I. INTRODUCTION
Survival of business depends on smooth operations, precisely the need for liquidation of funds. Focusing on the said issue, India for the very first time adopted a consolidated legal framework to be known as Factoring Regulation Act, 2011 (‘Act’) governing the factoring transactions in the country.
The basics of factoring transaction can be understood with a simple instance of a sale-purchase transaction, wherein the seller upon delivering his goods demands the payment but the buyer may or may not pay within the stipulated time. To remove this contingency, it became necessary to adopt the bill discounting method as a defined framework.
Thus, the Act is introduced to address the issues about payments and liquidity in the business of Micro, Small, and Medium Enterprises (MSMEs). Post the introduction of the said Act, there have been many changes in the industry, technology, and innovations, for which the Factoring Regulation (Amendment) Act, 2021 (‘Amendment Act’) has been passed by the Parliament.
II. CONCEPT OF FACTORING TRANSACTION
Understanding a factoring transaction in the simplest sense, let’s say there is a seller ‘A’ and a buyer ‘B’, A sells certain goods to B for which an invoice is generated for INR 1,00,000. The payment is to be made by B within 30 days, although A needs the payment urgently. The option with A is to visit a bank/ financer and receive the amount against the said invoice immediately at a certain discount and B will pay the amount against that invoice directly to the bank/financier.
This simple concept of a factoring transaction is recognized under the Act and it granted the opportunity to MSMEs for ease in liquidation and/or immediate financing. The Act further granted an opportunity to Banks and Non-banking financial companies (NBFCs) to act as financiers under the factoring transaction, which is governed by the Reserve Bank of India (RBI).
III. TYPES OF FACTORING TRANSACTIONS
| Domestic factoring | International factoring |
| Invoice discounting | Export factoring |
| Recourse factoring | Import factoring |
| Non-recourse factoring | Export invoice discounting |
| Collections | Reverse factoring |
| Reverse factoring | |
IV. FACTORING BUSINESS
1. Factoring as defined by Standing Committee
As noted by the Standing Committee, Factoring can be defined as a transaction where an entity (MSME) ‘sells’ its receivables (dues from a customer) to a third party (a ‘factor’ like a bank or NBFC) for immediate funds (partial or full).
2. Parties involved in a Factoring Transaction
Primarily, it is pertinent to understand that there are three Parties defined under the said Act which are involved in a factoring transaction, being the Assignor, Assignee, and Debtor—
a) Assignor (Seller)- Owner of receivable
b) Assignee (Company undertaking Factoring Business)- Factor in whose favour receivable is transferred
c) Debtor (Buyer)- Person liable to assignor to pay the receivable whether existing, accruing, future, conditional, or contingent
3. Factoring Business defined under the Amendment Act
The scope of earlier definition of Factoring Business has been enhanced under the Amendment Act, which is now aligned with international standards and can be simplified in the following manner—
| What is the Business? | Business of Acquisition |
| What is being acquired? | Receivable (Invoice due by Buyer) |
| How it is being acquired? | By way of Assignment |
| From whom it is acquired? | Assignor (Seller) |
Upon such acquisition, the Assignor can avail two facilities from the Assignee—
a) Consideration for collection of such receivable from Debtor (Buyer); or
b) Financing, by way of making loans or advances or otherwise against the assignment of receivables.
4. Factoring Business does not include
a) Credit facilities provided by a bank in its ordinary course of business against the security of receivables;
b) Any activity as a commission agent or otherwise for sale of agricultural produce or goods of any kind whatsoever or any activity relating to the production, storage, supply, distribution, acquisition, or control of such produce or goods or provision of any services.
5. Receivables defined under the Amendment Act
The term Receivables, in general, refers to a bill/ invoice, but under the Amendment Act, Receivables are defined as follows—
a) Money owed by a debtor and not yet paid to the assignor for goods or services; and
b) Includes payment of any sum, by whatever name called, required to be paid for the toll or the use of any infrastructure facility or services.
Further, the receivables can include any debt which may be present, future, conditional or contingent, such amount as is outstanding from the buyer to the seller. This type of receivable is eligible to be assigned by the seller in favour of the Debtor (financier/ factor).
V. FACTORS AND ITS REGISTRATION
1. Definition of Factor
Factor basically means the Financier/ Assignor and the Act provided specific types of factors to act as financiers which limit the number, involved in a factoring transaction, thereby not meeting object of the Act. Therefore, by virtue of the Amendment Act, the scope of the term Factor is widened, accordingly, the following entities are included in the definition of Factors—
a) Banks (Exempted from Registration)
b) Statutory Corporations (Exempted from Registration)
c) NBFCs (Obtain registration under Section 3 of the Act from RBI)
d) Companies (Obtain registration under Section 3 of the Act from RBI)
The major change in this regard to be noted is that earlier, only NBFC-Factors could undertake the Factoring Business who comply with the Principal Business Criteria i.e. its financial assets are in the factoring business and income from the factoring business should both be more than 50% (of the gross assets/net income) or more than a threshold as notified by the RBI. Whereas post the Amendment Act, there is no such requirement of principal business and any NBFC can obtain registration from RBI to undertake the Factoring Business.
2. Registration of Factor
NBFCs and Companies are mandatorily required to obtain a registration certificate from the RBI to carry on the factoring business as per the regulations issued by the said authority. Further, the Banks and Statutory Corporations that act as a Factor are required to follow the rules and regulations and directions or guidelines issued by RBI.
The registration of Companies and NBFCs intending to undertake factoring business are required to obtain registration under the Master Direction – Non-Banking Financial Company –Non-Systemically Important Non-Deposit taking Company (Reserve Bank) Directions, 2016. Whereas, there may be certain amendments by RBI in the said Master Direction concerning the Principal Business Criteria and other provisions as RBI may deem fit.
VI. ASSIGNMENT OF RECEIVABLES
1. Agreement for Assignment
The assignment of receivables may be undertaken by entering into an agreement in writing, such agreement shall be between the assignor (seller) and assignee (factor/ financier). Further, the points of consideration post the entering into Agreement shall be as follows—
a) Disclose any defences and right of set-off against the receivable available to the debtor;
b) Where debtor or factor are established outside India, the provisions of Foreign Exchange Management Act, 1999 laid down by RBI shall be complied with;
c) Upon execution of the agreement, all rights, remedies, and any security interest created over any property to secure the due receivable shall vest exclusively with the assignee;
d) Effect of such assignment shall give the absolute right to recover the receivable and exercise all rights and remedies as may be available to assignor including but not limited to damages;
e) Where an assignment of receivables is a part of any security for repayment of the loan (advanced by a bank or other creditor) and same is disclosed to the assignee then the consideration against such assignment shall be paid to the said bank or creditor.
2. Intimation to Debtor and Discharge of Liability
a) To demand payment of receivable from the debtor (buyer), it is mandatory to send the notice of assignment by the assignor or assignee with express authority (by assignor);
b) Upon receiving the notice, the debtor shall make the payment to the assignee in the discharge of the obligation as specified in the said notice in the manner specified therein;
c) Wherein case, no notice has been given to the debtor and the payment is made to the assignor then the same shall be held in trust by the assignor for the assignee and which shall be paid to the assignee.
VII. RIGHTS AND OBLIGATIONS OF PARTIES
1. Rights of Debtor
a) Debtor has the right to receive notice of the assignment of receivable between the assignor and assignee;
b) Until the aforesaid notice is served, the debtor is entitled to make payment to the assignor as per the original contract and he shall be fully discharged from his liability.
2. Liabilities of Debtor
a) Upon receiving the notice, the debtor shall intimate assignee with regard to details of the deposit, advance, or any payment which may have been made to the assignor and disclose other relevant details;
b) Liability persists only till the payment is made good against the assigned receivable;
c) Debtor shall make the payment on or before the date agreed in the original contract, wherein case is the payment is delayed for 45 days from such date, the assignee shall be entitled to compound interest with monthly rests at three times the rate notified by RBI and the assignee shall have the same rights as that of a Micro or Small MSME.
3. Obligations of Assignor
a) Where the assignor receives the payment against the assigned receivable from the debtor irrespective of the intimation of notice to the debtor, he shall hold such payment for the assignee in trust and make the payment immediately.
b) In case of any breach of contract by the assignor with the original contract, the debtor shall not have the right to recover from the assignee whereas a claim for loss or damages can be made against the assignee.
VIII. METHOD OF FACTORING TRANSACTION
A factoring transaction is generally a manual process and post the introduction of the Act, it was undertaken in a traditional physical manner, whereas in 2014 RBI released a concept paper on an electronic mechanism to undertake these transactions through exchange portals, and later in 2017, RBI introduced Guidelines pertaining to setup of Trade Receivables Discounting System (TReDs).
Since, the introduction of these guidelines, there has been an increase in the setup of the TReDS online platform to undertake the factoring transaction through online platforms. Presently, three entities RXIL, M1xchange, and Invoicemart are running the TReDS platform and recently BSE has also received in-principle approval from RBI to set up the TReDS platform.
IX. TRADE RECEIVABLES DISCOUNTING SYSTEM
1. TReDS as defined under the Amendment Act
TReDS mean a payment system authorized by the Reserve Bank under section 7 of the Payment and Settlement Systems Act, 2007 to facilitate the financing of trade receivables. Under the said Section, RBI had issued Guidelines in 2017 to ensure compliance with the TReDS platform, however, most likely a new master direction/ regulation may be issued by RBI shortly.
2. TReDS as defined by RBI
TReDS is an electronic platform for facilitating the financing / discounting of trade receivables of Micro, Small, and Medium Enterprises (MSMEs) through multiple financiers.
3. Existing Guidelines on TReDS
a) Participants
MSME sellers, corporate and other buyers, including the Government Departments and PSUs, and financiers (both banks and NBFC factors).
b) Activity on Platform
Facilitating uploading, accepting, discounting, trading, and settlement of the invoices/bills of MSMEs.
c) Definition of Factoring Unit
A standard nomenclature is used in the TReDS for an invoice or a bill on the system. Factoring Units may be created either by the MSME seller (in the case of factoring) or by corporate and other buyers, including Government Departments and PSUs, (in case of reverse factoring) as the case may be.
d) Process flow and procedure
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- Adopt a mechanism as detailed in Guidelines
- Facilitate discounting of factoring units by the financiers resulting in an inflow of funds to the MSME with a final payment of the factoring unit being made by the buyer to the financier on the due date
- Further enable discounting / re-discounting of the discounted factoring units by the financiers, thus resulting in its assignment in favour of other financiers
- TReDS platform shall undertake the following—
√ Uploading of invoices/bills and creation of factoring units by the MSME sellers
√ Acceptance of invoices/bills by the corporate and other buyers, including the Government Departments and PSUs, within a specified time limit;
√ Discounting, rating, and re-discounting of factoring units;
√ Sending of notifications at each stage to the relevant parties to the transaction; reporting and MIS requirements; and
√ Generation and submission of settlement of obligations.
In the case of reverse factoring, the buyer could also create factoring units based on the documents uploaded by the MSME seller.
e) Other responsibilities of TReDs
1. Undertake random audits of the factoring units uploaded on the exchange
2. Standardised process of on-boarding buyers and sellers for submitting KYC documents, resolutions, and/ or any other specific documents and an indemnity
3. There would be a one-time agreement drawn up amongst the participants in the TReDS:
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- Master agreement between the financier and the TReDS
- Master agreement between the buyers and the TReDS
- Master agreement between the MSME sellers and the TReDS
- In the case of financing based on invoices, an assignment agreement would need to be executed between the MSME seller and the financier.
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The TReDS will be in the custody of all the agreements.
4. Registration as TReDS
An entity may be registered with RBI to set up and operate TReDS if it fulfills the following criteria—
a) Financial Criteria
- minimum paid-up equity capital shall be Rs. 25 crore;
- foreign shareholding as per the extant foreign investment policy;
- entities, other than the promoters, will not be permitted to have a shareholding over 10 percent of the equity capital;
- overall financial strength of the promoters/entity;
b) Due diligence of promoters
- entities and their promoters/promoter groups as defined in the SEBI (Issue of Capital & Disclosure Requirements) Regulations, 2009 should be ‘fit and proper;
- RBI would assess the ‘fit and proper’ status of the applicants based on their record of sound credentials and integrity;
- financial soundness and track record of at least 5 years in running their businesses.
c) Technological capability
- sound technological basis to support its operations;
- provide an electronic platform for all the participants;
- information about bills/ invoices, discounting and quotes shall be disseminated by the TReDS on a real-time basis, supported by a robust MIS system;
- suitable Business Continuity Plan (BCP) including a disaster recovery site;
- online surveillance capability which monitors positions, prices, and volumes in real-time to check system manipulation.
5. Registration on CERSAI
Under the Amendment Act, where any trade receivables are financed through TReDS, the details of the said transaction shall be filed with the Central Registry (Setup under Securitisation and Reconstruction of Financial Assets and Enforcement of Security Interest Act, 2002) by TReDS on behalf of the factor.
X. OPPORTUNITIES FOR THE PARTIES
| S. No. | Party | Opportunities |
| 1. | MSMEs* | a. Register on the TReDS platform for ease in liquidity of funds in capacity of a seller
b. Either receive consideration or financing from the Financiers/ Factors registered on the platform against an outstanding invoice |
| 2. | NBFCs** | a. Obtain registration from RBI to be registered on the TReDS platform even where your principal business is not of factoring
b. Better and hassle-free bidding process can be availed on the TReDS platform |
| 3. | Companies | a. Other companies who are not registered as NBFC may also act as Financier/ Factor upon receiving registration from RBI as per the required criteria
b. Tech-based companies interested in setting up a TReDs platform, upon meeting the eligibility criteria register with RBI and obtain approval |
*Currently, entities with a turnover of INR 500 Crore are mandatory to be registered on the TReDS platform.
**Currently, there are only 7 NBFC-Factors who undertake the business of financing, whereas now on uplifting the criteria of principal business, it has opened gates for a wide no. of NBFCs.
XI. CONCLUSION
The entire regime of Factoring Regulation has taken a massive shift, under which MSMEs liquidation issues may be resolved more effectively as the existing TReDS are constantly performing well in the market. In a short period, if new TReDS platforms might be set up, more MSMEs are registered and more NBFCs act as Factors/ Financiers in this enhanced and transparent regime, the objective of the Act does not seem too far. RBI with enhanced power to make regulations about registration requirements, filing requirements and other matters may introduce a revolutionary regulation that will change the framework of the financial market in India.
LEGAL FRAMEWORK AND REFERENCES
1. Factoring Regulation Act, 2011
2. Registration of Assignment of Receivables Rules, 2012
3. Payment and Settlement Systems Act, 2007
4. Micro, Small and Medium Enterprises Development Act, 2006
5. Master Direction – Non-Banking Financial Company – Non-Systemically Important Non-Deposit taking Company (Reserve Bank) Directions, 2016
6. Master Direction- Reserve Bank of India (Financial Services provided by Banks) Directions, 2016
7. Guidelines for setting up of and operating the Trade Receivables Discounting System (TReDS) issued by RBI in 2017
8. Other circulars/ directions issued by RBI from time to time
9. Factoring Regulation (Amendment) Act, 2021
10. Securitisation and Reconstruction of Financial Assets and Enforcement of Security Interest Act, 2002
11. 24th Report of Standing Committee on Finance (2020-2021), February, 2021 / Magha, 1942 (Saka) presented and laid on 3rd February 2021
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Invoice discounting platform legality