M/s Canbank Factors Ltd. Vs. M/s. Shree Jaya Laboratories Pvt. Ltd. - In other words, in a case of factoring with recourse, it is the assignor, who will be the borrower and in cases of factoring without recourse, it will be the debtor (purchaser of invoiced goods or person liable to pay the receivable) who will be the borrower.

 NCLT Hyderabad (21.07.2022) in M/s Canbank Factors Ltd. Vs. M/s. Shree Jaya Laboratories Pvt. Ltd. [Company Petition IB/83/2021] held that;

• In other words, in a case of factoring with recourse, it is the assignor, who will be the borrower and in cases of factoring without recourse, it will be the debtor (purchaser of invoiced goods or person liable to pay the receivable) who will be the borrower.

• The reason to restrict the mischief of Section 5(8)(e) to debt arising from discounting of bills otherwise than on non-recourse basis only fits perfectly into the concept of Financial Debt under the Code having the two intrinsic ingredients of "disbursal" of funds for "time value of money" which would obtain in the case of an Assignor only.

• Since the factoring agreement relied upon by the Applicant herein is without a doubt "on recourse basis", the Applicant will be entitled to pursue the instant Application in the case of the Assignor only and following the RBI Circular also it has to reckon the debt in the hands of the Assignor namely M/s P. Praful & Company Agency (India) Pvt. Ltd and not in the hands of the Respondent.

• In any case, we have referred earlier to the RBI guidelines which provide for recognizing the debt in the hands of the customer/debtor only if the factoring has been done on non-recourse basis which clearly and admittedly is not the case before us.

• That while the Applicant here may have recourse against the assignor namely M/s P. Praful & Company Agency (India) Pvt. Ltd. u/s 7 of the Code, it certainly has no eligibility to file and maintain the instant Application against the respondent herein namely M/s Jaya Laboratories Pvt Ltd. as a Financial Creditor. 

• In view of the explicit clause in the factoring agreement entered into between the Applicant/Assignee and the Client/ Assignor in relation to the purchase of debts ON RECOURSE basis, read with the RBI Guidelines discussed supra, there is no jural relationship of creditor and borrower between the Applicant and Respondent.

Excerpts of the order;

# 1. Under consideration is a Company Application filed by M/s Canbank Factors Limited (in short “ Petitioner/Financial Creditor") under section 7 of the Insolvency and Bankruptcy Code, 2016 (in short IB Code, 2016) read with rule 4 of the Insolvency and Bankruptcy (Application to Adjudicating Authority) Rules, 2016, for initiation of Corporate Insolvency Resolution Process (CIRP) against M/s. Shree Jaya Laboratories Private Limited (in short, “Respondent/ Corporate Debtor').

 

# 4. Heard and perused the record. 

# 5. It is the case of the Financial Creditor that M/s P. Praful & Company Agency (India) Pvt. Ltd (hereinafter referred to as “Client) entered into Factoring agreement dated 20.01.2015 with M/s Canbank Factors Ltd. after execution of Escrow mechanism with escrow authorization letter (E AL) in lieu of Authorization letter and undertaking letter (AL/UTL) from the Respondent namely Shree Jaya Laboratories Pvt. Ltd (hereinafter refer to as “Customer/ debtor) during the year 2015. The second escrow authorization letter (E-AL) in lieu of UTL/AL by the Customer got executed on 24.04.2018. That initially, the Corporate Debtor herein had made payments to the Applicant herein, however, subsequently defaulted in payment of same and after following up with the respondents to no avail, the Applicant has filed the instant application. 

# 6. Per contra, the Corporate Debtor has assailed the instant Application on the ground that the Applicant herein is not the Financial Creditor of the Respondent herein. That a fraud was committed by one Shri Neel P. Bhalakia, Director of P. Praful & Company Agency (India) Pvt. Ltd in collusion with one Shri. K.S.N.S.V.N Murthy, who was working with the Corporate Debtor in the accounts department. The Corporate Debtor realized that fake invoices were raised, fake confirmations of receipt, and fake unauthorized undertaking and authorization was given by Shri. K.S.N.S.V.N. Murthy who was hand in glove with Shri. Neel P. Bhalakia. That an FIR was registered and chargesheet has also been filed and the same is pending Adjudication before XXI Metropolitan Magistrate, Cyberabad, Medchal, Hyderabad. 

# 7. Before proceeding with adjudication of instant matter, it is pertinent herein to adjudicate the nature of transaction and also to decide whether the said transaction falls within the parameter of financial transaction and whether the Applicant herein is a Financial Creditor to the Respondent herein or not. 

# 8. During the course of hearing, the Applicant herein has contended that the impugned transaction will fall within the meaning of Financial Debt as defined in Section 5(8) of the Code and especially relied upon provisions of Section 5(8)(e) of the Insolvency and Bankruptcy Code, 2016,which is extracted hereunder: 

• "5(8): “financial debt" means a debt along with interest, if any, which is disbursed against the consideration for the time value of money and includes - 

• ...... 

• (e) receivables sold or discounted other than any receivables sold on non recourse basis;" 

 

# 9. To decide the issue of maintainability of the instant application filed by M/s Canbank Factors, it would be necessary to refer to the provisions of the Factoring Regulation Act, 2011 and the RBI Guidelines issued for viding Factoring Services by the Banks and NBFCs. 

# 10. The Factoring Regulation Act, 2011 was enacted by the Government to regularize and facilitate the business of factoring which enabled the Banks and NBFCs registered as factors to undertake the business of factoring in India. Section 2() of the said Act defines factoring business as follows: 

• "(j) “factoring business” means the business of acquisition of receivables of assignor by accepting assignment of such receivables or financing, whether by way of making loans or advances or otherwise against the security interest over any receivables but does not include— (i) credit facilities provided by a bank in its ordinary course of business against security of receivables; (ii) any activity as commission agent or otherwise for sale of agricultural produce or goods of any kind whatsoever or any activity relating to the production, storage, supply, distribution, acquisition or control of such produce or goods or provision of any services. 

• Explanation.--For the purposes of this clause- (i) the expression “agricultural produce” shall have the meaning assigned to it under clause (a) of section 2 of the Agricultural Produce (Grading and Marking) Act, 1937 (1 of 1937); and (ii) the expressions "goods” and "commission agent” shall have the meanings assigned to them respectively under clause (d) and Explanation (ii) of clause (i) of section 2 of the Forward Contracts (Regulation) Act, 1952 (74 of 1952);" 

# 11. Section 6 of the said Act provides as follows: 

• 6. Powers of Reserve Bank to give directions and to collect information from factors.--

• (1) The Reserve Bank may, at any time by general or special order, direct that every factor shall furnish to it, in such form, at such intervals and within such time, such statements, information or particulars relating to factoring business undertaken by the factor, as may be specified by the Reserve Bank from time to time. 

• (2) The Reserve Bank may, if it considers necessary in the interest of business enterprises availing factoring services or in the interest of factors or interest of other stake holders give directions to the factors either generally or to any factor in particular or group of factors in respect of any matters relating to or connected with the factoring business undertaken by such factors. 

• (3) If any factor fails to comply with any direction given by the Reserve Bank under sub-section (2), the Reserve Bank may prohibit such factor from undertaking the factoring business: Provided that before prohibiting any factor from undertaking the factoring business, the factor shall be given a reasonable opportunity of being heard." 

 

# 12. Here it is important to note that both banks and NBFCs are subject to the guidelines of the Reserve Bank of India (RBI) on matters pertaining to prudential norms and exposure requirements under the Factoring Regulation Act, 2011.The RBI therefore issued its circular titled “Provision of Factoring Services by Banks - Review”, dated 30 July 2015 to clarify these issues. 

# 13. The RBI Circular clearly adopts the concepts and definitions of the Factoring Regulation Act in Para 1 of the Circular: 

• "1. Adherence to the provisions of Factoring Regulation Act, 2011: EO The business of factoring should be undertaken in compliance with the statutory provisions under the Factoring Regulation Act, 2011. The terms assignee, assignor and debtor will have the same meaning as assigned to them in the Factoring Regulation Act, 2011 viz., "assignee" means a factor in whose favour the receivable is transferred; "assignor" means any person who is the owner of any receivable; and "debtor" means any person liable to the assignor, whether under a contract or otherwise, to pay any receivable or discharge any obligation in respect of the receivable whether existing, accruing, future, conditional or contingent." 

# 14. Going by these definitions, in the instant case, the Applicant is the "Assignee", the Client namely M/s P. Praful & Company Agency (India) Pvt. Ltd. is the "Assignor" and the Respondent/ Customer herein namely M/s Jaya Laboratories Pvt Ltd is the "Debtor". It is also pertinent to note that admittedly the factoring agreement between the Assignor M/s P. Praful & Company Agency (India) Pvt. Ltd. and the Assignee M/s Canbank Factors Ltd. is ON RECOURSE BASIS. The same term is envisaged in all the connected factoring agreements enclosed along with the Application. For the sake of clarity, the page No. 123 of instant Application is extracted below: 

 

15. In Paragraph 3 of the Circular, the RBI has recognized three types of factoring services: 

• (i) factoring “without recourse", where banks will have no recourse against the assignor (owner of the receivable), except in the case of misrepresentation or non-performance of obligations by the assignor; 

• (ii) factoring “with recourse”, where the sale of the receivables by the assignor to the banks would not amount to a true sale on the books of the assignor and the assignor would remain liable for any amount not paid by the debtor (the purchaser of goods) to the Bank; and 

• (iii) factoring with “limited recourse”, where the conditions of recourse may be contractually agreed between the bank and the assignor. 

 

# 16. The circular prescribes the prudential norms and exposure norms in relation to the different kinds of factoring in Paragraphs 5 and 6 as extracted hereunder: 

• "5. Classification - Prudential Norms  Factoring would be treated on par with loans and advances and accordingly extant prudential norms on loans and advances would be applicable to this activity. It is further clarified that a receivable acquired under factoring which is not paid within 90 days of the due date should be treated as non-performing asset (NPA) irrespective of when the receivable was acquired by the factor or whether the factoring was carried out on with recourse basis or non-recourse basis. The entity on which the exposure was booked should be shown as NPA and provisioning made accordingly. 

• 6. Exposure Norms-Single and Group Borrower Limits The facilities extended by way of factoring services would be covered within the overall exposure ceiling. The exposure shall be reckoned as under: 

• (a) In case of factoring on with-recourse basis, the exposure would be reckoned on the assignor. ( Emphasis supplied) 

• (b) In case of factoring on without-recourse basis, the exposure would be reckoned on the debtor, irrespective of credit risk cover/protection provided, except in cases of international factoring where the entire credit risk has been assumed by the import factor." 

# 17. The above clarification by the RBI makes it abundantly clear that in the case of factoring "with recourse", the exposure is to be reckoned on the assignor and in the case of factoring "without recourse", the exposure is to be reckoned on the debtor (person liable to pay the receivable). 

# 18. In other words, in a case of factoring with recourse, it is the assignor, who will be the borrower and in cases of factoring without recourse, it will be the debtor (purchaser of invoiced goods or person liable to pay the receivable) who will be the borrower. 

# 19. In the background of the aforesaid guidelines of the RBI, when we refer the definition of Financial Debt in section 5(8) of the Code , more particularly the clause ( e) thereof, it becomes immediately clear that only the factoring transactions in respect of "receivables other than on non recourse basis" are included therein. In other words, factoring transactions on recourse basis only will fall within the mischief of Section 5(8)(e) of the Code. The reason to restrict the mischief of Section 5(8)(e) to debt arising from discounting of bills otherwise than on non-recourse basis only fits perfectly into the concept of Financial Debt under the Code having the two intrinsic ingredients of "disbursal" of funds for "time value of money" which would obtain in the case of an Assignor only. Since the factoring agreement relied upon by the Applicant herein is without a doubt "on recourse basis", the Applicant will be entitled to pursue the instant Application in the case of the Assignor only and following the RBI Circular also it has to reckon the debt in the hands of the Assignor namely M/s P. Praful & Company Agency (India) Pvt. Ltd and not in the hands of the Respondent. In fact the Respondent herein has completely denied the supply and delivery of goods by the assignor by reference to copies of E-way Statements for the relevant period and a Certificate also has been issued by the Deputy Commissioner of the Central Tax Department to that effect that no E way bills were raised by the Assignor for outward supply during the period as claimed by the Applicant and that none of the Invoices match with the data available on E way portal of the said Department. The said letter is extracted hereunder for ready reference: 

 

# 20. Based on these evidences, the Respondent has alleged that fraud was committed by the Client of the Applicant herein in connivance with an unscrupulous staff member in the Respondent Company's Accounts Department. A criminal case has also been filed by the Respondent which is pending against the accused persons. 

# 21. In any case, we have referred earlier to the RBI guidelines which provide for recognizing the debt in the hands of the customer/debtor only if the factoring has been done on non-recourse basis which clearly and admittedly is not the case before us. We also hasten to observe here that even if such an event would have occurred, i.e., the factoring transaction was on "non-recourse" basis, the Factor/ Assignee may have a right to reckon the debt in the hands of the Customer/ debtor and may have legal remedies to recover the debt but will have no eligibility to file an Application U/s 7 of the Code against the Customer/ debtor / purchaser of goods as Section 5(8)(e) shall not be applicable in such factoring "with non-recourse" cases. 

# 22. In the instant case, it is seen that the Applicant/Financial Creditor has nowhere discounted the bills on request of the Corporate Debtor nor has there been any disbursal of funds from the Applicant to the Respondent so as to claim the existence of a financial debt. 

# 23. The terms and conditions in the agreement between the Financial Creditor and M/s P. Praful & Company Agency (India) Pvt. Ltd at pg 1 of instant Application clearly states about the Type of factoring Facility, which clearly shows “Sale Bill Factoring Limit – With Recourse'. 

# 24. Therefore, in view of the above discussion based on the provisions of the Factoring Regulation Act, 2011 and the RBI Guidelines, we are of the considered view that while the Applicant here may have recourse against the assignor namely M/s P. Praful & Company Agency (India) Pvt. Ltd. u/s 7 of the Code, it certainly has no eligibility to file and maintain the instant Application against the respondent herein namely M/s Jaya Laboratories Pvt Ltd. as a Financial Creditor. 

# 25. It is not out of place to mention here that according to the Applicant factor/ financier itself, Corporate Insolvency Resolution Process has already been initiated against the client i.e. M/s P. Praful & Company Agency (India) Pvt. Ltd. vide order of NCLT Ahmedabad bench dated 03.07.2020 and the factor) Applicant had also filed a claim in Form-C on 11.08.2020 before the RP of M/s. P. Praful & Company Agency (India) Private Limited. 

# 26. On a consideration of all the facts and the legal position, we have no doubt in holding that in view of the explicit clause in the factoring agreement entered into between the Applicant/Assignee and the Client/ Assignor in relation to the purchase of debts ON RECOURSE basis, read with the RBI Guidelines discussed supra, there is no jural relationship of creditor and borrower between the Applicant and Respondent. Consequently, the Applicant herein cannot claim to be a Financial Creditor qua the Respondent so as to maintain the instant Application filed u/s 7 of the Code against the Respondent. 

 

# 27. Accordingly, instant Application is dismissed with liberty to the Applicant to seek remedy elsewhere in a manner known to Law. 

# 28. With the above, Company Petition IB/83/2021 stands disposed. No Order as to costs. 

 

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