Further evolution required for ‘factoring’ to fulfil needs

Where businesses are clamouring for liquidity, especially manufacturing entities, “factoring” presents a viable option towards maintaining a steady cash flow by providing finance against the receivables due to such entities. Prior to the Factoring Regulation Act, 2011 (Factoring Act), coming into force, there was no regulatory structure for assignment of debt. This rendered the enforcement of rights under an assignment in a factoring arrangement rather difficult.

Further, an assignment deed for the purposes of factoring services was subject to high rates of duty under the provisions of the applicable stamp laws. In 1988, the Reserve Bank of India (RBI) set up the Kalyanasundaram Committee to examine the feasibility of factoring in India.

Features of the statute

Pursuant to the Kalyanasundaram Committee report and recommendations of various committees set up later, the Factoring Act came into force in February 2012. The Factoring Act for the first time has defined “factoring business” and identifies the rights and obligations of the assignor and assignee under factoring transactions. Further, to provide a much needed boost to factoring business in India, the schedule to the Factoring Act required the insertion of section 8D into the Indian Stamp Act, 1899, under which documents for assignment of receivables to a factor are exempted from payment of stamp duty.

Although the Factoring Act provides a much needed framework within which and clarity on how factoring can be conducted in India, and clearly identifies rights and obligations of parties to contracts for the assignment of receivables from one to another, a host of areas remain unregulated and ambiguous.

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Unresolved issues

The Factoring Act envisages both “recourse” and “non-recourse” factoring. However, it does not distinguish between recourse and non-recourse factoring with regard to the nature of the transaction and the corresponding effect on the rights and liabilities of the parties.

With the Factoring Act allowing banks to undertake factoring business without any requirement for registration, one would have expected a greater response from banks. But unfortunately, with lack of clarity from the RBI on certain fundamental concepts, e.g. provisioning requirements and exposure norms, this has not been the case.

Additionally, banks currently are prohibited from purchase of bills drawn otherwise than under a letter of credit on a “without recourse” basis (as specified in the RBI’s master circular on Loans and Advances – Statutory and Other Restrictions, dated 1 July 2014). Where most entities are looking to assign their receivables on a “true sale” basis, this serves as a major hindrance to banks undertaking factoring business because “‘with recourse’ factoring may not be treated as true sale for assignor” (as pointed out in the Report of the Technical Committee on Services/Facilities to Exporters dated 29 April 2013. Further, there is a lack of clarity on who the “debtor” is in case of payment of receivables falling overdue under a factoring arrangement.

Insurance restrictions

Restrictions imposed by the Insurance Regulatory and Development Authority on the issuance of trade credit insurance to banks/financial institutions, other than by ECGC (formerly called Export Credit Guarantee Corporation of India), are also not helping the cause. Banks and financial institutions cannot be expected to undertake such credit exposures without due protection.

Further, most Indian exporters obtain a buyers cover policy from ECGC to insure against from risk of default of buyers. When obtaining factoring facilities from banks these exporters assign these instruments to such banks. As highlighted in the technical committee report of 2013, in several instances of default by the buyers in making payments, these exporters decline to lodge claims with ECGC leaving the banks high and dry. There is a need to statutorily install certain deterrents to prevent such actions.

As far as extending the provisions of the Securitisation and Reconstruction of Financial Assets and Enforcement of Security Interest Act, 2002, to non-banking financial companies is concerned, the final call rests with the central government.

Conclusion

While the Factoring Act brings a much needed structure to factoring in India, it has to further evolve to be in tandem with the market needs. The RBI needs to ensure that there is due synergy between the act and its policies on factoring in India. Ambiguities in concepts and understanding are not giving the much needed impetus to factoring in India.

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Babu Sivaprakasam is a partner, Deep Roy is an associate partner and Okram Singha is an associate manager at Economic Laws Practice. This article is intended for informational purposes and does not constitute a legal opinion or advice.