Factoring is a financial transaction whereby a business entity sells its receivables, i.e. invoices to a Factor at a discount. Although a receivable is a property right and is transferable, there was a long-felt need for a statutory framework for Factoring.
Passing of the Factoring Regulation Bill, 2011 by Parliament has almost gone unnoticed on account of other important Bills pending. The object of the Factoring law is to address the problem of delayed payments to micro and small business entities by large businesses for purchase of goods and services.
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 legislatiions did not improve the position of MSEs because of their dependence on large businesses for continued business. Salient features of the new Factoring Law need to be noted.
- 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.
- 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;
- 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.
Growth of factoring will solve the liquidity and working capital problems of 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's capacity 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.
(The author is Chief Advisor-Legal, IBA. The views expressed are personal)
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