Published on: August 13,2021 11:25 IST
By Neha Choudhary
Introduction
Recently, with certain necessary amendments for the smooth working of the banking provisions, the Factoring Regulation Act, 2011 had sought to be amended with the Factoring Regulation Amendment Bill passed in 2021 which was tabled the previous year and developed this year with the recommendations of the U.K Sinha Committee with an aim that the alterations would widen the scope of the factors in the factoring business for the economic and financial sustainability in the nation.
‘Factoring’ refers to the fiscal relationship and arrangement between the financial institution and the client. In this type of agreement, the firm (client) receives advances from the factors i.e. the financial institutions, non-financial banking company, or any company registered under the Companies Act in return for the receivables.
The factoring business involves the financing technique which is a downright selling of trade debt from a firm to the factor at discounted prices so that it gets immediate money for its business.
However, it is different from the system of assigning loans from the bank, as the credit facilities against the security of receivables is not a factoring business.
The Amendment Bill suggesting the altered provisions for the Factoring Regulation Act 2011 was passed by the Parliament with the Rajya Sabha passing it on 29th July 2021 and by the Lok Sabha on 26th July 2021 with the ultimate motive that certain revisions in the provisions would benefit the Micro, Small and Medium Enterprises.
The amendments that have been passed by the parliament ensure the solutions to the complexities that the MSMEs have been facing due to delayed receivables and further ensure the smooth functioning of the cash flow and working capital cycle.
Nirmala Sitharaman, the Finance Minister of the country quoted that the 2011 Act came into force to tackle the problems arising due to lag in payments and the liquidity issues faced by the enterprises and thus the modification and reforms were paramount as the problems still exist and need certain alterations and additional provisions that would eradicate these obstacles for the betterment of the economy and banking functionaries.
What is the Factoring Regulation Act?
The Factoring Regulation Act 2011 was enacted on 22nd January 2012 by the parliaments in the 62nd year of the Republic of India to provide and regulate assignments of receivables by making provision for registration and rights and obligations of parties to contract for assignment of receivables and matters connected therewith or incidental thereto.
According to the definition clause under Section 2(i) of the Factoring Regulation Act 2011, it states that “”factor” means 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 anybody 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”
The Factoring Business has also been explicitly defined under the section 2(j) of the act and quotes 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-
- Credit facilities provided by a bank in its ordinary course of business against the security of receivables;
- 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 products or goods or provision of any services.”
According to the Act, factoring is a financial transaction with the third party where the receivables are traded by a business to the 3rd party and gets their immediate payments for their business at discounted rates.
The factoring business is usually a technique used by the small business at the time of contingencies to generate backing in terms of funds for their business.
The Factory Regulation Act deals with the assignments to the factors regarding debts, requirements for the registration, and the provisions regarding debtor protection. The objective of the act is to make provisions for the regulation of factoring and receivable’s assignments.
Furthermore, it provides certain special provisions for the advancement of micro and small businesses and one of the crucial steps taken through the act is the registration of the assignments via SARFAESI Act, 2002 and the exemption from the stamp duty.
According to Section 3 of the act, “No factor shall commence or carry on the factoring business unless it obtains a certificate of registration from the Reserve Bank to commence or carry on the factoring business under this Act. Every factor shall make an application for registration to the Reserve Bank in such form and manner as it may specify:
Provided that a company registered as a non-banking financial company and existing on the commencement of this Act and engaged in factoring business as its principal business before such commencement shall make an application for registration as a factor to the Reserve Bank before the expiry of the period of six months from such commencement and, notwithstanding anything contained in sub-section (1), may continue to carry on the factoring business until a certificate of registration is issued to it or rejection of application for registration is communicated to it.”
The Act provides certain regulations and one of them is that the factoring business cannot be commenced by any factor without proper certification of registration from the Reserve Bank of India.
Moreover, if it is necessary, the Reserve Bank of India through any general or special order can ask for any particulars regarding the factoring business and can issue directions to the factors running the business in its own interest.
In case, any factor does not adhere to the guidelines and directions delivered by the Reserve Bank can face repercussions and would be rejected to run factoring business after getting the reasonable and legitimate opportunity of being heard.
Furthermore, in case the factoring engagement is not in compliance with the regulations and norms of the reserve of India, then such failure may lead to punishment and a fine which has to be paid within a specified time, and thus the same has been quoted under Section 22 of the Act.
It has also been mentioned under the Act that any violations with the provisions mentioned under the Act, the offender shall have to undergo imprisonment with a fine.
However, any person punished under this Act cannot be tried under any other act unless the bank permits it in writing.
The provisions regarding the ‘assignment of the receivables’ are added in Chapter II of the Factoring Regulation Act 2011 and according to Section 7 of the Act,
- “Any assignor may, by an agreement in writing, assign any receivable due and payable to him by any debtor, to any factor, being the assignee, for consideration as may be agreed between the assignor and the assignee and the assignor shall at the time of such assignment, disclose to the assignee any defenses and right of set-off that may be available to the debtor:
Provided that if the debtor is liable to pay the receivable or the business of factor is situated or established outside India, any assignment of receivable shall be subject to the provisions of the Foreign Exchange Management Act, 1999 (42 of 1999).
- On execution of the agreement in writing for assignment of receivables, all the rights, remedies and any security interest created over any property exclusively to secure the due payment of receivable shall vest in the assignee and the assignee shall have an absolute right to recover such receivable and exercise all the rights and remedies of the assignor whether by way of damages or otherwise, or whether notice of assignment as provided in section 8 is given or not.
- Any assignment of receivables which constitute security for repayment of any loan advanced by any Bank or other creditor and if the assignor has given notice of such encumbrance to the assignee, then on accepting assignment of such receivable, the assignee shall pay the consideration for such assignment to the Bank or the creditor, as the case may be.”
Moreover, the assigner and the assignee in the factoring engagement have to agree and acknowledge terms of considerations before proceeding to the business.
The assigner has to disclose at the time of assignment of receivables, the defenses and rights to set off the arrangement available to the debtor which is thereby mentioned under Section 16 of the Act.
Also, under the provisions of the Regulation Act, the assignee holds the rights to the amount received for the assignment of the receivables.
In case of any hindrances in the assignment, the assignor has the right to get the consideration as he assigns receivables upon secured payment. Such rights and obligations of the parties to the contract are thereby mentioned under Chapter IV of the Act.
However, unless any notice has been served to the assignee regarding the authority by the assignor, the assignee has absolutely no right to demand payments from the debtor. On the other hand, the debtor has the right to notice of assignment without any injustice to the law in force.
However, the debtor has to operate and perform following the contract and intimate all information regarding deposits and has to make all the payments to the assignor on assigned receivables as then he would be liable for invalid clearance and discharge of the payment.
Furthermore, the Act also mentions the liability of the debtor in case of an assignor being micro or small enterprises and states, “If the assignor of receivables is a micro or small enterprise, the liability of the debtor to make payment due on assigned receivables shall be subject to the provisions contained in sections 15 to 17 of the Micro, Small and Medium Enterprises Development Act, 2006 (27 of 1006) with regards to the delayed payments of the receivables.
In the event of delay in payment on the part of the debtor to pay the receivable of any micro or small enterprise, the assignee shall be entitled to receive interest for the delayed period and shall take steps under the provisions of the Micro, Small and Medium Enterprises Development Act, 2006 (27 of 2006) for the purpose of the recovery of the interest and shall pay such interest to the micro or small enterprise.”
Lastly, the Act under Section 34 also notifies the power to remove the difficulty and states that in case any adversity arises in aftermath of the provisions of this Act, the Central Government is eligible to make changes and amendments but must not be inconsistent with the provisions of the already established 2011 Act, provided that no order shall be made after the expiry of a period of two years from the commencement of this Act.
What are the Amendments suggested in the Factoring Regulation Bill 2021?
The parliament passed the amendment Bill for the Factoring Regulation Act 2011. The Bill aimed to broaden the credit facilities for small businesses by helping them in accessing up to 9000 non-banking financial companies.
The Bill also anticipated making the healthier cash flow and smooth functioning of the working capital cycle for MSMEs. Thus there are certain key alterations made through the Factoring Regulation Amendment Bill 2021 and the following are:
- Change in the Definitions
The amendment Bill suggested the changes in the definitions of the ‘Receivables’, ‘Assignment’ and ‘Factoring Business’ to bring them at par at the international level. The Bill amends the definition of receivables that would now mean any money (toll or use of any facility or service) payable by the debtor to the assigner rather than the amount defined under the contract.
The Bill also amended the definition of assignment which was defined as a transmission (by agreement) in favor of the factor due from the debtor which after the amendment added that such a transfer can be in whole or in part (of the undivided interest in the receivable dues). The Bill also tends to change the definition of factoring business which is now amended as “acquisition of receivables of an assignor by assignment for a consideration. The acquisition should be for the purpose of collection of the receivables or for financing against such assignment”
- Registration of Factors
Factoring Regulation (Amendment) Bill 2021 suggested the amendments in the Factoring Regulation Act, 2011 which according to the current law states that the Reserve Bank of India holds the authority to allow NBFCs to remain in factoring business only if their assets and income is more than half of the threshold allowed by the RBI as now according to amendment the threshold has been removed to allow the small businesses at the time of financial tension.
- Registration of Transactions
The Factoring Regulation Act before the amendment mentioned that the factors must register the details of every transaction of assignment of receivables and the details shall be documented with the Central Registry setup under the SARFAESI Act, 2002 within 30 days and in case of any failure to comply with the norms, the offender may be punished with a fine of up to Rs. 5000 per day till the default extends. After the 2021 amendment, the 30 day time period has been removed.
- Registering Charges (Trade Receivables Discounting System)
Trade Receivables Discounting System is a digital system shortly known as TReDS to register charges and it also provides the financing of trade receivables of MSMEs.
The 2021 Bill amends and inserts under Section 2, the Trade Receivables Discounting System and states that the details regarding such transaction and financing shall have to be filed with the Central Registry by the TReDS on behalf of the factor and the same has been inserted in sub-section 1A of Section 19 of the Act.
What is the need and significance of the Amendments?
The significance and necessity for the amendment Bill can be determined from the following:
- The amendment tends to permit the non-NBFC factors and other entities for factoring that would increase the opportunities for the small businesses by providing funds, reducing the cost of funds, enabling credit facilities to the small businesses, and no delay in payments against receivables.
- The amendment Bill tends to change certain provisions through which the challenges faced by the MSMEs regarding the delayed receivables would be curbed and furthermore, these amendments would aid in substantial and stable functioning of the working capital cycle and healthier cash flow.
- Moreover, with the new Factoring Regulation Bill, there will be more NBFCs for MSMEs to arrange working capital through Bill discounting, thus shortening the cycle of taking up new work assignments. According to the records, there are only 7 Factoring companies in India and with this bill, the Government aims and aspires to boost the number of companies offering to factor to over 9,500.
- Finance Minister Nirmala Sitharaman has also quoted that “even as the economy revives, for MSMEs to have great access to liquidity and working capital and have the chance to sell their receivables to a third party in exchange for cash would make a significant difference.”
- The amendments liberalize the restrictive provisions of the Act and also ensure that a strong regulatory oversight mechanism is placed through the Reserve Bank.
- With these amendments, it has been expected that the global factoring market would reach 9.2 trillion dollars by 2025 as according to recent reports the factoring market only accounts for 0.2% of India’s GDP which is dreadful as long as the growth per year is concerned compared to economically developing countries like Brazil and China.[1]
- The key alterations in the definitions under Section 2 of the Act were significant as they would make it easier for the financing companies to undertake factoring business and would ultimately boost the economy of the country and efficient working capital cycle.
Lastly, the amendments are indispensable in every sector and as long as the factoring is considered, all the alterations have been proved to be fruitful for the smooth functioning of the system and sustaining the economy.
Conclusion
The Factoring Regulation Amendment Bill which was tabled in the parliament last year has finally been passed currently in 2021 with the passing of the Bill in Lok Sabha and Rajya Sabha, unlike last year when Rajya Sabha did not accept the conversions.
The Bill has aimed to widen the scope of the factors in the factoring business for the economic and financial sustainability in the country and due to various other factors.
The Bill has liberalized the mechanism of the system and added various other provisions which would aim at continuous and interrupted functioning of the working capital cycle of the micro, small and medium enterprises and which would ultimately lead to healthier cash flow.
The new Bill aims at boosting the economy and expanding the number of companies that would offer to factor and thus it has been expected that it would reach 9.2 trillion dollars by 2025.
In a nutshell, the amendments made via the Factoring Regulation Amendment Bill 2021 would be a great initiative by the Indian Government in all aspects.
References
- Ashish M. Shaji , “Factoring Regulation (Amendment) Bill 2021: Drawing 9000 NBFCs” available at: enterslice.com (last visited on 5th august 2021)