Newsletter 24/2013
Commentary
FACTORING: A WAY TO MAINTAIN LIQUIDITY ?
According to figures published in Monitor Sądowy i Gospodarczy, in 2012 Polish courts declared the bankruptcy of 941 companies – the largest number in 8 years. Most of the bankruptcies were caused by a lack of liquidity, as a consequence of longer terms for payment by customers.
Factoring may offer a solution to this problems.
What is factoring? In a nutshell it is a form of short-term financing in which a company sells its accounts receivable, documented by invoices, some one to three months before the due date, to a third party called a factor. This releases cash to the seller to operate its business which would otherwise be “frozen” in the receivables.
Factoring was known in the Polish legal literature before the systemic changes beginning in 1989, but was not offered by Polish financial institutions until the 1990s. The first ruling by the Supreme Court of Poland related to factoring was issued in 2003 (judgment of 18 December 2003, Case I CK 7/03). It was not until the advent of the free market and the IT revolution that factoring services became a common tool.
According the reports from the Polish Factors Association, the turnover of Polish factoring companies doubled between 2009 and 2012, from PLN 54.4bn to over PLN 100 billion. Factoring services now cover 5% of Polish GDP. In 2012 alone, turnover of member firms of the Polish Factors Association grew by 22%. Factoring services have proved to be a life raft that can prevent bankruptcy.
Factoring consists not only of purchasing accounts receivable. Factoring services are comparable to working capital credit, but there are many features differentiating these two instruments. A factoring contract is concluded for an indefinite period and is of a continuous character. The seller is not limited in the purpose for which the proceeds may be used. The obligation is not secured by a mortgage or pledge, but by the invoice for each receivable sold. The upper limit of accounts receivable is specified in the contract. Significantly, the seller’s credit capacity is not reduced.
Another important element of factoring services is ongoing monitoring of the condition of the debtor to evaluate the risk associated with acquisition of specific receivables. Therefore, a factoring contract may combine the features of credit, accounting, debt collection, insurance, and legal audit services. The common element is the purpose of factoring, which is to provide cash for the seller’s activity. Polish law does not regulate factoring in detail, but a definition may be found in international law. Under the UNIDROIT Convention (1988), a factor must meet at least two of the four following requirements: financing the seller, recording the receivables on account, collecting the receivables, and protecting the seller from the risk of the debtor’s insolvency.
The main types of factoring available are recourse factoring and non-recourse factoring. Recourse factoring consists in purchasing receivables, paying 80-90% of their face value in advance. The remaining 10-20% is paid when the debtor pays the debt. If the debtor does not pay the receivable when due, the seller must return the advance payment. The cost of such operations is usually low and there are few formalities.
The second type of factoring (non-recourse) shifts the risk of the debtor’s insolvency to the factor. This means that in the case of non-payment, the seller is not required to return the advance payment. This type of factoring involves more formalities, a longer pre-contract stage, and higher cost. Usually the factor concludes an insurance contract to cover the risk of non-collection. The volume of non-recourse factoring is increasing, rising from 29% of all factoring services in 2007 to 54% in 2012.
The cost of factoring services must be considered. Usually it is higher than working capital credit. The Polish market for factoring services characterized by a law degree of consolidation, and there are major differences in the contractual terms offered and consequentially in the rates. Conclusion of a factoring contract should be preceded by a detailed review of the available offers and a cost-benefit analysis.
Piotr Brych
The Newsletter is published free-of-charge and is designed chiefly for clients of the law firm of Mikulski & Partners. The articles are written by lawyers at the firm, but do not constitute legal advice.