Factoring Regulation Bill, 2011

Recently, the parliament of India has passed the Factoring Regulation Bill, 2011, which has gone almost unnoticed in media. Here is a brief discussion on the important bill:

What is Factoring?

We take an example. We suppose that I owe Rs. 10000 by a company who I expect will pay me in a couple of months. However, I need the money at an earlier date. What I can do is to sell my invoice to a factoring company who gives me Rs. 8800 immediately. The factoring company then will collect and keep the full Rs. 10000 two months later. This means that factoring is a quick and easy way of turning your invoices into cash. This is the advantage. There are some disadvantages also. In the above example, while selling my invoice at Rs. 8800, I faced a loss of Rs. 1200. This is my cost of factoring. Cost depends upon many factors such as nature of business transaction, nature of debt.

The definition of Factoring is as follows:

“Factoring is a financial transaction whereby a business sells its accounts receivable (i.e., invoices) to a third party (called a factor) at a discount. In "advance" factoring, the factor provides financing to the seller of the accounts in the form of a cash "advance," often 70-85% of the purchase price of the accounts, with the balance of the purchase price being paid, net of the factor’s discount fee (commission) and other charges, upon collection. In "maturity" factoring, the factor makes no advance on the purchased accounts; rather, the purchase price is paid on or about the average maturity date of the accounts being purchased in the batch." (wikipedia)

The question is that – if I owe somebody some money, that is my property right, then why there was need of some law over factoring. The reason is as follows:

We know that the MSMEs depend upon the large business entities for continued business and the object of the Factoring law is to address the problem of delayed payments to micro and small business entities by large businesses for purchase of goods and services.

But this is not the first time that such law is enacted in India. In India, such a law was passed earlier also. The title of this 1993 law was "Interest on Delayed Payments to Small Scale and Ancillary Industrial Undertakings Act". This act was later incorporated into the Micro Small and Medium Enterprises Act, 2006. However, practically, these legislations did not improve the position of MSEs because of their dependence on large businesses for continued business. That is why a separate legislation has been enacted.

Important Features

Here are the salient features of the new bill:

  • Any company can commence Factoring by obtaining registration from the RBI as a non-banking finance company. Such registration shall be governed by the existing law applicable to NBFCs (Chapter IIIB of the RBI Act, 1934) as well as the new Factoring Regulation Act, 2011.
  • Banks or corporations established under an Act of Parliament can also undertake factoring without being required to obtain registration from RBI. Thus, organisations like NHB, SIDBI, EXIM Bank can also undertake factoring.
  • Definition of factoring also includes assignment of export receivables and thus includes ‘forfaiting’, subject to the requirements of the Foreign Exchange Management Act.
  • Term receivables are widely defined to include toll or any other charges payable for use of infrastructure facilities. However, bank loans are excluded from the definition of receivables.
  • The law applies to all business entities i.e. large, medium, small and micro entities, whether engaged in any manufacturing activity or trading or providing any services or in any other business activity. Applicability of the new law is, therefore, much wider and even large industrial houses and multinational corporations can avail factoring services;
  • The definition of ‘factoring’ covers both, with recourse and without recourse factoring.
  • The law requires that all transactions of assignment of receivables in favour of Factors shall be registered with the Central Registry established under the SARFAESI Act, 2002. The registry record shall be available for search by the public.
  • Factors are declared to be credit institutions for the purposes of Credit Information Companies (Regulation) Act, 2005 and can have access to credit information relating to firms availing factoring services;
  • Factors are not financial institutions for the purposes of SARFAESI Act and hence will not have rights of enforcement without the intervention of courts. But provisions of the Code of Civil Procedure, 1908 regarding summary suits are made applicable to claims of Factors to facilitate speedy recovery of receivables,
  • The most important provision in the Act is insertion of section 8D in the Indian Stamp Act, 1899, granting exemption from stamp duty on documents executed for the purpose of assignment of receivables in favour of Factors notwithstanding anything to the contrary contained in any other law in force. In view of such exemption, assignment of receivables in favour of Factors becomes a viable proposition and is expected to give a boost to factoring

Thus we see that that the legislation aims at growth of factoring for healthy growth of factoring and healthy growth of MSMEs also. Growth of factoring will solve the liquidity and working capital problems of numerous small and medium scale industries, which supply spare parts and operate as ancillary units of large manufacturing units and other business entities.