International Trade Factoring in Russia: Legal Guide

October 31, 2023

BRACE Law Firm ©

Payment is an essential component of interactions between foreign partners, which often occurs with a deferral of payment, while participants require guarantees of receiving funds for supplied goods or rendered services. To provide security for international trade activities, various financial services help participants receive funds immediately, earlier than the contractually established payment deadline.

One such financial service is a factoring agreement, which is a contract whereby, in exchange for the assignment of a monetary claim, one party (the client) undertakes to assign to another party — a financial agent (the factor) — monetary claims against a third party (the debtor) and to pay for the services rendered, while the financial agent (the factor) undertakes to perform at least two of the following actions related to the monetary claims that are the subject of the assignment: [1]

• Transfer funds to the client against the monetary claims, including in the form of a loan or an advance payment;
• Maintain accounting of the client’s monetary claims against third parties (debtors);
• Exercise rights under the client’s monetary claims, including presenting monetary claims to debtors for payment, receiving payments from debtors, and performing settlements related to the monetary claims;
• Exercise rights under agreements securing the performance of the debtors’ obligations.

Factoring allows a party to receive payment immediately after shipping goods or rendering services without waiting for funds from the buyer or customer. Furthermore, the obligations of the financial agent under a factoring agreement may include performing bookkeeping for the client, as well as providing other services to the client related to the monetary claims that are the subject of the assignment.

The parties’ obligations to the debtor under a factoring agreement may be reflected as follows:

• The client undertakes to notify the debtor in writing of the assignment of the monetary claim to the financial agent, defining the monetary claim to be performed and identifying the financial agent to whom the payment must be made;
• The financial agent undertakes to provide the debtor, within a reasonable time, with evidence that the assignment of the monetary claim to the financial agent has actually taken place;
• Upon the financial agent’s demand for payment, the debtor has the right to set off its own monetary claims arising from the contract with the client that the debtor already held by the time it received notice of the assignment of the claim to the financial agent;
• The performance of the monetary claim by the debtor to the financial agent discharges the debtor from the corresponding obligation to the client.

At the same time, the financial agent’s right to the amount received from the debtor is structured as follows:

• Under a factoring agreement, the financial agent acquires the right to all amounts it receives from the debtor in performance of the claim, and the client bears no liability to the financial agent if the amounts received are less than the price for which the financial agent acquired the claim;
• In the event of the client’s failure to perform its obligations under the contract concluded with the debtor, the latter has no right to demand that the financial agent (the factor) return the amounts paid. The debtor may present the corresponding claim to the client.

A distinguishing feature of factoring in international trade is that the seller and buyer are residents of different countries; consequently, international law norms regulating the assignment of monetary claims apply to such legal relationships.

UNIDROIT Convention on International Factoring

The UNIDROIT Convention on International Factoring (the "Factoring Convention") [2] applies to international trade transactions. It entered into force on May 1, 1995. Russia joined this convention via Federal Law No. 86-FZ dated May 5, 2014; however, the document entered into force for Russia on March 1, 2015.

The Factoring Convention regulates relations arising from the use of factoring agreements and the assignment of claims. The Factoring Convention defines a factoring agreement as a contract concluded between a supplier (on one side) and a factor (on the other side), pursuant to which:

1. The supplier may or must assign to the factor monetary claims arising from contracts for the sale of goods between the supplier and its customers (debtors), except for those cases where goods are purchased for personal, family, or household use.
2. The factor must perform at least two of the following functions:

• Financing for the supplier, including loans and advance payments;
• Maintaining accounts related to accounts receivable;
• Collection of accounts receivable;
• Protection against the insolvency of debtors.

3. Debtors must be notified of the assignment of the claim.

The Factoring Convention applies whenever the claims assigned under a factoring agreement arise from a contract for the sale of goods concluded between a supplier and a debtor who are residents of different states, and:

• These states, as well as the state where the factor is located, are Contracting States to the Factoring Convention;
• The contract for the sale of goods and the factoring agreement are governed by the law of a Contracting State to the Factoring Convention.

If a party conducts business in more than one state, its place of business is deemed to be the state that has the closest relationship to the specific contract and its performance, considering the circumstances known to the parties or contemplated by them at any time before or at the time of the conclusion of that contract.

The application of the Factoring Convention may be excluded only in its entirety, and such exclusion may occur in two cases:

• By the parties to the factoring agreement;
• By the parties to the contract for the sale of goods regarding claims arising during or after the factor has received written notice of such exclusion.

The Factoring Convention also provides for the rights and obligations of the parties. For example, a debtor is obligated to pay the factor only if it does not have information regarding the existence of a person with a superior right to receive payment, and if the written notice of assignment:

• Was transferred to the debtor by the supplier or by a factor authorized by the supplier;
• On legal grounds, identifies the assigned claims and the factor to whom or for whose account the debtor must make the payment;
• Relates to claims arising from a contract for the sale of goods concluded before or at the time the notice was provided. [3]

A factoring agreement may validly provide for the transfer, with or without a new act of transfer, of all or any of the supplier's rights arising from the contract for the sale of goods, including an expanded right of ownership in the goods or any security rights. [4]

If the factor presents a claim to the debtor to discharge accounts receivable arising under a contract for the sale of goods, the debtor is entitled to assert against the factor’s claims any defenses that, in accordance with the contract for the sale of goods, it could have asserted against the supplier. [5] The debtor may also assert against the factor any claims for set-off regarding the supplier's monetary claims that the debtor held at the time it received written notice of the assignment in accordance with Article 8(1) of the Factoring Convention. [6]

Without limiting the aforementioned rights of the debtor, the non-performance, defective performance, or late performance of a contract for the sale of goods does not, in itself, entitle the debtor to recover a sum paid to the factor if the debtor has the right to recover this sum from the supplier. A debtor that has the right to recover from the supplier a sum paid to the factor to discharge accounts receivable is entitled to recover such a sum from the factor, provided that:

• The factor failed to perform its obligation to pay the supplier the amount against the assigned claims;
• At the time the factor paid the supplier the specified sum, the factor had knowledge of the non-performance, defective performance, or late performance of the contract for the sale of goods against which the debtor made the payment.

At the same time, in accordance with Article 833 of the Civil Code, if the client fails to perform its obligations under a contract concluded with the debtor, the latter has no right to demand that the financial agent (the factor) return the amounts paid. The debtor may present the corresponding claim to the client.

Compliance with Currency Legislation in International Factoring

When concluding a factoring agreement, it is important to pay attention to compliance with currency legislation. Thus, the obligations established by Article 19(1) of Federal Law No. 173-FZ dated December 10, 2003, On Currency Regulation and Currency Control (the "Law No. 173-FZ" or the "Law on Currency Regulation") remain with the supplier, specifically the resident’s duty to ensure the receipt of foreign currency or Russian rubles due under a foreign trade contract from a non-resident. Furthermore, if the financial agent is an authorized bank, the foreign currency or Russian rubles must be credited to its correspondent account. However, if the financial agent is not an authorized bank, the foreign currency or Russian rubles must be credited to the financial agent’s (factor's) bank account at an authorized bank. [7] Additionally, a set-off of mutual claims in factoring is possible if it relates to the performance of transactions specified in Article 19(2) of the Law on Currency Regulation, or if the parties to the factoring agreement are residents of Contracting States to the Factoring Convention.

In addition to complying with the Law on Currency Regulation, when concluding a factoring agreement, it is also necessary to comply with the requirements established by Bank of Russia Instruction No. 181-I dated August 16, 2017, On the Procedure for Residents and Non-residents to Submit Supporting Documents and Information to Authorized Banks When Conducting Currency Operations, on Unified Forms of Accounting and Reporting for Currency Operations, and the Procedure and Deadlines for Their Submission (the "Instruction No. 181-I"). If a resident that has registered a contract with an authorized bank (the "Bank UK") assigns to a financial agent (factor) that is a resident (as specified in Article 19(5) of Law No. 173-FZ) a monetary claim for foreign currency or Russian rubles due to the resident under the corresponding contract as payment for goods transferred to a non-resident, work performed for it, services rendered to it, or information and intellectual property results (including exclusive rights thereto) transferred to it, the resident that registered the contract must submit to the Bank UK the information on the unique contract number under which settlements are performed, as well as the financing agreement against the assignment of a monetary claim (factoring) and/or the subsequent assignment agreement, within the following deadlines:

• Upon receipt of foreign currency from a resident financial agent (factor) into its account opened at the Bank UK — no later than 15 business days after the date the foreign currency is credited to the account of the resident that registered the contract;
• Upon receipt of Russian rubles from a resident financial agent (factor) into its settlement account in Russian rubles opened at the Bank UK — no later than 15 business days after the date the Russian rubles are credited, as specified in the account statement of the resident that registered the contract or in another document provided by the Bank UK to the resident that registered the contract containing information on the credit of Russian rubles received from the resident financial agent (factor) to its settlement account.

If funds from a resident financial agent (factor) are credited to an account of the resident that registered the contract opened at an authorized bank other than the Bank UK, the resident that registered the contract must submit the documents and information specified in Instruction No. 181-I to that authorized bank within the established deadlines. In this case, no later than 2 business days after the date the resident that registered the contract submits the specified documents and information, the authorized bank other than the Bank UK must transfer to the specified resident, in the manner determined by the authorized bank, the authorized bank’s details regarding the conducted operation, including the unique contract (loan agreement) number, upon the credit of the specified funds to its account opened at that bank.

The resident that registered the contract must submit the authorized bank’s details regarding the conducted operation, including the unique contract (loan agreement) number, to the Bank UK no later than 30 business days after the date the funds from the resident financial agent (factor) were credited to the account of the resident that registered the contract opened at an authorized bank other than the Bank UK.

If the Bank UK is simultaneously the financial agent (factor), the Bank UK independently records information on its credit of foreign currency or Russian rubles to the account of the resident that registered the contract under a financing agreement against the assignment of a monetary claim (factoring) and/or a subsequent assignment agreement into Section II of the bank control statement, without the resident that registered the contract needing to submit the documents and information specified in the first paragraph of this clause.

Upon the credit of funds from a non-resident to a resident financial agent (factor) that is not the Bank UK toward the performance of obligations provided for by the contract, the resident financial agent (factor) to whom the monetary claim was assigned (including as a result of a subsequent assignment) must submit the documents and information listed in Instruction No. 181-I to the authorized bank where the specified funds were credited.

At the same time, the resident financial agent (factor) submits the specified documents and information to the authorized bank within a period no later than 15 business days after the date the funds are credited to the resident financial agent’s (factor's) account at the authorized bank. In this case, the authorized bank must, no later than 2 business days after the date the documents and information are submitted, transfer to the resident financial agent (factor), in the manner determined by the authorized bank, the authorized bank’s details regarding the conducted operation, including the unique contract (loan agreement) number.

No later than 30 business days after the date the funds from the non-resident were credited to the resident financial agent (factor) that is not the Bank UK toward the performance of obligations provided for by the contract, the resident that registered the contract must submit the following to the Bank UK:

• The authorized bank’s details regarding the conducted operation, including the unique contract (loan agreement) number for the specified operation, received from the resident financial agent (factor) in the manner determined by those residents;
• The financing agreement against the assignment of a monetary claim (factoring) and/or the subsequent assignment agreement.

Taxation in Factoring

Taxation is also an important aspect of a factoring agreement, during the signing of which a list of assigned monetary claims is compiled. A key factor in this case is the date the right of claim is transferred, upon which the timing of an event depends. For example, if the date the list of claims is signed and the payment date fall in different tax periods, the tax authorities may raise claims regarding the unreliability of accounting data and the understatement of revenue. To reduce tax risks, in addition to the lists of assigned claims (on the date the agreement is signed), deeds of assignment of monetary claims may be executed (on the date each specific monetary claim is transferred).

At the same time, in its Letter No. 03-08-05/506 dated January 11, 2019, regarding the application of value-added tax [8] to services for financing against the assignment of a monetary claim, the Ministry of Finance of Russia expressed the position that the territory of the Russian Federation is recognized as the place of supply of services if the activity of the organization providing the services is carried out on the territory of the Russian Federation. In this regard, the territory of the Russian Federation is recognized as the place of an organization's business activities if the organization is present on the territory of the Russian Federation based on state registration, or — in its absence — based on the place specified in the organization’s constituent documents, the place of management, the location of the organization’s permanent executive body, or the location of a permanent establishment in the Russian Federation (if the services are rendered through that permanent establishment). Furthermore, the territory of the Russian Federation is not recognized as the place of supply of services rendered to a Russian organization by a foreign organization that does not conduct business on the territory of the Russian Federation, and such services are not subject to value-added tax in the Russian Federation.

Court Disputes in Factoring under International Transactions

Court disputes in factoring arise on various grounds; some examples are provided below:

• A commission fee is not a mandatory condition of a factoring agreement; [9]
• A financial agent is not entitled to recover a penalty from the debtor that is payable under the contract between the debtor and the client unless otherwise specified in the notice of assignment of the monetary claim; [10]
• The liability of the client and the debtor is joint and several if, under the terms of the factoring agreement, the client is liable to the factor for the debtor’s improper performance of the monetary claims assigned to the factor, unless the agreement provides otherwise. [11]

The development of the financial services market in the area of supporting international trade transactions leads to various types of disputes related to the provision of such services. However, the study and application of current regulations, both national and international, allow for a reduction in the number of contentious issues in interactions between foreign partners.

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References

1. Clause 1 of Article 824 of the Civil Code.
2. The Convention was adopted in Ottawa on May 28, 1988.
3. Article 8(1) of the UNIDROIT Convention on International Factoring.
4. Article 7 of the UNIDROIT Convention on International Factoring.
5. Resolution of the Arbitration Court of the Ural District dated December 9, 2016, No. F09-11318/16 in Case No. A60-1368/2016. The claim sought to recover debts under supply contracts and, under the factoring agreement, commissions for factoring services and penalties. During the case review, it was established that the delivery was not confirmed; therefore, the court denied the first claim. Given that financing was provided to the client, the second claim was granted due to the lack of evidence of the return of the disputed amount.
6. Article 9 of the UNIDROIT Convention on International Factoring.
7. Article 19(5) of Law No. 173-FZ.
8. Resolution of the Federal Arbitration Court of the Volga-Vyatka District dated May 24, 2006, in Case No. A82-16240/2005-14. The court did not recognize the taxpayer’s conclusion of a factoring agreement before the payment deadlines under the disputed sales contracts or the related expenses as either economically justified or incurred for business activities aimed at generating income; therefore, the disputed expenses do not reduce taxable profit. The disputed expenses also do not grant the right to a value-added tax deduction.
9. Resolution of the Federal Arbitration Court of the East Siberian District dated August 11, 2006, No. A19-20812/05-20-F02-3867/06-S1 in Case No. A19-20812/05-20. The case files show that the consideration provided to the client for the assigned right of claim is the financing by the financial agent under the factoring agreement. Civil legislation norms do not provide for the client’s duty to pay a commission fee to the financial agent. On this basis, the society's expenses for payments to the bank were accepted by the Authority only in the part constituting the limit for interest expenses on debt obligations to banks.
10. Resolution of the Arbitration Court of the North-Western District dated September 10, 2015, No. F07-5315/2015, F07-6043/2015 in Case No. A56-73205/2014. In its claim, the financial agent cited the buyer's failure to fully pay for the delivered goods. Since no legal assessment was provided during the case review as to whether the factoring agreement’s subject matter included monetary claims for penalties for late payments under supply contracts, the case was remanded for a new hearing.
11. Resolution of the Arbitration Court of the Far Eastern District dated August 24, 2015, No. F03-3638/2014 in Case No. A51-11662/2014. The statement of claim requested the joint and several recovery of a debt for the commission of a factoring service agreement for supplies. Given that the client is not liable for the debtor’s failure to perform or improper performance of the claim that is the subject of the assignment when it is presented for performance by the financial agent, unless otherwise provided for by the agreement between the client and the financial agent, and because the fact of the defendants’ improper performance of obligations to transfer funds for product payment was confirmed, the claim was granted by the court.