Factoring and invoice financing are essential mechanisms in modern commercial finance, allowing businesses—especially SMEs—to convert trade receivables into immediate liquidity. Although often treated as simple cash-flow tools, their legal nature, ownership structure, and regulatory implications are complex. Banking law interacts with commercial law, insolvency rules, and secured-transactions frameworks to define the rights of lenders, factors, and debtors.
This post breaks down the legal and economic foundations behind these instruments, highlighting why they matter in real business lending and how they are regulated.
1. What Is Factoring? (Commercial Overview)
Factoring is a financial arrangement where a business (the client) sells its accounts receivable (invoices) to a third party (the factor), usually a specialised finance company or a bank subsidiary.
The factor provides:
The economic rationale:
Businesses trade their future receivables for today’s liquidity—improving working capital.
2. Legal Nature of Factoring: Assignment of Receivables
At its core, factoring is legally built on assignment of receivables, meaning the transfer of rights under a contract from the seller (client) to the factor.
Two key forms:
(1) Legal Assignment (Statutory Assignment)
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Written notice is given to the debtor.
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The factor obtains a direct right to enforce the debt.
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Protected against competing claims.
(2) Equitable Assignment
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No notice required initially.
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Factor’s rights are weaker until notice is given.
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In insolvency, an unnotified factor may lose priority.
Most factoring agreements start as equitable assignments and are perfected by later notification.
3. Types of Factoring
A. Recourse Factoring
The client bears the credit risk.
If the debtor fails to pay, the factor can reclaim the advance.
Legally: resembles a secured loan backed by receivables.
B. Non-Recourse Factoring
The factor assumes the risk of non-payment, typically due to debtor insolvency.
Legally: closer to a true sale of receivables.
Regulators analyse whether risk has genuinely transferred.
C. Maturity Factoring
Payment is made to the client only when the debtor pays, but the factor manages the collection and administration.
D. Confidential (Undisclosed) Factoring
The debtor is not informed that receivables have been assigned.
Used to avoid reputational or relational concerns.
Creates complex priority issues in insolvency.
E. Reverse Factoring (Supply Chain Finance)
Initiated by the buyer, not the seller.
A bank pays suppliers’ invoices early, and the buyer repays later.
Often used by large retailers and manufacturers.
Risk debates:
Regulators worry companies use SCF to mask leverage and inflate working capital.
4. Invoice Financing (Invoice Discounting)
Invoice financing is a broader term referring to the use of invoices as collateral for borrowing. Unlike factoring, the lender does not usually purchase the receivables; the client remains responsible for collection.
Two main approaches:
A. Invoice Discounting
Business borrows against the value of receivables and repays the loan when customers pay.
B. Asset-Based Lending (ABL)
Receivables are one category of assets used to secure a revolving credit facility (together with inventory, equipment, etc.).
Factoring = sale + services.
Invoice financing = secured lending.
5. Key Legal Issues: True Sale vs Secured Loan
A central question in banking law:
Has the receivable been truly sold, or is it collateral for a disguised loan?
This distinction matters for:
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Insolvency priority
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Balance sheet treatment
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Capital requirements
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Risk transfer
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VAT/tax treatment
Courts consider:
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Who carries the credit risk?
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Can the factor charge back unpaid invoices?
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Does the client guarantee payment?
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Pricing structure (fee vs interest)
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Control over collection
Non-recourse factoring is usually classified as a true sale.
Recourse factoring is often treated as a secured loan.
6. Notice to Debtors and Debtor Protections
When receivables are assigned, debtors must know whom to pay.
Notice protects the factor from:
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Payments mistakenly made to the client
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Set-off claims arising after notice
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Double assignments or fraud
Many jurisdictions require notice to complete the assignment.
Debtor defences
A debtor may:
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assert contractual rights,
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raise defences existing before notice,
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claim invalid assignment if contract prohibits assignment.
Contracts with anti-assignment clauses raise enforceability issues:
some countries invalidate such prohibitions to support liquidity markets.
7. Regulatory and Licensing Considerations
Factoring companies may or may not be banks, depending on jurisdiction.
Where factoring involves:
regulators often require:
AML/KYC
High-risk because:
Banks must verify:
8. Priority and Insolvency Issues
In insolvency, priority conflicts occur between:
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the factor,
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secured lenders,
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administrators,
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other creditors.
Key issues:
A. Was the assignment perfected?
If debtor notice was not given, the factor may lose priority to:
B. Recharacterisation risk
A “factoring agreement” may be reclassified as a secured loan if:
Then the “factor” must have properly registered security interests.
C. Clawback rules
Assignments made shortly before insolvency may be invalidated as:
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preferences,
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undervalue transactions,
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sham transactions.
9. Non-Payment, Fraud, and Disputes
Factoring is vulnerable to fraud, including:
Legal disputes often concern:
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whether invoices are valid,
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whether goods/services were actually delivered,
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the factor’s duty to investigate authenticity,
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credit limit disputes,
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recourse trigger conditions.
Most factoring agreements include:
10. Benefits of Factoring and Invoice Financing
For Businesses:
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improved cash flow
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reduced DSO (days sales outstanding)
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outsourcing of credit control
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protection from bad debts (non-recourse models)
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alternative to bank loans
For Banks/Factors:
11. Cross-Border Factoring (Legal Complexity)
International factoring agreements raise advanced legal questions:
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governing law of assignment
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whether assignment is recognised in debtor’s country
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conflict of laws rules (Rome I Regulation, UNIDROIT Convention)
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currency risk
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enforceability of notices abroad
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collection rights in foreign courts
The UNIDROIT Convention on International Factoring provides guidance but is not universally adopted.
Cross-border deals often require:
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legal opinions
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local filings
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compliance reviews
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credit insurance
12. Comparison: Factoring vs Invoice Financing vs Securitisation
| Feature | Factoring | Invoice Financing | Securitisation |
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| Nature | Sale (usually) | Loan secured on receivables | Sale to SPV |
| Who collects? | Factor | Client | Servicer |
| Risk transfer | Medium-high | Low | Full transfer to SPV/investors |
| Cost | Medium | Low | High but scalable |
| Regulatory scrutiny | Moderate | High | Very high |
Factoring is flexible and suitable for SMEs; securitisation is institutional.
Conclusion
Factoring and invoice financing are not simple liquidity products—they are embedded in a sophisticated legal architecture involving assignment law, secured transactions, banking regulation, and insolvency principles. Whether a transaction is treated as a true sale or secured loan significantly impacts risk allocation, accounting treatment, and regulatory compliance.
Properly structured, factoring provides firms with essential working capital while giving banks and finance companies a secure and profitable asset class. Poorly structured, it exposes all parties to fraud, priority disputes, and regulatory penalties.
