most cases
● The law solve or streamline the fundamental requirement of issuance
of notice of assignment to the debtor. Thus, while issues of product
awareness, growth and cooperation between banks and factors still
remain unaddressed, the effort has been to primarily protect factors if
and when they need to recover

35.  The real unmet demand for credit flow is from the lower
/micro SMEs which have difficulty in availing funding. As
per an IFC Washington-Intellecap research done in 2012,
as much as INR 3.7 Trillions was the ‘viable and
addressable credit demand’ which organized players can
tap
 One way to tap this could be to act like a banker i.e. set
up a funding account which would be have a ‘dynamic’
credit limit based on the level of approved receivables
and in addition also take control of the borrower’s
current account by converting it into a de-facto
collection account thereby trapping all inflows to set off
advances made. All invoicing can be routed thru the
factor to avoid fraud. Investment in shared technology
platforms will be a useful investment.
WAY FORWARD

36. ● Instead of operating purely as standalone outfits, Factors should
consider joining hands with entities where mutually beneficial product
solutions can be designed and offered. For instance, alliance with
smaller banks for funding receivables of their small clients can be done
● Combine Factoring- Leasing and Supply Chain finance solutions which
together represent a powerful set of cash flow solutions for growing
manufacturing companies
● Tap the e-commerce boom in the B2B segment. Clearly an opportunity
which regular NBFCs have started to tap. Factors need build
technology platforms to offer a seam receivables finance services. E
commerce majors like Flipkart, Snapdeal, Amazon etc already have
dedicated divisions for financing vendors. High time that the Factoring
companies are incentivised in that direction
● Factors can do with such support .MUDRA Bank will have a corpus for
issuing guarantees which must be tapped

37. ● Launch joint awareness and education program for market
development. There remains a crying need to educate the market and
build awareness. All parties should come together and use the
network of entities like NSIC /SIDBI/ MSME –DIs and large MSME
associations to spread awareness
● Debt protection to Factors and Non recourse factoring to assignors.
The new Bankruptcy code should look into it
● Community factoring should be given legal backing and should be
incentivised. Co-operatives and Guilds should be used for this
purpose