3.4 Management of Working Capital 51For example, Anglo-American law restricts the use of “penalty clauses”. Anglo-American
law will strike down a stipulated payment as a penalty, where it is extravagant or uncon-
scionable in relation to the other party's greater loss, or where it is not a genuine pre-
estimate of that loss. Default interest clauses have been treated as penalties when the higher
rate is payable for both the interest period and the period of default from the due date. On
the other hand, many default interest clauses are not prohibited. There is no penalty if the
clause provides for a reduction of interest on punctual payment. There is no objection if the
default rate is modest and is confined simply to the period from the due date (the increased
rate payable by the debtor is justified because, being in default, the debtor is now a worse
credit risk).^114
Community law. In the EU, the Late Payment Directive^115 prohibits the use of abu-
sive contract terms on interest (see section 3.4.2 above). Article 3(1) sets out the
main rules on the duty to pay interest for late payment. Article 3(3) restricts the
use of contract terms that are not in line with those provisions.
Factoring
After doing what it can to reduce accounts receivable, the firm can reduce its
working capital further by introducing factoring. Legally, factoring means that the
firm’s trade debts are bought by a factor. Ownership of those debts is transferred
to the factor by way of an assignment (for the assignment of claims, see Volume
II).
Major banks usually have subsidiaries involved in factoring business debts. Fi-
nancially, factoring is a form of accounts receivable financing. Factoring compa-
nies also provide a wide range of other factoring services.
Functions of factoring. Factoring may therefore have different functions (fi-
nance, del credere, services). The factor may merely provide a service of collect-
ing the debts, or it may advance money to its client in advance of the debts being
collected.^116 In addition, there are different forms of factoring (recourse factoring
or non-recourse factoring, full factoring or confidential invoice discounting).
Finance function. Factoring affords the firm the opportunity to sell its trade
debts at a discount to factors or to use them as a security (finance function). This
will improve cash-flow.
The firm will obtain funds faster, because the firm is no longer dependent on
the conversion of accounts receivable to cash from the actual payment from their
customers, which takes place on, say, 30 to 90 day terms.
The factor will offer the firm a cash percentage of the face value of the receiv-
ables. For example, factors might advance up to 80% of invoice value.^117
(^114) Cranston R, Principles of Banking Law. Second Edition. OUP, Oxford (2002) pp 310–
311.
(^115) Directive 2000/35/EC (Late Payment Directive).
(^116) The Law Commission, Registration of Security Interests, paragraph 6.26.
(^117) See Finch V, Corporate Insolvency Law. Perspectives and Principles. Cam U P, Cam-
bridge (2002) pp 112–113, citing a Bank of England study from 1998.