Factoring is an asset-based finance product where the credit extended is based on the value of the borrower's accounts receivable or the payments owed by the borrower's customers. This asset-based lending is purchase of receivables by the factor rather than using it as collateral in a loan. That is, under Factoring, the title and ownership of the receivables shift from the seller to the factor. Factoring also typically involves more than just financing and generally includes two other services: credit and collections.
Shortage of working capital is a common problem for businesses throughout the world as a bulk of corporate funds is locked up in receivables. A finance product to finance receivables allows funds to be released without waiting for the debts to mature for payment. This method increases overall liquidity position and allows the corporate to finance new commercial ventures. Factoring is a transaction of sale and purchase of existing non-matured or future short-term receivables arising from agreements on the sale of goods or provision of services, either nationally or internationally. The maturity of receivables may even be up to 180 days from the date of sale of goods or provision of services.
Factoring has been defined in the Civil Code of a country: "Under the contract of financing for assignment of the monetary claim, one party (the finance agent) transfers or undertakes to transfer to the other party (the client) monetary funds with reference to a monetary claim of the client (creditor) against a third party (the debtor) arising from the supply of goods, performance of works or provision of services by the client to the third party, and the client assigns or undertakes the duty to assign that monetary claim to the finance agent." Factoring is presumed to be non-recourse, unless otherwise stipulated in the contract as refereed as: "Unless otherwise provided by the contract between the client and the finance agent, the client is not liable for non-performance or improper performance of the assigned claim by the debtor …"
Unidroit Convention on International Factoring (28 May 1988) came to a conscious that International Factoring has a significant role to play in the development of international trade. It has given due importance to adopting uniform rules to provide a legal framework that will facilitate international factoring, while maintaining a fair balance of interests between the different parties involved in factoring transactions.
Factoring is usually contracted as a complex partnership agreement, covering a range of business services based on two main functions: financing and administration of receivables. Unidroit Convention on International Factoring (1988) came to conclusion that "Factoring contract" means a contract concluded between one party (the supplier) and another party (the factor) pursuant to which:(a) the supplier may or will assign to the factor receivables arising from contracts of sale of goods made between the supplier and its customers (debtors) other than those for the sale of goods bought primarily for their personal, family or household use; (b) the factor is to perform at least two of the following functions: (i)- finance for the supplier, including loans and advance payments; (ii) - maintenance of accounts (ledgering) relating to the receivables; (iii)- collection of receivables; and (iv) - protection against default in payment by debtors. By combining these functions, the Factoring market has developed various types of products that require different and specific contract law considerations, not legally supported in every jurisdiction.
Factoring provides services such as domestic and international Factoring, Factoring with recourse and without recourse and reverse Factoring. Additionally, a Factoring company is assigned to perform services which are directly or indirectly related to the business of factoring, in particular: (a) the gathering, producing, analysing and giving of information about the creditworthiness of legal entities and natural persons which are self-employed; (b) managing the client's receivables arising from sale of goods, provision of services and consultations in relation to these; (c) export financing on the basis of a purchase with a discount and without recourse to long-term, still undue claims on secured financial instruments (forfeiting); (d) purchase of due claims (under certain conditions); (e) discounting bills of exchange issued based on the sale of goods or provision of services and (f) issuing credit cover when performing foreign factoring.
Bangladesh is not a member of the UNIDROIT, The Convention on International Factoring or UNCITRAL Convention on the Assignment of Receivables in International Trade. There is neither a law on Factoring nor special contract law provisions for Factoring in general. No special definition of Factoring or Factoring types exists in the existing legislative framework. Some of the financial institutions use discount invoice/bill against some local transactions. There are some overseas companies (PrimaDollar and DS Concept) offering export trade finance services, which are close to factoring. It is understood that Bangladesh Bank is in the process of formulating a policy on Factoring, particularly International Factoring and more specifically Factoring for export trade.
Factoring can be seen as simply an assignment of accounts receivable, which is possible in the majority if not all jurisdictions. Due to the lack of understanding of the product in a developing environment and due to the lack of developed case law and the tradition of publishing judicial decisions, this sometimes creates uncertainties in relation to interpretation of contracts and hence increases perceived risks and/or stifles creativity of business practices.
Of late, many of the countries have started working on or have already introduced specialised laws on Factoring. There are still some countries where there are no special provisions on Factoring contracts or established and published court practice that would compensate for this lack of clarity.
The Unidroit Convention (1988) does not require that the agreement complies with specific formalities. These are left to be regulated by national law. India passed The Factoring Regulations Act, 2011 while USA and some other countries have law on Factoring and some have incorporated it in the code of civil procedure. China regulates Factoring under law of contract and some guidelines of court. Armenia does not have a special law on factoring, but a chapter of the Civil Code (Chapter 48 - "Financing upon assignment of monetary claim (Factoring)") is dedicated thereto. Some countries regulate Factoring by Banking law or law of Non-Banking Financial Institutions. Instead, in these countries the factoring framework constitutes only of general contract law provisions. Many countries have either adopted a specific code on factoring or their civil code contains some specific provisions on factoring. A number of countries do not have specific contract law rules on factoring. This is why parties there rely on the general assignment provisions when drafting contracts.
Both Civil Code and Banking Code contain a definition of a contract of financing against assignment of monetary claims (Factoring), which are quite similar. The lack of clear definitions or long established court practice increases legal risks thus, influencing on the price and competiveness of factoring.
Both monetary claims-the payment under which it is already due (existing claim) and the right to claim payment that will arise in the future (future claim)-can be assigned to a Factoring company.
As regards the types of factoring, the rule indicates that the factoring company becomes an owner of assigned claims, thus it should be entitled to dispose of such claims including by negotiating/ restructuring their terms. No conditions are stipulated in the law with respect to such disposal.
A third type of an approach that is somewhat of a middle ground approach is represented by countries regulating factoring industry as a type of a financial service but stopping short from subjecting it to extensive capital requirements. This type of regulatory approach usually consists of introducing regulators/supervisors authorised to issue operating licenses, approve managers, review business plans and financial reports, control start-up capital and conduct occasional on-sight inspections.
Bangladesh needs either a law or a rule to regulate Factoring for smooth operation of Factoring companies. In a proper legal atmosphere, a good environment for regulating factoring companies is usually subject to capital adequacy rules and prudential risk-based supervision of their supervisors. On the other hand, in jurisdictions where factoring is not at all considered a regulated financial service, each factoring company has the liberty to operate according to its own corporate rules and contractual relationships being usually subject only to anti-money laundering laws.
Bangladesh should either make a law and or rule so that local and overseas companies come forward with Factoring services to support both local and import and export trade.
M S Siddiqui is a Legal Economist.