# **Factoring From A Global Perspective**

rights should minimize the threat of competing interests from other creditors. Still, a weak rule of law will make a factor’s collection activities more costly and less efficient. It will also decrease the value of the factor’s recourse against its customers when it engages in recourse factoring and when it takes a security interest in its customer’s assets as a secondary source of repayment.

As noted, factoring is the world’s dominant form of asset-based finance, and there are no significant amounts of asset-based lending except in Australia, Canada, the United Kingdom, and the United States. Although it is difficult to draw strong conclusions from the data, these four countries score extremely high on the rule of law measures—while many countries where factoring is widespread (such as Greece and Italy) score much lower. On the other hand, there are countries with a strong rule of law that have significant amounts of factoring, the most notable of which is the United Kingdom. Other examples include Austria, Denmark and the Netherlands. This suggests that variables other than a weak rule of law may be important in driving factoring. One may be how well commercial law works; another may be how security interests are treated in commercial law.

A financial system’s commercial law and the level of its enforcement help determine the environment in which financial contracting occurs. Commercial law specifies the property rights associated with a commercial transaction, and enforcement of these rights determines the confidence of contracting parties in financial contracts. Together these two features constitute the rule of law. At one extreme are countries where commercial law is unambiguous and conducive to commercial transactions and where enforcement is predictable. At the other extreme are countries where commercial law is ambiguous and incomplete, enforcement is problematic, and criminal and racketeering behavior block the creation of new businesses, undermine existing ones, and deter foreign investment (EBRD Transition Report 2003a, p. 24).

In terms of security interests—that is, collateral liens—a country’s commercial law should clearly define how a collateral lien can be perfected, how collateral priority is determined, and how notification of a lien is made. Rules on security interests likely affect the efficacy of all non-factoring lending technologies because collateral can be used in conjunction with each of them. But even in a factoring relationship, a factor may take a collateral interest in the non-receivables of a client firm as a secondary source of repayment.

Still, a country’s commercial law on security interests likely has the biggest impact on asset-based lending, because collateral is the primary source of repayment under such lending. Australia, Canada, the United Kingdom, and the United States have well-defined and strongly enforced laws on security interests, which partly explains why asset-based lending exists in these countries but not elsewhere. Such laws give asset-based lenders confidence that they will have the right to liquidate their collateral or receive comparable value in case of bankruptcy.<sup>22</sup> (See Udell forthcoming for a detailed discussion of U.S. law and Clark 1999 for a discussion of Canadian law.) The third column of Table 2B presents data on the strength of creditor rights, from La Porta and others (1998). This composite index ranges from 0 to 4, with 4 reflecting the strongest rights. The index is constructed by adding a “1” for every one of the following conditions: if secured creditors have priority over others, if there are restrictions on management’s right to file for reorganization, if there is no automatic stay, and if management is forced out in bankruptcy. An automatic stay involves

> 22 There has been an attempt to encourage the adoption of a standard set of laws on security interests on a global basis. In December 2001 the United Nations, under its United Nations Commission on International Trade Law (UNCITRAL) initiative, approved a template for security interests in accounts receivable. It is also working on a template for security interests in other assets. The main goal of these initiatives is to promote cross-border lending. Arguably, an important byproduct of global adoption of these templates would be an improvement in creditor rights worldwide. At this stage, however, it is not clear whether a meaningful number of countries will adopt these templates.

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**THE WORLD BANK**