Factoring

Definition and Legal Nature of Factoring

Factoring refers to a financing agreement in which a company (known as the client or receivables seller) continuously or on a one-time basis sells monetary receivables from goods deliveries or services to a so-called factor (usually a specialized financial services institution or a bank) and in return receives a large part of the invoice amount immediately. Factoring is regarded as receivables financing and, in legal terms, is considered a combination of the sale of receivables (assignment pursuant to §§ 398 ff. BGB), service contract (in particular receivables management), and risk transfer (del credere). It is a so-called “collective transaction” which, in practice, is regularly incorporated into General Terms and Conditions (GTCs) and encompasses both individual and framework contracts.

Legal Framework and Regulatory Structure

Civil Law Framework

At the core of factoring is the assignment of receivables by the receivables seller to the factor. The legal basis is § 398 BGB (assignment). The validity of the assignment depends in particular on the legal existence and assignability of the receivable. The factoring contract regularly stipulates further modalities such as the scope of assignments, collection authorization, and any rules for rescission.

Requirements for Assignment

• Definability: The assigned receivables must be sufficiently determinable (see § 398 sentence 1 BGB).
• Assignability: Receivables must not be excluded from assignment by contract (assignment prohibition) or by law (§ 399 BGB).
• Notification Obligation: In practice, the assignment is usually notified to the debtor, but notification is not fundamentally required for its effectiveness (§ 409 BGB).

Ancillary Obligations of the Receivables Seller

• Warranties: The seller is liable pursuant to § 437 BGB in conjunction with § 398 BGB for the legal existence of the receivable and—if contractually agreed—for the creditworthiness of the debtor.
• Reporting Obligations: Regularly, there are reporting and documentation obligations, including submission of original invoices and all documents necessary to enforce the receivable.

Contractual Structure

Factoring contracts are regularly structured as framework agreements with individual assignments. The legal relationships between the parties are largely determined by General Terms and Conditions, whose transparency and effectiveness are measured against §§ 305 ff. BGB.

Types of Contracts

• Genuine Factoring: The factor assumes the del credere risk (risk of receivable default). Contractually, there is usually a full purchase of receivables.
• Non-genuine Factoring: The risk of default remains with the receivables seller; if a receivable defaults, the receivable is reassigned to the seller or a liquidity adjustment is made.

Principal Services in the Factoring Contract

• Purchase of the receivable (assignment and, if applicable, payment of the purchase price with retention of a security deposit)
• Assumption of default risk (depending on the type of contract)
• Assumption of receivables management (dunning, debt collection, accounting)

Factoring and Insolvency Law

The insolvency law implications of factoring are diverse, particularly in interaction with §§ 129 ff. InsO (contesting transactions in insolvency) as well as concerning treatment within the insolvency estate.

Structuring to Prevent Contestation

According to §§ 129 ff. InsO, legal actions, including in particular assignments of receivables, may be contestable, for example, in cases of intent to disadvantage creditors or during a critical period before the opening of insolvency proceedings. So-called non-genuine factoring models may be particularly vulnerable to contestation if the default risk has not been effectively transferred and the economic purpose is solely to circumvent creditors’ interests.

Segregation Rights of the Factor

If the client becomes insolvent, the factor’s legal position is governed by §§ 47 ff. InsO. If the receivable was validly and finally assigned, the factor is entitled to a right of segregation from the assigned receivable. The prerequisite is structuring that is insolvency-proof, in particular an effective and unconditional assignment before the opening of insolvency proceedings, as well as transparent contractual conditions.

Effects in Case of Debtor Insolvency

If the debtor becomes insolvent, the assigned receivable usually falls into the debtor’s insolvency estate. The factor must register its claims in the insolvency schedule and will participate in the dividend accordingly.

Factoring and Banking Supervision Law

Since 2009, factoring providers are subject to the regulations of the German Banking Act (KWG) as financial services institutions. Therefore, a license according to § 32 (1) KWG is required before commencing business activities.

Money Laundering Act and Data Protection

Factoring companies are obligated parties under the Money Laundering Act (GwG) and must comply with extensive auditing, documentation, and reporting requirements. In addition, the provisions of the General Data Protection Regulation (GDPR) and the German Federal Data Protection Act (BDSG) must be observed, as personal data are regularly processed in the debt collection process.

Tax Aspects of Factoring

From a tax perspective, factoring is primarily influenced by value added tax law (UStG) and income or corporate tax law.

VAT Treatment

The acquisition of receivables by the factor does not generally constitute a supply, but rather another service. It depends on whether the factor pays the full amount of the receivable to the seller (genuine factoring) or acts only as a lender (non-genuine factoring). There may be VAT peculiarities for shortfalls and fees, particularly regarding the assessment base or the taxability of additional services such as dunning fees or default interest.

Treatment under Income and Corporate Tax Law

The proceeds from the sale of receivables must be treated as part of business profits. Write-downs and the consideration of income reductions must be made according to commercial and tax law principles. For the factor, fee income and, if applicable, interest income are operating income.

International and Cross-border Factoring

In cross-border factoring, the regulations of private international law must be observed. The key aspects here are both the International Law of Assignments (Rome I Regulation) and the UNIDROIT Convention on International Factoring. Decisions on jurisdiction and applicable law are typically expressly regulated in factoring contracts.

Particularities in the International Context

• Applicable law to the assignment: Determined according to Art. 14 Rome I Regulation.
• Recognition of the assignment abroad: May depend on the legal order of the debtor’s country, particularly with regard to the effectiveness of the transfer of receivables and the enforceability against the debtor.

Summary

Factoring is a complex contractual model that touches on various areas of law, in particular civil, insolvency, supervisory, and tax law. The effective structuring of factoring contracts requires careful compliance with all legal requirements to ensure both economic flexibility and legal certainty for all parties. Factoring therefore represents a versatile and legally secure financing and risk management solution for companies across different sectors.

Frequently Asked Questions

What legal requirements must be satisfied to conclude a factoring contract?

Several legal requirements are crucial for the conclusion of a factoring contract. Firstly, the seller (the so-called client) must be legally authorized to dispose of the receivables to be assigned, meaning they must be the owner of these receivables and these must not already have been assigned or pledged elsewhere. The underlying contract between the client and the factor is generally not subject to any prescribed form; it can be made orally or in writing. However, for evidentiary reasons and to meet the written form requirement under § 398 BGB, the written form is usually chosen. Furthermore, all civil law provisions regarding the assignment of receivables (especially §§ 398 ff. BGB) must be observed, such as the existence, determinality, and transferability of the receivables. For consumers, a right of withdrawal often needs to be considered under § 355 BGB; data protection requirements also become prominent due to the transfer of customer information to the factor and must be implemented according to the GDPR. Finally, depending on the factoring model (disclosed, undisclosed or non-genuine factoring), the debtor’s consent to assignment may sometimes be required, particularly if such consent is stipulated in the original debtor relationship (assignment prohibition under § 399 BGB).

What rights and obligations arise for the client from a factoring contract?

The client is obliged to properly disclose the assigned receivables and to provide the factor with all documents and information relevant to their enforceability. There is also a contractual obligation not to dispose of the assigned receivables further and not to reassign or encumber them. There is typically a warranty obligation for the legal existence and freedom from objections of the assigned receivable (legality and determinability). If the client’s customer (debtor) can raise objections against the receivable, liability risks may arise for the client. In return, upon commencement of the contract, the client will usually receive immediate compensation for the value of the receivable less factoring fees, and typically bears no responsibility for further receivables collection (in the case of genuine factoring) or bears the risk of default (in the case of non-genuine factoring).

What effect does factoring have on existing contractual relationships between the client and its customers?

By assigning (cession) the receivable as part of factoring, the client’s customer (debtor) is either directly informed of the change of creditor (disclosed factoring) or not (undisclosed factoring). Legally, the factor becomes the creditor and is entitled to collect the receivable. Through effective factoring, however, the underlying debtor relationship remains unchanged; any objections arising from the underlying transaction (e.g., complaints of defects) may still be asserted by the debtor (so-called objections under § 404 BGB). If a contractual prohibition on assignment has been agreed, a cession is not permissible without the debtor’s consent, meaning factoring in such cases carries increased legal risk. Data protection obligations to provide information may also result from the transfer of debtor data to the factor.

Are there legal differences between genuine and non-genuine factoring?

Yes, the legal differences between genuine and non-genuine factoring are fundamental: In genuine factoring, the factor assumes, in addition to the collection of the receivable, the default risk (del credere risk) upon assignment. The factor thus bears the risk of the debtor’s non-payment; the client is released from liability provided the receivable existed lawfully and was enforceable. In contrast, with non-genuine factoring, the risk of default remains with the client, so in the event of non-payment the factor can have recourse against the client (recourse clause). This is particularly relevant in cases of debtor insolvency, since under non-genuine factoring the factor can take recourse against the client. In terms of accounting, this means that only in the case of genuine factoring is derecognition of the receivable by the client possible, because the economic ownership is transferred to the factor.

What regulatory requirements and supervisory duties apply to factoring institutions in Germany?

Factoring companies in Germany are generally subject to the Trade Regulation Act under § 34 GewO and require official authorization if they operate commercially. Under the Payment Services Supervision Act (ZAG), a license issued by the Federal Financial Supervisory Authority (BaFin) is required if the factoring falls under the scope of the ZAG—particularly for collecting receivables on behalf of third parties. In practice, factoring is frequently classified as a financial service and thus subject to the requirements of the German Banking Act (KWG). Supervisory duties include, among others, requirements to comply with due diligence obligations under the Money Laundering Act (GwG), reporting and auditing duties, and compliance with minimum capital requirements. Particularly important is the duty to segregate and safeguard client funds, which minimizes insolvency risk.

How should tax issues in factoring be treated legally?

From a tax perspective, the sale of receivables generally constitutes a VAT-relevant transaction. Upon payment by the factor to the client, the receivable is fulfilled under civil law; however, VAT liability still depends on the taxation of the underlying supply or service. The factor acts as the creditor and, upon successful collection, is entitled to collect the gross amount of the receivable, but must consider the possibility of receivable default; in the case of irrecoverable receivables, a correction of the VAT claim may be required (see § 17 UStG). Additionally, there are income tax consequences, especially regarding the recognition of profits on the sale of receivables under § 4 (1) EStG and their accounting treatment. Of particular importance in tax law is the correct accounting treatment by the client and the factor, especially with regard to the distinction between genuine and non-genuine factoring.