Factoring in the context of existing financing structures

Receivables Financing in Context

Receivables financing encompasses a range of transactions in which a company sells or otherwise transfers trade receivables to raise liquidity. Factoring and invoice discounting are commonly used by small and medium-sized businesses, while securitisation, which requires larger, more homogeneous receivable pools and a bankruptcy-remote special purpose vehicle, is generally employed by larger corporates.

Despite these structural differences, all forms of receivables financing give rise to similar legal considerations, including the transfer of receivables, perfection, the allocation of credit risk, and the interaction with other creditors’ rights. These considerations are relevant whether the arrangement is documented as an outright sale or as a security assignment.

Receivables financing is frequently implemented alongside, rather than in place of, existing bank loans, bond financing, and security packages. Consequently, companies seeking to enter into receivables financing must carefully evaluate the legal issues that arise when receivables are sold within a contractual and security framework already shaped by other lenders and creditors.

Purpose and Basic Recourse or Non-Recourse Structure of Factoring

The commercial purpose of factoring is to improve liquidity by converting trade receivables into immediate cash. After a seller has delivered goods or services and issued an invoice to its customer, the resulting receivable can be transferred to a factoring company, which advances a discounted amount to the seller. Although receivables can also be pledged as security for a loan from the factor, this article focuses on transfers structured as sales.

Factoring may be conducted on either a recourse or a non-recourse basis. Under a recourse structure, the seller retains the credit risk, typically through an obligation to repurchase receivables that remain unpaid. Non-recourse factoring shifts the credit risk to the factor. The allocation of credit risk is significant not only for pricing but also for the legal characterisation of the transaction, including whether it may constitute financial indebtedness under a borrower’s existing financing arrangements.

Perfection of Transfers under Swedish Law

A central issue in receivables financing is whether the transfer has been perfected. Under Swedish law, a transfer of receivables is generally perfected, and thus becomes effective against third-party creditors and the seller’s insolvency estate, only when the underlying debtor has been notified of the transfer and the seller is deprived of control over the receivable.

If perfection is not achieved, the debtor may discharge its obligation by paying the seller, notwithstanding the attempted transfer, and the receivables will generally form part of the seller’s bankruptcy estate. Moreover, an unperfected transfer exposes the factor to the risk that the same receivable could be transferred a second time, with priority going to a subsequent purchaser who perfects the transfer in good faith.

In practice, several features of factoring complicate the perfection analysis. The required specification of receivables, the timing of notification, treatment of future receivables, contractual restrictions on transfer, set-off rights, the seller’s ability to issue credit notes, co-mingling of collections and servicing arrangements can all affect whether perfection has in fact been achieved. Perfection may also depend on foreign law aspects in cross-border structures.

True Sale Considerations

Although Swedish law does not use the term “true sale”, as it is considered an accounting concept, Swedish legal literature recognises that a transaction described as a sale may be re-characterised as a security arrangement where the substance of the transaction indicates that ownership has not in reality passed to the purchaser. Indicators of a security purpose include a right for the seller to require the return of the receivables and the seller’s retention of the credit risk.

The consequences of such re-characterisation are less dramatic in Sweden, where both sale and pledge transactions require the same perfection measure (i.e. notification), than in jurisdictions where the creation of security interests requires registration or other formalities. Nevertheless, re-characterisation may have significant implications. The receivables could be regarded as part of the seller’s bankruptcy estate, subject to a security interest in favour of the factor, and rules governing the enforcement and custody of security may apply. The legal assessment of whether a transfer should be regarded as a sale is therefore relevant not only from an accounting perspective but also in assessing the rights and expectations of other creditors.

Interaction with Other Financing Arrangements

Financial Indebtedness Considerations

Companies that enter into factoring arrangements often have existing bank or bond financing that restricts additional borrowings through a definition of “Financial Indebtedness”. Under LMA-based loan documentation and the standard terms of bonds published by the Swedish Securities Markets Association, receivables sold on a non-recourse basis (and, where relevant, derecognised in accordance with applicable accounting principles) are generally carved out of the definition of Financial Indebtedness. Non-recourse factoring therefore typically does not count as incurring new debt.

By contrast, recourse arrangements in which the seller retains the credit risk or bears a repurchase obligation may fall within the definition of Financial Indebtedness and may consequently require consent or fall within permitted debt baskets.

Negative Pledges and Restrictions on Disposals

Even where factoring does not constitute Financial Indebtedness, it may still be restricted by negative pledge clauses or asset disposal covenants. From a legal perspective, a sale of receivables is a disposal of assets, and factoring structures frequently involve the granting of security interests over both purchased and non-purchased receivables. Many financing agreements prohibit disposals of material assets and prohibit granting security in favour of third parties.

The seller must therefore consider whether an intended factoring transaction is permitted under its existing financing documents or whether waivers or amendments are required.

Existence of Prior Transfer or Security Arrangements

Another point to consider is whether the factoring receivables have been pledged or transferred to a third party under any separate, previous arrangements. Where receivables have been pledged or transferred in favour of a third party and that pledge/transfer has been duly and fully perfected, any subsequent transfer of the same receivables will in general be made subject to the earlier pledge/transfer (chapter 3, clause 31 of the Promissory Notes Act 1936:81 (Sw. Lag (1936:81) om skuldebrev)). In the event of the seller’s insolvency, the prior pledgee/transferee will therefore have priority to the proceeds of such receivables, and the factor will only receive what remains after the secured creditor/previous transferee has been satisfied. A transfer in these circumstances may also constitute a breach of the seller’s existing financing arrangements. For this reason, factoring agreements routinely include eligibility criteria requiring that any receivable transferred to the factor must not be subject to any pledge or other third-party right.

Receivables evidenced by negotiable instruments (Sw. löpande skuldebrev) are commonly excluded from the eligibility criteria for similar reasons. The legal transfer of such receivables requires physical delivery of the instrument to the transferee. Factoring arrangements, by contrast, assume that receivables exist as ordinary book debts, capable of being identified in schedules or electronic ledgers and transferred without the handling or physical delivery of instruments. The operational structure of factoring is therefore generally incompatible with the formal requirements that attach to negotiable instruments.

If, despite these eligibility criteria, a receivable is transferred that is in fact encumbered or otherwise ineligible, the factor is typically afforded a contractual right to require the seller to repurchase the receivable. Such repurchase rights, when limited to breaches of representations or eligibility criteria and not extending to the general credit risk of the underlying debtor, are generally not believed to alter the classification of the factoring arrangement as a non-recourse transfer or its treatment under true sale analysis.

Floating Charges

A further layer of complexity arises where the seller has registered and pledged a floating charge (Sw. företagshypotek). Under Swedish law, a floating charge covers all movable assets used in the business, except cash, bank accounts, financial instruments, assets that can be mortgaged, and assets that are neither subject to attachment nor included in a bankruptcy estate. Trade receivables therefore fall within the scope of a floating charge. Although a Swedish floating charge does not prevent the seller from disposing of assets in the ordinary course of business, the security agreement may contain contractual restrictions on transfers of assets subject to the charge or on the granting of security over them. These provisions should be reviewed before entering into a factoring arrangement, and in some cases a waiver from the holder of the floating charge may be needed.

The status of perfection is particularly important in this context. If the factoring arrangement is left unperfected, the receivables will form part of the seller’s insolvency estate, and the holder of the floating charge will have priority over the factor.

In practice, if the seller has registered floating charges in its business, in order to avoid misrepresentation due to a breach of eligibility criteria, it may be advisable to clarify in the relevant factoring agreement that any security over the trade receivables based on a floating charge is permitted. To the extent the factoring is carried out on an unperfected basis, the factor should acknowledge and reflect on the risks that follow from the existence of a floating charge.

Concluding Remarks

Factoring can be an effective means of improving liquidity, but its legal implications cannot be assessed in isolation from a company’s wider financing arrangements. Issues such as perfection, the allocation of credit risk, and true sale considerations all have a direct impact on the effectiveness of the transfer and the rights of the parties. Equally, the implications of factoring under existing loan and bond documentation, including restrictions on financial indebtedness, asset disposals, security and the presence of floating charges, must be analysed with care.

A coherent review of these elements is essential to ensure that a factoring structure is enforceable as intended, aligns with existing contractual obligations and does not inadvertently trigger covenant breaches or undermine other creditors’ expectations. When approached with a proper understanding of its interaction with the broader financing framework, factoring can operate smoothly alongside traditional debt financing and contribute meaningfully to a company’s liquidity management.