Factoring

Factoring is a receivables finance arrangement in which a supplier assigns trade receivables arising from the sale of goods or services to a factor. Under the UNIDROIT Convention on International Factoring (Ottawa, 28 May 1988), a factoring contract is one under which the supplier may or will assign such receivables, the factor performs at least two of four core functions, and notice of the assignment is given to the debtors.

Factoring use on bank export finance desks

On EF and trade desks, factoring sits inside working-capital and supplier-credit toolkits. A bank-owned or independent factor advances funds against assigned invoices, maintains the receivables ledger, collects from debtors and, where agreed, absorbs debtor default risk. International two-factor programmes often split export and import roles between a factor in the supplier's country and a factor in the buyer's country, so collection and credit protection sit closer to the debtor.

The Convention's four functions are:

• finance for the supplier, including loans and advance payments
• maintenance of accounts (ledgering) relating to the receivables
• collection of receivables
• protection against default in payment by debtors

References to goods and sale of goods in the Convention include services. Household consumer sales are outside its factoring definition.

Mechanics, notice and risk allocation

Convention mechanics treat existing and future receivables as assignable if they can be identified to the contract. A future-receivables clause transfers claims when they arise without a fresh transfer act. Notice in writing to the debtor is central: the debtor's duty to pay the factor turns on receiving notice that reasonably identifies the assigned receivables and the factor, and on the absence of knowledge of a superior right to payment.

Risk allocation is contractual. Non-recourse factoring places agreed commercial risk of debtor default on the factor. Recourse factoring leaves dilution, dispute and non-payment risk with the supplier to the extent the agreement provides. Debtor defences arising under the sale contract, and set-off rights existing when notice is given, may still be asserted against the factor under the Convention's party-rights rules.

Boundaries versus forfaiting and borrowing-base lending

Factoring differs from forfaiting. ICC materials define forfaiting as without-recourse discounting of a transferable instrument representing an exporter's future receivable, often under bills, notes, guarantees or letters of credit. Factoring is usually a continuing assignment of an invoice book with servicing duties. A borrowing base facility may finance receivables as collateral under advance rates without transferring ownership in the same way as a true sale to a factor. A letter of credit can secure or replace open-account risk that would otherwise be factored.