Mehmet Taş,Attorney at Law

Factoring is an activity based on the purchase by financial institutions named as factor or factoring of the rights of receivables arising from a short term promissory note issued due to credit sales to be made within and outside the country by the commercial enterprises selling goods or providing services. In legal terms, factor is defined as a real person or legal entity who acquires the receivables of the firms arising from the sale of goods and/or services and assumes the collection duty for these receivables; who provides finance by making advance payments against these receivables and who earns interest, commissions or fees in consideration for the administrative, commercial and financial services provided to these firms.

Factoring as a finance type is different than other financing instruments such as loans because of its intrinsic properties. Because except for factoring transactions, the institution providing the credit has always a right of recourse to the seller that obtains credit against a promissory note in case the promissory note can not be collected; but in factoring, after the seller sells his receivables to the factor under a factoring agreement, the risk of not collecting the receivables is transferred to the factor.

DEVELOPMENT OF FACTORING

Factoring activities became widespread after 1970s and this new financing technique commonly used in USA and in the European countries today is started to be used in developing countries, too.
In many countries important part of the factoring institutions providing modern services since 1950s were established with the participation of banks and finance institutions. In the European countries, factoring and leasing transactions were commenced forty years ago but certain finance circles believe that factoring is not given sufficient importance as compared to leasing. In fact most of the European countries did not need to issue separate laws for factoring transactions. For example in some European countries (such as Italy, Spain and Sweden), there are no legal arrangements made on this issue but in some of them (Germany and France), certain legal arrangements are existing. Our country adopted the new financing techniques applied in developed countries and started to apply these techniques without delay and factoring activities commenced first in 1983 allowing our firms to take advantage of this new finance technique.

TYPES OF FACTORING

Factoring is divided into certain types depending on the fact that the seller and the buyer are operating in the same country or in different countries; the manner of utilization of the factoring facility by the seller; and determination of certain conditions in the factoring contract.

A-National and international factoring
Factoring is grouped into two and named as international and national factoring depending on the residence of the parties in the same or different countries.

1-National factoring
If all parties to the factoring transaction (seller, buyer and factor) reside in the same country, the seller firm transfers his receivables determined in promissory notes issued due to credit sales to the factor and in this way the seller converts all or part of his receivables into cash. In the application adopted in our country, domestic (national) factoring transactions are grouped into two as revocable and irrevocable.

2-International factoring
If the seller and the buyer reside in different countries, this type of factoring is present where follow-up and collection of the seller’s receivables is made by the factor and depending on the type of commercial transaction, being either importation or exportation, international factoring is grouped into two as exportation factoring and importation factoring. Although the mechanism is same for national and international factoring, in case of international factoring a correspondent company to which the buyer makes the payments (such as bank, branch of factor or another factor acting as intermediary) steps in.

(a)Exportation factoring
Factoring transactions made for exports are grouped into two as revocable and irrevocable as follows:
(i)Irrevocable exportation factoring
Irrevocable exportation factoring transaction develops with the following phases:
The seller (exporter) applies to a factoring institution (factor) and informs the factor about the name of the importer firm which is his customer residing at abroad and about the limit needed by the seller (amount of receivables payable by the importer according to the due dates determined by the exporter).
Then the factor informs his correspondent (correspondent factor) operating in the country of the buyer (importer) about the name, address of the buyer and the limit requested.
If the investigation made for the buyer firm results positively, correspondent factor determines a limit.
This limit is informed by the factor to the exporter and a contract is made between the seller and the factoring institution.
The seller makes the shipment of the goods and sends the goods to his customer (buyer) after affixing an assignment annotation to the original copy of the invoice issued by the seller and stating that relevant payment should be made to the correspondent factor. He also delivers another copy of the invoice to the factor.
Factor makes the collection of this invoice on the due date through correspondent factor and makes payment to the seller. If the seller requests advance payment, maximum 80% of the amount invoiced may be paid to the seller (exporter).
As the collection risk is assumed by the factor in factoring transactions, all problems except for reclamation are resolved by the factor and necessary information is provided to the seller.
In this type of factoring transactions, factor pays full amount (100%) subject to the guarantee limit on the 90th day following the due date if the buyer suffers financial problems and fails to make the payment on the due date. Here the seller (exporter) is given the possibility to make forward sale under 100% guarantee without facing financial problems and the buyer (importer) is given the possibility to make forward purchase irregardless of his liquidity problems and without being forced to open a letter of credit.
(ii)Revocable exportation factoring
If the seller makes business with buyers that he knows since a long time and that do not bring risks for the seller, the seller may irrevocably assign his rights arising from exportation receivables to the factor. In such type of transaction the factor assumes the follow-up and collection of the receivables and may provide advance payment before the due date. However all responsibilities arising from the risk of not collecting the receivables belong to the seller.
(b)Importation factoring
If the buyer desires to make import goods from abroad on the basis of forward buying or in exchange of goods and subject to factoring, the buyer makes an agreement with the seller. Then the seller makes contact with the factor in Turkey through the factor operating in his country and requests necessary limits. The factor in Turkey makes contact with the buyer for the determination of this limit and obtains necessary information and documents and if the examination results positively, a limit is established in the name of the buyer (importer) and this limit is informed to the factor operating in the country of the seller (exporter). Then the buyer makes the payment on the due date to the bank account number notified by the factor. By this way the importer is given the possibility to make forward importation against goods irregardless of his liquidity problems.

B-Factoring types determined according to the existence of certain services in a factoring transaction

Existence of certain services in a factoring transaction determines following factoring types:

1-Traditional factoring
This is a factoring transaction where the factor assumes all commercial risks and frequently makes an advance payment to the seller and it is a commonly used factoring type in case of international transactions.

2-Artificial factoring
This is a factoring transaction where the factor does not assume the commercial risks and only assumes the collection as per relevant documents and it is not a commonly used factoring type in case of international transactions.

3-Discounted factoring
This is a factoring transaction where the receivables are discounted by the factor before the due date and the balance is paid to the seller,

4-Futures factoring
This is a factoring type where the seller makes single time collection from the factor at the end of each month according to the average maturity of the monthly credit sales. The seller does not receive advance payment from the factor and payments are made at the end of maturity periods. No financing support is provided to the seller in this type of factoring.

5-Open factoring
The name of the factor acquiring the invoices of the seller and collecting his receivables is informed to the buyer and a notification is placed on the invoices stating that payment shall be directly made to the factor on the due date.

6-Secret factoring
In this type of factoring transactions, if the seller places a note on the invoices stating that the payments should be made to the factor, the seller may elect to keep the name of this factor as confidential because he thinks that disclosure of this name would have a negative impact on its relations with the buyer. This transaction is executed by the seller selling the goods subject to credit sale to the factor in consideration for advance payment and then the factor grants a power of attorney to the seller to ensure the delivery of the goods to the buyer and collection of the relevant amount. Thus the buyer is not aware of the existence of a factor.

FUNCTIONS OF FACTORING

1-Crediting function
In factoring transaction, crediting function may be used in two different ways. First method can be described as payment of an advance against the receivables. Factoring company applies interest at a rate applicable for current accounts to its customer realizing the sale within the period before the due date of the receivables up to a limit of 80-90% of the amount of these receivables. Balance of the receivables is retained as a guarantee for return of the goods or for discounting the amount payable which are not subject to the responsibilities of the factoring company.

Second method for the operation of crediting function is discounting the receivables. In this method the factoring company deducts expenses, interest and similar amounts from the total amount of receivables and pays the balance to his customer. But this is not a commonly used method.

2-Guarantee function
In this function which is typical for irrevocable factoring transactions, the factoring company assumes all types of risks together with the receivables. This risk does not relate to the existence of the receivables in fact but it relates to the possibility of collection. In such a case, real owner of the receivables becomes the factoring company and if the receivables could not be collected, the factoring company may not take recourse against its customer.

3-Service function
This function is common to all factoring types and it describes the administrative services provided to the seller by the factoring company. This service is rendered by keeping the accounting records in respect to the debts, sending official warning to the debtor, collecting the receivables and applying to forced collection methods in case of default in payment.

ADVANTAGES OF FACTORING

The advantages conferred to the seller and to the factor firm from a factoring transaction are described below.

On the part of the seller (exporter)
Factoring transaction helps the seller in the follow-up and collection of receivables, elimination of risks and making advance payment before the due date.
1-Follow-up and collection of receivables
Following the execution of factoring contract, the authority to follow-up and collect the receivables is transferred to the factor and thus company’s managers are relieved of the duty to follow-up collection and credit control and since no sales accounting and book entries are necessary, the company’s administrative expenses are reduced and it also gives a chance to the company to program its cash flow and thus to make efficient and reliable plans for the future. In addition the sales are directed towards buyers having enough liquidity according to the information provided by the factor and sales made under open account become easier and more reliable. In case of sales made to abroad, the language problems ensuing between the seller and the buyers are resolved by the factor.

2-Elimination of risks
Since all losses (subject to determined limits) arising from non-collection of credit sale payables are assumed by the factor, the problems that may be encountered by the seller and the risks of not completing foreign exchange transactions are eliminated. The seller transfers the risk of not collecting the amount payable for the goods to the factor and in this way it may grant a maturity date in its sales made to the buyers in domestic and-or international markets and it may have the possibility of enhancing its competitive power and extending its markets. On the other side, with the help of factoring transaction the buyers at abroad are relieved of the burden of establishing a letter of credit and make the payments to the correspondent factor and save money and time.

3-Advance payment before due date
In factoring transactions, generally the factor undertakes to pay to the seller immediately and in cash approximately 80% of the total amount payable under credit sales and undertakes to pay the balance after collection. In this way the seller may use the advance payment made by the factor to obtain necessary raw materials with advance payment, reduces the production costs, does not utilize bank loans at unnecessary times and reduces his interest expenses. The company reducing its receivables, stocks and debts is given the possibility to increase its operational capital and to make its balance sheet more liquid. Since cost of finance provided by factoring transaction is less than the cost of commercial loans, additional money is earned in future sales.

On the part of factor (factoring company)
Following the execution of a factoring contract, the factor assumes the duty of keeping all accounting records in relation to the credit sales made by the seller, collecting the receivables arising from these sales on the respective due dates and in case of failure in collection, fully bearing all losses arising from default in payments. In consideration for his services, the factor receives commission at a certain rate of the credit sales amount from the seller benefiting from the factoring transaction and in the event of advance payment to the seller, the factor collects the amount of interest corresponding to such advance payment. In this way factor comes to know a lot about the financial position of the sellers and buyers as a result of the evaluation it makes on the creditability of the firms with which it makes business and is able to use this know-how in its other activities. Also the factor may increase the volume of customers for these firms (for the bank with which it is affiliated) since its influence on its customers increase by time.

COST OF FACTORING
The cost of a factoring transaction consists of the commission and interest (discount) paid by the seller to the factor. In consideration for his services such as examination of creditability, assumed risks, keeping accounts of receivable, collection of the receivables etc., the factor receives a certain rate of commission from the seller according to the amount of transferred receivables which depends on the type of factoring transaction. The rate of commission is determined by taking into account number of buyers, creditability of the buyers, characteristics of the business line, annual turnover undertaking by the seller, risk position of the countries to which factoring is made and currency of the receivables. The difference of factoring from other financing techniques based on loans in terms of cost is this commission. This might be interpreted as the cost of risk transferred to the factor.

If the seller desires to receive a certain amount of advance payment as a set-off against the receivables transferred to the factor before the due date determined for the collection of the receivables by the factor, the seller is then obliged to pay to the factor an interest (discount) at a rate determined before in respect to such advance payment. In case of advance payments, the interest (discount) rate is determined according to current interest rates in respect to the receivables payable for domestic sales and international interest rates (Libor +spread) applicable for the currency of the invoice are taken as a basis in case of receivables payable for foreign sales.

Let us give now an example of how the cost mechanism operates in factoring. The seller wishes to take factoring services for a six months forward foreign sale with an amount of USD 100.000,- If we assume that factor’s commission is 2% and international interest rate (Libor + spread) is 10% and if the seller desires to take the payment for the goods immediately upon the sale, the cost of factoring service for the seller will be USD 7.000,- Thus the seller will be able to collect its receivables as USD 93.000,- without waiting for six months. The calculation of the transaction is made as follows:
USD 100.000,- x 2% = USD 2.000,- (commission)
USD 100.000,- x 5% = USD 5.000,- (interest)

Total cost: USD 7.000,-
(Note: Interest for six months based on annual interest rate of 10% is equal to 5%).

In factoring services, generally the factor undertakes to pay to the seller immediately and in cash approximately 80% of the total amount payable under credit sales and undertakes to pay the balance after collection. In this way the seller is able to meet its cash requirements arising from credit sales at any time easily.

APPLICATION OF FACTORING IN TURKEY

It is a fact that competition among banks increased considerably because of important changes and developments seen in the banking system in our country in the recent years and because of international banks opening branches in Turkey and bankers increasingly adopting the trend of specialized banking. Thus the banks started to provide to their customers new financing techniques such as consumer loans, credit cards, leasing, factoring and forfeiting. The concept of factoring entered into the banking terminology of our country as a finance technique first in 1983 upon the issue of “Law Decree on Lending Money”. Clause 3 of this law decree defines factoring as follows: “Assignment of the receivables that have arisen or will arise from the sale of goods and services; assuming the duty of collection and providing finance by making payments against these receivables”. And the companies established to carry on factoring business are named as “factoring companies”.

Although factoring is a new finance method, it developed rapidly in our country and became an indispensable instrument in the finance markets of our country. The transfer of short term receivables arising from the sale of all types of goods and services is becoming widespread each passing day. As factoring includes the services of following-up and collecting the receivables, guaranteeing their payment, providing finance, making market research, making credit investigation, assuming commercial risks, keeping the accounting records etc., it meets the short term capital requirements of the firms.

The factoring transactions made in our country by the banks or the companies especially established to perform factoring transactions have a close relation with the below mentioned legislation.

The infrastructure of the legal framework of this sector is based on the Code of Obligations and Turkish Code of Commerce. However Under Secretariat of Treasury of Prime Ministry of Republic of Turkey prepared an amendment to the Law Decree No. 90 in order to create an infrastructure for the sector’s operations and made the first legal arrangement in 1994 with the approval of the Council of Ministers. This law decree gives the first definition of factoring in a legal document besides other definitions as follows: “To take assignment of receivables that have arisen or will arise from invoices or from the sale of goods and services and assuming the duty of collection and making payments against receivables and thus providing finance”.

A-Turkish Code of Commerce

There are no provisions in the Turkish Code of Commerce for factoring transactions and the transfer and assignment by the sellers of their receivables subject to invoice are subject to the “provisions of assignment of receivables” as stipulated in the Code of Obligations.

B-Code of Obligations

Article 162 of the Code of Obligations stipules as follows: “Any creditor may assign his receivables to a third person without taking the consent of the debtor, unless such assignment is banned under a law or convention or because of the nature of the concerned business. The debtor may not claim to the third person accepting such assignment of the receivables that it has been stipulated not to assign the receivables by relying on a confirmation that does not include this stipulation which is based on an inscription”. Article 163 covering the type of contract stipulates as follows: “Assignment of receivables shall not be valid unless it is made in writing. The promise to assign a receivable is not subject to any special format.” On the other side, articles 164 to 172 of the same Law stipulate that “the receivable should be suitable for assignment; the assignment transactions shall be made in writing in the form of a contract and the parties shall be entitled to exercise their civil rights”.

C- Banking Law

Article 6 of the Banking Law stipulates as follows: “Cash credits and non-cash credits to be granted by a bank such as letter of guarantee, bailment, bill guarantee, endorsement and acceptances; debentures and similar capital market instruments to be bought by a bank; monies lent by making payment or in any other manner; receivables arising from the forward sale of the assets; overdue cash loans; amounts that may converted into cash under non-cash credits; futures and option contracts and other similar contracts and partnership shares shall be regarded as credit irregardless of the account kept for them. (Article 11 of the Banking Law No. 4389 which was amended by article 6 of the Law on Amendment to the Banking Law No. 4672)

There are different opinions when it comes to decide whether the advance payment made to the customer by the factoring company should be considered as credit. According to one of thee opinions, since factoring services is a credit granted to the buyer and no recourse is taken against the seller, factoring should be evaluated as a non-cash credit opened in favor of the buyers in terms of the Banking Law. Another opinion states that advance payment made against a certain amount of receivables should be evaluated as a credit transaction. The receivables shown as a consideration for such advance payment are not given as security like in credit transactions. The reason for that arise from the fact that advance payment is made on the basis of the invoice in respect to the receivables that have not yet arisen. However it should be kept in mind that upon this advance payment, if interest is accrued in addition to the commission taken for the transferred receivables, this transaction may have the characteristics of a credit transaction. On the other side, the advance payment is actually the money drawn before the due date by the customer selling his goods. Here we see an application similar to short term credit transaction based on discount principle.

D- Law Decree on Lending Money

Law Decree on Lending Money No. 90 defines factoring companies as “companies providing finance by taking assignment of the receivables that have arisen or will arise from the sale of goods and services, by assuming the duty of collection and by making payments against these receivables”. (Article: Amended by Law Decree No. 3/545). It is a rule that factoring companies are incorporated as joint stock companies only after obtaining the preliminary permission of the Under Secretariat of Treasury and the capital amounts for such companies are determined by this Under Secretariat. The Under Secretariat of Treasury has the authority to determine the interest rates to be applied by the factoring companies and the maximum rate of costs and expenses payable to them or to grant freedom to these companies in the determination of the same; and these companies may not carry on other operations except for main activity of factoring; may not issue letters of guarantee or collect deposits and may not buy the receivables that are not related to an invoice or to the documents confirming that such receivables have arisen from the sale of goods and services even if the receivables are made subject to a promissory note. However issue of marketable securities and borrowing money from international markets by these companies are not subject to the restrictions in this provision (Article: 12 and amended by Law Decree No. 13/545).

E- Insurance Legislation
The guarantee forwarded by the factoring companies for the payment of receivables should not be confused with insuring the receivables. Because pursuant to article 110 of the Code of Obligations, in case of guarantee the action of third persons is undertaken to another person. However in case of insurance business, compensation is paid if a risk arises to cause losses to the interest of a third person that could be measured as money. Since insurance services are subject to a special legal arrangement, no other company except for insurance companies may issue an insurance policy and thus it is not possible for factoring companies to render insurance services.

F- Regulation No. 26315
Incorporation and working principles applicable for the factoring companies acquiring the receivables that have arisen and will arise from the sale of goods and services (and based on invoice or other confirming documents), assuming the duty of collection and providing finance to the firms by making payments against these receivables have been regulated in a regulation by the Under Secretariat of Treasury.
The companies that will carry on factoring operations are subject to incorporation permit and operation permit as stipulated in this regulation.

Conditions required to be fulfilled when incorporating a factoring company are listed in article 3 of the regulation no 22148. In order to be incorporated, factoring companies:
a-should have the status of a joint stock company;
b-should have a paid-in capital not less than YTL 5 million;
c-should issue all their shares as registered shares and in consideration of cash;
d-“Factoring Company” shall be included in their trade names.

In addition to the above conditions, certain criteria are determined for the incorporator partners of such companies such as not being insolvent, not being involved in infamous crimes such misappropriation, corruption and swindling and having the economic power and reputation to cover the amount of capital subscribed.

Factoring companies shall apply to the Under Secretariat of Treasury in order to obtain operational permit within 180 days following the registration of the company in the Trade Register. If the factoring company does not start operating within 1 year following the date of the operational permit certificate, the operational permit granted to the company will be cancelled.

The factoring companies required to be incorporated as a joint stock company have to issue written contracts for the transactions to be made with their customers and may not carry on the following activities:
These companies may not carry on other activities except for core business;
May not issue a letter of guarantee;
May not collect deposits or monies against a consideration whatsoever except for issuing marketable securities in accordance with the Law on Capital Market and borrowing money from the international markets;
May not buy the receivables that are not related to an invoice or to similar documents confirming that the receivable has arisen from the sale of goods and services even if promissory notes have been issued in respect to such receivable.