Factoring – definition, main purpose, and types  

Factoring can be defined as a legal undertaking, i.e., a financial service for the purchase of an existing non-mature claim or a future short-term monetary claim, the basis of which is the contract for the sale of goods or services, whether domestically or internationally. Hence, the subject of factoring can be any existing or future short-term claim, either in whole or in part. To explain the matter further, short-term receivables refer to receivables that are due within one year of the sale of goods or the provision of a particular service. In the Republic of Serbia, factoring transactions are governed by the Law on Factoring (‘Official Gazette of RS’ No. 62/2013 and 30/2018). Such legal undertakings are considered as cost-effective for assignors, namely sellers, due to the removal of the risk of collecting receivable and liquidity enhancements. There are particular benefits for factors as well such as the possibility of retaining the agreed amount of receivables and the ability to minimize credit risks by purchasing receivables with solvent debtors. 

In factoring transactions as participants, we have the assignor, i.e., the seller who sells receivables and the factor as the buyer. The role of the assignor can be assumed by a bank, a company or entrepreneur in the Republic of Serbia, while in the role of a factor we may encounter a bank, a company established as a limited liability or joint-stock company with the approval of the Serbian Ministry of Finance for performing factoring activities, or a foreign bank or company in the case of international factoring. Particular conditions for providing factoring services have been set out in more detail by the Serbian Law on Factoring. 

 The main types of factoring can be divided into domestic and international factoring, which differ whether the factoring transaction is taking place in the internal market between domestic parties or in a foreign trade of goods or services. The rules on international factoring have been laid down by the 1988 UNIDROIT Convention on International Factoring. Furthermore, according to the obligation to assume the risk of debt collection, we may distinguish the non-recourse type of factoring, and recourse factoring where the assignor corresponds to the factor for collecting receivables on the day of maturity. It is important to emphasize that if there is a dilemma regarding the type of factoring, it is assumed that the parties had in mind recourse factoring. As a special type of factoring, reverse factoring occurs – namely, a factoring transaction contracted between a factor and a debtor from the basic contract on the sale of goods or services where the factor assumes the obligation of payment to creditors with the right to collect in relation to the debtor. 

The Factoring Agreement 

The factoring agreement is a named agreement regulated by the provisions of the Law on Factoring that may be concluded in writing or electronic form. At first glance, the factoring agreement seems to encompass elements of other familiar contracts, such as a loan agreement, a cession, a commission or a Lombard loan agreement, yet it is considered to be a sui generis agreement that began its development in the 19th century American business practice. In accordance with the provisions of the Law on Factoring, the factoring agreement should contain certain elements such as data regarding contractual parties; data on the type of factoring; the basis and data on the receivable that constitutes the subject of the contract; amount, manner of calculation and payment of the purchased receivable to the assignor; amount, manner of calculation and compensation payment to the factor; the right of factor to interest and other costs that may arise from the realization of the contract; the date of the conclusion of the contract and finally, the signatures of the legal representatives of the contractual parties, other persons authorized to sign on other grounds or with the power of attorney. If the contract has been concluded under a specific expiration date, it is deemed to end along with the expiration of the deadline to which it is concluded. Otherwise, if a certain deadline has not been contracted, it cannot cease to exist before all sold receivables have been collected or regressed by the assignor. The Law on Factoring lays down one case of contractual nullity in case one assignor has concluded factoring agreements with divergent factors that have as a subject the sale of the same receivable. 

Forfaiting – definition, purpose and forfaiting vs. factoring differences 

Forfaiting can be defined as a legal undertaking by which the bank, as the forfaiter, purchases from its client, as the other contractual party, his non-mature claim to a third party for the purpose of debt collection, and without the right to recourse in relation to the seller. The concept of forfaiting was created back in the 50s in the autonomous business practice of Swiss banks as a form of financing trade between buyers in Western Europe and the Eastern Bloc. While the agreement in question has not been regulated by most national laws, in the Republic of Serbia it has been enabled in a certain manner by relevant provisions of the Law on Foreign Exchange Operations (‘Official Gazette of RS’ No. 62/2006. 31/2011, 119/2012, 139/2014 and 30/2018). 

In other words, the forfaiting agreement obliges the bank to pay the agreed price to the client for the transferred receivable, minus the amount of commission, interest and other relevant collection costs. The very word forfaiting stems from German ‘forfaitirung’ or the French counterpart ‘a forfait’, which translates to buying something in its entirety for a predetermined price. Forfaiting is considered to be a manner of financing export loans through the purchase of long-term export receivables grounded on the presentation of documents guaranteeing debt repayment, such as bank guarantees or letters of credit. Taking on the role of a forfaiter, the bank assumes the risk of collecting receivables, and the seller gets the opportunity to charge the receivables immediately. 

At first glance, factoring and forfaiting may look alike, yet there are particularly significant differences. Namely, factoring involves the purchase of short-term receivables, usually those maturing up to one year, whereas forfaiting is about purchasing long-term receivables that are often considered to be higher monetary amounts as well. In addition to being more specific to foreign trade, forfaiting also includes higher commissions and costs due to longer maturity periods. 

The Forfaiting Agreement 

In the legal theory, the forfaiting agreement is considered to be a mixed contract encompassing elements of other contracts such as a sales agreement and an escount loan. Being a creation of the banks’ business practice, the forfaiting agreements remains as an unnamed contract, yet it is also an express and aleatory agreement. The transfer of the receivables itself can be done by purchasing receivables through bills of exchanges with a ‘without recourse’ clause, cession agreement or through documentary letters of credit. The advantages of this legal instrument in foreign trade are multiple – namely the export gets rid of traditional risks associated with the business of export such as risks related to currency changes, interest rate fluctuations, credit risk and other, while enhancing its liquidity.