This article is written by Bhavyika Jain, a Student of Symbiosis Law School, NOIDA. This article explains the Factory Regulation Act, 2011, the rules and amendments made to it, and all aspects related to it.

Introduction

The Factoring Regulation Act of 2011 established a cohesive legal framework in India for the first time, governing all aspects of factoring operations and codifying laws applicable to them. The fundamental goal of this act is to tackle the payment delays and liquidity issues that micro, small, and medium-sized businesses encounter, and to also establish a framework that will allow for easy accessibility to working capital financing. The Act also removed stamp duty on factory transactions in order to stimulate more transactions by eliminating the burden of excessive duties that otherwise would have applied to moveable property transfers.

On January 22, 2012, the Central Government published the Factoring Regulation Act, 2011. Factoring firms other than banks, government companies, and others would be required to register with the Reserve Bank of India (RBI hereinafter) as NBFCs and be subject to Reserve Bank prudential requirements.

Definitions 

A factor in Section 2 is a non-banking financial company, as defined in Section 45-I(f) of the Reserve Bank of India Act, 1934, that has been granted a certificate of registration under Section 3(1), 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 engaged in factoring business under Section 2(i).

Section 2(j) of the Factoring Regulation Act of 2011 defines factoring business as “the business of acquiring receivables of assignors 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 it excludes: 

1. Credit facilities offered by a bank in the ordinary course of business in exchange for receivables as collateral.

2. Any activity relating to the production, storage, supply, distribution, acquisition, or control of agricultural products or goods of any kind, or any activity relating to the commission agent or otherwise for the sale of agricultural produce or goods of any kind, or any activity relating to the production, storage, supply, distribution, acquisition, or control of such products or goods, or any activity relating to the provision of any services.

Section 2(p) defines “receivables” as all or a portion of, or an undivided interest in, any right of any person under a contract, including an international contract, where either the assignor, the debtor, or the assignee is located or established in a state outside India; to payment of a monetary sum, whether such right is existing, future, accruing, conditional, or contingent arising from and including.

Factor registration

Every factor must submit an application for registration to the RBI in the prescribed form and format. A company registered as an NBFC and existing at the time of the commencement must apply to the RBI for registration as a factor before the end of the six-month period following the commencement and, notwithstanding anything contained herein, may continue to operate as a factor until a certificate of registration is issued to it or rejection of the application for registration is communicated.

Every applicant for a certificate of registration as a factor shall comply, for the purposes of registration, with all requirements to be fulfilled by an applicant for a certificate of registration as an NBFC under the RBI Act 1934, and all provisions of the Act that relate to NBFC registration shall apply mutatis mutandis.

Assignment of receivables

An assignor may assign any receivable due and payable to him by any debtor to any factor, or assignee, for such consideration as the assignor and the assignee may agree upon, and the assignor must disclose to the assignee any defenses and right of setoff that the debtor may have at the time of such assignment.

Upon the execution of an assignment in writing, all rights, remedies, and any security interest created over any property exclusively to secure the due payment of a receivable shall vest in the assignee, and the assignee shall have an absolute right to recover such receivable and exercise all of the assignor’s rights and remedies, whether by way of damages or otherwise, whether or not notice of assignment is given.

Non-applicability of the Act

Section 31 of the Act states that the provisions of this Act shall not apply to any assignment of receivables arising under or from any of the following transactions: 

1. A merger, acquisition, or restructuring of business activities, or a sale or change in the ownership or legal status of the business;

2. A transaction that takes place on a stock market or a commodity exchange; 

3. Financial contracts governed by netting agreements;

4. Foreign exchange transactions except for receivables in any foreign currency;

5. Money in the bank;

6. A letter of credit or a third-party assurance; 

7. The selling of products or services for personal, family, or household use;

8. Securitization transactions.

Rights and duties

The rights and obligations of the parties to a contract for the assignment of receivables are addressed in the Act. The debtor has the right to notice of assignment before the assignee makes any demand on the debtor, and until the debtor receives notice, the debtor is entitled to make payments to the assignor in respect of the assigned receivable in accordance with the original contract, and such payment fully discharges the debtor from corresponding liability under the original contract.

When a notice of assignment is served, the debtor must:

1. Notify the assignee of any deposits or advance payments on account made to the assignor prior to receipt of the notice of assignment, and provide any other information relating to the receivable to the assignee as and when requested by the assignee;
2. Unless he makes the payment due on the assigned receivables to the assigner, he will not be entitled to a legal discharge of his liability in respect of such receivables.

When a debtor makes a payment to an assignor that reflects payments due on an assigned receivable, the payment is deemed to be for the assignee’s benefit, and the assignor is deemed to have received the payment as a trustee of the assignee, and the assignor is compelled to pay the assignee.

If the assignor of the receivable is a micro or small business, the debtor’s obligation to make payments due on assigned receivables is governed by the requirements of Section 15 and Section 17 of the Micro, Small, and Medium Enterprises Development Act, 2006, which deal with late payments. In the event of a payment delay, the assignee is entitled to interest for the time of delay and must take action under the terms of the Micro and Medium Enterprises Development Limited Act, 2006 to recover the interest and pay it to the micro or small business.

Registration of assignments

The registration of assignments is covered in Chapter V of the statute. The procedure for registering assignments and matters related to them is as follows:

1. The factor must file the particulars of every transaction in his favor with the Central Registry established under the SARFAESI Act, 2002 within 30 days of the date of such assignment in Form 1 and pay a fee of Rs. 500/-;
2. A record called the central register shall be kept at the Head Office of the Central Registry for entering the particulars of the transaction relating to assignment or a loan; 
3. The factor must file a satisfaction in Form II with a fee of Rs. 250/- when the allotted receivables against the debtor are realized.
4. The SARFAESI Act’s provisions for transaction registration will apply here as well.

Inspection by the general public

On payment of a stipulated price, the central registry in electronic form shall be open for examination by any person via electronic media during business hours as specified by the central registry.

Wrongdoing and penalties

Being defined under Section 22 of the Factoring Regulation Act it states that, if a firm or an officer of the company fails to register assignments, the company and any officer of the company who fails to register assignments will be fined up to Rs.5000/- per day the default persists. If any factor fails to comply with any RBI directive, the RBI may impose a penalty of up to Rs.5 lakhs, plus an additional punishment of up to Rs.10,000/- for each day the default continues.

If any person violates, attempts to violate, or aids and abets the violation of any provision of the Act or any rules issued thereunder for which no specific penalty has been given, he will be punished by imprisonment for a term not exceeding one year, a fine, or both.

Recent amendments made to the Act

The Factoring Regulation (Amendment) Bill,2020, expected to take effect in 2021, will:

1. Increase credit opportunities for small enterprises by allowing them to access cash from 9,500 nonbank financial institutions. The Rajya Sabha reforms will boost the economy by enabling a more efficient working capital cycle for micro, small, and medium businesses.
2. Raise the number of NBFCs that provide factoring services from seven to over 9,500. Factoring is a transaction in which a company sells its customer receivables to a third party, or a “factor,” in order to get funds.
3. All NBFCs will now be able to factor in and participate in the TReDS (Trade Receivables Discounting System) for discounting Ministry of Micro, Small & Medium Enterprises’ (MSME) invoices.
4. The Bill aims to provide a strong monitoring mechanism for the factoring ecosystem, and it will give the Reserve Bank of India the power to regulate the factoring industry.

5. MSMEs frequently have delays in receiving payment for their bills for serving numerous buyers.

According to the Parliamentary Committee’s findings, this results in working capital being locked up and MSMEs’ productive operations being hampered. The government’s proposed modifications aim to address these concerns by allowing additional types of NBFCs to engage in factoring activity. In India, factoring credit accounts for only 2.6% of total formal MSME lending. Only around 10% of the receivables market is now handled by formal bill discounting mechanisms, with the balance being serviced by traditional bank cash credit overdraft arrangements.

Conclusion

While the Factoring Act is a significant piece of legislation, its Achilles heel has always been the restrictions it imposed on the types of businesses that could engage in factoring, particularly its odd treatment of non-banking financial companies (NBFC), a key form of the lender in India. Several requests for action have already been made and heard, but in light of the COVID-19 epidemic, the necessity to reform the Factoring Act has taken on a new urgency. One of the urgent issues that the Government is focusing on in combating the COVID-19 pandemic is measures that can be taken to encourage the provision of finance to and to generally boost the MSME sector – amending the Factoring Act to broaden the scope of lenders who can engage in the factoring business is low hanging fruit, and now would be the ideal time to put it in place. Given the constraints imposed by the Factoring Act’s original wording, any amendment introduced should ideally provide flexibility for new classes of lenders to be permitted to engage in factoring on a case-by-case basis through government/ RBI notifications, without the need for further legislative amendments.

References

• https://www.azbpartners.com/bank/imminent-need-to-amend-the-factoring-regulation-act-2011/
• https://legislative.gov.in/actsofparliamentfromtheyear/factoring-regulation-act-2011
• https://www.taxmanagementindia.com/visitor/detail_article.asp?ArticleID=5989
• https://prsindia.org/billtrack/the-factoring-regulation-amendment-bill-2020
• https://www.business-standard.com/article/economy-policy/factoring-regulation-bill-to-open-more-credit-facilities-for-msmes-fm-121072901533_1.html
• https://www.business-standard.com/article/economy-policy/msmes-seeking-factoring-credit-should-get-ratings-parliament-panel-to-govt-121020402194_1.html

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