Account receivables, also known as trade receivables, serve as an important alternative financial asset within the trade finance industry in the United Arab Emirates (UAE). By financing receivables, businesses can better sustain day-to-day operations and mitigate credit defaults. The UAE has enacted laws and regulatory frameworks to support account receivables in trade finance. This includes legislation governing factoring and other receivables financing arrangements, offering legal clarity for businesses operating within the UAE.

Beginning with the definition provided in Federal Decree-Law No. (16) Of 2021 On Factoring and Transfer of Civil Accounts Receivables, factoring isa financial activity in the UAE defined as "A transaction whereby the assignor transfers the current or future debtor’s accounts receivable, or both, to an assignee, or agrees that the assignee maintains and collects entries related to the transferred accounts receivable and provides protection to the assignee in case the debtor breaches the payment." Notably, the latter part of this definition sparks controversy, which will be addressed later in this article.

In other words, factoring occurs when a business sells its invoices to a third party. This third party, known legally as the assignee, then assumes the right to collect the invoiced amounts. This transaction effectively transfers ownership of the invoices from the original business (the assignor) to the assignee.

Factoring activities may not be practiced in the UAE except after obtaining a license to do so from the Central Bank of the UAE (CBUAE). These activities must comply in accordance with the terms and conditions issued by a decision of the CBUAE.

A significant aspect of Federal Decree-Law No. 16 of 2021 is that receivables assignment agreements are effective in relation to future receivables. This provision introduces regulatory certainty and instills confidence among key industry stakeholders.

It is worth noting that there is often confusion between the activities of bill factoring and bill discounting. Unlike bill factoring, bill discounting lacks a clear definition, leading to the following distinction: Invoice discounting emerges as an alternative model within the scope of invoice financing.

However, in bill discounting, the business (i.e., the original creditor) retains the responsibility of collecting the invoice, unlike in bill factoring where the assignee, to whom the receivables are assigned, assumes this role. Additionally, the said business retains control over its sales ledger in bill discounting, which raises questions regarding the transfer of ownership of the invoices, unlike in bill factoring. These two criteria highlight the principal distinctions between the two models.

Furthermore, another important criterion for discussion is confidentiality, specifically whether the client who initiated the invoice is informed of the arrangement between the assignor and the assignee. In practice, it is observed that most invoice discounting facilities are kept confidential, while most factoring facilities are disclosed. Indeed, it logically follows that when the assignee is responsible for collecting the debt (factoring), the client is automatically informed of the transfer. Conversely, when the assignor assumes debt collection (discounting), the certainty of confidentiality becomes less assured.

Some may question the rationale behind these two activities, both of which serve the same objective: enabling businesses to unlock liquidity and address their immediate cash flow requirements instead of waiting for full payment from clients at a later date. The primary purpose is to support business growth.

Furthermore, when considering the advantages and disadvantages, bill factoring offers certain benefits. For instance, both the assignor and the assignee possess the right to send notifications and payment instructions to the debtor regarding the accounts receivable. However, if the debtor receives notifications from both parties, only the assignee is authorized to issue payment instructions, ensuring clarity in payment processing. Additionally, the assignee retains the primary right, even in cases involving multiple debtor accounts receivable or divided or undivided rights in the debtor's accounts receivable. Small enterprises often prefer invoice factoring for its simplified approach, which absolves them from the responsibility of managing receivables collections, while simultaneously enabling access to a significant share of the value of the outstanding invoice.

While factoring is often viewed as the preferred activity, it's noteworthy that factoring without recourse may present a high risk for the assignor due to the potential of non-payment. Hence, recourse factoring typically emerges as the more prudent path.

However, revisiting the initial discussion on the definition of factoring in Federal Decree-Law No. (16) Of 2021, it's highlighted that the assignee shall be afforded protection. Yet, this assurance seemingly contradicts with Article 10(2) of the same Federal Decree Law, which explicitly states, "The assignor shall not guarantee the ability of the debtor to pay, whether now or in the future." This discrepancy raises questions about the extent to which the assignee is genuinely safeguarded and whether recourse factoring remains viable in light of such a provision.

To mitigate the risk of nullifying recourse provisions and ensure the assignee is adequately protected without contravening existing legal stipulations, it is imperative that any recourse agreement is meticulously drafted to align with the prevailing legal framework.