Factoring allows companies to receive immediate cash on their sales without having to wait for payments to come in from customers in due course
In view of the advantages of assignment of receivables over lending against receivable as defined in the Factoring Regulation Act, 2011 (the Act), companies may strategically decide to undertake transactions that are in the style of assignment of receivables rather than lending against receivables. While the business of factoring covers both assignment of receivables and lending against receivables the provisions of chapter 3, 4 and 5 of the Act are not applicable to lending against receivables.
Factoring works mainly on the principle of seller selling the receivables of a debtor to a specialized financial intermediary called a factor. The sale of the receivables takes place at a discount and the ownership of the receivables is transferred to the factor who shall on purchase of receivables, collect the dues from the debtor instead of the seller, enabling the seller to receive upfront funds from the factor. This allows companies to receive immediate cash on their sales without having to wait for payments to come in from customers in due course. With the purchase of the receivables, the factor enters the shoes of the seller and dawns the liability under the contract.
Section 2(i) of the Factoring Regulation Act, 2011defines factor to mean:
“a non-banking financial company as defined in clause (f) of section 45-I of the Reserve Bank of India Act, 1934 (2 of 1934) which has been granted a certificate of registration under sub-section (1) of section 3 or any body corporate established under an Act of Parliament or any State Legislature or any Bank or any company registered under the Companies Act, 1956 (1 of 1956) engaged in the factoring business;"(Emphasis Supplied);
Further, Section 2(j) of the Act defines factoring business which states that:
"factoring business means the business of acquisition of receivables of assignor by accepting assignment of such receivables or financing, whether by way of making loans or advances or otherwise against the security interest over any receivables but does not include— (i) credit facilities provided by a bank in its ordinary course of business against security of receivables; (ii) any activity as 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" (Emphasis Supplied)
Further Explanation under the Section 3(2) of the Act defines the principal business criteria for an NBFC-Factor. It states that:
For the removal of doubts it is hereby clarified that a non-banking financial company engaged in factoring business shall be treated as engaged in factoring business as its "principal business" if it fulfils the following conditions, namely:—
(a) if its financial assets in the factoring business are more than fifty per cent of its total assets or such per cent as may be stipulated by the Reserve Bank; and
(b) if its income from factoring business is more than fifty per cent. of the gross income or such per cent. as may be stipulated by the Reserve Bank.
Given the above pretext, it is clear that an NBFC principally engaged in the factoring business will be referred to as a Factor under the Factoring Regulation Act, 2011.
For the purpose of definition of factoring business, it can be construed basis that the business has two limbs first being assignment of receivables and second being financing / lending against receivables. However, if one was to read the Preamble of the Act, the focus of the Act was to facilitate assignment of receivables. Therefore, the larger construct and substantive clauses in the factoring Act deals with assignment of receivables as also is evident from the reading of Chapter III onwards of the Factoring Act.
Following chart is a graphical representation understanding of factoring business by entities as specified in the Act and the kind of business they may undertake to qualify to be a factor: