1. Economic function of factoring
Factoring, the modern version of which can be traced back to the United States, constitutes an attractive alternative for small and medium-sized businesses to more traditional forms of financing. It allows businesses to avoid the cash flow problems which arise due to the fact that businesses often have only minimal resources of their own accord and need to rely on outstanding credits, but have often agreed with their debtors on a remote date of payment. Factoring allows the businesses not to have to rely on their outstanding credit, thus avoiding, for instance, having to acquire loan capital to overcome the aforementioned cash flow problems and having to use their credit as security. The liquidity deriving from factoring can be used, for instance, to reduce debts, allowing for a more favourable balance sheet and improving the capital ratio, which in turn leads to a better rating.
Apart from this financing and liquidity function, which is often decisive for entering into a factoring relationship and guarantees financing that is not dependent upon the credit limit imposed by a bank, factoring also has a service or administrative function. This function allows companies not only to focus on their core business (such as production and sale), but also to reduce overheads as they will need less personnel. The activities relating to this function include all activities—which from the point of view of the company are foreign to its core business—that are aimed at, or facilitate, the payment of the company’s outstanding credit on the part of the debtor. These activities include, inter alia, invoice processing, issuance of orders to pay, initiation of court proceedings, management of the proceedings, judicial execution and accounts receivables accounting.
Factoring can also have yet another function, namely that of protecting the business from delinquent payments, at least in those instances where the factor—after careful and very detailed examination of the creditworthiness of the business’ debtors—assumes the credit risk, ie the risk of non-payment by the debtors. Where the factor assumes the credit risk, which occurs only in certain types of factoring, the business is not responsible for the delinquent payment; rather, it is merely responsible for the existence of the receivables. The advantage of these types of factoring for the business lies in it being able to assume greater risks when extending credit to their clients.
It goes without saying that the fact that the factor assumes certain service obligations comes at a cost for the business; these costs vary according to the various types of factoring. Generally, these costs can be calculated in advance, thus giving the business the necessary information to take an informed decision by allowing it to compare these costs with those that they would run into if they were not to resort to factoring (such as the costs for not being able to take advantage of certain discounts, the costs associated with exceeding the credit limit established by the bank, the costs arising from unfavourable conditions imposed by the bank on the grounds of a bad rating and the costs to be incurred in the administration of the accounts receivables).
2. Definition and types of factoring
An express definition of factoring contracts can be found in only a few European legal systems. One such system is the Estonian one, where in § 256 of the Law of Obligations Act of 26 September 2001 the factoring contract is defined as the contract pursuant to which ‘one person (client in factoring) undertakes to assign to another person (factor) financial claims against a third person (debtor in factoring) which arise from a contract on the basis of which the client, in the client’s economic or financial activities, sells an object or provides services to the debtor, and the factor undertakes to: 1) pay for the claim and bear the risk of non-fulfilment of the claim, or 2) grant cre- dit to the client out of the fulfilment of the claim, administer the claim for the client and exercise rights arising from the claim, including organising related accounting, and collect the claim’.
There are other legal systems where an express definition of the factoring contract can be found. This is true, for instance, in Austria, where § 1(1)(16) of the Austrian Banking Act of 7 July 1993 contains a definition of the factoring contract, as did § 1(2)(13) of the Austrian Banking Act previously in force. This does not mean, however, that a trend can be discerned that leads to the factoring contract achieving a standardized definition. In most legal systems, the factoring contract continues, despite it being recognized and widely used, as in France and Germany for instance, to be an innominate contract, that is, a contract that lacks a statutory definition. This lack of an express definition is advantageous as it allows one to attain a—flexible—definition of factoring contracts consistent with the different types of factoring to be found in legal practice. On the other hand, it is this flexibility that leads to the lack of a widely recognized and uniform definition. Since, however, commentators and courts give different weight to the various functions served by factoring (as mentioned in the previous part) and since this is witnessed not only throughout the various legal systems, but also within the same system, this does not come as a surprise.
From what has just been said, it follows that only a definition that does not weigh the various functions against each other may claim general acceptance. Thus, in light of the foregoing, the factoring contract can be defined as a contract pursuant to which the supplier (creditor, assignor) undertakes to assign receivables—generally short-term receivables—arising from contracts with its customers (debtors) against payment to an assignee (factor) who undertakes to perform at least two of the three functions referred to earlier (financing, service and protection against risk).
At first sight, the foregoing definition appears very vague and not too useful in practice, but it does allow one to distinguish the factoring contract from other types of contracts, such as forfaiting, contracts concerning the purchase of (generally) just one (long-term) receivable from exporters, which impose not only the risk of the debtor being unable or unwilling to perform but also the currency risk on the forfaiter. From this it follows that in forfaiting the most important function to be performed is that of securing the credit; as can be derived from the aforementioned definition of factoring, this is not necessarily the case in factoring. This does not exclude, however, that the factor may assume that function as well in respect of certain types of factoring. This is true, for instance, regarding non-recourse factoring where the factor, apart from assuming the service and, in most instances, the financing function, also assumes the risk of the debtor being unable to make payment (excluding the risk of non-payment due to political reasons or non-performance on the part of the assignor); thus, as regards this kind of factoring, the assignor is liable solely for the existence of the receivables. Recourse factoring, on the other hand, is characterized by the factor assuming both the service and the financing function but not the risk function, which is why in this kind of factoring the assignor is also liable for the debtor making payment.
It must be pointed out that the other functions mentioned at the beginning of the previous section do not necessarily have to be assumed by the factor for there to be a factoring contract, as long as the factor assumes two of the various functions referred to earlier. Thus, there is also factoring where the factor does not assume a financing function, as is the case with maturity factoring, which requires the factor to make payment only at the time the receivables are due. Thus, in this kind of factoring the factor does not make any advance payment. By contrast, there are types of factoring where the factor advances payment, ie the factor makes payment as soon as the existence of the receivables and the debtor’s solvency have been verified.
The various types of factoring are distinguished not only on the basis of the possible combinations of the functions assumed by the factor, but also on the basis of whether the assignment has to be notified to the debtor or not. On the basis of this criterion, a distinction is made between notification and non-notification or undisclosed (confidential) factoring. The difference consists in the debtor being able—where non-notification factoring is concerned—to make payment to the original creditor even after the assignment of the receivables; thus, it is the assignor who bears the risk of transferring the sums paid to the factor. In contrast, where factoring takes the form of notification factoring, which is much more widespread, the notification of the change of the creditor makes it impossible for the debtor to make payment to the original creditor and be discharged from its payment obligation. This is advantageous to the factor insofar as the factor is protected from the debtor wrongly making payment to the assignor.
3. Specific issues
Despite factoring being widely recognized and resorted to, very different rules apply to factoring contracts throughout the various legal systems. This is due to the differences in the rules on assignment of receivables to be found in the various legal systems, since it is upon those rules that most—although not all (see France and Belgium, for instance)—legal systems base their rules on factoring. One of the most important differences relates to the legal effects of the assignment of receivables that are non-assignable due to a non-assignment clause agreed upon between the creditor and the debtor. It is mostly debtors who insist upon such clauses, as they believe that the non-assignment clause guarantees an unconditioned right to set-off and allows them not to have to deal with a number of creditors which, at the time of the conclusion of the contract, is unforeseeable.
Furthermore, by insisting upon a non-assignment clause, debtors believe themselves always entitled to make payment to the assignor and in this manner necessarily be discharged from their payment obligation. This reasoning is, however, correct only to the extent that the rules of one of the very few legal systems apply that give absolute—erga omnes—effect to a non-assignment clause. Indeed, only in very few legal systems is the assignment of receivables in violation of a non-assignment clause considered to be completely ineffective, both inter partes and erga omnes. This is the case, for instance, in the Netherlands as well as in Germany, but only to the extent that § 399 of the Bürgerliches Gesetzbuch (BGB) is not superseded by § 354a of the German Commercial Code, introduced in 1994, which provides for the effectiveness of an assignment concluded in violation of a non-assignment clause as long as the parties to the assignment are both merchants in the sense of §§ 1 ff of the German Commercial Code and the object of the assignment are monetary claims arising from a contract other than a loan agreement where the creditor is a credit institution as defined in the statute governing the financing sector (this limitation was introduced by virtue of a statute on 12 December 2008, limiting the risk connected to financial investments). Thus, the German legislature has limited the absolute effectiveness of a non-assignment clause provided for in § 399 BGB, thereby facilitating credit access for small and medium-sized companies. In most other legal systems, a non-assignment clause has mere inter partes effects (France, Italy), if any at all (United States).
In relation to multiple assignments of the same receivables, there are noticeable differences. In some legal systems, the determination of exactly who is creditor is accomplished by making reference to the priority in time of a given formal act. This is true, for instance, in Italy, where this priority issue is solved on the basis of what assignment was first notified to the debtor or was first accepted by the debtor in a given form (Art 1265(1) Código civil). Similarly, in England priority of an assignment depends on the assignment being notified first, unless the assignee knew of a competing assignment prior to notification (see Dearle v Hall  38 ER 475 (HL)). Other legal systems, such as the German and the French—at least where the assignment is governed by the loi Dailly—determine priority on the basis of the moment in time when the assignment is perfected.
There are differences among the various legal systems also in respect of the retention of title, which, where it is attached to receivables to be assigned, is an accessory right. While an assignment automatically transfers the retention of title under French and Italian laws, German law requires a separate agreement. Under English law, accessory rights do not automatically follow the main claim, which is why, where an assignment of receivables is concerned, an express provision in the assignment is required to transfer accessory rights.
Finally, it is worth mentioning that differences also exist as regards the requirements that have to be met for an assignment to be effective vis-à-vis third parties. While this third-party effectiveness depends in some legal systems on a registration accomplished by filing a financing statement, in the German legal system the third-party effectiveness of the assignment requires neither registration nor notification—which, conversely, is required under Italian law (alternatively to the acceptance by the debtor, at least where the Italian Civil Code applies). In France, a distinction is to be made: while the French Code civil requires certain publicity requirements to be met (formal notification to the debtor through a court officer or acceptance of the assignment by the debtor), no such publicity requirements have to be met in cases of subrogation or where the loi Dailly applies.
4. Unification of law
From what has been said thus far, it is apparent that factoring contracts can be subject to very different national rules. This leads to legal uncertainty where the factoring contract is linked to more than one country. This uncertainty may have a negative impact on the willingness of businesses to resort to this form of financing. To promote legal certainty and, thus, make it easier for businesses operating on an international level to have recourse to factoring, the International Institute for the Unification of Private Law (UNIDROIT) elaborated the UNIDROIT Convention on International Factoring which was adopted on 28 May 1988 and entered into force on 1 May 1995.
Article 1 of the Convention defines the factoring contract as ‘a contract concluded between one party (the supplier) and another party (the factor) pursuant to which: (a) 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; (b) the factor is to perform at least two of the following functions: 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; (c) notice of the assignment of the receivables is to be given to debtors’. Despite this rather broad definition, not all types of factoring fall into the substantive sphere of application of the Convention. Since Art 1 requires, for instance, that notice of the assignment be given to the debtor, non-notification factoring is not governed by the Convention. The same goes for invoice discounting, which is practised, for instance, by factoring companies in England.
Regarding the object of the international factoring contracts governed by the Convention, it has often been pointed out that factoring contracts may relate to both single receivables or a bulk quantity of receivables, and that the receivables do not need to exist at the time of the assignment because the Convention also allows for the assignment of future receivables (Art 5). In providing for this possibility, the drafters wanted to make sure that bulk assignments of existing and future receivables would not be ineffective, unlike, for instance, in the Netherlands. It is worth pointing out that the Convention is also innovative vis-à-vis some legal systems that allow for the assignment of future receivables. In Italy, for instance, the assignment of future receivables is expressly provided for in statute n 52, of 21 February 1991 on the assignment of commercial receivables. Unlike the Italian statute, however, the Convention does not require that the (future) receivables come into existence within two years from the conclusion of the factoring contract.
Regarding the scope of the Convention, it must be stressed that the Convention does not govern all issues that may arise in connection with factoring contracts. Rather, the Convention merely governs certain, albeit very important, issues, such as the effectiveness of assignments done in violation of a non-assignment clause (Art 6); the validity of a transfer with or without a new act of transfer of all or any of the supplier’s rights deriving from the contract of sale of goods, including the benefit of any provision in the contract of sale of goods reserving to the supplier title to the goods or creating any security interest (Art 7); the effects of a notice on the debtor’s possibility of being discharged from making payment (Art 8); the defences that the debtor may set up against the factor (Art 9); as well as the issue of whether non-performance or defective or late performance by the supplier shall by itself entitle the debtor to recover a sum paid by the debtor to the factor if the debtor has a right to recover that sum from the supplier (Art 10).
There are many important issues that the Convention does not settle, ranging from the priority in case of subsequent assignments of one and the same receivable to the insolvency of the parties involved and issues of general contract law. Since these issues are not governed by the Convention, they have to be settled by resorting to the applicable (domestic) law to be determined by means of the private international law rules of the forum. This, however, impacts negatively on the uniformity the drafters aimed to achieve by creating the Convention. To avoid this recourse to domestic law, the drafters of the Convention on the Assignment of Receivables in International Trade of 12 December 2001, promulgated by UNCITRAL, expressly settled some of the aforementioned issues. Still, even the drafters of that Convention were unable to avoid entirely the need to resort to domestic law. As opposed to the drafters of the Convention on International Factoring, however, they have provided for uniform private international law rules to reduce the legal uncertainty resulting from their text not being exhaustive.
Samuel Pisar, ‘Legal Aspects of International Factoring—An American Concept goes Abroad’ (1969-70) 25 Business Lawyer 1505; David Hawkins, Business of Factoring: A Guide to Factoring and Invoice Discounting (1993); Jean-Pierre Deschanel and Laurent Lemoine, L’affacturage (1993); Javier Garcia de Enterria, Contrato de factoring y cesion de creditos (2nd edn, 1995); Ermanno Calzolaio, Il factoring in Europa (1997); Jürgen Basedow, ‘Internationales Factoring zwischen Kollisionsrecht und UNIDROIT-Konvention’ (1997) 5 ZEuP 615; Karl F Hagenmüller and others (eds), Handbuch des nationalen und internationalen Factoring. Factoring-Handbuch (3rd edn, 1997); Christoph Häusler, Das UNIDROIT Übereinkommen über internationales Factoring (Ottawa 1988) unter besonderer Berücksichtigung seiner Anwendbarkeit: Zugleich ein Beitrag zur Lehre vom internationalen Einheitsrecht (1998); Franco Ferrari, Il factoring internazionale (1999); Francesco Santi, Il factoring (1999); Klaus Bette, Factoring (2001); Noel Ruddy and others, Salinger on Factoring: The Law and Practice of Invoice Finance (4th edn, 2005); Mauro Bussani and Marta Infantino, Cessione del credito e factoring (2006).