Act to bring regulation to business of factoring

Factoring is the assignment of certain debts owed (receivables), for a price, by a person (assignor) to whom the receivables are owed, in favour of a third party (assignee). A much favoured means of financing, for small and medium-sized enterprises to raise and manage their liquidity requirements, factoring is now to be regulated in India with the passage of the Factoring Regulation Bill, 2011, which is awaiting presidential assent after being passed by both the houses of the parliament.

Applicability & registration

The bill provides that the business of acquisition of receivables or financing against the security of such receivables (factoring business) can be carried on by assignees that are registered as factors with the Reserve Bank of India (RBI).

The eligibility criteria for registration as a factor are the same as those applicable to a non-banking financial company (NBFC) under the Reserve Bank of India Act, 1934. NBFCs, banks and bodies corporate (established under statute) can apply to the RBI for registration as factors.

[ihc-hide-content ihc_mb_type=”show” ihc_mb_who=”3″ ihc_mb_template=”2″ ]

The RBI has been granted regulatory oversight over factors and the factoring business, and can issue directions, call for information from factors, and prohibit financial institutions from undertaking this business if they fail to comply with its directions.

The bill excludes from the purview of the factoring business and therefore will not apply to credit facilities advanced by banks in the ordinary course of their business against security of receivables, securitization transactions, assignment of loan receivables by banks or NBFCs to one another, etc.

However, it remains to be seen whether financial institutions (other than banks) which extend loans or advances against security of receivables as a one-off transaction will fall under the purview of the bill.

Assignment

The bill contemplates the assignment of receivables with or without notice being provided to the debtor. Where notice is given, the debtor is discharged of its payment obligations in relation to the receivable on payment to the factor.

If the assignment is not brought to the notice of the debtor, a factor is not entitled to demand payment of the receivables from the debtor and payment made by the debtor to the assignor fully discharges the debtor of its payment obligations in relation to the receivables. Further, all such payments received by the assignor from a debtor after the assignment has taken place are held in trust by the assignor for the benefit of the factor.

Prior rights & obligations

If a factor makes a claim for payment of assigned receivables, the debtor retains all defences and set-off rights accruing to it under the original contract. The debtor is not entitled to recover from the factor any sum paid by the debtor in respect of any breach of the original contract prior to the assignment. However, the debtor retains the right to claim from the assignor any loss or damages caused to it by reason of breach of the original contract.

If the assignor is a micro or small enterprise, the liability of the debtor will be subject to certain provisions of the Micro, Small and Medium Enterprises Development Act, 2006, which regulate payment and recovery of debt.

Additionally, unless the debtor grants its written consent, an assignment of receivables does not affect the rights and obligations of a debtor under the original contract. The factor is not entitled to issue any instructions in relation to the payments to be made by the debtor which modify the original amount, the manner or the date on which such payments are to be made by the debtor.

Consequential effects

In passing the bill, the parliament’s intention was not to replace any existing laws. The terms of bill are in addition to, and do not derogate from, any legislation that was passed previously. However, the provisions of the bill are to prevail in case of any inconsistency which may arise due to the applicability of other laws as far as the factoring business is concerned.

Of far-reaching consequence would be the proposed amendment sought to be made to section 8 of the Indian Stamp Act, 1899, which would exempt factoring transactions from any stamp duty implications. This would provide a great impetus to transactions of this nature.

The Central Registry (set up under the provisions of the Securitisation and Reconstruction of Financial Assets and Enforcement of Security Interest Act, 2002) has been made the repository of records relating to factoring transactions. The onus to make such filings is on the factor.

[/ihc-hide-content]

Megha Gupta (Megha.Gupta@trilegal.com) and Abhijeet Das (Abhijeet.Das@trilegal.com) are associates at Trilegal in Mumbai. Trilegal is a full-service law firm with offices in Delhi Mumbai, Bangalore and Hyderabad and has over 140 lawyers.