Factoring without Recourse

Factoring without recourse (also called non-recourse factoring) is the sale of trade invoices to a factor that agrees to bear the loss if an approved customer cannot pay because of insolvency or, in many contracts, prolonged default. The seller receives cash early and, within the agreed limits, no longer carries the bad-debt risk on those invoices. Exporters and companies selling to a concentrated group of buyers use it to protect their cash flow and tidy their balance sheets.

It differs from factoring with recourse, where the seller must repay the factor for unpaid invoices. The protection is narrower than many sellers assume: it covers the buyer's inability to pay, not disputes over the goods. Cross-border deals usually follow the General Rules for International Factoring published by FCI, the industry association, and some countries apply the 1988 UNIDROIT Convention on International Factoring.

Think of it as selling an IOU outright. You hand a customer's invoice to a buyer who pays you most of it now and takes over the job of collecting. If that customer goes bust, it is the buyer's problem, not yours. You have swapped an uncertain future payment for certain cash today, and paid a fee for the peace of mind.

There is fine print. The buyer of your invoices only takes on customers it has checked and approved, and only up to a set amount for each. If your customer refuses to pay because the goods arrived broken or late, that is still your argument to settle. The protection is against a customer who cannot pay, not one who says they should not have to.

The factor's promise is limited by three features of the contract. First, it sets a credit limit for each debtor; invoices above the limit are financed, if at all, with recourse. Second, it defines the covered events, usually legal insolvency and "protracted default", meaning non-payment for a set number of days after the due date without a dispute. Third, it excludes commercial disputes. If the debtor claims the goods were faulty, the factor can reassign the invoice to the seller until the dispute is resolved.

• Covered. Debtor insolvency, administration or bankruptcy, and protracted default within the approved limit.
• Not covered. Quality complaints, short delivery, credit notes, set-off claims and fraud by the seller, such as invoicing for goods never shipped.
• Sometimes covered. Political or transfer risk on export debtors, depending on the factor and any insurance behind it.

Because the factor carries the default risk, it adds a credit protection fee to the usual discount and service charges. The total cost of one invoice can be written as:

Here $F$ is the invoice value, $A$ the advance rate, $r$ the annual discount rate, $d$ the days to payment, $s$ the service fee rate and $p$ the credit protection fee rate. On a 200,000 invoice with a 90 percent advance, an 11 percent rate, 60 days, a 0.8 percent service fee and a 0.5 percent protection fee, the discount charge is about 3,255, the service fee 1,600 and the protection fee 1,000, for a total cost of about 5,855, or roughly 2.9 percent of face value.

Factors manage their exposure by assessing each debtor's credit rating and payment history, by spreading limits across many buyers and, very often, by buying trade credit insurance themselves. For overseas buyers the factor may lean on export credit insurance or an export credit agency.

In cross-border deals a two-factor system is common. The export factor in the seller's country buys the invoices and finances the seller. It passes the credit risk and collection to an import factor in the buyer's country, which knows local law, language and payment habits and guarantees payment by approved debtors. Both factors are usually FCI members bound by its rules on assignment, approvals, dispute handling and payment of funds between them. This offers an alternative to a letter of credit for sellers trading on open account, though it covers only credit risk and not documentary compliance.

A properly structured non-recourse sale can achieve derecognition of the receivables under IFRS 9, because substantially all the credit risk passes to the factor, which lowers reported debt and days sales outstanding. Auditors look closely at any residual exposure, such as dilution reserves or deferred purchase prices, which can keep part of the asset on the books. Legally the deal must be a true sale of the receivables, documented in a receivables purchase agreement, so that the invoices sit outside the seller's estate if the seller itself fails. It is close in spirit to forfaiting, which buys longer-dated trade paper without recourse, but factoring deals in many short invoices rather than single bills or notes.

• FCI (global factoring association)
• UNIDROIT