A special chapter of book three, “Contracts” of the Civil Code, provides explicit stipulations on factoring contracts, upgrading them to the category of nominate contracts. Most factoring business in China is factoring with recourse.
According to article 766 of the Civil Code, a factor with recourse may claim the return of the principal and interest of factored financing from the creditor or the repurchase of the creditor’s right of accounts receivable, or claim the right of accounts receivable from the debtor. Therefore, a factor enjoys the recourse, repurchase/reassignment right and the claim right. So how can they exercise the three rights? And can they co-exist?
Factoring with recourse
Factoring with recourse is where a factor may request the creditor to repurchase all or part of the assigned accounts receivable, return the paid consideration and the principal of the advance payment, and pay the interest and related expenses, concerning three parties, namely the factor, the creditor of accounts receivable and the debtor of accounts receivable.
Factor’s recourse refers to a factor’s right to recover the outstanding financing amount from the creditor when the debtor fails to pay the receivables due. Factor’s repurchase right/reassignment right refers to the factor’s right to ask the creditor to repurchase the assigned accounts receivable or reassign the accounts receivable to the creditor.
Factor’s claim right refers to a factor’s right to ask the debtor to pay the accounts receivable due.
When a factor exercises the repurchase/reassignment right, the creditor repurchases the assigned creditor’s right of accounts receivable or the factor assigns it to the creditor, by which the relevant right of accounts receivable is assigned back to the creditor. Essentially, this terminates the factoring contract, and the factor no longer has the right to claim against the debtor.
For example, in the Supreme Court Civil Retrial No. 164 (2017) case, the court held that when the factor reassigned the creditor’s right to the creditor without violating the provision of the factoring contract, it should no longer hold the creditor’s status against the debtor in the underlying transaction after the termination of the assignment contract of creditor’s rights, and the basis of factor’s right to request the debtor to pay off the debt should no longer exist. Therefore, the reassignment right and the claim right should not coexist.
In the Supreme Court Civil Appeal No. 132 (2017), the court held that when the factor filed a separate lawsuit to request the creditor to repurchase the creditor’s account receivable rights and won the lawsuit, it should no longer have the right to request the debtor to pay off the receivables.
Recourse and claim right
As for whether a factor can claim the recourse and claim right at the same time, it is generally believed, before the creditor’s right is paid off, the factor with recourse can claim compensation from the debtor and the creditor at the same time.
In Supreme Court Civil Appeal No. 1222 (2017), the court held that the factor with recourse could claim the rights against both the creditor and the debtor under the receivable amount in the same case when the creditor’s right was not paid off. In Supreme Court Civil Appeal No. 1518 (2019), the court held that the legal nature of the assignment contract of creditor’s rights contained in the factoring with recourse should be regarded as the indirect performance contract with the function of guaranteeing the performance of the debt, and it had no effect of eliminating the original debt.
Only when the new debt was performed and the original creditor’s rights were realised, could the original debt be eliminated. Accordingly, if the creditor’s right of the factor has not been paid off, the factor has the right to request the debtor to pay off the debt and, at the same time, to seek recourse against the creditor.
In terms of the order of liability, in the event that a factor sues the creditor and debtor at the same time, the following distinctions shall be made:
. If the factoring contract explicitly stipulates that the creditor and debtor shall assume joint and several liability, it shall be dealt with in accordance with the contract. In the first factoring dispute under the Civil Code, the Pudong New District People’s Court ruled that the creditor and debtor should assume joint and several liability according to the agreement.
. If there is no specific provision or it is ambiguous, according to the legal principle of indirect payment, the debtor shall assume the first order of repayment liability. For example, in Supreme Court Civil Retrial No. 164 (2017), the court held that the factoring contract did not specify the order of payment between creditors and debtors for accounts receivable, and due to lack of precedent judgment, according to the legal principle of indirect payment, the creditor could only claim performance on the new debt first.
. If performance on the new debt fails, the creditor could ask for performance of the old debt. The function of recourse in factoring contracts is equivalent to the creditor of accounts receivable providing guarantee for the debtor’s solvency. Therefore, the debtor assumes the first order of repayment liability, and the creditor the supplementary liability for what the debtor cannot pay.
To sum up, the recourse of the factor does not “co-exist” with the repurchase/reassignment right, and the factor must choose one. However, the recourse and claim right can co-exist, and if the factor files a lawsuit, it is recommended to sue the creditor and debtor at the same time.
Yang Guang is a partner and He Yanmei is an associate at Lantai Partners
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