Factoring
works mainly on the principle of seller selling the receivables of a debtor to
a specialized financial intermediary called a factor. The sale of the
receivables takes place at a discount and the ownership of the receivables is
transferred to the factor who shall on purchase of receivables, collect the
dues from the debtor instead of the seller, enabling the seller to receive
upfront funds from the factor. This allows companies to receive immediate cash
on their sales without having to wait for payments to come in from customers in
due course. With the purchase of the receivables the factor enters the shoes of
the seller and dawns the liability under the contract.
The
business of factoring in India is regulated by the Factoring Regulation Act, 2011 (‘Act’)[1]. The Act
defines the terms ‘factoring business’ and ‘factor’.
Section
2(i) of the Factoring Regulation Act, 2011defines factor to mean:
“a non-banking financial company as defined in clause (f) of section 45-I of the
Reserve Bank of India Act, 1934 (2 of 1934) which has been granted a certificate of registration under sub-section (1) of section 3 or any
body corporate established under an Act of Parliament or any State Legislature
or any Bank or any company registered under the Companies Act, 1956 (1 of 1956) engaged in
the factoring business;”(Emphasis Supplied);
Further,
Section 2(j) of the Act defines factoring business which states that:
“factoring
business means 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
otherwise against the security interest over any receivables 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” (Emphasis
Supplied)
Further
Explanation under the Section 3(2) of theAct defines the principal business criteria for an NBFC-Factor. It states that:
For
the removal of doubts it is hereby clarified that a non-banking financial
company engaged in factoring business shall be treated as engaged in factoring
business as its “principal business” if it fulfils the following conditions,
namely:—
(a)
if its financial assets in the factoring business are more than fifty per cent.
of its total assets or such per cent. as may be stipulated by the Reserve Bank;
and
(b)
if its income from factoring business is more than fifty per cent. of the gross
income or such per cent. as may be stipulated by the Reserve Bank.
Given
the above pretext, it is clear that an NBFC principally engaged in the
factoring business will be referred to as a Factor under the Factoring
Regulation Act, 2011.
For
the purpose of definition of factoring business, it can be
construed basis that the business has two limbs first being assignment of
receivables and second being financing / lending against receivables. However,
if one was to read the Preamble of the Act, the focus of the Act was to
facilitate assignment of receivables. Therefore the larger construct and
substantive clauses in the factoring Act deals with assignment of receivables
as also is evident from the reading of Chapter III onwards of the Factoring
Act.
Following
chart is a graphical representation understanding of factoring business by
entities as specified in the Act and the kind of business they may undertake to
qualify to be a factor:
With
a bit of reflection on the Factoring Act, it seems that there are several
advantages in undertaking assignment of receivables vis-Ã -vislending against
receivables as the Act has a greater inclination towards substantively dealing
with the assignment of receivables. Below we have enumerated some of the
advantages of undertaking assignment of receivables:
Advantages
of Assignment of Receivables over Lending against Receivables
1. Registration of
assignment/satisfaction of receivables
Section
19 of Act requires every factor in capacity of an assignee to register the particulars of every transaction
of assignment and satisfaction of receivables in its favour with the central
registry set up under SARFAESI Act, which aims to curb double financing of
debtors and safeguards the interests of the factors. The same has been done
with the motive of enhancing transparency
2. Exclusive right over
the receivable
Section 7(2)
of the Act empowers a factoring company to have an absolute right of recovering
the receivables and to exercise all rights and remedies of the assignor whether
by way of damages or otherwise for recovering the receivables. Such exclusive
right is available only to factor who undertakes assignment of receivables.
3. Unaffected by
bankruptcy of debtor
Section
7(2) of the Act empowers the factoring company to have an absolute right of
recovering the receivables. Further, Section 26 of the Factoring Regulation
Act, 2011 states that
“The
provisions of this Act shall have effect, notwithstanding anything inconsistent
therewith contained in any other law for the time being in force or any
instrument having effect by virtue of any such law.”
Based
on the above text read with Section 7(2) of the Act we can construe that the
factor has an absolute right for recovering the receivables and any provisions
contained in any other applicable law which is inconsistent with the provisions
of the Act shall not apply to a Factor.
4. Exemption from Stamp duty
Pursuant
to the enactment of the Act an amendment was made to the Indian Stamp Act
1899due to which all agreements for assignment of receivables were exempted
from stamp duty. Hence, huge cost in terms of stamp duty is saved if one
undertakes assignment of receivables as opposed to lending against receivables.
5. Off-Balance Sheet Financing
Customer
may hope to put receivables off their balance sheets if the transaction
satisfies the conditions of off-balance sheet treatment as specified in AS
30/IFRS 9.
Conclusion
While
the business of factoring covers both assignment of receivables and lending
against receivables the provisions of chapter 3, 4 and 5 of the Act are not
applicable to lending against receivables. In view of the advantages of
assignment of receivables over lending against receivable, the Companies may
strategically decide to undertake transactions that are in the style of
assignment of receivables rather than lending against receivables.
[1]http://voiceofca.in/siteadmin/document/FACTORINGREGULATIONACT_2011.pdf
(Article is written by CS Aman Nijhawan and CS Surbhi
Jaiswal who can be reached via email at aman@vinodkothari.com
and surbhi@vinodkothari.com
respectively. Both the Author are associated with Vinod Kothari & Co.)
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