May 13, 2022

Factoring case law review 2021

The year 2021, was not rich in factoring case law. One gets the impression that business was going so well this year that many disputes did not have to go to court (unfortunately, this admission will probably "age beautifully" soon). We have extended the review to the whole of 2021. In the following review, we have selected 5 judgments worth citing.

Judgment of the District Court in Warsaw on September 1, 2021. (Reference: XXIII Ga 914/21) -. identity theft of the recipient / distribution fraud (case of "British university hospital")

Introduction

A very interesting dispute under the full factoring agreement regarding the obligation to investigate the factoring counterparty (recipient) and the fee/commission charged for such a service with the identity theft of the counterparty (a British university hospital) in the background and the factoring party's contribution to the damage.

Factual state

The factor received by email an order for... 500 kg of Folic Acid, reported the counterparty to the factor with a limit request, received the counterparty's limit, obtained a signed notice of assignment. The counterparty issued a FV, the factor reported it for financing along with a shipping document, the FV was financed in EUR, then the financing of another FV took place. However, it turned out that there was in fact a so-called distribution fraud (impersonation of the entity indicated as the counterparty). The factor sent recourse information and a denial of coverage of the transaction due to fraud and impersonation of an employee, and the lack of an effective assignment excludes coverage of the receivable due to its non-existence. The factor offset the receivable with funds from the claim on the other counterparties. The factor and factoring party fell into dispute as to:

- responsibility for the advance paid by the factor (which the factor offset);

- fees charged by the factor for counterparty examination and assumption of risk.

Court of First Instance

The District Court accepted the claim of the plaintiff (factor) and indicated that, in its opinion, the defendant failed to perform with due diligence its obligations under the contract, as its wording guarantees the plaintiff that it should protect him from the insolvency of his debtors. Failure to make an examination of the counterparty, or to do so in a cursory manner, as well as failure to verify the receivables from the invoice (...) submitted for financing and the redemption of this invoice without such an examination, in the opinion of the District Court, constituted improper performance UF.

Court of Second Instance

The Court of Appeals assessed the case differently, including the contractual obligations and the extent of their performance, additionally applied the provisions on the contribution of the claimant (factor) to the damage. In particular, the Court of Second Instance pointed out that:

in light of the contract, where there are no provisions on the scope of the term "counterparty examination," a literal interpretation of the term "counterparty" in the Regulations, clearly allows us to conclude that such examination does not include verification of whether the entity in question entered into a contract with the plaintiff and under what conditions, i.e. whether an obligatory relationship in the sense of "obligation" was created. Also in connection with the factoring agreement is not necessary, since the claimant itself is obliged to determine with whom and on what terms it enters into commercial contracts.
(...) The claimant was obliged to exercise due diligence in granting trade credit to its counterparties, both with regard to its amount and credit period: "All actions taken in connection with making sales to counterparties shall be performed by the seller with the same care and diligence as it would have exercised if the receivables had not been assigned to the factor."
Both from the documents attached to the lawsuit and the testimony of witnesses who are current or former employees of the plaintiff, it is clear that the plaintiff has not fully complied with the above obligation (The factor established business contact with the counterparty and then conducted email and telephone correspondence without, however, taking steps to verify that the person with whom they correspond and to whom they intend to send the goods covered by the invoice is indeed a person authorized to represent (...). Moreover, as is evident from the email correspondence attached to the lawsuit, it was the designated person who showed his connection with the above university hospital only through the "footer" of the email.
Contrary to what the District Court indicated on the defendant (factor) there was no contractual obligation to, among other things: "to make a full investigation of the counterparty, to check the veracity of its representations," as no such obligation is found in any provision of the contract.
(...) the plaintiff did not check with whom she was contracting, and certainly did not contract with the described British university hospital, but with a person who allegedly acted on behalf of the hospital, or in other words impersonated the hospital.
The Regional Court, taking into account all the considerations made above, found that the wrongful conduct of the claimant consisted in the fact that she did not exercise sufficient care and caution both during her contacts with the potential counterparty and in terms of its even basic verification before concluding the contract. (...) The claimant did not actually determine with whom she was entering into the contract, while the sending of the invoice to the factor took place after all, after the contract had been concluded. By its omission, the claimant actually led the defendant to check an entity with whom the claimant had not actually entered into a contract.
In the opinion of the District Court, the above considerations based on partially supplemented findings and evaluation of evidence, provide reasonable grounds for assuming that the described conduct of the plaintiff entitles to establish on her side 50% contribution to the occurrence of the event justifying the liability for damages of the defendant.

Conclusions

Recipient identity theft / distribution fraud is still occasionally the subject of litigation. This is because it should be remembered that it involves the lack of effective origination and transfer of claims to the factor against the debtor (recipient) whose identity was stolen, which in a straightforward way leads to the denial of insurance coverage for the event, but also most often falls into the so-called "excluded risks" of the factoring agreement for which the factor does not take responsibility. The above continues to confirm the need for careful drafting of contracts, conducting trainings and the application of high compliance standards - by both the factoring company and the factor.

Judgment of the District Court in Toruń dated June 17, 2021. (Ref: V GC 1407/20) -. place of payment and promissory note and no requirement to attach to the summons

The case concerned the effectiveness of the promissory note obligation under the factoring agreement. The defendants filed objections claiming, among other things, that the promissory note was not filled in accordance with the promissory note declaration, and that the time limit for notifying the defendant that the note had been filled in accordance with the promissory note declaration had not been observed, which, according to the defendant, indicated that the note was invalid. Thus, the case was in fact simple, but it is worth quoting some legal statements made by the Court. First, it made the interesting observation that filling the bill of exchange contrary to the declaration does not affect the validity of the bill of exchange obligation. In addition, the court pointed out that The promissory note creditor is not required to attach the bill of exchange to the demand for payment, as such a transfer of the security (bill of exchange) could lead to negative consequences for the creditor. In addition, he stressed that the designation of the place of payment is basically arbitrary, and it is the creditor who decides where payment is to be made.

Judgment of the WSA in Olsztyn dated November 18, 2021. (Ref.: I SA/Ol 287/21) -. factoring carousel

Dispute of a factor (importer of construction materials) with the tax office about VAT illustrating the construction of a tax carousel but also a factoring carousel (fraud increasingly appearing in factoring). Unfortunately, an entity known in the financial market (including factoring) for years (conclusion at the end).

The factor created a merry-go-round by selling goods to counterparties, which then went back to the factor through subsequent affiliates or intermediaries.
Fiscal challenged VAT on a total of 146 invoices for more than PLN 1,750,000 to the factor.
There were 2 factories involved, age-old contracts because even from 2012-2013;
The above gives food for thought - perhaps for a few years factoring worked normally, or perhaps from the beginning factoring was just a means to support tax extortion;
Fraud Features:
Recipients of the factor did not act as end customers but as intermediaries / representatives / agents;
The factor decided to whom they were to sell the goods on and under what conditions;
The goods often staggered in a "merry-go-round" returning through a further intermediary or related company back to the factor. In fact, in the part concerning the disputed invoices, it was supposed to be a "paper turnover" that was not followed by the actual turnover of the goods;
Related companies were "staffed" with members of the factoring company's president's immediate and extended family;
Some interesting quotes:
(...) part of the turnover of insulation mats was plotted only in fiscal documentation. Issued invoices documenting these transactions were drawn up only to formally authenticate them.;
President of Factor He was also able to decide on all the important elements of the transaction, including deciding when the transaction was to be concluded and with which entity. Some of the transactions took place directly with related companies:
He cited the following as features of these transactions: Failure of witnesses to specify the details of the transaction; being only an "intermediary" in transactions between companies located at the same address (the same address of the seller and the buyer of the goods as evidenced by the VAT invoices also proves the lack of movement of the goods); lack of contact with the goods (and even lack of knowledge of the existence of the goods - only conjecture); the purpose of establishing cooperation (guaranteed profit from the transaction); lack of economic risk (guaranteed buyer of the goods: reducing the role of the intermediary only to the issuance of an invoice); the speed of the transaction (acquisition and further sale).
NUS said that in order to establish the full factual context surrounding the disputed transactions, the findings in the part concerning the conclusion and execution of factoring agreements with financing institutions are also important.
Pointing to the mechanism factoring fraud and the facts of the case, he stated that the decisions of the Authority of first instance correctly observed that the invoice turnover was created in order to obtain financial support from various financial institutions, and part of the Party's activities were based on fraudulent solicitations, which has nothing to do with the conduct of economic activity.
The goods, after being sold by the factor to the factoring customer, went on to the intermediary/affiliate to return to the factor. Thus, the circulation of invoices for the purchase and sale of insulation materials in the chain of companies created a kind of carousel..
Finally, I will add a sad conclusion. When we enter the land and mortgage register kept for a villa located on a large plot of land on one of the Masurian lakes (associated with the president of the factoring company), we can sadly trace the picture of the history of a large part of the invoice financing market in Poland and find there even factoring agreements from as early as 1999, and in the case itself from 2012-2017. When we add to this that, to my knowledge, the delinquent is still operating in the market and also after 2018 entered into new factoring agreements, we have a sad picture of the lack of effective exchange of information in the market by financial institutions.

Judgment of the WSA in Warsaw dated November 25, 2021. (Reference: III SA/Wa 828/21) -. Discount as a cost of debt financing

Tax case, a factoring company in the automotive industry (distributor of cars and parts selling to car dealers) with 2 factoring agreements - for cars and for parts (customers - dealers) asks for an interpretation. The case may be of interest mainly to the financier of closed group transactions. The Factor receives the Discount and assumes all rights related to the receivables in connection with the assumption of the risk of the Dealer's failure to pay the obligation by the date indicated in the vehicle supply contract or parts supply contract. The risk is extinguished when the Dealer makes payment.

The dispute in the case centers around the question of whether, in the facts described, the amount of the Discount constitutes a cost of debt financing and is subject to the limitations indicated in Article 15c of the PDOPrU. In the Company's view, the amount of the Discount does not constitute a cost of debt financing and is not subject to the restrictions indicated in Article 15c of the PDOPrU, while in the view of the Fiscal Office it is.

What did the court find?

Therefore, in the case of the Company, it is not possible to talk about the cost of raising funds (the cost of debt financing, or the Company's indebtedness to which the ATAD Directive refers).
In full factoring, there is no return element. The factoring company neither provides the customer with cash of a repayable nature, nor does it make available the object that it has purchased itself. The only activity it performs is the transfer of funds for the acquired receivable. At the same time, the transfer does not cover 100 % of the receivable, while the difference is the Factor's fee for redeeming the receivable ahead of schedule. As a result of this activity, the client gets the cash earlier than he would have received if he had waited for the standard payment date from his debtors. In addition, it also gets rid - and definitively - of the risk of debtors' insolvency.
Thus, factoring proper, unlike reverse factoring, does not fulfill the economic function of a loan. Discounting is therefore an expense associated with the sale of receivables. The funds received from the sale of receivables constitute a definite gain and are not refundable.
In the opinion of the Court, taking into account the above considerations, including bearing in mind that the cost of debt financing is understood as "all kinds of costs associated with obtaining funds from other entities and with the use of such funds." the amount of the Discount is not a cost of debt financing and is not subject to the limitations indicated in Article 15c of the PDOPrU..

Judgment of the WSA in Warsaw dated September 6, 2021. (Reference: III SA/Wa 2418/20) -. Transaction fee, VAT at different models of assignment of cooperative banks

A cooperative association bank asked the Fiscal about the tax approach to its planned model of acquiring loan receivables from cooperative banks affiliated in several models (syndicate with assignment of loan / syndicated loan and assignment from co-consortium / full assignment of loan) at a market price that takes into account the discounted value of future cash flows and other relevant factors.

The inquiry concerned write-offs and write-downs of loan receivables.

The inquiry concerned write-offs and write-downs of loan receivables:

- whose uncollectibility will be made probable in the manner specified in Article 16(2a) in conjunction with Article 16(1)(26c)(a) of the CIT Law,

- whose uncollectibility is not made probable in the manner specified in Article 16(2a) in conjunction with Article 16(1)(26c)(a) of the CIT Act, whose delay in repayment exceeds 12 months,

- whose uncollectibility will be documented in the manner specified in Article 16(2) in conjunction with Article 16(1)(25)(b) of the CIT Law.

The bank also inquired of the Fiscal whether, under these models, (i) the assumption by assignment of loan receivables constitutes an activity subject to VAT as a supply of services for consideration, (ii) whether the amount of the transaction fee is the basis for VAT, (iii) whether the services provided by the association bank to the cooperative bank are exempt from VAT, pursuant to Article 43(1)(38) of the VAT Law as credit services or Article 43(1)(40) of the VAT Law as debt services?

And here, somewhat as an aside, the WSA commented on factoring:

"In the Court's view, in the future event described in the application, there will be a classic, code-based assignment of debts. The interpretation authority's understanding of the described future event would lead to the fact that the part of the provision of Article 43(1)(40) of VATU constituting the exemption of debt service would lose its normative meaning. This is because, in fact, any assignment of a debt, by operation of law (Article 509 § 2 of the Civil Code.), entails the right of the buyer to collect the debt. The authority seems to infer from the general right of the assignee to collect the claim that the legal core of the assignment of the claim is the collection of the claim, including in factoring. Such an interpretation is incorrect. One cannot put an equal sign between a (tax-exempt) debt service and a debt collection service, including factoring."
"Factoring or other debt collection services take their essence from relieving the creditor from collecting (his) debt. However, the essence of the assignment of receivables is not the collection of someone else's debt. Not every act of acquiring receivables automatically constitutes the provision of debt collection or factoring services. In order for a given assignment of receivables to be considered a debt collection activity, including factoring, there must be additional prerequisites in addition to the assignment of receivables indicating that the assignment of receivables in the given factual circumstances is an element of a debt collection activity, including factoring (such as, for example, the provision of certain additional services by the assignee to the assignor)."

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