Factorin Bill

7/30/2019 Factorin Bill

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A

REPORT ON

BILL OF FACTORING

Submitted To

PROF. (DR.) J. D. JADEJA

Offg. Dean

Submitted By

Ami D. Thakkar

ROLL NO. 33

M. S. PATEL INSTITUTE OF MANAGEMENT STUDIES

Faculty of Management Studies

The Maharaja Sayajirao University of Baroda


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INTRODUCTION

Factoring is a financial transaction whereby a business sells its accountsreceivable (i.e., invoices) to a third party (called a factor) at a discount.

Around the world, factoring is the dominant form of asset-based financeand an important source of external financing for corporations and small

and medium-size enterprises (SMEs).

Under asset based finance the credit provided by a lender is explicitlylinked on a formula basis to the value of a borrowers underlying

(working capital) assets, not the borrowers overall creditworthiness. This

explicit link is continuously managed so that the value of the underlying

assets always exceeds the amount of the credit.

In factoring the underlying assets are the borrowers accountsreceivablethat is, sale payments due from customerswhich the factor

(lender) purchases at a discount.

For example, a seller (borrower) might receive from a factor 70 percentof the value of an account receivable, and the remaining 30 percent (less

interest and service fees) upon receiving payment from the customer.

The three parties directly involved are: the one who sells thereceivable, the debtor (the account debtor, or customer of the seller), and

the factor.

The receivable is essentially a financial asset associated with the debtor'sliability to pay money owed to the seller (usually for work performed or

goods sold).

The seller then sells one or more of its invoices (the receivables) at adiscount to the third party, the specialized financial organization (aka the

factor), often, in advance factoring, to obtain cash.

The sale of the receivables essentially transfers ownership of thereceivables to the factor, indicating the factor obtains all of the rights

associated with the receivables.

Accordingly, the factor obtains the right to receive the payments made bythe debtor for the invoice amount and, in nonrecourse factoring, must

bear the loss if the account debtor does not pay the invoice amount due

solely to his or its financial inability to pay.


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Usually, the account debtor is notified of the sale of the receivable, andthe factor bills the debtor and makes all collections; however, non-

notification factoring, where the client (seller) collects the accounts sold

to the factor, as agent of the factor, also occurs.

There are three principal parts to "advance" factoring transaction;

(a) The advance, a percentage of the invoice face value that is paid to the

seller at the time of sale,

(b) The reserve, the remainder of the purchase price held until the

payment by the account debtor is made and

(c) The discount fee, the cost associated with the transaction which is

deducted from the reserve, along with other expenses, upon collection,

before the reserve is disbursed to the factor's client.

The History of Factoring

Factoring is one of the oldest forms of commercial finance. Somescholars trace its origins to the Roman Empire and some even further

back to the Hammurabi, four thousand years ago.

The termfactorcomes from the Latin verbfacio, which means he whodoes things. As the Latin verb suggests, the history of factoring is the

history of agents doing things for others.

For example, factoring was a well-developed activity in England in the14th century, where it evolved with the growth of the wool industry. The

job of factors centred on their functions as sales agents, or commission

merchants, for textile mills.

The distances between customers and manufacturers made commerceproblematicgiven the primitive forms of transportation and

communicationso factors assumed complementary functions to address

the business challenges that arose because of these distances.

At the centre of these functions was the factors role as the sales force forthe textile mills. As a by-product of this activity, factors assumed other

marketing and distribution functions, including offering advice on

customer tastes, product demand, and warehousing services-so that

mills could ship merchandise to the factors, who would then ship to the

final customers.


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Factors also assumed some critical financial functions on behalf of themills. They offered credit advice on how much to sell on account to

potential customers.

They also guaranteed payments to the mills, assuming full responsibilityfor the creditworthiness of the mills customers.

To protect themselves, factors established reserves to cover claims fordefective merchandise and any disputes that arose out of those claims.

Finally, and equally important from an historical perspective, factorsadvanced funding to the mills based on the value of the merchandise sold.

Thus, in essence, factoring was fully reflected economically in thefinancial component of the factoring business as it existed 600 years ago.

The difference between today and 600 years ago is that the sales, oragenting, component has been purged from the factoring relationship.

But factoring as it is typically practiced in both developed and developingeconomies can still be viewed as a bundle of activities. In addition to

financing, factors typically provide their clients with two other services:

credit and collections.

In developing countries factoring offers several advantages over othertypes of lending.

First, factoring may be particularly useful in countries with weak securedlending laws, inefficient bankruptcy systems, and imperfect records of

upholding seniority claims, because factored receivables are not part of

the estate of a bankrupt SME.

Second, in a factoring relationship the credit is primarily based on qualityof the underlying accountsnot the quality of the borrower. Thus

factoring may be especially attractive to high-risk SMEs.


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How factoring works?Characteristics of factoring

Usually the period for factoring is 90 to 150 days. Some factoringcompanies allow even more than 150 days.

Factoring is considered to be a costly source of finance compared to othersources of short term borrowings.

Factoring receivables is an ideal financial solution for new and emergingfirms without strong financials. This is because credit worthiness is

evaluated based on the financial strength of the customer (debtor). Hence

these companies can leverage on the financial strength of their customers.

Bad debts will not be considered for factoring. Credit rating is not mandatory. But the factoring companies usually carry

out credit risk analysis before entering into the agreement.

Factoring is a method of off balance sheet financing. Cost of factoring=finance cost + operating cost. Factoring cost vary

according to the transaction size, financial strength of the customer etc.

The costs of factoring vary from 1.5% to 3% per month depending uponthe financial strength of the client's customer.

Indian firms offer factoring for invoices as low as 1000Rs


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Domestic and International Factoring in 2010

Total Factoring Volume by Country in the Last 7 Years

Total factoring volume


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The overall results illustrate that exporters and importers, around theworld, are becoming more and more familiar with the advantages to be

derived from a factoring arrangement: working capital, credit risk

protection and collection service for the exporter.

India has shown a notable increase in factoring volumes since 2005. In2007 factoring volumes were Euro 5.20 billion in comparison to Euro

1.99 billion in 2005. So we can say that factoring is moving upward in

India, and soon factoring will spread its wings across the length and

breadth of the country.

It is quite implied now that factoring is a very easy and fast method. Still,its implementation is not so good. There are certain hiccups that have

come up in the way of releasing the full potential of factoring in India.

One of the main reasons for it was the legal framework of India, which

has now been put in place by passing The Factoring Regulation Bill,2011.

Generally factoring companies need legal protection as all advances are

uncollateralized.

The benefits of factoring The most obvious benefit of working with a factor is the ability to quickly

get working capital. The accelerated cash flow a factor can provide may

help the success of a start-up, a company experiencing high growth or a

seasonal sales spike, or even a business in a turnaround situation.

Factors typically offer favourable advance rates for accounts receivable,inventory or other assets. A factor can also provide credit protection

against customer bad debt losses.

An established factor can offer the ability for a client to outsource credit,accounts receivable bookkeeping and collections functions.

This typically speeds accounts receivable collections and can free-upadditional working capital for a company. It also converts accounts

receivable management costs from fixed to variable, and they may be

eligible for off balance sheet treatment.

Disadvantages The basic disadvantage of factoring is that it may lead to ruined relations

with the customers especially if factor engages in aggressive orunprofessional practices when collecting accounts


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Cost is another disadvantage, cost involved in factoring agreement maybe more than the cost of other methods of financing available in the

business


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Factoring in India Indias factoring turnover in 2009 was around Euros 2500

Million in domestic and Euros 2650 million in total as compared to a total of

Euros 1,283,559 million worldwide1 and the turnover over the last 7 years has

seen a tremendous growth and steep downfall as well; while that of Asia has

risen 219% from 2004 to 2010 and is valued at $637 billion. Some of the

challenges faced by the factoring companies in India are

a) There was no specific law for assignment of debt,

b) There was no recovery forum available to the factoring NBFCs such as DRT

or under Sarfaesi Act,

c) Lack of access to information on credit worthiness and

d) Assignment of debt involves heavy stamp duty cost.

Factoring service in India is of recent origin. It owes its genesis to therecommendations of the Kalyanasundaram Study Group appointed by the

RBI in 1989. Pursuant to the acceptance of these recommendations, the

RBI issued guidelines for factoring services in 1990.

The first factoring companySBI Factors and Commercial Ltd (SBIFACS) started operation in April 1991.

The main recommendations of the Committee/Group are listed asfollows:

(1) Taking all the relevant facts into account, there is sufficient scope for

introduction factoring services in India which would be complementary to the

services provided by banks. (2) The introduction of export factoring services

would provide additional facility to exporters. (3) While quantification of the

demand for factoring services has not been possible, it is assessed that it would

grow sufficiently so as to make factoring business a commercially viable

proposition within a period of two/three years. (4) On the export front, there

would be a fairly good availment of various services offered by export factors.(5) With a view to attaining a balanced dispersal of risks, factors should offer

their services to all industries and all sectors in the economy. (6) The pricing of

various services by factors would essentially depend upon the cost of funds.

Factors should attempt a mix from among the various sources of funds to keep

the cost of funds as low as possible, in any case not exceeding 13.5 percent per

annum, so that a reasonable spread is available. (7) The RBI could consider

allowing factoring organizations to raise


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funds from the Discount and Finance House of India Ltd, as also from other

approved financial institutions, against their usance promissory notes covering

receivables factored by them, on the liens of revised procedure under bills

discounting scheme. (8) The price for financing services would be around 16

per cent per annum and the aggregate price for all other services may not exceed

2.5 percent to 3 percent of the debts services. (9) In the beginning only select

promoter institutions/groups of individuals with good track record in financial

services and competent management should be permitted to meter into this new

field. (10) Initially the organizations may be promoted on a zonal basis. (11)

There are distinct advantages in the banks being associated with handling of

factoring business. The subsidiaries or associates of banks are ideally suited for

undertaking this business; initially, it would be desirable to have only four or

five organizations which could be promoted either individually by the leading

banks or jointly by a few major banks having a large network of branches. (12)

Factoring activities could perhaps be taken up by the Small Industries

Development Bank of India, preferably in association with one or more

commercial banks. (13) The business community should first be educated

through bank branches about the nature and scope of these services and the

benefits accruing there from. (14) Factors cannot extend their services

efficiently, effectively and economically without the support of computers, as

quick and dependable means of communication. Concurrent with consideration

of various aspects relating to commencement of factoring operations the

promoters should initiate measures for organizing network of computers

/dedicated lines the branches/agents in different parts of the country for

accounting follow up remittance and other activities involved in factoring

business. (15) The Central Government ad RBI should initiate appropriate

measures immediately for setting up specialized agencies for credit

investigations; until such agencies become fully operative, factors may have to

rely on such information about clients/customers as could be collected through

banks or other sources. (16) Since the suppliers would be able to obtain

financial services from both banks and factors, it is necessary to provide for

proper linkage between banks and factoring organizations.


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THE FACTORING REGULATION BILL, 2011

The Parliament recently passed the Factoring Regulation Bill 2011(Factoring Bill or Bill). Given the fact that several other important

bills have taken years to ascend into the statute book, the Factoring Bill

has really been commendably quick to progress. No one would perhaps

know what the urgency was for the Billit is not as if factoring business

was a mushrooming business which needed regulation.

On the contrary, factoring is an idea that the RBI has been meaning topromote over decades, and there has not been any substantial pick up in

factoring volumes over the years. If at all factoring business needed

anythingit was support and promotion. But the tone of the Bill is far

from promotionit is full of a regulatory slant.

This is exactly the model that RBI used when passing the SecuritisationActwith the idea to promote securitisation, and it ended up in

regulating securitisation to the extent that no securitisation transaction has

ever happened so far under the Act.

The regulatory tone of the Bill apart, the Bill seeks to enact the provisionsof the UNCITRAL model law on assignment of trade receivables1, whichitself, 11 years after its proposition, has been affirmed only by 4 countries

in the world.

Factoring has obviously not been something to attract the fascination ofeither the banks or the NBFCs. The factoring volumes in India have not

been significant enough, and unlike other facets of NBFC activity,

factoring business has not drawn foreign players to any appreciable

extent, except recently when some foreign banks seem to have begun

factoring services.

Receivables financing:

While factoring might have picked up much, receivables financing hascontinued to grow with the growth of the NBFC sector.

The NBFC sector today views receivables as much as a part of asset-based financing as other tangible assets. And lot of investments in

happening today in the infrastructure as well as IT sector where the basis


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of investment is receivables. To give instancesa PSU/ government

department goes for a massive system upgradation where equipment and

services are provided by an aggregator, who in turn finances himself

based on the receivables committed by the client.

Receivables discounting is also common as a mode of sales-aid financingseveral software and hardware vendors provide the facility of instalment

or deferred payments to their clients and in turn sell the receivables to

finance companies. None of this is factoring in the real sense, because

none of the so-called receivables financiers are going anywhere beyond

pure financing.

First of all, was there a case at all that a factoring company was notcovered by the regulatory ambit prior to the enactment of the new law? If

the factoring activity was being carried out as a true acquisition of

receivables by the factor, it is possible to argue that what is a purchase of

receivables cannot be a financing transaction, and hence, a factor is not a

non-banking finance company under existing definition in the RBI Act.

However, most factors actually carry out full recourse factoringwithfeatures that hardly imply intent of purchase of receivableshence, such

activities nothing but lending on the security of receivables, and hence,

would still amount to a financial business for being regulated as anNBFC.

Therefore, if the law is based on the premise that factors were notregulated so far, and the idea is to regulate them, the basis is misplaced.

As regards receivables financing - admittedly, this is a financing activityand hence, thebusiness is a financial business, bringing the business

under RBI supervision.

However, the key feature of the existing NBFC regulation is that financialbusiness needs to be the principal business to bring an entity into

NBFC domain. If a non-banking, non-financial entity carries financial

business, it may still retain its status as a non-financial business as long as

the business remains non-principal. The RBI has been using a

percentage of assets and income as the criteria for determining

principality.

If the idea of the Bill is to bring entities engaged in factoring businessinto the regulatory ambit, let us examine to what extent does the law go inmeeting this objective.


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First of all, the Bill defines factoring business to include bothacquisitions of receivables as well as receivables financing. That is to say,

any financial transaction where receivables are accepted as a security.

Clearly, the definition is thoughtlessly inserted and can be stretched to

completely unintended extent. For example, if someone gives a loan

against a machine, and accepts receivables as a collateral security, it is

certainly not a transaction of financing of receivables, but looking the

way the definition is worded, the transaction will amount to factoring

business.

The biggest problem lies in the language of sec. 3 which saysno factorshall commence or carry on the business of factoring without RBI

registration. The word factor is defined in sec. 2 (i) as a non-bankingfinancial company, a body corporate, orany other company. Sec 3 (2)

and its proviso pertain to an NBFC presently carrying out, as its principal

business, on the date of commencement of the Act. However, sec 3 (1)

nowhere says that the provision will be applicable only where the factor

carries on factoring as its principal business. That is to say, if the

language of sec. 3 is taken as it is, every company carrying on factoring

business, whether as a principal business or not, needs to apply for RBI

registration.

The only exception to this will be banks, and statutory corporations, interm of sec 5 of the Bill.

This brings a completely over-stretched arm of the Bill which requiresmandatory registration, and RBI supervision, in case of non-financial

companies which may be engaged in acquisition or security interest over

receivables as a non-principal activity. Several manufacturing/trading

companies do so. Several IT companies may also be doing the same.

There is an exception specifically made in case of securitisationtransaction, further reinforcing the assumption that whether or not the

business of factoring is the main business, registration under the Bill

becomes mandatory.

Thus, NBFCs will need registration under the law only if their principalbusiness in factoring, but other companies, excluding banks, will come

under the registration requirements irrespective of whether factoring

business is principal business or not. If it is a business, it will come under

the law.


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Substantive provisions:

The substantive provisions of the law inclusively pertain to giving effectto an assignment agreement. Section 7 provides that an assignment shall

be effective between assignor and assignee on the execution of the

agreement, and section 8 provides that no right shall exist against the

debtor unless the debtor has been served with the notice of assignment.

This is exactly the common law position understood through more than a

century. Sec 130 of the Transfer of Property Act provides for the same

thing and common law jurisdictions all over the world work on the same

principle. This was the law before; this remains the law after the Bill.

To put the point in perspective, several assignment of receivables aresilent assignments meaning, the fact of the assignment is not notified

to the debtor. This is the universal practice in case of securitisation

transactions. In case of financing transactions also, the lender typically

does not need to, and hence does not, notify the obligor.


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However, section 17 of the Bill makes silent assignments completelyfragile and almost impossible. This section says that in case of silent

transfers, the assignee will be bound by any such modification of the

original contract that the assignor may make with the debtor. It is only

after the notification of the assignment that such modifications become

ineffective. That is to say, unless the assignee gives immediate notice of

the assignment to the debtor, the assignee is virtually at the mercy of the

assignor. This provision is borrowed from UNCITRAL model law on

international assignment of trade receivables, but will certainly give

major jolt, particularly those who lend money against receivables. By

way of saving grace, the provisions of the Bill have been excluded in case

of securitisation transactions, but what is a securitisation transaction itself

will remain queer.

Registration provisions

The Bill mandates registration of all assignment transactions, and alsosatisfaction of claims of the assignee. Non-registration does not affect the

validity of the assignment; registration does not amount to a notice to the

debtor. However, non-registration is punishable with a fine up to Rs 5000

per day.

The registry office is the Central Registry under the SARFAESI Act,currently being run by NHB.

The way the language of the law is, filing notice of satisfaction orrealisation of a debt may, in case of instalment or partial payments,

notifying innumerable events. In case of trade receivables, factoringtransactions involve revolving lines of credit, with numerous receivables

getting assigned in succession. Hence, the mandatory registration

requirement, with no advantage as to validity or deemed notice to the

obligor, only impose an added administrative burden.

Among other provisions, the bill proposes to ban financial institutionsfrom directly entering the factor business.


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The regulation of factor (Assignment of Receivables) Bill 2011provides... for empowering the RBI to issue directions, call for

information from the factor and prohibit financial institutions from

undertaking factoring business, if the factor fails to comply with the

directions given by the RBI," says the Bill's statement of Objects and

Reasons.

If any factor fails to comply with a direction issued by the Reserve Bankof India, the factor and every officer in default may be punished with a

fine of up to 5 lakh rupees and an additional fine of Rs 10,000 for each

day the default continues.

Other Salient features The Bill also provides for establishment of a Central Registry which

would maintain details regarding all transactions carried out by factors. It

makes registration of all factor transactions mandatory.

Besides, factors would be entitled to take legal recourse for recoveringassigned debt and receivables from buyers of goods and services.

Definition of factoring also includes assignment of export receivables andthus includes 'forfaiting', subject to the requirements of the Foreign

Exchange Management Act.

Term receivables are widely defined to include toll or any other chargespayable for use of infrastructure facilities. However, bank loans are

excluded from the definition of receivables.

The law applies to all business entities i.e. large, medium, small andmicro 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 housesand multinational corporations can avail factoring services;

The definition of 'factoring' covers both, with recourse and withoutrecourse factoring.

The law requires that all transactions of assignment of receivables infavour 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.


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Factors are declared to be credit institutions for the purposes of CreditInformation Companies (Regulation) Act, 2005 and can have access to

credit information relating to firms availing factoring services;

Factors are not financial institutions for the purposes of SARFAESI Actand 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 theIndian 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 inany 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.

Factors are barred from disclosing personal information obtained fromany assignor, its present and future customers, its commercial and

business activities, and the terms of sale between the assignor and any

debtor.

The bill allows factors to take legal recourse to recover assigned debt andreceivables from buyers of goods and services.

After the assignment of receivables takes place, the payment instructionissued to the debtor may modify whom payment is to be rendered to, but

not

(a) the amount of debt specified in the original contract,

(b) the place where payment is to be made, and

(c) the date on which payment is to be made.

The Bill refers to the factor as the assignee, the industry selling thereceivable to the factor as the assignor, and the person liable to the

industry as the debtor.

Future Prospects

As per IFCI Factors, India accounts for a meagre 2.2 percent of the globalfactor business worth 1.325 trillion euros. Potential clients of the factor


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business include SMEs that account for 45 per cent of Indias industrial

output and 40 per cent of exports. In 2013, these SMEs will account for

22 per cent of GDP. Dun & Bradstreet, an independent consultancy, has

estimated that the factoring business could be worth Rs 2, 45,000 crore in

four years.


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CONCLUSION

Growth of factoring will solve the liquidity and working capital problemsof numerous small and medium scale industries, which supply spare parts

and operate as ancillary units of large manufacturing units and other

business entities.

Traditionally, banks take lending decisions based on the borrower'scapacity to pay and other securities. Factoring will be undertaken

considering the capacity, standing and status of debtors. The new law is a

major step in financial sector reforms, and needs to be appreciated.

There is only one direction in which factoring can go in India: upwards.As the awareness level about the benefits of factoring increases, factoringwill spread its wings across the length and breadth of the country.


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REFERENCES1. URL: http://www.indianexpress.com/news/lok-sabha-approves-factoring-bill-to-help-msme-

sector/890430/2

2. URL:http://articles.economictimes.indiatimes.com/2012-02-01/news/31012822_1_receivables-

factoring-services-business-activity3. URL:http://www.prsindia.org/billtrack/the-regulation-of-factor-assignment-of-receivables-bill-

2011-1602/

4. URL: http://www.citeman.com/4934-factoring-in-india.html

5. Factors Chain International, Annual Review, 2011

6. SAMPADA Factoring Bil l: Blow to receivables fi nancing: Article by Vinod Kothari

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