Factoring

Factoring (팩토링, 채권매입업/債權買入業) is a financial transaction whereby a merchant assigns its accounts receivable (i.e., invoices) to a factor at a discount, and the factor collects the accounts receivable on the installment plan from the customer.

Factoring differs from a bank loan in several ways. The emphasis is on the value of the receivables (essentially a financial asset), whereas a bank focuses more on the value of the borrower's total assets, such as inventory, equipment and real property. Secondly, factoring is not a loan – it is the purchase of receivables. Third, a non-recourse factor assumes the "credit risk", that a purchased account will not collect due solely to the financial inability of account debtor to pay. In the United States, if the factor does not assume credit risk on the purchased accounts, in most cases a court will recharacterize the transaction as a secured loan.

In Korea, factoring with recourse is preferred to factoring without recourse because factors hesitate to assume the credit risk of customers. Accordingly, the factor may claim the amount of unpaid receivables from its client.

It is different from forfaiting in the sense that forfaiting is a transaction-based operation involving exporters in which the firm sells one of its transactions, while factoring is a financial transaction that involves the sale of receivables.

Key words
factoring, factor, account receivable, with recourse, without recourse, non-recourse, forfaiting

Provisions of the Commercial Act
The amendment to the Commercial Act in 1995 included factoring as one of the basic commercial activities together with financial lease and franchise. It was because factoring was increasingly used by financial companies for their clients ever since its introduction to Korea in the 1980s.

At first, only a few provisions of the Commercial Act and the Non-Bank Banking Act regulate such commercial transactions. In this connection, a paper was presented at a seminar explaining who and how factoring is conducted, how factoring is possibly evolved in the future, and what legally matters with factoring in Korea.

Article 46 (Basic Commercial Activities) of the Commercial Act provides:
 * The following activities which are effected as business are called "basic commercial activities"; provided, however, that this shall not apply to such activities as performed for the purpose of earning wages: 
 * 1-20. Omitted
 * 21. Act concerning purchase, recovery, etc. of any business claims

Chapter 14 Factoring Article 168-11 (Definition of Factor)
 * A person who is doing business by purchasing and collecting accounts receivable which other person has required or will required through the sales of goods or securities, provision of services, etc. (hereinafter referred to as "business claims" in this Chapter) shall be called the factor. 

Article 168-12 (Factor's Recourse)
 * In case that the obligor of business claims fails to perform its obligation, the factor may claim the obligor, pursuant to the factoring agreement, the amount of such business claims; provided, however, that this shall not apply where the said factoring agreement has otherwise provided. 

In the United States
It should be noted that factoring has been very useful in the United States, where the merchants issue checks for the payment of commercial transactions and don't know the discount of promissory notes. Factoring without recourse is prevailing in the United States while Korean factors prefer factoring with recourse because they have little information about the financial status of customers.

Legal Implications
In short, factoring is being utilized as a tool of asset-based financing as well as custom-made financial innovation. Therefore, sufficient statutory provisions will be necessary so that small-sized enterprises with plenty of accounts receivable may properly cash in on them.

In principle, the factors can secure the priority of their claims assigned through factoring by notification to the customers or customers' acceptance of such assignment. For the purpose of perfection, the electronic filing could be most effective.

It might be reasonable to regulate factoring within the scope of secured transactions as in the U.S. UCC Article 9. In this regard, the Act on Security Interests in Movable Properties, Receivables, etc. (동산 및 채권 등의 담보에 관한 법률, the "Act"), which came into force on June 12, 2012, is expected to enlarge the factoring transactions, because account receivables are assigned like collateral on the basis of eletronic registration.

Accordingly, when a factor is assigned account receivables on the basis of eletronic registration, it has secured the right on te relevant account receivables not as perfection but as effective claim. As far as electronic filing is employed for the transactions, the e-registry will be accessible by the interested parties via the Internet. In this connection, the factors will be safeguarded from the risk of contingent encumbrance levied by unknown creditors.