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. The Indian Factoring industry is set to grow and attract a larger number of private players. The factoring market is currently dominated by public sector banks and financial institutions such as SBI Global Factors and Canbank Factors. Banks such as DBS, HSBC and Standard Chartered offer factoring services. SBI Global Factors lead the market with nearly 80% market share. Though banks are offering factoring either through subsidiaries or as part of their service offerings, it is felt that there is a room for more independently owned factoring companies. Private players are buoyed by the new factoring Bill passed in Parliament, which has brought in greater clarity to the business. The factoring business has not scaled up in India in the last decade. SBI Globals 2010-11 annual report notes that the levels of factoring business in India are much lower compared with other countries and the share of Indian factoring is less than 1% of the total volumes generated in the world and the contribution of factoring products in meeting the total working capital requirement of the companies in India is less than 0.50%. Globally factoring accounts for around 5% of the total credit. Factoring is a kind of short-term commercial finance for SMEs selling goods and services on credit. The SME will raise an invoice for payments with credit period of 60 to 120 days. This invoice or trade receivables are sold to the Factor at a discount for immediate cash. The Factor purchases the invoice from the SME and then collects the amount from the debtor when the credit period ends. The burden on collecting the payment is now on the Factor. If a bad debt occurs, then the Factor recovers money from the SME. If the factoring is done on a non-recourse basis, then in case of a bad debt the Factor absorbs the losses or shares the losses with the customer. A growing factoring business in India would improve the cash flow for SMEs and reduce their working capital constraints as they can raise funds against invoices from factoring companies. The Factoring company funds to the extent of 85% of the invoice value and then collects it from debtors instead of the SME chasing payments. The current Indian factoring market is estimated to be worth R25,000 crore. India Factoring & Finance Solutions, a recent entrant into the factoring business, says it will reach business of R10,000 crore in three years by doubling business every year. This year, India Factoring has achieved volumes of R2,300 crore. Sudeb Sarbadhikary, the CEO of India Factoring says they will be growing faster than SBI Global Factors which not been able touch the R10,000 crore mark despite being around for more than a decade. Sarbadhikary reckons they will be able to grow faster because as a company they are totally focused on the factoring business and is not part of a large banking set up. India Factoring is promoted by FIM Bank Group, Malta (49%), Punjab National Bank (30%), Banca IFIS, Italy (10%) and year ended March 31, 2012 was their first full year in business in India. Another private player in India is Bibby Financial Services too feels that they bring flexibility into the business and can tailor-make products to suit customers as they are a flat and lean organisation which means the can react and respond significantly faster than large banks. Liverpool-based Bibby Financial Services is the UKs largest independent factoring and invoice discounting company and runs a subsidiary in India. PuneThe Indian Factoring industry is set to grow and attract a larger number of private players. The factoring market is currently dominated by public sector banks and financial institutions such as SBI Global Factors and Canbank Factors. Banks such as DBS, HSBC and Standard Chartered offer factoring services. SBI Global Factors lead the market with nearly 80% market share. Though banks are offering factoring either through subsidiaries or as part of their service offerings, it is felt that there is a room for more independently owned factoring companies. Private players are buoyed by the new factoring Bill passed in Parliament, which has brought in greater clarity to the

business. The factoring business has not scaled up in India in the last decade. SBI Globals 2010-11 annual report notes that the levels of factoring business in India are much lower compared with other countries and the share of Indian factoring is less than 1% of the total volumes generated in the world and the contribution of factoring products in meeting the total working capital requirement of the companies in India is less than 0.50%. Globally factoring accounts for around 5% of the total credit. Factoring is a kind of short-term commercial finance for SMEs selling goods and services on credit. The SME will raise an invoice for payments with credit period of 60 to 120 days. This invoice or trade receivables are sold to the Factor at a discount for immediate cash. The Factor purchases the invoice from the SME and then collects the amount from the debtor when the credit period ends. The burden on collecting the payment is now on the Factor. If a bad debt occurs, then the Factor recovers money from the SME. If the factoring is done on a non-recourse basis, then in case of a bad debt the Factor absorbs the losses or shares the losses with the customer. A growing factoring business in India would improve the cash flow for SMEs and reduce their working capital constraints as they can raise funds against invoices from factoring companies. The Factoring company funds to the extent of 85% of the invoice value and then collects it from debtors instead of the SME chasing payments. The current Indian factoring market is estimated to be worth R25,000 crore. India Factoring & Finance Solutions, a recent entrant into the factoring business, says it will reach business of R10,000 crore in three years by doubling business every year. This year, India Factoring has achieved volumes of R2,300 crore. Sudeb Sarbadhikary, the CEO of India Factoring says they will be growing faster than SBI Global Factors which not been able touch the R10,000 crore mark despite being around for more than a decade. Sarbadhikary reckons they will be able to grow faster because as a company they are totally focused on the factoring business and is not part of a large banking set up. India Factoring is promoted by FIM Bank Group, Malta (49%), Punjab National Bank (30%), Banca IFIS, Italy (10%) and year ended March 31, 2012 was their first full year in business in India. Another private player in India is Bibby Financial Services too feels that they bring flexibility into the business and can tailor-make products to suit customers as they are a flat and lean organisation which means the can react and

respond significantly faster than large banks. Liverpool-based Bibby Financial Services is the UKs largest independent factoring and invoice discounting company and runs a subsidiary in India. Unlike new players who are targeting the Indian domestic market, SBI Global Factors provides international factoring, import factoring, domestic factoring and forfaiting services under one roof in India but it is facing some challenging times. SBI Global posted negative income growth for 2010-11 and posted a loss of R152.34 crore. Apart from tight liquidity and increased rate, the reasons cited by SBI Factors was inadequacies in the legal framework and the stamp duty payable for factoring transactions. But this is set to change. The Regulation of Factors (Assignment of Receivables) Bill, 2011, passed by Parliament is going to be a game changer for the factoring business. According to Sarbadhikary the earlier laws of assigning the invoice was ambiguous but the new Act more clarity and also it calls for creation of a Central Registry for invoices which helps derisk the business. This will attract more private players to get into factoring and the market will grow. Some large private players are firming up plans to enter this business, says Sarbadhikary. However the stiff capital adequacy norms imposed by RBI on factoring companies means they will have to pump more capital which is tough on them so if you want this industry to grow a separate demarcation for factoring would help, suggests Sarbadhikary According to the Factors Chain International (FCI), a global association of 247 international factoring companies, the 2011 worldwide factoring industry volume saw a 22% growth and the world total now stands at well over two trillion dollars. FCI notes that overall, the factoring industry weathered the global financial crises much better than many other providers in the financial and insurance sectors. FCI said the major markets with spectacular growth were China which grew by 77%, Russia was up 74%, South Africa (41%), Netherlands (31%), and Australia (+28%). The potential for factoring business could follow the emerging country numbers soon.