February 15, 2024

Banking Laws and regulations for factoring companies

The Article has been written by Mr. Shivam Chopra, a 3rd year student at University of Petroleum and Energy Studies Dehradun

Introduction 

In India, the banking industry is among the most significant and established sectors of the national economy. Since the time before independence, it has been crucial to the growth of the national economy. Over time, the banking industry in India has experienced substantial transformations, and the country’s economic and social advancements are mirrored in the development of banking regulations in India. We shall go into great depth on the development of Indian banking rules in this article.

For the first time, India has a unified legislative framework regulating all facets of factoring activities and codifying relevant legislation with the enactment of the Factoring Regulation Act of 2011. This act’s main objectives are to address the payment delays and liquidity problems that micro, small, and medium-sized enterprises face and to provide a structure that would make working capital finance easily accessible. To encourage more transactions, the Act also eliminated the stamp tax that was previously applied to transfers of movable property. This was done by relieving the burden of exorbitant charges on manufacturing transactions.

The Central Government released the Factoring Regulation Act, 2011 on January 22, 2012. Factoring companies that are not banks, government agencies, or others must register as Non-Bank Financial Companies (NBFCs) with the Reserve Bank of India (RBI) and adhere to the prudential standards of the RBI.

 

Definition 

A factor under Section 2 is any corporate entity established under an Act of Parliament or any State Legislature, or any bank or company registered under the Companies Act, 1956 engaged in factoring business under Section 2(i); or 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).

Factoring business is defined 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” in Section 2(j) of the Factoring Regulation Act of 2011, but it excludes:

  1. A bank’s regular commercial credit facilities provided in return for receivables as security.
  2. All activities associated with the production, storage, supply, distribution, acquisition, or control of agricultural products or goods of any kind; all activities related to commission agents or other parties involved in the sale of agricultural produce or goods of any kind; all activities associated with the production, storage, supply, distribution, acquisition, or control of such products or goods; and all activities associated with the provision of any services.

According to Section 2(p), “receivables” are any or all of a person’s undivided interest in, or rights under, a contract, including an international contract, wherein one or more of the parties are located or established in a state outside of India; these rights may be existing, future, accruing, conditional, or contingent, and they may be contingent upon payment of a sum of money.

 

Factor Registration 

In the format and form specified by the RBI, each factor must submit an application for registration. Even though this clause states otherwise, an NBFC that was already in existence at the time of the commencement may still function as a factor until it receives a certificate of registration or receives notification that its application for registration has been denied. To do this, the NBFC must apply to the RBI for registration as a factor by the end of the six-month period that follows commencement.

The RBI Act 1934 stipulates that all applicants for a certificate of registration as an NBFC must meet certain requirements. Similarly, all Act provisions pertaining to NBFC registration will apply mutatis mutandis to any applicant for a certificate of registration as a factor.

 

Assignment of Receivables 

Any receivable that is owed to him by a debtor may be assigned by an assignor to any factor, or assignee, for any consideration that both the assignor and the assignee may agree upon. The assignor is required to notify the assignee of any defenses and setoff rights the debtor may have at the time of the assignment.

All rights, remedies, and security interests created over any property solely to ensure the timely payment of a receivable will be transferred to the assignee upon the execution of a written assignment. The assignee will also have the complete right to retrieve the receivable and to use all of the assignor’s rights and remedies, including the right to seek damages. This transfer of rights will occur whether or not notice of the assignment is given.

 

Non-Applicability of the Act 

The Act’s Section 31 specifies that any assignment of receivables resulting from or under any of the following transactions is exempt from the Act’s provisions: 

  1. A sale, transfer of ownership, alteration of the business’s legal status, or merger, acquisition, or reorganization of its operations;

2.A deal that happens on an exchange for commodities or stocks; 

  1. Financial contracts with netting arrangements in place;
  2. Exchange of currencies, excluding receivables denominated in any foreign currency;
  3. Cash in the bank;

6.A guarantee from a third party or a letter of credit; 

  1. The business of providing goods or services for domestic, familial, or personal consumption;
  2. Deals involving securitization.

 

Rights And Duties 

The Act deals with the duties and rights of parties to a contract for the assignment of receivables. In accordance with the original contract, the debtor is entitled to make payments to the assignor in relation to the assigned receivable up until the debtor receives notice of assignment, which completely releases the debtor from any associated liability. This right to notice of assignment exists before the assignee makes any demands on the debtor.

Upon receipt of a notification of assignment, the debtor is required to:

 1.Notify the assignee of any deposits or advance payments made to the assignor before receiving the notice of assignment, and give the assignee access to any further information on the receivable upon request;

 2.He will not be eligible for a legal discharge of his responsibility with regard to the assigned receivables unless he pays the assigner the amount owed on those receivables.

Payments made by a debtor to an assignor that represent amounts owed on an assigned receivable are considered made for the benefit of the assignee. The assignor is considered to have accepted the payment in their capacity as the assignee’s trustee, and they must be paid by the assignor.

The provisions of Sections 15 and 17 of the Micro, Small, and Medium Enterprises Development Act, 2006, which address late payments, apply to the debtor’s responsibility to make payments due on assigned receivables if the assignor is a micro or small firm. If there is a delay in payment, the assignee is entitled to interest for that period of time. To collect the interest and provide it to the micro or small firm, they must follow the procedures outlined in the Micro and Medium Enterprises Development Limited Act, 2006.

 

Registration of Assignments 

The statute’s Chapter V addresses the registration of assignments. The following is the process for registering assignments and related matters:

  1. Within thirty days following the date of the assignment in Form 1, the factory is required to pay a charge of Rs. 500/-and file the details of each transaction that goes in his Favour with the Central Registry set up under the SARFAESI Act, 2002;
  2. The Head Office of the Central Registry will maintain a record known as the central register where details about transactions pertaining to loans or assignments can be entered; 
  3. When the allocated receivables against the debtor are realized, the factor has to file a satisfaction on Form II along with a charge of Rs. 250/-.
  4. Here too, the transaction registration requirements set forth in the SARFAESI Act would be followed.

 

Inspection by the General Public 

The electronic version of the central registry will be available for public inspection via electronic media during the central registry’s designated business hours, upon payment of a predetermined fee.

Wrongdoing and Penalties 

In accordance with Section 22 of the Factoring Regulation Act, a company or an executive of the business that neglects to register assignments may be penalized up to Rs. 5,000/-per day that the failure continues. Any component that disregards an RBI direction faces a fine of up to Rs. 5 lakhs, with an additional penalty of up to Rs. 10,000 for every day the default persists.

Anyone who disobeys, seeks to violate, or helps and abets in the violation of any Act provision or regulation established under it for which no particular punishment has been specified faces up to a year in jail, a fine, or both.

 

Recent Amendments made to the Act 

Anticipated to become operative in 2021, the Factoring Regulation (Amendment) Bill, 2020 will:

  1. Give small businesses more access to credit by enabling them to get funds from 9,500 nonbank financial entities. Through the provision of a more effective working capital cycle for micro, small, and medium-sized enterprises, the Rajya Sabha changes will stimulate the economy.
  2. Increase the amount of NBFCs offering factoring services from seven to more than nine,500. A business that wants to raise money sells its customer receivables to a third party, or “factor,” in a process known as factoring.
  3. In order to discount the invoices of the Ministry of Micro, Small, and Medium Enterprises (MSME), all NBFCs will now be allowed to factor in and participate in the Tred’s (Trade Receivables Discounting System). 
  4. The Bill will allow the Reserve Bank of India the authority to oversee the factoring business and is intended to provide a robust monitoring system for the factoring ecosystem.
  5. MSMEs usually have difficulties in being paid for the several customers they serve on their invoices.

As per the conclusions of the Parliamentary Committee, MSMEs’ productive activities are hindered, and operating capital becomes locked up. By permitting more categories of NBFCs to participate in factoring activities, the government’s proposed changes seek to allay these worries. Only 2.6% of all official MSME loans in India come from factoring credit. The majority of the receivables market is still managed via conventional bank cash credit overdraft agreements, with formal bill discounting systems handling just around 10% of the market.

History of Bank Laws of India 

Over time, as the political and economic climate in India changed, so did the country’s banking regulations. An overview of India’s banking laws passed is provided below: 

  1.  The Reserve Bank of India Act, 1934: The Reserve Bank of India (RBI) was founded in 1935, and the Act of 1934 gave it the legal foundation to operate within. The RBI was granted authority by the Act to oversee banks, issue currency, and control the nation’s monetary policy.
  2. 2. The Banking Regulation Act, 1949: This law was passed in 1949 in order to control banking operations in India. It also established guidelines for the licensing of new banks and the management of already-existing ones, giving the RBI the authority to monitor and regulate the operations of banks.  
  3. 3 The State Bank of India Act, 1955: Using the State Bank of India Act, 1955, the State Bank of India (SBI) was founded in 1955. The Act established the legal foundation necessary for the SBI and its affiliates to operate. 
  4. The Acts of 1969 and 1980 Concerning the Acquisition and Transfer of Undertakings by Banking Companies: The main Indian commercial banks were nationalized by these Acts, placing them under government supervision. Fourteen banks were nationalized in 1969, and six more banks were added to the list in 1980. 
  5. The Foreign Exchange Regulation Act, 1973 was superseded by the Foreign Exchange Management Act, 1999 (FEMA), which established a legislative framework for controlling foreign exchange operations in India. 
  6. The Banking Regulation (Amendment) Act, 2020: This law was passed in order to increase the RBI’s authority to oversee cooperative banks. The Act placed the RBI in charge of cooperative banks.

 

Evolution of Indian Banking System 

  1. 1. Pre-Independence Era: The Bank of Hindustan, India’s first bank, was founded in 1770, marking the beginning of the country’s financial history. The British East India Company’s commercial activities were mostly financed by the banks that the East India Company founded, including the Bank of Bengal, the Bank of Bombay, and the Bank of Madras. The primary purpose of these banks was to finance British commercial operations in India. There were no particular banking rules in place during this time, and the banking industry was essentially uncontrolled. With the passage of the Indian Banking Act in 1895, the government assumed control over all banks. The Act established minimum capital requirements for banks and allowed for bank inspections and regulations. From 1906 to 1911, the Indian business community was motivated to establish banks of their own by the Swadeshi movement. Many of the banks that were founded at that time, such as the Central Bank of India, Canara Bank, Indian Bank, and Bank of Baroda, have managed to endure to this day. In 1934, the Reserve Bank of India was established, a momentous occasion that continues to highlight the development of banking. On April 1st, 1935, it was operationalized. Since then, the RBI has served as both the nation’s central bank and the authorities overseeing the banking industry. The RBI Act of 1934 is where it gets its authority.

 

  1. Post-Independence Period: Following India’s 1947 declaration of independence, the government implemented a number of measures to monitor and manage the banking industry. The Banking Regulation Act was created in 1949 with the intention of controlling bank operations and keeping them away from high-risk ventures. The Act established guidelines for the administration and operations of financial institutions. After gaining independence, the Reserve Bank of India (RBI), which was founded in 1935, took on the role of central banking regulator for the banking industry. The RBI was granted the authority to oversee bank operations, control bank mergers and acquisitions, and provide licenses to new banks. To encourage economic growth, the government nationalized a number of banks in the 1950s, 1960s, and 1980s. The Imperial Bank was nationalized and renamed SBI in 1955. With a combined capital of $50 billion, the government nationalized 14 large banks in 1969. Six further banks with a combined capital of almost 200 Cr were nationalized in 1980. Six further banks with a combined capital of almost 200 Cr were nationalized in 1980. Nineteen banks were nationalized after PNB, and the New Bank of India amalgamated in 1993. (Note that SBI was not engaged in any of these 19 banks.) The goals of social control, credit distribution, and the advancement of the rural sector were all pursued via nationalization. The nationalization of the banks was seen by the government as a means of directing financial resources from metropolitan regions to rural communities, where credit was most needed. Targets were set for the nationalized banks to meet, including financing for small-scale and agricultural sectors.

 

  1. Liberalization Era, also known as the LPG Era: The Indian economy saw substantial changes in the 1990s, and the banking industry was not exempt. In order to liberalise the banking industry, the government reduced government interference, let foreign banks to operate in India, and allowed private sector banks to join the market. To oversee the securities industry, the Securities and Exchange Board of India (SEBI) was founded in 1993. The Foreign Exchange Regulation Act (FERA) was superseded in 1994 by the Foreign Exchange Management Act (FEMA). The Act established guidelines for the nation’s foreign exchange dealings.

 

Recent Reforms 

The government has strengthened the banking industry further in recent years by implementing several initiatives. The Insolvency and Bankruptcy Code was enacted in 2016 with the intention of establishing a timely and effective process for handling insolvencies. In addition to offering protection to creditors, the Code offers a framework for the prompt settlement of stressed assets. To increase the size and efficiency of public sector banks, the government combined several of them in 2018.

 

Conclusion 

India’s banking industry has advanced significantly since the country’s founding. The government has implemented several policies aimed at promoting financial inclusion, controlling the banking industry, and advancing the growth of the rural economy. It is anticipated that the current changes would make the Indian banking industry more competitive and efficient, improving client services. 

 

Even while the Factoring Act is an important piece of law, its limitations on the kinds of firms that might participate in factoring—especially its peculiar handling of non-banking financial companies (NBFC), a crucial type of lender in India—have always been its weak point. Although there have previously been several demands for action that have been considered, the COVID-19 pandemic has made the need to amend the Factoring Act much more urgent. Modifying the Factoring Act to expand the range of lenders that can engage in the factoring business is low hanging fruit, and now would be the perfect time to put it in place. Enhancing the MSME sector’s ability to provide financing and boost its overall performance is one of the government’s top priorities in the fight against the COVID-19 pandemic. Any changes made should ideally allow for the flexibility of allowing new classes of lenders to factor on an individual basis through notifications from the government or RBI, in light of the limitations imposed by the original wording of the Factoring Act. This would eliminate the need for additional legislative provisions.

 

References 

 

 

 

 

 

Featured articles
IPR Laws Applicable to Theater in India – Notes
Basic Intellectual Property Rights for Digital Content Creators
THE DOCTRINE OF PREEMPTIVE DEFENSE: LEGAL IMPLICATIONS AND CONTROVERSIES
SEBI Regulatory framework for IPOs in India
     DEBENTURES – A Brief on Alternative Source of Capital
A study on the principle of separate legal entity and its exception

Related articles

All articles