By Divij Kishore and Mohit Bhatia.Introduction.Prior to the enactment and notification of the Factoring Regulation Act, 2011 (“Factoring Act”) and the Registration of Assignment of Receivables Rules, 2012 (“Factoring Rules”) on January 22, 2012, there was no specific statute which provided the legal framework for factoring in India. The Factoring Act applies to domestic as well as cross border factoring of receivables and clarifies that any assignment of receivable shall be subject to the provisions of the Foreign Exchange Management Act, 1999 (“FEMA”)..The Factoring Act addresses inter alia issues pertaining to assignment of debt to factor, registration requirements for factors and receivables and embodies principles in relation to debtor protection. The objective of the Factoring Act is to regulate factors and the assignment of receivables in favour of such factors and delineate the rights and obligations of parties to the assignment of receivables..What is Factoring?.The Factoring Act defines the ‘Factoring Business’ as “the business of acquisition of receivables of assignor by accepting assignment of such receivables or financing, whether by way of making loans or advances or in any other manner against the security interest over any receivables”. However, 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 accounts receivable in factoring can either be for products or services. Some examples of factoring are, factoring against goods purchased, factoring for construction services, etc. In its simplest form, a factoring transaction generally involves the following steps: (i) a company (hereinafter the “Client”) enters into transactions with its customers pursuant to which the Client issues certain invoices in relation to such transactions; (ii) the Client will provide a copy of the invoice to the Factor; (iii) the receivables in relation to the Client are assigned to an eligible financial institution (hereinafter the “Factor”) after giving a notice to the customers; (iv) the Factor pays up to 80%, or in some situations, 90%, of the receivables to the Client at or around the time of execution of the definitive agreements between the Factor and the Client – this is one of the most crucial steps in the transaction as it provides short term financing to the Client; (v) the Factor collects the receivables from the customers and then pays the remaining amount to the Client when all the receivables are recovered by the Factor. The Factor generally earns a commission or a fee for providing such short term financing to the Client..Factoring of receivables is, therefore, an ideal financial solution for new and emerging firms which lack a strong financial backing as such and can leverage on the financial strength of their customers as the Factor is exposed to the credit risk of the customers instead of the Client..Disclosed Factoring and Debtor Protection Principles .Factoring as envisaged under the Factoring Act must be disclosed factoring. Disclosed factoring means that the customer (i.e., the debtor), who is liable to make the payment to the Client must be informed by way of intimation in writing that receivables from the customer are being factorized. Prior to the commencement of the Factoring Act, the assignment of receivables was governed by the Transfer of Property Act, 1882 which does not make prior notice to the debtor before the assignment of receivables. Thus, it was open to the parties to decide whether they wanted to undertake disclosed or undisclosed factoring. However, as per the provisions of the Factoring Act, prior notice to the debtor is mandatory for the assignment of receivables to the Factor..The Factoring Act embodies the principle of debtor protection and contains various safeguards in relation to the rights of a debtor (i.e., the customer) in a factoring transaction. For example, in the event no notice of assignment of receivables is given by the assignor (i.e., the Client) or under his authority by the assignee (i.e., the Factor) to the debtor and any payment is made by the debtor in respect of such receivables to the Client, then the Client is under a statutory obligation to fold such payments in trust for the benefit of the Factor which shall immediately be paid to such Factor. Further, the Factoring Act restricts the modification of the contracts entered between the debtor and the assignor (barring a few exceptions) and states that any assignment of the receivable shall not affect the rights and obligations of the debtor (including the terms and conditions of the contract), without the express consent of the debtor in writing. It is pertinent to note in this regard that in the event a claim is made by the assignee against the debtor for payment of the assigned receivable, the debtor may raise the right of set-off against the assignee which was available under the original contract entered into between the assignor and debtor or any other contract that was part of the same transaction, as if the assignment had not been made. However, the assignee would, unless otherwise agreed between the parties, be entitled to recover any loss suffered by it as a result of any such defences and right of set off being exercised by the debtor from the assignor..Registration of Factors and Receivables .The Factoring Act provides that ‘banks’, as defined in the Banking Regulation Act, 1949 are not required to be registered as factors for the purposes of carrying out the factoring business. However, Non-Banking Financial Companies (NBFCs) engaged in the factoring business are required to be registered in accordance with the provisions of the Factoring Act. Further, factoring companies other than banks, government companies, etc. are required to be registered with the Reserve Bank of India (“RBI”) as NBFCs and the same would be subject to prudential regulations by the RBI and the provisions of the RBI Act in relation to NBFCs. NBFCs that carried on the business of factoring prior to the commencement of the Factoring Act would be required to apply for registration within six months of the coming into force of the Factoring Act. The RBI has also recently issued the Non Banking Financial Company – Factoring (Reserve Bank) Directions, 2012 on July 26, 2012 and has laid down certain minimum net owned fund requirements and states that the factoring business must constitute 75% of the business of the NBFC – Factor..Every Factor is under an obligation to file the particulars of every transaction of assignment of receivables in his favour with the Central Registry to be set-up under section 20 of the Securitisation and Reconstruction of Financial Assets and Enforcement of Security Interest Act, 2002 (54 of 2002), within a period of thirty days from the date of such assignment or from the date of establishment of such registry, as the case may be. Further, upon realisation of the assigned receivables or settlement of the claim against the debtors, the Factor would be required to file for satisfaction of the assignment of receivables in its favour, in such manner and subject to payment of such fees as may be prescribed in this behalf. Further, the Factoring Rules provide the procedural requirements to be met in relation to the registration of the assignment of receivables..Cross border transactions .‘Receivables’ are very broadly defined under the Factoring Act to mean all or part of or undivided interest in any right of any person under a contract, including an international contractor, where either the assignor or the debtor or the assignee is situated or established in a State outside India; to payment of a monetary sum whether such right is existing, future, accruing, conditional or contingent. Thus, the Factoring Act covers within its scope cross-border factoring transactions where the factor, the assignor or the debtor are situated outside the territory of India..In accordance with the provisions of the Factoring Act, a Factor, Client or a customer may be located outside the territory of India and such a transaction shall be governed by the provisions of the Factoring Act and FEMA..In this regard it is pertinent to note that enforcement of foreign judgments and arbitral awards are subject to the provisions of CPC (specifically in relation to foreign judgments and reciprocating territories) and Arbitration and Conciliation Act, 1996 (“Arbitration Act”), respectively. Another significant amendment that has been made in accordance with the Factoring Act is that Rule 1(2)(b)(iv) has been inserted in Order XXXVII of the Code of Civil Procedure, 1908 (“CPC”), whereby suits for recovery of receivables instituted by an assignee shall be subject to the summary procedure prescribed under the CPC. Further, Section 8D has been inserted in the Indian Stamp Act, 1899 pursuant to the which, the assignment of receivables to a factor in accordance with the provisions of the Factoring Act shall not be liable to be stamped. Such amendments are a much needed boost to the factoring business and would aid in speedier disposal of litigations and reduce the cost of entering and enforcing factoring transactions..Conclusion.The law pertaining to factorization in India is still in a nascent stage and it is expected that the legal framework for factoring will evolve into a more comprehensive regime. Since the notification of the Factoring Act, there has been a steady increase in the number of domestic and cross border factoring transactions and corporations in need of short term financing are resorting to factoring to meet their financial needs. The Factoring Act has laid the basic legal framework for factoring in India and it is expected that the RBI will introduce further regulations in this regard as factoring becomes more prevalent in the domestic and international business circle..Mohit Bhatia and Divij Kishore are Asssociate at AZB & Partners.
By Divij Kishore and Mohit Bhatia.Introduction.Prior to the enactment and notification of the Factoring Regulation Act, 2011 (“Factoring Act”) and the Registration of Assignment of Receivables Rules, 2012 (“Factoring Rules”) on January 22, 2012, there was no specific statute which provided the legal framework for factoring in India. The Factoring Act applies to domestic as well as cross border factoring of receivables and clarifies that any assignment of receivable shall be subject to the provisions of the Foreign Exchange Management Act, 1999 (“FEMA”)..The Factoring Act addresses inter alia issues pertaining to assignment of debt to factor, registration requirements for factors and receivables and embodies principles in relation to debtor protection. The objective of the Factoring Act is to regulate factors and the assignment of receivables in favour of such factors and delineate the rights and obligations of parties to the assignment of receivables..What is Factoring?.The Factoring Act defines the ‘Factoring Business’ as “the business of acquisition of receivables of assignor by accepting assignment of such receivables or financing, whether by way of making loans or advances or in any other manner against the security interest over any receivables”. However, 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 accounts receivable in factoring can either be for products or services. Some examples of factoring are, factoring against goods purchased, factoring for construction services, etc. In its simplest form, a factoring transaction generally involves the following steps: (i) a company (hereinafter the “Client”) enters into transactions with its customers pursuant to which the Client issues certain invoices in relation to such transactions; (ii) the Client will provide a copy of the invoice to the Factor; (iii) the receivables in relation to the Client are assigned to an eligible financial institution (hereinafter the “Factor”) after giving a notice to the customers; (iv) the Factor pays up to 80%, or in some situations, 90%, of the receivables to the Client at or around the time of execution of the definitive agreements between the Factor and the Client – this is one of the most crucial steps in the transaction as it provides short term financing to the Client; (v) the Factor collects the receivables from the customers and then pays the remaining amount to the Client when all the receivables are recovered by the Factor. The Factor generally earns a commission or a fee for providing such short term financing to the Client..Factoring of receivables is, therefore, an ideal financial solution for new and emerging firms which lack a strong financial backing as such and can leverage on the financial strength of their customers as the Factor is exposed to the credit risk of the customers instead of the Client..Disclosed Factoring and Debtor Protection Principles .Factoring as envisaged under the Factoring Act must be disclosed factoring. Disclosed factoring means that the customer (i.e., the debtor), who is liable to make the payment to the Client must be informed by way of intimation in writing that receivables from the customer are being factorized. Prior to the commencement of the Factoring Act, the assignment of receivables was governed by the Transfer of Property Act, 1882 which does not make prior notice to the debtor before the assignment of receivables. Thus, it was open to the parties to decide whether they wanted to undertake disclosed or undisclosed factoring. However, as per the provisions of the Factoring Act, prior notice to the debtor is mandatory for the assignment of receivables to the Factor..The Factoring Act embodies the principle of debtor protection and contains various safeguards in relation to the rights of a debtor (i.e., the customer) in a factoring transaction. For example, in the event no notice of assignment of receivables is given by the assignor (i.e., the Client) or under his authority by the assignee (i.e., the Factor) to the debtor and any payment is made by the debtor in respect of such receivables to the Client, then the Client is under a statutory obligation to fold such payments in trust for the benefit of the Factor which shall immediately be paid to such Factor. Further, the Factoring Act restricts the modification of the contracts entered between the debtor and the assignor (barring a few exceptions) and states that any assignment of the receivable shall not affect the rights and obligations of the debtor (including the terms and conditions of the contract), without the express consent of the debtor in writing. It is pertinent to note in this regard that in the event a claim is made by the assignee against the debtor for payment of the assigned receivable, the debtor may raise the right of set-off against the assignee which was available under the original contract entered into between the assignor and debtor or any other contract that was part of the same transaction, as if the assignment had not been made. However, the assignee would, unless otherwise agreed between the parties, be entitled to recover any loss suffered by it as a result of any such defences and right of set off being exercised by the debtor from the assignor..Registration of Factors and Receivables .The Factoring Act provides that ‘banks’, as defined in the Banking Regulation Act, 1949 are not required to be registered as factors for the purposes of carrying out the factoring business. However, Non-Banking Financial Companies (NBFCs) engaged in the factoring business are required to be registered in accordance with the provisions of the Factoring Act. Further, factoring companies other than banks, government companies, etc. are required to be registered with the Reserve Bank of India (“RBI”) as NBFCs and the same would be subject to prudential regulations by the RBI and the provisions of the RBI Act in relation to NBFCs. NBFCs that carried on the business of factoring prior to the commencement of the Factoring Act would be required to apply for registration within six months of the coming into force of the Factoring Act. The RBI has also recently issued the Non Banking Financial Company – Factoring (Reserve Bank) Directions, 2012 on July 26, 2012 and has laid down certain minimum net owned fund requirements and states that the factoring business must constitute 75% of the business of the NBFC – Factor..Every Factor is under an obligation to file the particulars of every transaction of assignment of receivables in his favour with the Central Registry to be set-up under section 20 of the Securitisation and Reconstruction of Financial Assets and Enforcement of Security Interest Act, 2002 (54 of 2002), within a period of thirty days from the date of such assignment or from the date of establishment of such registry, as the case may be. Further, upon realisation of the assigned receivables or settlement of the claim against the debtors, the Factor would be required to file for satisfaction of the assignment of receivables in its favour, in such manner and subject to payment of such fees as may be prescribed in this behalf. Further, the Factoring Rules provide the procedural requirements to be met in relation to the registration of the assignment of receivables..Cross border transactions .‘Receivables’ are very broadly defined under the Factoring Act to mean all or part of or undivided interest in any right of any person under a contract, including an international contractor, where either the assignor or the debtor or the assignee is situated or established in a State outside India; to payment of a monetary sum whether such right is existing, future, accruing, conditional or contingent. Thus, the Factoring Act covers within its scope cross-border factoring transactions where the factor, the assignor or the debtor are situated outside the territory of India..In accordance with the provisions of the Factoring Act, a Factor, Client or a customer may be located outside the territory of India and such a transaction shall be governed by the provisions of the Factoring Act and FEMA..In this regard it is pertinent to note that enforcement of foreign judgments and arbitral awards are subject to the provisions of CPC (specifically in relation to foreign judgments and reciprocating territories) and Arbitration and Conciliation Act, 1996 (“Arbitration Act”), respectively. Another significant amendment that has been made in accordance with the Factoring Act is that Rule 1(2)(b)(iv) has been inserted in Order XXXVII of the Code of Civil Procedure, 1908 (“CPC”), whereby suits for recovery of receivables instituted by an assignee shall be subject to the summary procedure prescribed under the CPC. Further, Section 8D has been inserted in the Indian Stamp Act, 1899 pursuant to the which, the assignment of receivables to a factor in accordance with the provisions of the Factoring Act shall not be liable to be stamped. Such amendments are a much needed boost to the factoring business and would aid in speedier disposal of litigations and reduce the cost of entering and enforcing factoring transactions..Conclusion.The law pertaining to factorization in India is still in a nascent stage and it is expected that the legal framework for factoring will evolve into a more comprehensive regime. Since the notification of the Factoring Act, there has been a steady increase in the number of domestic and cross border factoring transactions and corporations in need of short term financing are resorting to factoring to meet their financial needs. The Factoring Act has laid the basic legal framework for factoring in India and it is expected that the RBI will introduce further regulations in this regard as factoring becomes more prevalent in the domestic and international business circle..Mohit Bhatia and Divij Kishore are Asssociate at AZB & Partners.
