Archive for category: NBFCs

Originally by Nidhi Bothra (2011) | Updated by Simrat Singh | finserv@vinodkothari.com 

Credit Factoring or simply factoring is an asset backed means of financing (tripartite agreement between the buyer, seller and the factor), whereby the account receivables are assigned to a third party called factor for a discount, releasing the tied-up capital and providing financial accommodation to the Company. The origin of factoring goes back to the 14^th century in England. Earlier, factoring was confined to textile and garment industries, but later was spread across various industries and markets. Factoring has been defined as:

“Credit factoring may be defined as a continuing legal relationship between a financial institution (the “factor”) and a business concern (the “client”) selling goods or providing services to trade customers (the “customers”) whereby the factor purchases the client’s book debts either without or with recourse to the client, and in relation thereto controls the credit extended to customers and administers the sales ledger.”

UNIDROIT Convention on International Factoring, 1988 defines factoring as follows:

“Factoring contract” means a contract concluded between one party (the supplier) and another party (the factor) pursuant to which:

1. the supplier may or will assign to the factor receivables arising from contracts of sale of goods made between the supplier and its customers (debtors) other than those for the sale of goods bought primarily for their personal, family or household use;
2. the factor is to perform at least two of the following functions:
   1. finance for the supplier, including loans and advance payments;
   2. maintenance of accounts (ledgering) relating to the receivables;
   3. collection of receivables;
   4. protection against default in payment by debtors;
3. notice of the assignment of the receivables is to be given to debtors.

US accounting standard ASC 860-10-05-14 defines ‘factoring arrangements’ as:

Factoring arrangements are a means of discounting accounts receivable on a nonrecourse, notification basis. Accounts receivable in their entirety are sold outright, usually to a transferee (the factor) that assumes the full risk of collection, without recourse to the transferor in the event of a loss. Debtors are directed to send payments to the transferee

Though Europe provides largest volumes globally, factoring in Asia as well has been growing rapidly in the last few years. Global factoring volumes reached EURO 3.66 Trillion in 2024 (up 3.6% from the previous year)¹. In Asia-Pacific, India was the fastest-growing market in the region, up 120% to EUR 38.2 billion.²

The purport of factoring is to assign the account receivables to be able to: 

1. Instantly convert receivables into case, that enable the companies to have funds to finance the day to day operations of the company; 
2. Helps in efficient collection of the receivables and protection against bad debts; 
3. Outsourcing sales ledger administration and
4. Availing credit protection for receivables.

Typically in a factoring transaction, a seller gets a prepayment limit from the factor, then enters into a transaction with the buyer and submits the invoice; notice to pay etc to the factor. The factor makes upfront payment to the seller, as a percentage of invoice value based on criteria, such as, quality of receivables, number and quality of the buyers and seller’s requirements (80% – 95% of invoice value) and maintains the sales ledger of the seller and collects payment from buyer. The balance payment is made to the seller, net of charges. The seller is not required to open an LC or a bank guarantee. 

The cost to the seller in factoring is the service fees, which is dependent on a) sales volume, b) number of customers, c) number of invoices and credit notes and d) degree of credit risk in the customer or the transaction. 

Factoring and Bill Discounting

There is a very thin line of difference between factoring and bill discounting. Bill discounting unlike factoring is always with recourse to the client, whereas factoring may be with recourse or without. Generally there is no notice of assignment given to the customer in case of bill discounting and collections are done by the assignor , unlike factoring, where debt collection is done by the factor. Factoring can be called a financing and servicing function, whereas, bill discounting function is purely financial. 

Types of Factoring

On the basis of geographical distribution 

1. Domestic Factoring
   1. Sales bill factoring
   2. Purchase bill factoring
2. International Factoring – As international trade continues to increase, international factoring is being accepted as vital to the financial needs of the exporters and is getting the necessary support from the government, specifically in the developing countries to stimulate this mode of funding.
   1. Export factoring – It is seen as an alternative to letter of credit, as the importers insist on trading in open account terms. Export factoring eases the credit and collection troubles in case of international sales and accelerates cashflows and provides liquidity in the business.

On the basis of credit risk protection

• On recourse basis, wherein the factor can recover the amount from the seller, in case of non-payment of the amount to the factor. Thus, though the receivables have been assigned, the credit risk remains with the client.
• On non-recourse basis also called old line factoring, wherein the risk of non-payment of invoices is borne by the factor. However, the factor only bears credit risk in such transactions. In case non-payment is due to any other reason other than financial incapacity, such as disputes over quality of goods, breach of contract, set-offs or fraud , the factor does not assume liability and the risk remains with the client. 

Other types:

• Advance factoring: In case of advance factoring, the factor provides financial accommodation and non-financial services. The factor keeps a margin while funding, which is called the client’s equity and is payable on actual collection. 
• Maturity factoring: Here, the factor makes payment on a due date. This sort of funding is resorted to by clients who are in need of non-financial services offered by the factors. 
• Supplier guarantee factoring: Also known as drop shipment factoring. This sort of factoring is common where the client acts as a mediator between the supplier and the customer. 

Overview of factoring in India:

India’s factoring turnover in 2024 was around Euros 38,200 Million in total as compared to a total of Euros 3,894,631 million worldwide³ and the turnover over the last 7 years (2018-2024) has seen a tremendous growth; while that of Asia has risen 38% from 2018 to 2024 and is valued at Euros 3,894,631Million. 

Fig 1: Factoring volumes in India: Source: FCI Annual Review 2025

Some of the challenges faced by the factoring companies in India are a) there was no specific law for assignment of debt, b) there was no recovery forum available to the factoring NBFCs such as DRT or under Sarfaesi Act, c) Lack of access to information on credit worthiness and d) assignment of debt involves heavy stamp duty cost.

UNCITRAL laws on assignment

Article 2 of the United Nations Convention on the Assignment of Receivables in International Trade defines ‘Assignment’ as – 

“Assignment” means the transfer by agreement from one person (“assignor”) to another person (“assignee”) of all or part of or an undivided interest in the assignor’s contractual right to payment of a monetary sum (“receivable”) from a third person (“the debtor”). The creation of rights in receivables as security for indebtedness or other obligation is deemed to be a transfer;

The Factoring Regulation Act, 2011

In order to revive the business and render liquidity specifically to the small and medium enterprises, the Finance Minister, in the Parliament session held in March, 2011 had tabled a pilot bill to bring the factoring business in India under regulation. The Bill was passed as the Factoring Regulation Act, 2011

While the intent of the Act may be to stimulate the growth of factoring business in India, but a close look at the Act does not enumerate so. The Act is a regulation Act, but the need was for an Act to promote factoring and not so much to regulate. Some of the highlights of the Act are as mentioned below:

• The name makes it unclear whether the Act is for regulating assignment; factoring or both. Further it should have been a regulation of factor’s’ and nor factor, to be more appropriate.
• Section 2 (a) of the Act defines means transfer by agreement to a factor of an undivided interest, in whole or in part, in the receivables of an assignor due from a debtor…The definition talks about undivided interest to be assigned only and does not consider assignment of fractional interest within its ambit. This would mean that any assignment of fractional interest would not be covered under this definition. Further whether the assignment could be in terms of money, in terms of time or rate of interest is not clear from the definition.
• The definition of receivables, in Section 2(p) of the Act includes futures receivables as well, which is in line with international laws.
• Section 3(1) of the Act says – 

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.

The definition should have said no ‘person’ shall commence or carry on the factoring business rather than using the term factor. A person shall only become a factor after obtaining a certificate of registration from the Reserve Bank as the section suggests. However the section already terms such a person as a ‘factor’, making the definition circular.

• Section 3(3) of the Act states every company carrying or commencing factoring business to be registered with RBI, and such companies would be classified as NBFCs and all the provisions applicable to NBFCs would be applicable here as well. Section 3(4) requires existing NBFCs to take a fresh certificate of registration, if they are principally engaged in the business of factoring. But the Act does not render clarity whether there would be a separate class of NBFCs carrying out factoring business.

• Section 7(3) states that in case the receivables are encumbered to any creditor, the assignee shall pay the consideration for such assignment to the creditor to whom the receivables have been encumbered. In case of fixed charge created over assets, the provisions of this section are well thought, however in case of floating charges, this would render several difficulties for the assignor. Most companies have fixed and floating charges created over their assets, the assets on which floating charge is created are regularly rotated in business and are only crystallized in case of default or non-payment. If the company was to assign such assets it would be practically impossible for the assignee to identify which receivables are currently subject to the floating charge, and to whom the consideration ought to be paid. This uncertainty could discourage assignments, create disputes between secured creditors and assignees, and undermine the commercial utility of receivables financing.
• Section 8 of the Act requires the notice of assignment to be given to the debtor, without which the assignee shall not be entitled to demand payment of the receivables from the debtor. However Section 7(2) of the Act, makes Section 8 redundant, as it states that on execution of agreement in writing for assignment of receivables, the assignee shall have ‘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 sub-section (1) of section 8 is given or not.’ This is not in line with the proviso to Section 130 (1) of the Transfer of Property Act, 1882 which mandates that the assignee will be able to recover or enforce the debt when the debtor is made party to the transfer or has received express notice of such an assignment.
• Section 8, 9 and 10 provide for the requirements of notice of assignment. The intent of Section 11 seems that even in case notice of assignment is not provided the debtor would not be absolved from his duties to make payment. However the section is worded as ‘till notice is served on the debtor, the rights and obligations in its contract with the assignor, shall remain unchanged, excepting the change of the party to whom the receivables are assigned which may become entitled to receive the payment of the receivable from the debtor;’ this means whether or not notice for assignment is provided the rights and obligations of the debtor towards the assignee would remain unaffected. If so was the intent of the Section, then there was no need for any notice of assignment to be given to the debtor, as by the virtue of this section read with section 7(2), the assignee would have all the right on receivables as that of the assignor.
• The UNCITRAL model law on assignment requires that notification of assignment of debt is to be given by either the assignor or the assignee, the assignee may not retain more than the value of its right in the receivable and notification of the assignment or a payment instruction is effective when received by the debtor. However, until the debtor receives notification of the assignment, the debtor is entitled to be discharged by paying in accordance with the original contract.
• Import factoring is not permitted as per Section 31(1) of the Act.
• Further recourse to the assignor is not permitted under the Act. 
• The proposed law provides for compulsory registration of every transaction of assignment of receivable with the Central Registry to be set up under the Sarfaesi Act within a period of 30 days. 

Factoring or financing transaction?

In Major’s Furniture Mart, Inc v. Castle Credit Corporation⁴, the question in consideration in the case was whether the transaction was a true sale or mere financing. Major’s was into retail sale of furniture and Castle into the business of financing such dealers as Major’s. Under an agreement, Major’s had sold its receivables to Castle, with full recourse against Major’s. The Court held the assignment of receivables by the furniture seller to the factoring company a case of financing and not assignment, as the factor had full recourse on the seller and the factor only paid a part of the total debt factored by him.

In another case of Endico Potatoes Inc. and others vs. CIT Group/Factoring Inc.⁵, in case of a factoring transaction, the court opined:

“Resolution of whether the “contemporaneous transfer,” as CIT describes Merberg’s assignment of accounts receivable to CIT and CIT’s loan advances to Merberg, constitutes a purchase for value or whether the exchange provides CIT with no more than a security interest, depends on the substance of the relationship between CIT and Merberg, and not simply the label attached to the transaction. In determining the substance of the transaction, the Court may look to a number of factors, including the right of the creditor to recover from the debtor any deficiency if the assets assigned are not sufficient to satisfy the debt, the effect on the creditor’s right to the assets assigned if the debtor were to pay the debt from independent funds, whether the debtor has a right to any funds recovered from the sale of assets above that necessary to satisfy the debt, and whether the assignment itself reduces the debt. 

Major’s Furniture Mart, Inc. v. Castle Credit Corp.⁶, Levin v. City Trust Co.⁷, Hassett v. Sprague Electric Co.⁸, In re Evergreen Valley Resort, Inc.⁹. The root of all of these factors is the transfer of risk. Where the lender has purchased the accounts receivable, the borrower’s debt is extinguished and the lender’s risk with regard to the performance of the accounts is direct, that is, the lender and not the borrower bears the risk of non-performance by the account debtor. If the lender holds only a security interest, however, the lender’s risk is derivative or secondary, that is, the borrower remains liable for the debt and bears the risk of non-payment by the account debtor, while the lender only bears the risk that the account debtor’s non-payment will leave the borrower unable to satisfy the loan.

In CF Motor Freight v. Schwartz¹⁰, the court recharacterized what was labeled a factoring arrangement as a secured loan. The agreement expressly stated it was a “Factoring Agreement,” and each receivable was stamped as “sold and assigned.” The court even acknowledged that factoring typically involves the purchase of accounts receivable. Under the arrangement, the transferee advanced 86% of the invoice value upfront, with an additional 10% payable if and when collections were made. However, if a receivable was not collected within 60 days, the transferee could demand repayment from the transferor. Because of this recourse provision, the court concluded that the transferee had not truly assumed the risks associated with ownership and therefore treated the arrangement as a secured loan.

In Home Bond Co. v. McChesney¹¹, the US Supreme Court held that certain contracts labeled as “purchases” of receivables were in fact loans secured by receivables, because the transferor retained the risk of non-payment (through repurchase obligations and collection duties), and the transferee’s “service charges” were essentially disguised interest. The ratio being that a transaction is a loan, not a sale, when the transferor bears the risks and costs of collection, even if the contract is formally styled as a sale. In Taylor v. Daynes¹², the Utah Supreme Court stated that whether a sale has occurred depends not on labels or form but on whether the risks and benefits of ownership have been transferred to the transferee.

Another aspect considered by courts to determine whether it is a case of sale of receivables is alienability i.e. ability to transfer/resell for a profit. When an account is transferred, if the transferee has a right to alienate the acquired account, it is a case of sale and not financing. In Nickey Gregory Co. v. AgriCap, LLC, the court treated the transaction as a secured loan, partly because the transferee’s rights were closer to a lender’s,  it did not have full indicia of ownership, including unrestricted alienability. 

In a more recent case of Re: Qualia Clinical Service, Inc v. Inova Capital Funding, LLC; Inova Capital Funding, Inc, the bankruptcy court found that the invoice purchase agreement was clearly and unambiguously a financing arrangement. The court made that finding on the terms of the agreement itself. In particular, the court noted that the recourse provisions contained in section 7.02 of the agreement, which shift all collection risks to Qualia.

“….. “The question for the court then is whether the Nature of the recourse, and the true nature of the transaction, are such that the legal rights and economic consequences of the agreement bear a greater similarity to a financing transaction or to a sale.”

This agreement, which shifts all risk to Qualia, is a disguised loan rather than a true sale. Where the “seller” retains “virtually all of the risk of noncollection,” the transaction cannot properly be considered a true sale. 

If the assignment alone did not reduce the obligation of the assignor towards the assignee and the assignee at any given point of time, directly demand the money from the assignor, there is no transfer of risk. If the primary risk of customer’s non-payment remained with the assignor, then it cannot qualify as a true sale.

Credit insurance and factoring:

Insurers are allowed to offer Trade Credit Insurance which provides protection to suppliers against the risk of non-payment for goods and services by buyers. Typically, it covers a portfolio of buyers and indemnifies the insured for an agreed percentage of the invoice value that remains unpaid. As per IRDAI (Trade Credit Insurance) Guidelines, 2021 (‘Guidelines’), the scope of cover may include commercial risks such as insolvency or protracted default of the buyer, as well as rejection of goods (either after delivery or before shipment, in cases where the goods were exclusively manufactured for the buyer). It may also extend to political risks, such as changes in law, war, or related disruptions; however, this protection is applicable only for buyers located outside India and in countries agreed upon under the policy.

The risks covered under the Guidelines are not exhaustive, and insurers may extend coverage to additional risks, provided these have a direct nexus with the delivery of goods or services. As per the Guidelines, Trade credit insurance policy may be issued to the following:

1. Seller / Supplier of goods or services; 
2. Factoring company; 
3. Bank / Financial Institution, engaged in Trade Finance

As per the Guidelines, insurers are permitted to extend coverage for transactions involving factoring, reverse factoring on the TreDS platform (as clarified under the IRDAI circular dated 9 October 2023), and bill discounting. Lastly, insurance is available only in case of non-recourse factoring.

1. FCI Annual Review 2025 ↩︎
2. FCI Annual Review 2025 ↩︎
3. Data from Factors Chain International http://www.factors-chain.com/?p=ich&uli=AMGATE_7101-2_1_TICH_L1403780046 ↩︎
4. 602 F.2d 538; 1979 U.S. App. LEXIS 13808; 26 U.C.C. Rep ↩︎
5. SECOND CIRCUIT Nos. 1751, 1961 Decided: October 2, 1995, ↩︎
6. Supra ↩︎
7. 482 F.2d 937, 940 (2d Cir. 1973) ↩︎
8. 30 B.R. 642, 647-48 (Bankr. S.D.N.Y. 1983) ↩︎
9. 23 B.R. 659, 660-61 (Bankr. D. Me. 1982) ↩︎
10. 215 B.R. 947, 951 (Bankr. E.D. Pa. 1997) ↩︎
11. 239 U.S. 568 (1916) ↩︎
12. 118 Utah 61 (Utah 1950) ↩︎

See our other resources on Factoring:

1. Transfer of Factoring receivables exempted from MHP
2. PPT on Basics of Factoring
3. India Factoring Report 2023
4. Basics of Factoring in India
5. Money advanced by factor in factoring – a loan or not?
6. India Factoring Report 2013
7. Export Factoring
8. Fractured Factoring: Amendments may give a push to a potent trade finance solution