Legal aspects of factoring

Factoring contract is like any other sale- purchase agreement regulated under the law of contract. There is no codified legal framework / code to regulate factoring services in India. The legal relationship between a factor and a client is largely determined by the terms of the factoring contract entered into before the factoring process starts. Some of the contents of a factoring agreement and legal obligations of the parties are listed as follows:

(1) The client gives an undertaking to sell and the factor agrees to purchase receivables subject to terms and conditions mentioned in the agreement.
(2) The client warrants that the receivables are valid enforceable, undisputed and recoverable. He also undertakes to settle disputes, damages and deduction relating to the bills assigned to the factor.
(3) The client agrees that the bills purchased by the factor on a non-recourse basis (i.e. approved bills) will arise only from transactions specifically approved by the factor or those falling within the credit limits authorized by the factor.
(4) The client agrees to serve notices of assignments in the prescribed form to all those customers whose receivables have been factored.
(5) The client agrees to provide copies of all invoices, credit notes, etc., relating to the factored accounts, to the factor and the factor in turn would remit the amount received against the factored invoices to the client.
(6) The factor acquires the power of attorney to assign the debts further and to draw negotiable instruments in respect of such debts.
(7) The time frame for the agreement and the mode of termination are specified in the agreement.
(8) The legal status of a factor is that of an assignee. The customer has the same defense against the factor as he would have against the factor as he would have against the client.
(9) The customer whose account has been factored and has been notified of the assignment is under legal obligation to remit the amount directly to the factor failing which he will not be discharged from his obligation to pay the factor even if he pays directly to the client remits the amount to the factor.
(10) Before factoring a receivable, the factor requires a letter of disclaimer from the bank which has been financing the book debts through bank finance to the effect that from the date of the letter the bank can not create a charge against the receivables i.e. the bank will not provide post-sales finance as the factor provides.
(11) Priority over other claimants to book debts: It will be extremely important for the factor to make sure that the book debts it handles are free from any encumbrances which would entitle someone else to the money due. The firm has to guarantee that the book debts are free from any rights of a third party in the factoring agreement.
(12) Other powers: The factor has sometimes to act quickly to recover money due on an invoice. A customer with money outstanding to the factor may be in difficulty and nay delays in acting could see the money gone forever. The agreement must provide for the factor to act swiftly in his name, whenever necessary.
(13) The factoring agreement sets out in detail how the firm s to be paid.
(14) Approved and unapproved debts: The attraction of factoring for many companies is that non-recourse factoring can give a degree of insurance against the customer who does not pay. This depends on whether the debt is approved or not, which is decided before the factoring process starts.
(15) Where the factor may reclaim money already advanced. Factoring agreements provide for payment by the customer directly to the factor. If any of the customers pay it to the client by mistake, the agreement provides that the firm must hold the money for the factor. If he does not do so, this is effectively a breach of trust and the firm may be held responsible for any losses incurred by the factor.
(16) Warrants Some warrants that are required are:
(a) The firm should disclose any materials facts that it knows might affect the factor’s decision to approve a debt.
(b) It has to warrant that the invoices sent for factoring represents a proper debt for goods supplied.
(17) Disputed debts: The factor may require the customer to notify it immediately in case of disputed debts. The firm may be expected to return any advances made to it in respect of the disputed debt.
(18) The factor’s power to inspect the firm’s books and accounts and the period of the factoring arrangements is usually laid down in the agreement.

  • Santhosh

    very useful information