Positive scenarios for working capital development

Phan Anh Vu - Partner, Indochine Counsel and Pham Dac Hoang Legal assistant, Indochine Counsel

While both the Civil Code and Decree 21 do not define receivables, Article 3.7 of Circular 02 gives a satisfactory definition of receivables as “an amount of money that the seller has the right to receive from the purchaser under a good sales contract or a service contract”.

Although only defined in Circular 02, the use of receivables is commonly used by both credit institutions in their professional activities and civil subjects in many private transactions.

The activity of financing working capital with security assets being receivables in Vietnam is conducted under two major legal mechanisms, including the transfer of the right to reclaim debts and the mortgage of receivables.

The transfer of the right to reclaim debts, performed by purchasing receivables, is based on the principle of absolute assignment. This means that upon transfer, the borrower will transfer its ownership rights over the receivables to the lender. Therefore, the borrower will not receive any surplus for the liquidation of receivables, nor will the lender have the right to reclaim the payment once the transaction is completed.

In the lending activity of credit institutions, the purchase of receivables is mainly used in the form of factoring services provided by commercial banks and non-banking finance companies. For a long time, under a legal framework which expired in September 2017, there had been two forms of factoring services provided by credit institutions, namely non-recourse factoring and recourse factoring.

However, the current regulation of the Law on Credit Institutions and Circular 02 has excluded the legal framework of non-recourse factoring services, stating that credit institutions now can only provide recourse factoring services.

The reason for such change perhaps stems from the SBV’s policy to limit the risk in credit extension activity of domestic credit institutions.

In the civil sector, receivables are traded as the right to reclaim debts under the legal framework of the Civil Code. Accordingly, pursuant to Article 365 of the Civil Code, the borrower can transfer the right to reclaim debts to the lender upon parties’ agreement in the form of a transfer of the right to claim.

However, the Civil Code also provides the circumstances that such transactions are prohibited, as when it is a form of non-transferable asset set out by law; or it is not allowed to be transferred upon the prior agreement of the seller and debtor or as prescribed by law.

Due to the nature or purpose of certain rights associated with the human personality (also known as personal rights), for example, the right to claim alimony, the right to claim compensation for damage caused by infringing upon life, health, honour, dignity, and reputation, these rights are regulated as non-transferable assets.

Also, there are rights that have been agreed by parties on the restriction on transfers. With regard to receivables, the debtor (or the buyer) and the seller may reach an agreement not to transfer the right to reclaim debts, as well as the creation of any security over such rights. This is often implemented under the use of a non-assignment or non-transfer clause, which may prohibit the granting of security over the receivables (or other benefits under the contract) without the consent of the debtor.

Trade receivables in secured transactions are classified as a form of asset that can be mortgaged under Decree 21. Therefore, the conditions, validity, and realisation of receivables will be implemented on a legal basis of a type of collateral.

To be a qualified asset to mortgage, trade receivables must be a right arising from a contract of goods sale or services provision, which is owned by the borrower (the mortgager). When the borrower uses receivables to secure a transaction, the consent of the debtor is not necessary. However, the debtor must be notified by the lender (the mortgagee) in advance before performing its obligation.

Once the mortgage transaction is conducted, the mortgagee not only has the right to request payment upon its evidence on the rights over such requested payment but also the right to register a secured transaction with the National Registration Agency for Secured Transactions.

Consequently, the mortgagee will have the priority for payment when receivables are realised. Under the legal framework of Decree 21, the security on receivables has a clearer legal basis for implementation, thereby protecting the legitimate interests of the mortgagee in the secured transaction.

Another way of using receivables is for invoice financing. Invoice financing is the payment method where the borrower obtains a loan from the lender, and the debtor, as duly appointed by the borrower, will make a redirected payment to the lender.

Therefore, it is just a loan-repayment method that neither affects the liability of the borrower to the lender nor transfers the asset rights or the ownership rights of the receivables unless otherwise agreed between the relevant parties. Invoice financing is deemed to be simpler than other methods, yet no less effective during implementation.

Security over receivables in financing working capital activities is not strange to many legal systems in Asia. It is often that receivables are used as a security asset.

With regard to Vietnam, the use of receivables to get advanced payment from a third party, or to secure performance of obligations will create an opportunity for lending and capital mobilisation activities to catch up with the trend of the capital markets in other Asian countries.