FactoringBusinessinIndia

Dr.Prashant S.Desai,
AssistantProfessor,
NLSIU

Factoringisaserviceinvolvingthepurchasebya
financialorganization,calledafactor,of
receivablesownedtomanufacturerand
distributorsbytheircustomers,withthefactor
assumingfullcreditandcollection
responsibilities.
Inotherwords,factoringisafinancialtransaction
wherebyanexportersellsitsaccountsreceivable
(i.e.,invoices)toathirdparty(calledafactor)ata
discountinexchangeforimmediatemoneywith
whichtofinancecontinuedbusiness.

 Itisatypeoffinancialserviceprovidedbythe
specialistorganizations.Itisoneoftheoldest
formsofbusinessfinancing.
Factoringisaservicethatcoversthefinancing
andcollectionofaccountreceivablesindomestic
andinternationaltrade.
Factoringdiffersfromabankloaninthreemain
ways.First,theemphasisisonthevalueofthe
receivables(essentiallyafinancialasset),notthe
firm'screditworthiness.Secondly,factoringisnot
aloan itisthepurchaseofafinancialasset(the
receivable).Finally,abankloaninvolvestwo
partieswhereasfactoringinvolvesthree.

 Factoringenablesyouto:
1. Instantlyturnyourreceivablesintocash.
2. Availcreditprotectionforyourreceivables.
3. Takewellinformedcreditdecisions.
4. Outsourceyoursalesledgeradministration.
Factoringnotonlyhelpsinexpandingbusiness,
butalsoprovideswithanefficientcollection
mechanismandprotectionagainstbaddebts.

CHARACTERISTICSOFFACTORING
Usuallytheperiodforfactoringis90to150days.Some
factoringcompaniesallowevenmorethan150days.
Factoringisconsideredtobeacostlysourceoffinance
comparedtoothersourcesofshorttermborrowings.
Factoringreceivablesisanidealfinancialsolutionfor
newandemergingfirmswithoutstrongfinancials.This
isbecausecreditworthinessisevaluatedbasedonthe
financialstrengthofthecustomer(debtor).Hence
thesecompaniescanleverageonthefinancialstrength
oftheircustomers.

 Baddebtswillnotbeconsideredforfactoring.
Creditratingisnotmandatory.Butthefactoring
companiesusuallycarryoutcreditriskanalysis
beforeenteringintotheagreement.
Factoringisamethodofoffbalancesheet
financing.
Costoffactoring=financecost+operatingcost.
Factoringcostvaryaccordingtothetransaction
size,financialstrengthofthecustomeretc.The
costoffactoringvariesfrom1.5%to3%per
monthdependinguponthefinancialstrengthof
theclient'scustomer.

DIFFERENTTYPESOFFACTORING
DisclosedandUndisclosed
Indisclosedfactoringclient'scustomersarenotifiedof
thefactoringagreement.Disclosedtypecaneitherbe
recourseornonrecourse.
Inundisclosedfactoring,client'scustomersarenot
notifiedofthefactoringarrangement.Salesledger
administrationandcollectionofdebtsareundertaken
bytheclienthimself.Clienthastopaytheamountto
thefactorirrespectiveofwhethercustomerhaspaidor
not.Butindisclosedtypefactormayormaynotbe
responsibleforthecollectionofdebtsdependingon
whetheritisrecourseornonrecourse.

 RecourseandNonrecourse
Inrecoursefactoring,clientundertakestocollect
thedebtsfromthecustomer.Ifthecustomer
don'tpaytheamountonmaturity,factorwill
recovertheamountfromtheclient.Thisisthe
mostcommontypeoffactoring.
Recoursefactoringisofferedatalowerinterest
ratesincetheriskbythefactorislow.Balance
amountispaidtoclientwhenthecustomerpays
thefactor.

 Innonrecoursefactoring,factorundertakesto
collectthedebtsfromthecustomer.Balance
amountispaidtoclientattheendofthe
creditperiodorwhenthecustomerpaysthe
factorwhichevercomesfirst.
Theadvantageofnonrecoursefactoringis
thatcontinuousfactoringwilleliminatethe
needforcreditandcollectiondepartmentsin
theorganization.

ADVANTAGESOFFACTORING
Factoringprovidesalargeandquickboosttocash
flow.Thismaybeveryvaluableforbusinesses
thatareshortofworkingcapital.
therearemanyfactoringcompanies,sopricesare
usuallycompetitive.
itcanbeacosteffectivewayofoutsourcingyour
salesledgerwhilefreeingupyourtimeto
managethebusiness.
itassistssmoothercashflowandfinancial
planning.

 somecustomersmayrespectfactorsandpaymore
quickly.
youmaybegivenusefulinformationaboutthecredit
standingofyourcustomersandtheycanhelpyouto
negotiatebettertermswithyoursuppliers.
factorscanproveanexcellentstrategicaswellas
financialresourcewhenplanningbusinessgrowth.
youwillbeprotectedfrombaddebtsifyouchoose
nonrecoursefactoringcashisreleasedassoonas
ordersareinvoicedandisavailableforcapital
investmentandfundingofyournextorders.

DISADVANTAGESOFFACTORING
Queriesanddisputesmayhavetobereferredon.
Forthisreason,factoringworksbestwhena
businessisefficientandtherearefewdisputes
andqueries.
Thecostwillmeanareductioninyourprofit
marginoneachorderorservicefulfillment.
Itmayreducethescopeforborrowing book
debtswillnotbeavailableassecurity.
Factorsmaywanttovetyourcustomersand
influencethewaythatyoudobusiness.

 Itmaybedifficulttoendanarrangementwitha
factorasyouwillhavetopayoffanymoneythey
haveadvancedyouoninvoicesifthecustomer
hasnotpaidthemyet.
Somecustomersmayprefertodealdirectlywith
you.
Howthefactordealswithyourcustomerswill
affectwhatyourcustomersthinkofyou.Make
sureyouuseareputablecompanythatwillnot
damageyourreputation.
Youhavetopayextratoremoveyourliabilityfor
baddebtors.

ReasonforFactoring
Factoringisamethodusedbyafirmtoobtain
CashwhentheavailableCashBalanceheldbythe
firmisinsufficienttomeetcurrentobligations
andaccommodateitsothercashneeds,suchas
newordersorcontracts.
TheuseofFactoringtoobtaintheCashneededto
accommodatethefirm'simmediateCashneeds
willallowthefirmtomaintainasmallerongoing
CashBalance.
ByreducingthesizeofitsCashBalances,more
moneyismadeavailableforinvestmentinthe
firm'sgrowth.

 Acompanysellsitsinvoicesatadiscounttotheir
facevaluewhenitcalculatesthatitwillbebetter
offusingtheproceedstostrengthenitsown
growththanitwouldbebyeffectivelyfunctioning
asits"customer'sbank."
Factoringoccurswhentherateofreturnonthe
proceedsinvestedinproductionexceedthecosts
associatedwithFactoringtheReceivables.
Therefore,thetradeoffbetweenthereturnthe
firmearnsoninvestmentinproductionandthe
costofutilizingaFactoriscrucialindetermining
boththeextentFactoringisusedandthe
quantityofCashthefirmholdsonhand.

WORKINGOFFACTORING
First,importerplacesanorderwiththeexporter
Secondly,exportergivesthedetailsofthe
transactiontothefactor
Thirdly,exporterdispatchesthegoodstothe
importerandsendsaninvoicewelltopaythe
amountonduedatetothefactor
Exportersubmitsthecopyofinvoicetothefactor
Factorpaystheamounttoexporter
Customerpaystheamounttothefactorondue
date
Factorpaysthebalancetoclient

FactoringinIndiaandroleofReserve
Bank
Factoringservice,whichisperceivedas
complimentarytobankfinance,enablesthe
availabilityofmuchneededworkingcapital
financeforthesmallandmediumscale
industriesespeciallythosethathavegood
qualityreceivablesbutmaynotbeina
positiontoobtainenoughbankfinancedueto
lackofcollateralorcreditprofile.

 Byhavingacontinuousbusinessrelationshipwith
thefactoringcompanies,smalltraders,industries
andexportersgettheadvantageofimprovingthe
cashflowandliquidityoftheirbusinessasalso
thefacilityofavailingancillaryserviceslikesales
ledgeraccounting,collectionofreceivables,
creditprotectionetc.
Factoringhelpsthemtofreetheirresourcesand
haveaonestoparrangementforvariousbusiness
needsenablingsmoothrunningoftheirbusiness.

 TheKalyana Sundaram StudyGroupsetupbythe

ReserveBankofIndiainJanuary1988toexamine
thefeasibilityandmechanicsofstartingfactoring
organizationsinthecountrypavedthewayfor
provisionofdomesticfactoringservicesinIndia.
TheBankingRegulationAct,1949wasamended
toincludefactoringasaformofbusinessin
whichthebanksmightengage.
ReserveBankofIndiaissuedguidelines
permittingthebankstosetupseparate
subsidiariesorinvestinfactoringcompanies
jointlywithotherbanks.

 However,itwasgenerallyfeltthatabsenceof
FactoringLawwasoneofthemajor
impedimentsinthegrowthoffactoring
businessofthecountryincludingtheheavy
stampdutyoverassignmentdeed,ambiguity
inthelegalrightsofFactorsinrespectof
receivablesetc.

SuggestionsofC.S.Kalayana
Sundaram Committee
TheCommitteerecommendedtheintroduction
ofFactoringservicesinIndiatocomplementthe
servicesprovidedbybanks.ExportFactoringcan
alsobelaunched.
Factorsshouldcoverwiderangeofindustries
embracingallsectorsofeconomy.
Thecostoffundsshouldnotbemorethan13.5%
perannum.Factorswillhavetochargetheprice
forservicesataratenothigherthanbanks.The
priceforadministrativeservicesmaynotexceed
2.5to3%ofdebtservices.

 Factoringagenciesmaybepromotedonzonal
basis.OneeachforNorth,South,EastandWest(
ForSouth,Canara BankhassponsoredCanBank
FactorsLtd.whileintheWesternZoneSBIFactors
Ltd.hasbeensetup).
Bankshaveconsiderableexperienceinfinancing
andcollectionofreceivables.Besides,theyhave
accesstocreditinformationregardingboth
sellersandbuyers.Anadditionaladvantageisthe
largenetworkofbranches.

 Thecompanieswhichprovidefactoringin
IndiaareCanbank FactorsLimited,SBIFactors
andCommercialServicesPvt.Ltd,The
Hongkong andShanghaiBankingCorporation
Ltd.GlobalTradeFinanceLimited,Export
CreditGuaranteeCorporationofIndiaLtd,
CitibankNA,IndiaandSmallIndustries
DevelopmentBankofIndia(SIDBI)

 TheCommitteehasrecommendedthatthe
Governmentmayenactasuitablelegislationfor
thelevyofpenalinterestfordelayedpayment
fromthedebtorsbeyondspecifiedperiod.Ithas
alsorecommendedthattheGovernmentshould
exemptassignmentoffactoreddebtsfromstamp
duty.
FactoringservicesofarnotpickedupinIndiadue
tovariousdeficienciesincludinghighcostservice
charges,documentationdifficulties,legallacuna,
etc.

 GovernmentofIndiaenactedtheFactoringAct,
2011tobringinthemuchneededlegal
frameworkforthefactoringbusinessinthe
country.
Ithasprovideddefinitionsfortheterms
factoring,factor,receivablesandassignment.
TheActalsospecifiesthatanyentityconducting
factoringbusinesswouldneedtoberegistered
withRBIasNBFCs;whileexemptingbanks,
governmentcompaniesandcorporations
establishedunderanActofParliament,fromthe
requirementofregistrationwithRBIfor
conductingfactoringbusiness.

 TheAct,thus,gaveclaritytotheactivityof
assignmentofreceivablesandalsogranted
exemptionfromstampdutyondocuments
executedforthepurposeofassignmentof
receivablesinfavour ofFactorstherebymaking
thebusinessmoreviable.
TheActalsoenvisagesthatalltransactionsof
assignmentofreceivablesshallberegisteredwith
theCentralRegistryestablishedunderthe
SARFAESIAct,2002toreducethepossibilityof
fraudsandforstrengtheningtheduediligence
processfortheclients.

 TheActhasgivenpowerstotheReserveBankto
stipulateconditionsforprincipalbusinessofaFactor
asalsopowerstogivedirectionsandcollect
informationfromfactors.
SubsequenttothepassingoftheAct,theReserveBank
hascreatedaseparatecategoryofNBFCsviz;NBFC
Factorsandissueddirectionsfortheirregulation.
TheprudentialnormsasapplicabletoNBFCsengaged
inlendingbusiness,hasalsobeenextendedtothe
NBFCFactors.
Further,bankfinancetofactoringcompaniesandthe
factoringbusinessconductedbybanksarealso
regulatedbytheRBI.

Challengesfacedbyfactoringsector
Introductionofcreditinsuranceinthefactoring
businessandextendingthescopeofSARFAESIAct
tocoverNBFCsforspeedyenforcementof
securityinterest.
Asregardscreditinsurance,theFinanceMinister,
intheUnionBudget201314,hasmadean
announcementforsettingupaCreditGuarantee
FundwithSIDBIforfactoring,withaRs5billion
corpus.
Asfarasextensionoftheprovisionsofthe
SARFAESIActtoNBFCisconcerned,thefinalcall
restswiththeGovernmentofIndia.

 Lowpenetrationoffactoringbusinessinthe
countrystillremainsachallengewhichcouldbe
onaccountoflackofawarenessamongtheusers.
Withthenecessarylawnowinplace,sincere
attemptsneedtobemadebytheindustry
throughitsassociationsandotherfora for
articulatingthebenefitsoffactoringasnotjust
analternativesourceoffinancebutalsoan
avenueforprovidingabouquetoffinancial
servicesvisvistraditionalfinance,tosmall
scaleindustries.

 Theyshouldbeabletoidentifytheuntapped
potentialclientele,especiallyinvariousSME
industrysectors,andcreateawarenessonhow
thehighercostoffactoringvisvisthe
traditionalfinanceisjustifiableandcosteffective
forthebusinessesinthelongrun.
Factoringcompaniesshouldalsoconstantly
endeavour toupgradetheirexpertiseonboth
technologicalfrontasalsoontheoperational
levelforofferingcosteffectiveservicestotheir
clientele.

TheFactoringRegulationAct,2011
Toprovideandregulateassignmentof
receivablebymakingprovisionforregistration
offactorsandassignmentofreceivables.
Todefinetherightsandobligationsofparties
tocontractforassignment.
StatingthepenaltiesandoffencesfortheAct
Sections19,20,21&32oftheActhavebeen
broughtintoforcefrom2nd April2012bythe
CentralGovt.throughthenotification.

 Effectofthesaidnotification:
Filingofassignmentofreceivableswhichareinthe
favour offactorforregistrationpurposehasbeen
madecompulsory.
IthastoberegisteredwiththeCentralRegistrarwhich
hasbeensetupunderSection20ofSecuritisation and
ReconstructionofFinancialAssetsandEnforcementof
SecurityInterestAct,2002(SARFAESI)and
Securitisation andReconstructionofFinancialAssets
andEnforcementofSecurityInterest(CentralRegistry)
Rules,2011(CentralRegistryRules)madeunder
SARFAESImutatismutandis,applytotherecordof
assignmentofreceivablesinfavour ofafactorinthe
CentralRegisterwiththeCentralRegistry.

 Thefilingfortheassignmentofreceivableshasto
bedonewithin30daysfromthedateof
assignmentorthedateofestablishmentof
registry(whicheverisearlier)
Nonfilingofassignmentforregistrationpurpose
wouldleadtopenaltyforthedefaultingparties.
Onrealizationoftheassignedreceivablesor
settlementofclaimagainstthedebtorthenthe
factorshallfileforsatisfactionoftheassignment
inthereceivableinthefavoroffactor.

 Theparticularsofassignmentofreceivables
enteredintheCentralRegisterofsuch
transactionsundersection19areopenforpublic
inspectionandCentralRegistershallbe
maintainedinelectronicform.
Nonfilingforregistrationpurposewouldleadto
penaltyforthecompanyandeveryofficerofthe
companyresponsiblefortheactandthefine
imposedcanextendtofivethousandrupeeseach
daythedefaultcontinues.

 BriefOverviewoftheEnforcedSectionsoftheAct
Section19ofActstatesthateveryfactorbeforethe
CentralRegistrywhichhasbeensetupundersection20
ofSARFAESI,within:
a.30daysofassignmentor
b.Dateofestablishmentofregistry
Thefactorshallregistertheparticularsofevery
assignmenttransactionreceivableinthefavour ofthe
factorandreceivablesmaybedescribedspecificallyor
generallywithreferencetothedebtor,ortheperiodto
whichtheyrelateorbyanyothergeneraldescriptionby
whichsuchreceivablescanbeidentifiedandon
realizationofreceivablesorsettlementoftheclaim
againstthedebtorsthefactorshallfilesatisfactionof
assignmentofreceivablesinitsfavour.

 Theprovisionsforregistrationoftransactions
containedintheSARFAESIandtherulesmade
thereundershall,mutatismutandis,applytothe
recordofassignmentofreceivablesinfavour ofa
factorintheCentralRegisterwiththeCentral
Registry.
Section20ofTheAct Particularsoftransaction
ofassignmentofreceivablesenteredinthe
centralregistershallbeopenduringbusiness
hoursforinspectionbyanypersonbypaymentof
theprescribedfee.

 Section21oftheAct Ifthereisdefaultinfilingof
particularsofassignmentofreceivablesand
realizationbyafactorthenthedefaultcompanyand
everyofficerofthedefaultcompanyshallbe
punishablewithfinewhichmayextendtofive
thousandrupeesforeverydayduringwhichthe
defaultcontinues.
Section32oftheActgivesthepowertotheCentral
Governmenttomakerules.

 Applicabilityoftheenforcedsections
a.NonBankingFinancialCompany(NBFC)asdefined
inclause(f)ofsection45IoftheReserveBankof
IndiaAct,1934whichhasbeengrantedacertificate
ofregistrationundersubsection(1)ofsection3.
b.AnycorporateestablishedunderanActof
ParliamentoranyStateLegislatureoranycompany
registeredundertheCompaniesAct,1956engaged
inthefactoringbusiness.

 ProcessofFilingforRegistrationProcess:
Factorhastofileeveryparticularsoftransactionof
assignmentwiththeCentralRegistrywhichisinhis
favour inFormIwithin30daysfromthedateof
suchassignmentorfromthedateofestablishment
ofsuchregistry,asthecasemaybe,inthemanner
andsubjecttopaymentofsuchfeeasmaybe
prescribedasperRegistrationofAssignmentof
ReceivablesRules,2012.

 buttheseRulesstillhavenotbeenbroughtinto
forceandsection19(4)oftheActstatesthat
CentralRegistryRules,2011shallapplywhere
everrequired,thusitcanbepresumedthat
CentralRegistryRules,2011wouldapplyat
presentforregistrationpurpose.
TheFormIwouldbefilledbysuchformshallbe
authenticatedbyauthorised representativeof
Assignee/Factorusingavaliddigitalsignature.

 Notfilingofinformationispunishablebythewayof
penaltyandthecompanyandthepersonofthe
companywhoisliabletofileinformationwouldbe
thedefaulters.
Onrealizationoftheassignedreceivablesor
settlementoftheclaimagainstthedebtors,the
factorshallfilesatisfactionoftheassignmentof
receivablesinitsfavour inForm IIwhichshallbe
authenticatedbyapersonspecifiedintheformfor
suchpurposebyuseofavaliddigitalsignature.

 TestofSection19oftheAct
Thetestofsection19isthattheassignmentofthe
receivableshavetobeinthefavour ofthefactoras
thesectionusesthewordsassignmentof
receivablesinhisfavour,meaningthatonlythose
assignmentswhichwouldbeinthefavour ofthe
factorwouldhavetobefiledwiththecentralregistry
toberegistered.

 Anothertestofsection19isthetestofengagedin
thebusinessoffactoring.Section2(i)oftheAct
definesfactortobeacertifiedNonBankingFinancial
Company(NBFC)orbodycorporateestablished
underanActofParliamentoranyStateLegislature
oranyBankoranycompanyregisteredunderthe
CompaniesAct,1956whoallareengagedinthe
businessoffactoring.

LiabilityundertheEnforcedSections
Itshallbetheobligationofthefactortofile
beforethecentralregistryforregistration
purposeforallthoseassignmenttransactions
whichareinthefavour ofthefactoranditshall
notbetheobligationoftheassignortofilethe
informationforregistration.
Thefactorshallalsohavetofileforregistration
whentheassignedreceivableshavebeenrealised
ortheclaimhasbeensettledagainstthedebtors
asthelanguageusedbysection19isthatfactor
shallfilesatisfactionoftheassignmentof
receivablesinitsfavour.

 Everyfactoriscompulsorilyliabletofilethe
transactionofassignmentforregistration
purposebeforethecentralregistryassection19
usesthewordsshallfile,makingitcompulsory
onthepartofthefactortofiletheinformation
forregistration.
Ondefaultoffilingoftheassignmentof
receivablesthepartiesresponsiblewouldbe
liableforpenaltybuythewayoffinebutthe
assignmentwouldnotbecancelledfornonfiling
forregistrationprocess.

ImplicationonNonBankingFinancial
Companies
Filingofinformationforregistrationof
assignmentofanytypeofreceivableswhichis
receivableinthefavour ofthefactorandwhen
thereceivablehasbeenrealised hasbeenmade
obligatoryonthepartofNBFC.
Theassignmentofreceivablesdoesnotbecome
invalidduetothereasonofnonfilingfor
registrationbeforetheCentralRegistraras
Section21oftheActofimposespenaltybythe
wayoffineonnonfiling.

 Theregistrationprocesshasbeenmade
compulsoryassection19usesthewordshall
fileandanydefaultinfilingshallbepunishable
notonlyforthecompanybutforeveryofficerof
thecompanyisindefault.
Theinformationregardingtheassignmentof
receivableshastobefiledforregistrationasper
theRegistrationofAssignmentofReceivables
Rules,2012andrule4statesthatassignmentfor
receivableswouldberegisteredinthemannera
securityinterestisregisteredandsamerules
wouldapplyasitappliesforsecurityinterest.

 Thefilingofinformationistobemade,i.e.
Form I
Financialdetailsoftheassignment.
Istheassignmentabsolutewithoutrecourse
totheassignor?
Thedescriptionofdocumentbywhichthe
receivablesareassigned
Particularsoftheprincipaltermsand
conditionsoftheassignmentagreement

 Thusthecentralregistryistryingtokeepacheck
onastowhatareandhowtheassignmentis
beingdoneandthusbythisprocessthecentral
authorityiskeepingacheckonthewaythe
assignmentofreceivablesisdoneanditalso
givesthepowertopersonstogoandcheckthe
detailsoftheassignment.
ThustheActistryingtobringaprocessoftruth
andfairnessintheprocesswhichwouldgivethe
companiesachancetoseewhetherthedetails
aretrueornotanditisalsoputtingthe
informationofassignmentinpublicdomain.

Thanks