54 3 Reduction of External Funding Needs
the receivables are assigned to the factor, the factor has the right to proceed di-
rectly in its own name against the debtors.^124
The factor needs to mitigate the risk that the client firm only sells bad debts (for
ways to rise above the “market for lemons”, see Volume I). The factor often pre-
fers to conclude a master agreement, according to which the client firm will sell
all receivables that meet certain criteria and that the factor will manage the receiv-
ables that have been assigned to it. The factor can further mitigate the risk of bad
debts by choosing recourse factoring. On the other hand, recourse factoring can
increase other legal risks.
In Germany, recourse factoring (also called “unechtes Factoring”, “not genuine factoring”)
means a loan agreement between the factor and the customer firm complemented by a col-
lection service and the assignment of receivables by way of security.
In the master agreement, the parties agree, for example: that the firm is responsi-
ble for the existence (in Latin: veritas) of the receivables that it sells to the factor;
on price and other limits regarding the underlying customer contracts; on distribu-
tion of risk in the case of default by the firm’s customers (recourse or non-
recourse); on fees; on the duty of the firm to assign all receivables that meet the
agreed criteria; and on global assignment to the factor of all receivables that meet
the agreed criteria.
Factoring builds on the basic legal principles for transferring receivables:^125 (1)
Receivables can be assigned, if the assignor (the client firm) and the assignee (the
factor) agree on the assignment, provided that the assignment of the debt is not
prohibited according to its terms. (2) If the debtor (the firm’s customer) and the
firm have agreed or the law says that the debt cannot be assigned without the con-
sent of the debtor or otherwise, the assignment is not effective in relation to the
debtor. (3) Usually, the law does not prevent the assignment of trade debts. (4)
Usually, receivables may be assigned without the consent of the debtor, unless the
assignment is prohibited by law, contractual non-assignment clauses, or the nature
of the receivable. If there is a contractual prohibition on assignment, the sale of re-
ceivables is ineffective against the debtor, but the contractual undertaking of the
seller to assign the receivables to the purchased pursuant to the sale agreement can
be valid and effective as between the seller and the purchaser. Since the sale can-
not be completed if the receivable contract prohibits the assignment, the seller will
be liable to the purchaser for damages incurred by the purchaser due to the breach
of non-performance of its obligations under the sale agreement. (5) The assignee
(the factor) cannot rely on the assignment of the debt in relation to the debtor (the
client firm’s customer), the assignor’s creditors (the client firm’s creditors) and
other third parties, unless the debtor (the client firm’s customer) is notified of the
assignment. (6) It is therefore legally important to notify the client firm’s custom-
ers of the assignment.
(^124) See, for example, § 398 BGB: “Eine Forderung kann von dem Gläubiger durch Vertrag
mit einem anderen auf diesen übertragen werden (Abtretung). Mit dem Abschluss des
Vertrags tritt der neue Gläubiger an die Stelle des bisherigen Gläubigers.”
(^125) See, for example, Cranston R, op cit, p 355.