TAMIL NADU NATIONAL LAW SCHOOL

B.A.LL.B., (HONS.), IXth SEMESTER 2018-19

BANKING LAW PROJECT ON

Factoring business of commercial banks: comparative analysis through ‘IN

RE: DRYDEN ADVISORY GROUP, LLC’

PROJECT BY: SUBMITTED TO:

Samhita Vinod Ass. Prof. Mohammad Azaad

BA0140076

DECLARATION
I, Samhita Vinod, hereby declare that the project work entitled “Factoring business of
commercial banks: comparative analysis through ‘IN RE: DRYDEN ADVISORY GROUP,
LLC’” submitted to Tamil Nadu National Law School; Tiruchirappalli, is a record of bona-fide
work done by me under the supervision and guidance of Prof. Mohammed Azad, Faculty of
Banking Law, Tamil Nadu National Law School; Tiruchirappalli.

Date: 2/11/2018 SAMHITA VINOD

BA0140076
 ACKNOWLEDGMENT

I would like to thank my Banking Law professor Mohammed Azad, for giving me this
opportunity to work on this project.

The case analysis for better understanding of the concept of Factoring business in India and the
study of role of commercial banks in factoring immensely helped me to understand the issues
concerned in such field and significance of governance through related legislations.

TABLE OF CONTENTS
Sr. No Contents Page No.

1. Introduction

2. Analysis of In re Dryden Advisory Group LLC

3. Nature of Transaction of Factoring

Types of Factoring
4. Significance of Banks in

5. Overview of Factoring Business of Banks in India

6. Advantages of Factoring Business

Cross border transactions
7. Conclusion

8. Bibliography

INDEX OF AUTHORITIE
Statutes Referred:

 The Banking Regulations Act, 1969

 The Factoring Regulation Act, 2011
 Foreign Exchange Management Act, 1999
 The Stamp Duty Act, 1899
 CPC, 1908

Cases Referred:

 In Re: Dryden Advisory Group, LLC, 534 B.R. 612 (Bankr. M.D. Pa. 2015).

 IFCI Factors Ltd. v. Krish International Pvt. Ltd (KIPL), CO.PET. 471 of 2011.
 Chapter I

INTRODUCTION

With the advent of ‘factoring’ into commercial world, companies accelerate their source of
financing. Factoring is considered as one of the quick source of short term finance of the
company. The factoring in its simplest form means, transfer of accounts receivables held by the
company in their books of account to any banking company or non banking financial institution
for consideration. The account receivables or colloquially called ‘invoices’ in trading world are
then considered to be in the possession of the factor and later, the factors recovers money from
the buyer on the maturity date of the invoices. This is done so that the business can receive cash
more quickly instead of waiting 30-60 days for the customer to pay. This factoring is considered
as secondary function of banking company. Commercial banks often indulge into factoring
businesses departmentally.

To understand factoring business broadly, we need to consider all the nuances of factoring in
detail. For clear interpretation of factoring, let us consider the definition given by Biscoe as – “a
continuing legal relationship between a financial institution (the factor) and a business concern
(the client) selling goods or providing services to trade customers (the customers) on open
account basis. The factor purchases the clients book debts (account receivables) either with or
without recourse to the client and in relation there to controls the credit extended to customers
and administers the sales ledger.” 1 Thus it is unequivocal that factoring business includes three
major parties; one a factor who possesses the right of collection of debts, a client whose right is
transferred to factor, and a customer from whom the debt is to be collected.

Like any other business, factoring is also conducted through contract sometimes known as
‘factoring agreement’ which decides the nature of factoring transaction. Based upon the nature of
transaction, the further course of action and treatment to debts can be determined. For the
understanding the nature of whole factoring business and its transaction, let us analyze one US
bankruptcy court case that has dealt with minor nuances of factoring.

1
“B.L Mathur, Changing Profile of Financial Services, (1997), Discovery Publishing House, New Delhi”.
 Chapter II

ANALYSIS OF “IN RE DRYDEN ADVISORY GROUP, LLC”2

 Background of the case

The present suit was filed by Durham Commercial Capital Corp. (“Durham”) before United
States Bankruptcy Court of Pennsylvania, objecting the motion filed by Dryden Advisory
Group, LLC ("Dryden"). The bankruptcy petition filed by Dryden contained the accounts
which were purchased by Durham through a factoring agreement entered into between the
parties before Dryden filed its bankruptcy petition.

 Brief facts of the case

In the preset case, Dryden Advisory Group LLC, was a tax-consulting firm, Dryden entered into
three loan agreements with Beneficial Mutual Saving Bank (“Beneficial”). Two of those loans
were secured by ‘perfected liens’ over all assets of Dryden group including its accounts
receivables. Before 2012, Dryden was not in a financial position to make necessary payments to
Beneficial thus Dryden agreed to raise finance through factoring its accounts receivables after
taking prior consent from Beneficial. Beneficial approved the factoring of the Fiserv accounts,
comprising two invoices in a total amount of $310,000.”3

Accordingly, the parties entered into ‘without recourse factoring agreement’ with prior approval
of Beneficial on July 23, 2013. As per the agreement, Dryden provided original invoices to
Durham according to the schedule of invoices. Also, Dryden agreed upon creating a security
interest over his tangible and intangible personal property in favour of Durham but that was
subject to recognition of Beneficial Bank’s senior lien over it. Any amendment to agreement or
additional selling and purchase of accounts required prior consent of Beneficial bank. Further
the bank and Durham entered into a separate agreement in which bank accepted Durham’s right
over purchased accounts and agreed to release those accounts brought by him from the charge of
bank. They transferred the security interest in the account to Durham but subject to their
subordinate lien over it.

2
“In Re: Dryden Advisory Group, LLC, 534 B.R. 612 (Bankr. M.D. Pa. 2015).”
3
“Ibid”.
After these mutual promises, Dryden continued to factor additional accounts other than Fiserv
accounts without the prior consent of Beneficial.

In 2015, Dryden filed its bankruptcy petition and also seeking interim order for the use of cash
collateral to which Durham objected stating that some of the accounts receivable included in the
cash collateral order had been purchased by Durham more than a year before the bankruptcy
filing and thus they are no longer a part of or property of the bankruptcy estate. He filed for
reconsideration of order for use accounts as cash collateral. This was further objected by
Beneficial and Dryden.

 Issues
1. What is the nature of transaction of ‘factoring’? Is it construed to be ‘sale’ or ‘secured
loan’?
2. Whether the disputed accounts in the facts, the subject matter of factoring, are the
property of bankruptcy estate? If yes, then whether bank’s senior lien is to be recognized?

 Brief Arguments
 In favour of Durham
Dryden contended that to determine the nature of transaction, it must be relied upon
the terms of an agreement entered into by parties. It is clearly mentioned in the title
itself as ‘purchase agreement’ thus indicating ‘non-recourse’ type of factoring
agreement. “Further it was argued that the accounts that were sold were not
commingled with the general fund of Dryden showing it as a ‘sale’ transaction.
 In favour of Dryden
Dryden vehemently argued that the agreement was modified based upon the conduct
of the parties than the terms as the additional substitution of invoices which are
suggestive of loan transaction rather than a sale.
Apart from that, Beneficial argued that the amended version of an agreement and
subsequent transfer of additional accounts to Durham was without the consent of
bank which had the lien over all the assets of Dryden. Here Durham argued about the
agreement between bank and Durham and stated that bank had already relinquished
 all the charges over the accounts. But Beneficial reiterated that they had said that with
respect to Fiserv accounts only and not the additional accounts.

 Decision/Judgment

“The court held that the Amended Factoring Agreement is determined to be a true sale of
accounts and, therefore, the accounts receivable transferred by Dryden to Durham more than
ninety days before the filing of the bankruptcy petition are not assets of Dryden's bankruptcy
estate. Further, having determined that the accounts are not property of the estate, the
Bankruptcy Court ordered that it lacked jurisdiction to determine the relative interests of
Beneficial, Citibank, and Durham in the transferred accounts.”4

 Analysis with respect to issues

1. What is the nature of transaction of ‘factoring’? Is it construed to be ‘sale’ or ‘secured

loan’?

a) Factoring: Nature of transaction

Factoring is "the buying of accounts receivable at a discount. The price is discounted because the
factor (who buys them) assumes the risk of delay in collection and loss on the accounts
receivable”.5 When the owner of receivables enters into a factoring agreement with a party, the
transaction may be characterized as a true sale or as a financing agreement. For classification of
transaction accurately, there are certain attributes that has to be taken into consideration. They
are as follows:

i) “When buyer (factor) has right of recourse against the seller (client)
ii) whether the seller has a right to excess collections
iii) whether the seller retains an option to repurchase accounts
iv) whether the buyer can unilaterally alter the pricing terms

4
Supra note 2
5
Black's Law Dictionary (10th ed.2014).
 v) whether the seller has the absolute power to alter or compromise the terms of
the underlying asset
vi) the language of the agreement and the conduct of the parties”6

According to abovementioned factors, it can be construed that the factoring transaction can be
recognized based upon types of factoring.

b) Types of factoring
i) Without recourse or non recourse – This is the main crux of above discussed
case. If the factor bears full credit risk and all the interest over the accounts
receivables are transferred to the factor, thus amounting to sale transaction
ii) With Recourse – This is the case where, factor does not bear the liability of
default of payment by the debtors. The risk of non recovery of bad debts is
bore by factor.
iii) Undisclosed factoring – when debtor, that is to say customer in factoring
arrangement is unaware about the agreement between factor and client, then
that amount to undisclosed factoring.
iv) Disclosed factoring – it is exact opposite to undisclosed factoring. In this case,
customer knows the agreement or he may also be the part of the agreement.
v) Invoice discounting – this is the case where factor only provide finance and
client actually collects the debts from the customer/debtors. In above case, the
additional accounts that were sold to Durham were collected by Dryden itself.
vi) Forfeiting – this is the form of factoring involving cross border transactions
where import-and export companies want to factor their accounts receivables.

c) Role of Bank in above case

Another important type of factoring which I have not mentioned above involves active
participation of banks. “It is known as ‘Bank Participation Factoring’. In this type of
factoring, bank supplies finances to the client firm for the accounts which is maintained by

6
“Robert D. Aicher, William J. Fellerho, Characterization of A Transfer of Receivables as a Sale or a Secured
Loan Upon Bankruptcy of the Transferor, 65 Am. Bankr.L.J. 181, 186-94 (1991)”.
 the factors and in exchange to that firm creates a floating charge in favour of bank. This is
the precise situation in above case, where Beneficial bank has lien over Dryden’s accounts
and subject to their senior lien, the accounts have been transferred to Durham.”7

d) Criticism to the decision

Although the Bankruptcy Court has ruled in favour of Durham and stated that the accounts
transferred were actually ‘sold’ based upon the nature of the ‘factoring agreement’ between
Beneficial, Dryden and Durham. But this reasoning has serious flaws in it. Even though the
agreement clearly mentioned non-recourse factoring type, the agreement had another clause
which clearly mentioned any transaction shall precursor the consent from Beneficial. This
clause was seriously violated and thus determining the nature of factoring itself becomes
infructuous. The agreement shall stand null and void for acting against the clause.

This can again be reverted by stating that there was an acknowledgement between Durham
and Beneficial bank through which bank released all it’s lien from the accounts receivables.
But as correctly argued by the bank, the said acknowledgment was with respect to Fiserv
accounts that were already purchased by Durham and not any additional accounts. This
leaves us in a dilemma whether to consider it as loan or sale transaction because if bank has
lien over it then it will be more of a loan than a sale transaction. And thus bank will have a
right to use it as cash collateral as they are secured creditors of Dryden and has preemptive
right to recover from those additional accounts, if construed as bankruptcy estate due to
above reasoning.

7
“Supra note 1”.
 Chapter III

SIGNIFICANCE OF BANKS IN FACTORING BUSINESS

After analyzing the case and whole concept of factoring, the question remains in our mind is that
what is the significance of banks in this whole factoring business. The simplest answer to it is
that majority of factoring business throughout the world is carried out by banking companies and
NBFCs and other financial institutions. “Factoring services may be provided as a complement to
banking services in countries with overall financial development, while on the other hand,
factoring may substitute for bank financing in countries with less developed banking sectors.”8

Factoring even though can be carried by commercial banks as secondary function; it is slightly
different from traditional banking concept. Both factoring and bank loan are forms of finance to
the companies but they possess certain distinctions. Factors do not accept deposits whereas banks
act as custodian for the money deposited with them. Banks usually have recourse against debtors
if they default in payment but factors right of recourse depends upon the nature of factoring
agreement. Banks stipulates stringent policies when it comes to credit risk and financing through
loan but in case of factoring, the credit risk is high but the standards are not as strict as that of
banks. Another more basic difference is that factoring is mostly recognizable source of finance in
business world whereas loan transactions are diversified within business fraternity and normal
public.

There are certain advantages that banks may get if they entered into factoring business and act as
a factor to render the finance to corporate bodies. The reasons are:

a) Factoring is comparatively stable business of short term finance

b) As credit risk is higher the returns are also higher as compared to other commercial
banking business
c) The accounts that are factored by bank may act as a opportunity for bank to attract future
prospective customers for other transactions like loans, deposits etc.
d) Entering into a factoring business can be beneficial to bank as they occupy the space in
industry
8
“Leora Klapper, The Role of Factoring for Financing Small and Medium Enterprises, The World Bank,
http://siteresources.worldbank.org/INTEXPCOMNET/Resources/Klapper,_The_Role_of_Factoring_for_Financing_
Small_and_Medium_Enterprises.pdf”.
 e) Banks may get involved in factoring high, medium and small enterprises thus expanding
their banking business. If banks do not cop up with changing business requirements then
they may be thrown out of business. “The appropriate example would be renowned
telecommunication company Ericsson transferred its business from Chinese bank to
Citibank (China) in March 2002, mainly because of lacking of Factoring by Chinese
banks. Financial innovation is very essential to accommodate high quality international
accounts and to keep up with the increasing completion in the banking business at the
wake of liberalizing financial services sector in most of the countries all over the globe.”9

Chapter IV

OVERVIEW OF FACTORING BUSINESS OF BANKS IN INDIA

India, although contributes, less than one percent, of the world factoring business, but still
manages the internal factoring with proper governance through RBI guidelines and SEBI. The
need for governance and regulation of factoring was first discussed in January 1988, through The
Kalyanasundaram Study Group set up by the Reserve Bank of India. This group was established
to examine the feasibility and mechanics of starting factoring organizations in the country paved
the way for provision of domestic factoring services in India.
The Banking Regulation Act, 1949 was amended to include factoring as a form of business in
which the banks might engage. Reserve Bank of India issued guidelines permitting the banks to
set up separate subsidiaries or invest in factoring companies jointly with other banks.

“The ‘banks’ as defined under Banking Regulation Act, 1969 are not required to be registered as
‘factors’ under Factoring Regulation Act, 2011”10 “The non banking financial institutions
(NBFCs), on the other hand are required to be registered under the said Act and that too is
allowed if they are previously registered as NBFCs with RBI”. 11 “The RBI has also recently

9
“Ibrahim Farag, Factoring and Accounts Receivable Discounting. An Evidence from the Egyptian Market,
https://www.researchgate.net/publication/263697726_Factoring_and_Accounts_Receivable_Discounting_An_Evide
nce_from_the_Egyptian_Market (Last Visited: Nov. 2, 2018 (N.T.M))”.
10
“Factoring Regulation Act, 2011, Sec. 5”.
11
“Factoring Regulation Act, 2011, Sec. 3”.
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.”12

“The Act, thus, gave clarity to the activity of assignment of receivables and granted exemption
from stamp duty on documents executed for the purpose of assignment of receivables in favour
of Factors thereby making the business more viable. The Act also envisages that all transactions
of assignment of receivables shall be registered with the Central Registry established under the
SARFAESI Act, 2002 to reduce the possibility of frauds and for strengthening the due diligence
process for the clients.”13

The Act provides certain definitions for relevant parties to the factoring agreement. It postulates
the factoring agreement as an ‘assignment’ while referring factor as a assignee who takes the risk
and client firm as assignor who is the owner of the accounts receivables and assigns them to
assignee. This, prima facie, contemplates the nature of factoring as a sale where all the interest
over property is assigned to the factor. “It also states in section 7 that, if the accounts receivables
have any encumbrances over it then the assignor shall inform assignee and if assignee accepts it
then he is liable to pay consideration for such assignment to the Bank or the creditor.”14

Now, it is established that banks usually acts as a factor, major banks through subsidiary, have
started factoring business in India. “State Bank of India has started a subsidiary as ‘SBI Factors
and Commercial Services Pvt. Ltd.’ in western parts of India mainly factoring for the
manufacturers, traders of goods dealing in chemicals, pharmaceuticals, consumer durables, light
engineering, plastic dealing etc. along with SBI, UCO bank and Allahabad Bank has started a
joint factoring company in eastern parts whereas Punjab National Bank has subsidiary for
factoring in northern parts of India.”15

 Advantages of factoring business

1. Requirement of Registration
12
“Divij Kishore and Mohit Bhatia, Factoring An Overview, https://barandbench.com/wp-
content/uploads/2016/11/Factoring-An-Overview.pdf”.
13
“Ibid”.
14
“Factoring Regulation Act, 2011, Sec. 7”.
15
“Supra note 1”.
 “The said Act mandates registration of every particulars of factors that are assigned with the
central registry set up under SARFAESI Act, which aims to curb double financing of debtors
and safeguards the interests of the factors.”16

2. Exclusive rights over the accounts receivable

Unlike USA, India renders exclusive right to the factor to have absolute recourse against
debtor. “Factor has a right to recover the bad debts as well as ask for damages or remedies
otherwise provided”17. This can be demonstrated by following pronouncement.

In one of the cases, IFCI Factors Ltd. v. Krish International Pvt. Ltd (KIPL), 18 Delhi High
Court decided whether the factor can initiate winding up process of the client company if the
company is unable to recourse under factoring agreement. In this case, IFCI was a factor to
whom KIPL assigned accounts receivables from their approved debtor Koutons Retail India
Ltd. ('KRIL'). The factoring was ‘with recourse’ and KIPL, in clauses 3 and 9, undertook the
obligation to pay IFCI in case of default by KRIL. Accordingly, KRIL and KPIL defaulted
the payment and after due procedure, IFCI filed petition under section 433(e) read with
section 439 of Companies Act, 1956, to initiate winding up process of both the companies
and appointment of official liquidator. Court rules in favour of petitioner although cautioned
that this should not be used as coercive tool to pressurize debtors to pay debts. Under sec.
433(e), the company can be wound up by Tribunal if it is unable to pay its debts. So, with
this case we can take a inference that even Indian Judiciary considered factoring with
recourse as a loan transaction rather than sales and thus allowed for liquidation of the
company to pay for accounts receivables that were transferred to them.

 Cross Border Transactions

We have already seen the provisions related to domestic factoring as per the Act. “Accounts
receivables, as defined in the Act, include all or part of or undivided interest in any right of
any person under a contract, including an international contractor, where either the assignor
16
“Vinod Kothari Consultants Private Limited, Note on definition of factoring business, (2015)
http://vinodkothari.com/wp-content/uploads/2017/03/Note_on_definition_of_factoring_business.pdf”.
17
“Factoring Regulation Act, 2011, Sec. 7 (2)”.
18
“IFCI Factors Ltd. v. Krish International Pvt. Ltd (KIPL), CO.PET. 471 of 2011”.
 or the debtor or the assignee is situated or established in a State outside India.” 19 Also, if any
amongst Factor, Client or Customer is located outside India then that factoring transaction is
governed by “Factoring Act along with FEMA”.20

“With respect to cross border factoring amendment has been made to CPC via insertion of
Rule 1(2)(b)(iv) in Order XXXVII. This rule emphasize that 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.”21

Chapter V

CONCLUSION

“Factoring service, which is perceived as complimentary to bank finance, enables the

availability of much needed working capital finance for the small and medium scale
industries especially those that have good quality receivables but may not be in a position to
obtain enough bank finance due to lack of collateral or credit profile. By having a continuous
business relationship with the factoring companies, small traders, industries and exporters get
the advantage of improving the cash flow and liquidity of their business as also the facility of
availing ancillary services like sales ledger accounting, collection of receivables, credit
protection etc. Factoring helps them to free their resources and have a one-stop arrangement
for various business needs enabling smooth running of their business.”22

19
“Supra note 11”.
20
“Foreign Exchange Management Act, 1999”.
21
“Supra note 11”.
22
“P. Muthulakshmi, Factoring – An Untapped Resource For Indian SMEs, Global Journal for Research Analysis,
Volume-3, Issue-11, Nov Special Issue -2014”.
Factoring as a thriving business is adopted by most banks through their subsidiaries. Pre-
2011, i.e., before the enactment of Factoring Regulation Act, the factoring business as a
whole was very minimal in India but with introduction of full-fledged legislations, it has now
become a blooming industry.

Banks incorporate factoring as a secondary function. Most of the commercial big scale banks
have now become prone in factoring businesses. The banks which act as a factor are more
reliable as company already have trust and confidence in functionality of banks and thus they
can easily factor their accounts to banks as compared to non-banking institutions. This way it
becomes advantageous to both companies as they can fearlessly rely upon banks for factoring
and for banks as they can indulge into more business thus ultimately increasing the liquidity
of money into the market.

REFERENCES

 Primary sources
 1. Factoring Regulation Act, 2011
2. Banking Regulations Act, 1969
3. FEMA, 1999
4. CPC, 1908

 Secondary sources

1. IN RE: DRYDEN ADVISORY GROUP, LLC, 534 B.R. 612 (Bankr. M.D. Pa.
2015).
2. B.L Mathur, Changing Profile of Financial Services, (1997), Discovery Publishing
House, New Delhi.
3. Robert D. Aicher, William J. Fellerho, Characterization of A Transfer of Receivables as a
Sale or a Secured Loan Upon Bankruptcy of the Transferor, 65 Am. Bankr.L.J. 181, 186-
94 (1991).
4. Leora Klapper, The Role of Factoring for Financing Small and Medium Enterprises,
http://siteresources.worldbank.org/INTEXPCOMNET/Resources/Klapper,_The_Role_of
_Factoring_for_Financing_Small_and_Medium_Enterprises.pdf
5. Ibrahim Farag, Factoring and Accounts Receivable Discounting. An Evidence
from the Egyptian Market,
https://www.researchgate.net/publication/263697726_Factoring_and_Accounts_R
eceivable_Discounting_An_Evidence_from_the_Egyptian_Market.
6. Divij Kishore and Mohit Bhatia, Factoring An Overview, https://barandbench.com/wp-
content/uploads/2016/11/Factoring-An-Overview.pdf
7. Vinod Kothari Consultants Private Limited, Note on definition of factoring business,
(2015) http://vinodkothari.com/wp-
content/uploads/2017/03/Note_on_definition_of_factoring_business.pdf
8. P. Muthulakshmi, Factoring – An Untapped Resource For Indian SMEs, Global
Journal for Research Analysis, Volume-3, Issue-11, Nov Special Issue -2014
1. Guruswamy, Financial Services, (2nd Ed. 2009), Tata McGraw-Hill Education Pvt.
Ltd., New Delhi.
2. https://www.leagle.com/decision/infdco20150730d31
3. RBI allows banks to fix value for factoring business,
https://www.thehindubusinessline.com/money-and-banking/rbi-allows-banks-to-
fix-value-for-factoring-business/article7896688.ece
4. https://www.rbi.org.in/Scripts/BS_CircularIndexDisplay.aspx?Id=9965