OVERVIEW

MODEL LAW ON FACTORING

Development of the Model Law on Factoring

Many States around the world are working to strengthen their legal frameworks for factoring in order to better facilitate a broad range of receivable finance products. In particular, legal frameworks are being strengthened by clarifying what constitutes a receivable, whether receivables can be transferred, what formalities are required to transfer receivables, how to determine priority between competing transfers, and the relationship between outright transfers (sales) of receivables and security rights over receivables. States that are strengthening their legal frameworks to address these issues encourages financiers to provide finance to companies for whom receivables are their most important asset. These legal reforms enable MSMEs to access credit, thereby allowing them to accept new orders, increase output and participate in local, regional and global supply chains.

 

The MLF is designed to provide an international best practice legal standard to assist States with reforming their domestic frameworks for factoring. Adopted in May 2023 by the International Institute for the Unification of Private Law (UNIDROIT), the MLF was the result of a legislative project first proposed by the World Bank Group. The World Bank’s proposal to develop the MLF was based on three elements: (i) the importance of factoring as a mechanism to increase finance for MSMEs (ii) ongoing constraints in access to credit for MSMEs in developing States; and (iii) the existing gap in the international legal framework in relation to factoring.

 

Policy Objectives and Key Features of the UNIDROIT Model Law on Factoring

The MLF’s ultimate objective is to facilitate factoring. This ultimate objective is achieved through the cumulative effect of the following five Policy Objectives:

i.    Transparency, predictability and certainty. The MLF provides a set of clear and comprehensive legal rules that provides certainty, predictability and transparency for parties involved in factoring.

ii.    Transactional efficiency. The MLF provides a simplified set of rules that in many States will make it easier to transfer a receivable.

iii.    Balanced rules for parties. The MLF carefully balances the rights and obligations of the debtor, transferor and transferee to ensure that no party is unfairly disadvantaged by the implementation of the law.

iv.    Flexibility in facilitating a variety of different financing arrangements. The MLF is designed to flexibly apply to a variety of different receivable finance arrangements encompassing both the outright transfer of receivables and transfer of receivables by way of security.

v.    Facilitation of cross-border transactions and international harmonisation. The MLF provides a set of rules that, where uniformly implemented, will create a harmonised legal framework for both domestic and cross-border factoring.

 

The MLF is built around seven Key Features that are designed to collectively achieve the five Policy Objectives noted above:

1)  Application to both outright transfers and security transfers.

2)  Clear scope in defining receivables.

3)  Simple legal requirements for the transfer or grant of security in receivables.

4)  Effectiveness of transfers of receivables notwithstanding agreements between the debtor and transferor limiting such transfers.

5)  Registration of a notice in an electronic registry in order to achieve third-party effectiveness and priority of a transfer.

6)  Efficient enforcement and collection rules.

7)  Conflict of law rules based on the location of the transferor for third-party effectiveness and priority.

While it is recommended for States to implement the entire MLF, in certain circumstances States may choose not to implement certain rules. As a soft law instrument, such an approach is permissible. In many States, partial implementation of the MLF may still provide a significant improvement of the legal framework and facilitate additional factoring transactions. However, in identifying and explaining the MLF’s Key Features and related Policy Objectives, this Guide is designed to inform implementing States of the potential disadvantages of diverging from the Key Features. As such, throughout this Guide, the purpose and objectives of certain articles or approaches will be explained with reference to the MLF’s Key Features.

 

Overview of the MLF

The MLF is divided into a number of chapters, and this overview largely follows the order of those However, provisions relating to the operation of the Registry are found in Annexe A to the MLF. These are in a separate annexe as a State may want to incorporate them into legislation relating to an existing registry system. However, these provisions are summarised in this overview as part of chapter 4.

 

The MLF addresses the private law relating to factoring transactions, and does not address regulatory law. Regulation is, however, a very important part of the law in this area and a State may want to include some regulatory provisions in the legislation implementing the MLF. The interaction with regulation is further discussed at Part III(2).

 

The scope of the MLF is dealt with in Chapter I and is clearly delineated by definitions of many terms used within it. It applies (and only applies) to transfers of receivables. A transfer of a receivable is defined widely as either an outright transfer or a security transfer[1] by agreement. If a receivable is transferred, the transferee also obtains a right to the proceeds of that receivable.

[1]           The term “security transfer” in the MLF can include security transactions that are not, under domestic law, transfers.

 

The scope, however, is limited by the definition of “receivable” which, very broadly speaking, is limited to “trade receivables”. A receivable is a contractual right to payment of money arising from the supply of things supplied in the course of trade, such as goods, services, data (or data processing) and intellectual property. Thus, for example, receivables arising from the making of loans and other financial transactions are not included, nor are rights to payment contained in instruments such as negotiable instruments and letter of credit. Policy based domestic law rules, such as those in consumer protection law and those limiting the transfer of specific types of receivables, are not affected by the Law.

 

Many of the provisions in the Law relating to the relationship between two parties can be varied by the agreement of those parties, while those affecting third parties (such as the provisions about third-party effectiveness, priority and conflict of laws) cannot. The rights and obligations under the Law must be exercised or performed in good faith and in a commercially reasonable manner.

 

Under Chapter II, receivables can be transferred by an agreement between the transferor and the transferee. The formal requirements for an agreement are minimal. It can describe the transferred receivables generically: it is not necessary to identify specifically every receivable transferred. Future receivables can be included in a transfer agreement, with transfer taking place when they arise. For example, the agreement can cover all the transferor’s present and future receivables.

 

Moreover, a receivable can still be transferred effectively even if the debtor and the transferor agree that the transferor’s right to transfer it is completely or partially limited. The agreed limitation is completely ineffective.

 

Under Chapter III, a transfer of receivables will only be effective against third parties if a notice relating to it is registered in the registry. There is no other way under the MLF to make a transfer effective against third parties. Without registration the transfer only takes effect as between the transferor and the transferee. A transfer that is effective against third parties remains effective if the transferor enters into insolvency proceedings.

 

The MLF provides detailed rules for the establishment and operation of the registry which are found in Annexe A. The registry is a notice filing system, not a document filing system. A notice relating to one or more transfers can be registered either before or after the actual transfers have taken place, and is designed to inform anyone searching the registry that a transfer may have taken place. It will then be up to the person searching to make further enquiries as to whether the transfer has actually taken place, and as to the details of the transfer.

 

A notice contains quite minimal information: identification of the transferor and the transferee, plus a description of the transferred receivables that allows them to be identified. The main search criterion is the identifier of the transferor. Registration of a notice is effective from the time that its information is accessible to searchers; as will be seen below, that time is the priority point for the transfer(s) included in the notice. Under the electronic registration system, once a registrant submits the relevant information for a notice, the registration of a notice containing that information takes place automatically without any act by the registry staff.

 

Chapter V contains the priority rules. There is one simple rule for priority between transfers: a “first to file” This means that the order of priority between competing transfers is the order in which notices relating to transfers are registered, and this priority rule also applies to the proceeds of transferred receivables. This priority rule applies even if a notice is registered before a transfer actually takes place. It also applies irrespective of any knowledge of any competing transfer. The order of priority outside the insolvency of the transferor largely survives within insolvency proceedings relating to the transferor.

 

Chapter VI deals with the rights and obligation of the transferor, transferee and debtor as between themselves. The relationship between a transferor and transferee is largely governed by the agreement between them, but the MLF provides for certain rights and obligations which exist unless varied by the parties’ agreement. For example, it provides that the transferor makes certain representations to the transferee about the transfer and the receivable, but does not represent that the debtor can pay the receivable.

 

The MLF provides various rules governing the protection of the debtor when a transfer takes place, which reflect the balancing of interests between the interest of the debtor (that its position vis a vis the receivable does not change) and that of the transferee (that it has an unrestricted right to the receivable and its proceeds). The balance is carefully constructed so that, while consent of the debtor to a transfer is not required for an effective transfer, the debtor’s position only changes once it has been given relevant information about the transfer and who it needs to pay to obtain a discharge of the receivable.

 

It is possible under the MLF for a debtor not to be notified of a transfer at all (non-notification factoring), in which case the debtor is discharged by paying the transferor, and the transferor must then pay the proceeds to the transferee.

 

A debtor can be given information by a notification of a transfer and/or by a payment instruction, either of which must be in writing. If a debtor is notified of a transfer, it must, to be discharged, pay the identified transferee or, if different, as instructed in a payment instruction. The Law provides more detailed rules about who the debtor must pay to be discharged in various situations where a receivable has been transferred more than once.

 

The MLF also sets out which dealings between the debtor and the transferor affect the transferee. For example, the debtor is able to assert defences or set-offs against the transferee, except those that are unconnected with the receivable and that arose after the debtor was notified of the transfer. Similarly, any modification of the contract giving rise to the receivable made before the debtor is notified of the transfer binds the transferee.

 

Under Chapter VII, an outright transferee can collect a receivable once it is due, subject to the operation of the debtor protection rules, for example, if the debtor has a set-off that is effective against the transferee. The rules in the MLF in relation to enforcement of a security transfer are more complicated, since the security right only extends to the amount of the secured obligation, and so rules are required to protect the transferor or anyone else interested in any surplus value in the receivable.

 

Chapter VIII provides rules identifying the applicable law in relation to various issues. There are two main situations in which such issues are likely to arise. The first is where the receivable being transferred is an international receivable, that is, where the debtor and the transferor are located in different jurisdictions. The second is where there is an international transfer, that is, where the transferor and the transferee are located in different jurisdictions. The rules include identification of the applicable law to the mutual rights and obligations of the transferor, transferee and debtor, the effectiveness and priority of transfer and the enforcement of transfers. A national court or arbitral tribunal can still apply mandatory provisions or public policy of a State other than that of the applicable law.

 

Chapter IX includes transitional provisions, which are required to deal with the situation where a transaction concerning receivables is entered into under the law in force before the MLF comes into force but the transaction continues after the MLF comes into force.

 

While it is recommended for States to implement the entire MLF, in certain circumstances States may choose not to implement certain rules. As a soft law instrument, such an approach is permissible. In many States, partial implementation of the MLF may still provide a significant improvement of the legal framework and facilitate additional factoring transactions. However, in identifying and explaining the MLF’s Key Features and related Policy Objectives, this Guide is designed to inform implementing States of the potential disadvantages of diverging from the Key Features. As such, throughout this Guide, the purpose and objectives of certain articles or approaches will be explained with reference to the MLF’s Key Features.