The article is a complete article, we have published a summary of it in In-Sight May 2019 Edition. 

For years FCI has been on the forefront of supporting efforts to help build sustainable legal and regulatory environments to support the growth of factoring and receivables finance. FCI supports the development of factoring legislation and the implementation of proper central bank policy and industry regulation. FCI is taking numerous measures to raise awareness by organising workshops to explain to government officials and important stakeholders the importance of factoring. We also have supported the creation of sound policy and good regulatory framework for the healthy development of factoring. But we also want to ensure that the increase in regulations impacting the industry do not have unintended consequences.

Some countries have either adopted a specific code on factoring or their civil code contains some language relating to assignment language in support of factoring. But in emerging countries, most do not possess proper contract law, and hence do not have language to support proper assignment of accounts and protection of the rights of third parties to legally execute factoring transactions. Parties have to rely on the general assignment provisions when drafting contracts. Due to the lack of understanding of the 1) product in developing environments 2) developed case law and 3) tradition of publishing judicial decisions, this sometimes creates uncertainties in relation to interpretation of contracts and hence increases perceived risks and/or stifles creativity of business practices. Unfortunately, many emerging countries do not yet have proper assignment laws and as such there is a lack of confidence embedded in investors minds, who are concerned about redress in courts and attempts to recoveries from their rights as owners of the debts, resulting in a disregard for this valuable asset class.

FCI Model Law on Factoring

FCI continues to support the development of proper assignment laws, protections of rights of third parties, and the promotion of good governance, to create a sensible legal and regulatory framework to support the development of a healthy legal infrastructure for the industry. As such, FCI (initially developed by the IFG Legal Committee) created a draft Model Law on Factoring (FML), which has been used in certain countries to the benefit of local economies. The FML was invoked and guided by the UNCITRAL’s Convention on the Assignment of Receivables in International Trade, a document created in part by the late Freddy Salinger, a past member of the FCI legal committee and infamous luminary in our industry, together with Spiros Bazinas, recently retired executive and principal driver of the creation of the Convention. The Convention was used as a backdrop for the formation of the FML. The convention was put into force in 2001, however it wasn’t until this year, on January 2, 2019, that the US Senate gave its consent for the ratification of Convention. It will take five countries to allow the convention to become a formal treaty, but with the adoption by the United States, it is anticipated this will now occur in the coming years ahead. FCI has promoted and supported the adoption of the Convention by governments around the world.

While restricted in scope to factoring only, it is in full conformity with the UNCITRAL ideas of receivable finance, as later expressed in the Model Law on Secured Transactions (UNML). Based on the IFG Model Factoring Law, Afreximbank issued an Afreximbank Model Law on Factoring for African countries which also largely conforms to the Convention and the UNML. We can learn from the Afreximbank initiative that this text is a sound basis for further evolution. International good practices in factoring can also be found in the FCI General Rules of International Factoring (GRIF), available on the FCI website (www.fci.nl). The GRIF has been constantly updated and interpreted by the Legal Committee of FCI.

UNCITRAL Model Law on Secured Transactions

Around the same time, FCI and IFG were active in creating in the UNCITRAL Working Groups a Model Law on Secured Transactions (2016) (UNML). In 2016, at the time of the Union between the two organizations, the UNCITRAL finalized its work, at the time led by Ulrich Brink and Harvey Guberman. The Convention sets forth modern uniform rules governing the assignment of receivables for use in international financing transactions. In particular, the Convention facilitates the use of cross-border receivables financing by: (a) recognizing the legal effectiveness of a wide variety of modern receivables financing practices; (b) overriding certain contractual obstacles to receivables financing; and (c) providing clear, uniform conflict-of-laws rules to determine which country's domestic law governs priority as between the assignee of a receivable and competing claimants. FCI Legal Committee actively participated in the creation of the original Convention at the United Nations Commission on International Trade Law.

Meanwhile, we see a strong demand by countries for model laws that have a narrower scope than the UNML. Some countries have started to reform secured transaction laws. This is also evidenced by the World Bank’s suggestion to launch a formal Model Factoring Law under the auspices of the UNIROIT, the International Institute for the Unification of Private Law who’s projects include drafting of international conventions and production of model laws . Other than a convention which is binding on countries after ratification, and subject to deviations only to the extent allowed by the convention itself, a Model Law is a suggestion for the harmonization of domestic law. Its authors wish it to be accepted by many countries, but by definition it is only the model for a national law which can deviate from the ideas, limit or widen the scope or make other changes. This is contrary to harmonization, but national legislators can disregard the idea of globalization and put their country first. A Model Law that has the blessing of an international body such as UNIDROIT and the World Bank is more convincing to the national lawmaker, and may cause less deviations, thereby increasing harmonization.

We understand that the UNIDROIT, in a preliminary meeting on the 8th May, 2019 in Rome agreed to move forward with the formation and adoption of the Model Law on Factoring.

The Future of Receivables Finance Why is this important.

Well most developed countries have adequate laws protecting investors in factoring. However, most of the largest countries in terms of population are either considered low, lower and middle income as defined by the World Bank (Tier 1-3, representing countries with per capita income of less than US$12K). As you can see below, most of these countries are deemed “emerging” with the exception of the U.S. If you look at expected population growth and estimates by 2060, over 40 years from now, all of these countries except for the US and India have proper factoring laws in place to protect investors. However, in most of these markets, factoring is just getting started. They represent our industry’s future, and FCI is making numerous inroads to help develop factoring in all corners of the world. This is why the question of supporting a FML is of paramount important to FCI, our members and stakeholders.

A recent World Bank study states that weak contract enforcement, tax, and regulatory impediments will hamper the growth of factoring in most developing markets. But based on our own experiences these six impediments to growth for the factoring industry must be addressed:

1. Weak Legal Infrastructure - A sound legal system that allows for the legal assignment of the receivable to a third party. The assignment must be legally enforceable, normally legal notification to the debtor (buyer) should be required, and all rights of the receivable must be absolute.
2. Strict Tax Impediments - Elimination of the stamp duty tax system, put in place by the British common law system during the rise of the British empire, stymies the growth of factoring throughout the emerging market
3. Lack of a Central Registry or Mechanism to Prevent Fraud – Most developing markets do not have the legal process in place to register Lack of a The development of a receivables registry to deter fraud
4. Strict Foreign Currency Controls - The permission for NBFIs to receive and manage foreign currency on behalf of their clients. Eliminating foreign currency controls whereby importers and exporters are forbidden to source or export on an open account basis
5. Floating Charge on the Assets: Many factors run into the problem of being unable to “carve out” a portion of the accounts from the bank which has taken a fixed charge on the assets (encumbrance of the receivables), making them un-factorable
6. Minimum Regulatory Requirements: Where factoring is permitted by the local authorities but is unregulated, or without any specific guidelines ie. Capital requirements, maximum pricing levels, anti competition, etc… leads to aggressive loan sharking and ultimately creates a bad reputation of the product

Differences between Factoring Model Law vs UNCITRAL Model Law on Secured Transactions

A factoring law is substantial for the development of a safe environment, creating trust in the handling of transactions. If it does not exist a law, financial institutions can only base account receivables financing with the only support of their Legal Codes, Civil and/or Commercial, follwing the bureaucratic steps stated there, keeping in mind that the rules in LA are based on Roman Napoleonic Codes and not in Common law like in the US, for instance. And it is extremely important at the moment of performing transactions, that the transfer of rights, primary for open account financing, needs sets of simplified procedures if the financier wants to be legally protected.

An assignment of a receivable is effective notwithstanding any agreement between the initial or any subsequent assignor and the debtor or any subsequent assignee limiting in any way the assignor’s right to assign its receivables. Whether or not a prudential regulation system should extend to receivable financiers, and to which extent they should be subject to banking supervision, is also a question outside the Model Law itself. These issues must be solved by the legislator, taking into account the structure of the business in the relevant country.

We understand that there are serious objections to single out receivable finance from a model law on secured transactions covering also other collateral. It has been widely accepted to include outright assignments used in factoring in a secured transactions regime to allow the same rules to govern priority conflicts. Model laws (ML) relating to only a limited class of assets might endanger that approach. On the other hand, it may be difficult to convince legislators to fully implement the UNML in one go as various established ways to secure credit are involved and might need to be reformed. This might even disrupt the extension of credit for a certain time, damaging a weak economy and resulting in more damage than benefit. If there is a demand for reform in certain areas of secured transactions, this should not be neglected; not all countries use all types of secured transaction with the same intensity, and the need for new rules is likely to be more pressing in those fields that offer the most opportunities for the growth of the economy.

Any Model Law on Secured Transaction, whatever its scope is, must deal with interfaces to other laws when implemented by national legislators. The number and type of such interfaces depend on the scope of the ML and certainly a ML with a smaller scope will have other conflicts with existing laws of that jurisdiction. But conflicts are sure to arise and are to be solved by restricting either the scope of the ML, or the existing laws. For example, certain goods are not subject of the UNML, such as aircrafts: ships may follow a different regime, and bills of exchange have their own rules. Grandma’s lending to the family are not covered, and proceeds of immovable property such as rents may be subject to the appropriate securities on immovable property. All these conflicts, wherever they arise in implementing a Model Law, must be carefully analyzed and solved in a manner acceptable to that jurisdiction. However, a Model Law addressing those issues will serve to make countries aware of those challenges.

Expectations of the MLF

FCI, in following the ideas of the UN Assignment Convention and the UNML, has certain expectations for a Model Factoring Law. First of all, we would like the scope expanded to all kinds of receivable finance. We note that the limited success of the Ottawa Convention on International Factoring was caused by a somewhat narrow scope, the lack of substantive rules and the failure of the authors to at least find a conflict-of-law rule for priorities among competing claimants. Receivable finance industry nowadays offers various kinds of credit facilities, among them factoring, supply chain finance or reverse factoring, and others – all based on outright assignments of receivables (with the exception of some domestic legislation based on pledges or subrogation). Hence, such a FML should be all encompassing under the heading of Factoring / Receivables Finance.

a.           should be based on the UNCITRAL Legislative Guide, the Assignment Convention, the Ottawa Convention on International Factoring and the UNML, and widen the scope from traditional factoring to all kinds of receivable finance, including supply chain finance and other modern forms of receivable finance by electronic means

b.           Would be a subset of rules relating to movable asset securities, thus leaving the door open for widening the scope to also cover other movable assets

c.           Would have a scope of covering domestic and international assignments of receivables (which requires alignment with the Assignment Convention)

d.           Would apply to receivable finance in trade receivables (definition pending), including but not limited to factoring

e.           Would allow assignments of future receivables

f.            Would outlaw contractual ban of assignments

g.           Would have rules for assignors, assignees and debtors (as already suggested by the UNML)

h.           Would have substantive rules on priorities as suggested by the UNML based on an easy-to-access electronic registration system open for the registration of other movable assets securities 

Case Studies 

For this article, FCI looked a five factoring markets around the world, all of whom implemented or are in the process of implementing some kind of factoring law or enhanced legislation that addresses fixes in the legal system to allow for factoring to flourish.

CHILE: We find here the most matured country in LA, as far as account receivables financing is concerned. With the Government and Regulators support, in 2003 it started drafting a factoring law which was later passed and duly ruled. The industry started to grow on this legal frame and after passing ¨The invoice law¨ which refers to e-invoicing, the growth was at a faster trend. Banks started offering account receivables financing in a consistent way, and could act in a clear legal environement which brought confidence and diminished disputes and fraud risk. ¨The Invoice law¨ received several improvements and today all actors, Banks and Commercial factoring companies, regulated or not, have the open account financig as one of their core services, offered for the benefit of SMES. Proof of that is the high factoring penetration compared to Chilean GDP.

COLOMBIA: This country also followed the Chilean steps, not only on factoring law but also on e-invoicing law. The factoring law in this country is the Law 1231 passed on 2008 with the aim of promoting and developing this financial tool as a means of lowering the inbalance position between SMES and big corporates. Law 1676 of 2013 modified the above mentioned law 1231, allowed the invoices be treated as a non-registered security with which Micro and SMES could obtain financing. Also the same law can be used on a larger scale, strenghtening the legal framework for the use of factoring. Later, Decree 2242 of 2015, Decree 1349 of 2016 and Law 819 of the same year setting a tax reform, drove the establisment of the electornic invoice , which become mandatory to all companies from January 1st. 2019. This for sure will lead to a strong growth of factoring transacted volumes. From the issuance of the factoring law, SMES´ open account financig grew consistently with a strong participation of Banks, keeping Bacolombia the leading position (see chart below). It is estimated that Banks hold 85 % of the market which clearly shows how a factoring law may influence positively the use of the factoring tool, providing a trustable legal framework and bringing confidence to the market. The following chart clearly shows the growing trend of factoring volumes in Colombia, which on estimated basis, the penetration is over 6 % of the GDP.

RUSSIA: For more than 10 years, the factoring community in Russia has been lobbying for improvement of the only legislative act regulating the national factoring industry - chapter 43 of the Civil Code of the Russian Federation (the “Civil Code”). In July 2017 brought in a clear victory for the factoring community: The Federal Law No. 122-FZ of July 26, 2017 On Introducing Amendments to Parts One and Two of the Civil Code of the Russian Federation and Certain Legislative Acts of the Russian Federation was adopted, which introduced long-awaited amendments governing factoring to the Civil Code. The above victory was preceded by a series of events which paved the way for it, namely: Russia acceded to the UNIDROIT Convention on International Factoring (2015), abolished the legislative provisions related to the possibility to offer factoring only by banks (2009), reacted against State Duma on the use of factoring in the alcohol industry (2014), prevented the attempt to introduce paid registration of factoring contracts (2016).The AFC Legal Committee, which includes representatives of the 15 largest Russian factors, actively participated in development and approval of the main articles of Chapter 43 of the Civil Code. The concept of strengthening protection of factor against unfair behavior of clients and debtors in the new edition of the Civil Code was implemented through adding new provisions to Chapter 24 of the Civil Code (Substitution of persons in an obligation) (please see below), plus providing a clearer description of rights and obligations of the parties to the factoring transaction (Chapter 43 of the Civil Code). The terms factoring (instead of the previously used term “financing against assignment of monetary claims” and its derivatives), factor, factoring agreement will now be the official terms used in business as well as in legal documents, including judicial documents.

INDIA: India like many British commonwealth countries inherited the law of assignment from the United Kingdom. As factoring is based on the law of assignment, there is no need for a separate law on factoring. As such there is no law on factoring. Whilst this have served many of these countries well to enable to them to go into factoring, it has also caused many problems as the UK law is based on case law and hence it is subjected to different interpretation by the judges. It is for this reason that it took quite a while for the Indian factoring industry to kicks off. Although Indian factoring is doing well, a model law will be good for India and the commonwealth countries as it will be a good reference for their judges. In addition, the current law of assignment is old, and it does not take into account the new developments in many successful factoring countries such as US and Europe. The model law will also be a good reference material for India and the commonwealth countries as each country could passed legislation in their respective jurisdiction to incorporate the best practices in factoring. For example, prohibition of assignment is a big problem in India and the commonwealth countries, but it is not a problem in the US. Should this be incorporated in the model law, it could be legislated in India subsequently and it will be a boon to the factoring industry. This is one example but there are many examples which can help India and the commonwealth countries.

CHINA: Factoring, particularly commercial factoring businesses have been growing dramatically in China since 2012. However, the lack of factoring legislation, misunderstanding and confusion on concept, caused more and more argues or disputes among practitioners, regulators, and courts, along with the business volume booming. Article 4.2 of FCI Factoring Model Law clearly stipulates what kind of assignment of receivable is applicable. But in the legal system in China, there is no unified rule on this issue, which caused market mess and manipulation activities by the abuse of the concept of receivables, or factorable receivables. Factoring model law makes it clear that finance under factoring is an advance payment. But it is still under severe disputes in China’s legislation. And regarding Prohibition on assignment, the Factoring model law stipulates that an assignment of a receivable is effective notwithstanding any agreement between the initial or any subsequent assignor and the debtor or any subsequent assignee limiting in any way the assignor’s right to assign its receivables. If this is adopted by factoring law in China, it will facilitate the circulation of receivables and ensure of deal safety. Eventually, SMEs will benefit from it. 2018 proved to be the year of high exposure of legal risk in China’s factoring industry. There are up to 10,000 factoring legal cases dealt with in local courts of Beijing city only in 2018. The figure almost reaches the total factoring legal cases in the whole country during the past four years (2014-2017). In one of the local courts in Beijing, its factoring legal case volume is only 1 in 2016, 10 in 2017, but 2282 in 2018. The legal risk is undermining the healthy development of the factoring business as an industry in China as well as the successful economic transforming of the world’s second largest economy, particularly during the time of financial downturn. Thankfully, China is actively setting up its legislation infrastructure on factoring business, though it still has lots to improve compared to factoring model law.

• In March 2018, Supreme Court organized working conference on factoring industry and asked CFEC to draft a proposal on factoring contract chapter under Contract code of Civil law
• In October 2018, FCI organized a Legal Workshop together with members of the China Supreme Court, in conjunction with the China Banking Association and sponsored by our member Postal Savings Bank of China.
• In December 2018, The NPC standing committee agreed to add Factoring contract chapter into Contract Code of Civil Law draft for deliberation.

As you can see, the positive and negative effects of the legislation or lack thereof had an impact on the business. We prepared a chart to show the factoring volumes over the past 5 years, to show the effects the legislation had on the factoring industry.  

Conclusion

There are many considerations as well outside of a ML that investors must consider. Questions should be raised to determine whether: A functioning and unbiased court system exists to facilitate collection of receivables, Availability of civil courts Sufficient capacity for short procedures Predictability of court decisions Clear rules in substantive law including legislation and prior court decisions Clear procedural rules safeguarding the parties’ rights while disallowing delays caused by the judge or by the parties Short procedures for clearing disputes, including the availability of technical experts advising on the disputed quality of the goods or services, Including rules for the court and the parties to request relevant documents, Special procedures for undisputed claims to ensure speedy collection. Many payment delays are not caused by genuine disputes but are based on the inability of the debtor to meet its payment obligation. For that reason, fake disputes may be brought forward to profit from the delay in procedures. For undisputed cases it is useful to have a special procedure bypassing litigation and allowing the creditor speedy collection Availability of Appeals courts for important cases Availability of court officers (or other officers) to execute verdicts by seizures, attachments or other types of execution.   But in summary, FCI welcomes the idea of the formation of a Factoring Model Law. FCI is willing to assist UNIDROIT in its work, as it is in FCI’s interest to promote the FML. If there were ever a moment in time to support and push for a worldwide factoring law it is now. We appreciate the support of the World Bank/IFC, the UNCITRAL and UNIDROIT to help us achieve this dream.

The author thanks Mr. Ulrich Brink, Attorney at Law, Bette Westenberger Brink, Germany for his contributions to this article.