Factoring Accounts Receivable in Kenya: A Legal Perspective

Many businesses often face a cash crunch. This mainly occurs when collections are not coming in steadily or when it takes time for invoices to be honoured. This has led to many of such business seeking alternative short-term financing based on invoices and account receivables. This is called factoring.

Think of invoice factoring as getting paid today for a sale you made for tomorrow. Factoring is selling of a business’s receivable at a discount to a factor which assumes the credit risk of the customer (debtor) and the factor receives money from the debtor when they pay. Factoring operates majorly without recourse. Mostly the factor will take charge of controlling the account receivables and will receive payment directly from the debtor.

On the other hand, invoice discounting is the process where the invoices are not sold but discounted with full recourse to the company. Simply put, a business agreed to accept a slightly lower sum on an invoice but is responsible for collecting its own debts.

There can also be a hybrid arrangement which uses elements of discounting and factoring depending on what the parties agree.

Generally this is how it works. Instead of waiting 30, 60 or 90 days for a client to pay their invoice, a business sells that unpaid invoice to a third-party company (the factor). They give the business the bulk of the cash right away, to allow the business pay its staff and keep running. Afterwards, the factor collects the full payment from the client later. The business received funding faster and the factor gets to keep a small share (often a percentage) of the invoice as fee.

In the Kenyan commercial landscape, factoring and receivable financing have emerged as vital tools for businesses. While not very popular the trend is catching up especially within the Small and Medium-sized Enterprises (SMEs). Factoring is used to unlock liquidity by converting the outstanding invoices and receivables into immediate cash. Factoring is very common in sector like manufacturing, wholesale, staffing, recruitment agencies, transport, logistics, consulting and IT. For example in the US factoring is a trillion-dollar industry.

The North America Factoring Services Market is projected to grow from US$ 1.58 trillion in 2024 to US$ 2.63 trillion by 2033, achieving a CAGR of 5.77% during 2025-2033.

The process begins when the business provide goods or services to the customer (the debtor) and issue an invoice with standard payment terms (for instance Net 30, 60, or 90 days).

Instead of waiting for the customer to pay, the business submits (seller of invoice) this invoice to the factoring company. The factor conducts a brief due diligence check to verify that the goods services were indeed delivered and that the invoice is legitimate. This may include verification of invoices against delivery notes, attendance sheets.

Initial due diligence is often conducted by the factor before entering in the factoring agreement. The business which requires financing and which submits its invoices to the factor is called the seller.

Once the invoice is approved, the factor will pay the business an advance. Depending on the business risk factor and the agreement, this advance will typically range from 70% to 90% of the total invoice value. This cash hits the bank account, often within 24–48 hours, allowing the business to cover immediate costs like payroll, rent, or inventory without hurdles.

The factor then takes responsibility for collecting the payment from the customer when the invoice reaches its due date.

Disclosed Factoring: The customer will be notified that the debt has been assigned to the factor and pays the factor directly. This is what many factoring companies use as it gives them security and control of the collections.

Undisclosed (Silent) Factoring: The customer is not notified and continues paying the business. The business then promptly forward those payments to the factor.

Once the customer pays the full invoice amount to the factor, the factor releases the remaining balance (or reserve) to the business. This is the portion of the invoice not covered by the initial advance. In some cases, the factoring agreement is written so that the factor can build large reserves which are released to the business after a certain period of time.

Before releasing that final balance, the factor deducts their factoring fee (discount rate). The fee is the cost of the service and is typically a percentage of the total invoice value.

Currently, there is no specific legislation solely dedicated to regulating factoring transactions in Kenya. Consequently, the legal validity of these arrangements rests on two primary pillars: Parties have to rely on contract law principle and the Moveable Property Security Rights Act (MPSRA) of 2017.

Factoring is fundamentally a contractual relationship between the supplier (the client) and the factor (the financial institution). The rights, obligations, and risk-allocation mechanisms are governed by the specific terms negotiated within the factoring agreement.

This is the most significant statutory instrument for this sector. Section 2 of the MPSRA recognizes receivables as intangible assets that can be used as security to obtain financing. It provides a legal mechanism for the creation and registration of security interests, which is crucial for factors seeking to protect their interest in the assigned debt.

The Act covers both future assets and intangible assets. Intangible assets includes receivables, choses in action, deposit accounts, electronic securities and intellectual property rights while future assets means a movable asset, which does not exist or which the grantor does not have rights in or the power to encumber at the time the security agreement is concluded.

In a legal dispute, a court might re-characterize a factoring agreement as a loan secured by receivables. If the transaction is treated as a loan, the factor may be subject to the In Duplum Rule (which limits the total interest charged to the principal amount).

The agreement must be drafted to reflect a true sale of the debt rather than a collateralized lending arrangement. Ensure the language clearly distinguishes between the assignment of an asset and the granting of a security interest, although the MPSRA provides a mechanism to register the latter to protect your interest.

Even so, the law does not support unconscionable contracts terms. If the terms of the factoring agreement are unconscionable for instance excessive interests and penalties.

The MPSRA 2017 allows factors to perfect their interest in receivables by registering them on the Collateral Registry.

The risk of non-registration of the collateral: If a factor fails to register their security interest, another creditor (such as a bank with a floating charge over the seller’s assets) might claim priority. In a liquidation scenario, the unregistered factor risks becoming an unsecured creditor, losing their right to the specific receivables they intended to factor.

Mitigation of risk by registration of collateral: Immediate registration of the assignment/security interest in the Collateral Registry is mandatory to establish priority over subsequent creditors.

Even after an invoice is assigned to a factor, the customer (debtor) may retain legal rights that undermine the factor’s position. If the business failed to deliver the goods or services correctly, the customer my legally be entitled to set off the value of the defect against the debt. The factor may find that the invoice they purchased has been reduced or invalidated by a dispute between the seller and the buyer.

In addition, there may be circumstances such breach of contract which may affect the ability of the factor to collect on the invoice.

The factoring agreement can mitigate such eventualities by inclosing Representations and Warranties from the business, confirming that the invoices are free from disputes, existing liens, or claims of set-off at the time of purchase.

If the seller of the invoices enters insolvency, the liquidator may challenge the factoring agreement. A liquidator might argue that the factoring arrangement constitutes a preferential payment or a transaction at an undervalue, potentially voiding the transfer of receivables.

For a factoring it is crucial to ensure that factoring agreement is negotiated at arm’s length and that all assignments are properly documented and registered to prove that the factor acquired the rights in good faith and for value.

While factoring is a commercial activity, financial institutions providing it must remain compliant with the Central Bank of Kenya (CBK) guidelines if they operate as deposit-taking institutions or specific types of credit providers. Operating a financing business without proper regulatory standing can lead to the agreement being deemed unenforceable in court.

It is crucial to verify that the factoring entity is properly licensed to carry out credit business and adheres to relevant consumer protection and anti-money laundering (AML) laws. Nothing stops banks, microfinances and saccos from offering factoring services as long as this is done within their respective regulatory framework and licencing conditions of the regulators.

Factoring can be categorised as traditional lending and this means that lending rules may be applicable such as in duplum rule.

When entering into a factoring agreement, businesses must exercise due diligence. Because the law relies heavily on contract terms rather than a specific regulatory code, the following clauses are critical:

Recourse Factoring: The business remains liable if the customer defaults. If the customer fails to pay, the factor can demand that the supplier buy back the invoice or deduct the amount from future advances.

Non-Recourse Factoring: The factor assumes the credit risk of the customer. If the customer becomes insolvent or fails to pay, the factor generally bears the loss. This is typically more expensive due to the higher risk taken by the factor. This is not common in factoring, as many factors will often protect risks and hold the business liable.

The contract will explicitly define which invoices qualify for factoring. A factor may want to deal with invoices from a reputable customers and avoid invoices from some institutions after due due diligence. Common hurdles will include:

• B2B Limitation: Most factors only accept favour or business-to-business (B2B) invoices, excluding consumer (B2C) sales.
• Dispute Status: Factors generally refuse to purchase invoices that are subject to disputes, chargebacks, or quality complaints.
• Customer Creditworthiness: The factor will reserve the right to vet your customers. If your customer base has a poor credit profile, the factor may reject specific invoices. This could potentially affect the relationship between the business and the customer.

Factoring costs can quickly erode profit margins. Look for clarity on:

• Factoring Fees: Administrative charges (often a percentage per invoice) for processing and collection. These fees may be high depending on the risk factor associated with the business or the customer.
• Discount Rates: Interest charged on the cash advance, usually tied to the time the invoice remains outstanding.
• Hidden Costs: Be wary of setup fees, credit-check fees, and penalties for late payments or invoice cancellations. Penalties may erode any profitability of the business of the business leading to the business being over reliant on the factor.

Disclosure: It is important to determine whether the arrangement is disclosed. That is whether the customer has been notified that the debt has been assigned to the factor.

Control: It is also crucial to specify who handles collection efforts. If the factor interacts directly with your clients, ensure their communication style aligns with your brand’s standards and customer service expectations to prevent damaging long-term business relationships.

In operation, the factor may contact the customer and demand payment of invoices directly if the customer dies not pay on time. This may create hostile working environment when invoices are often delayed. For many businesses a late invoice is normal as a delay of a couple of days is not a big deal. This may not sit well with the factor.

It is also important to ensure the contract specifies the procedure for ending the relationship. Some agreements may include restrictive exit fees or long notice periods that could trap you in a high-cost financing cycle.

Herein below is a summary of the case Trans National Bank Limited v Swift Truckers Limited (In Receivership) & 3 Others [2012] KEHC 2988 (KLR) formatted as a classic case brief, followed by an analysis of what the judgment establishes regarding invoice factoring.

In October 2005, Trans National Bank (the Plaintiff) granted an invoice factoring facility of up to KShs 25 million to Swift Truckers Limited (1st Defendant). This commercial arrangement allowed the 1st Defendant to assign its accounts receivables (invoices) to the bank in exchange for immediate cash flow funding. The financing was secured by verified invoices alongside personal guarantees executed by the company’s directors, including Nazir J. Virjee (the 3rd Defendant).

By December 2007, the 1st Defendant fell into financial arrears. The parties restructured the credit facilities, converting KShs 25 million of overdue, mature invoices into a formal loan, while KShs 19.7 million in current invoices remained under the active factoring arrangement. The 3rd Defendant signed a restructured personal guarantee to secure up to KShs 44.7 million.

In January 2010, Diamond Trust Bank placed the 1st Defendant under receivership. The Plaintiff subsequently filed suit, claiming outstanding balances on the loan account, overdrafts, a US dollar account, and further alleging that the directors fraudulently bypassed the factoring agreement by intercepting and directly collecting payments from clients (such as Damco Logistics and Desbro Uganda) on invoices already assigned to the bank.

The 3rd Defendant offered no testimonial or documentary evidence at the hearing. Instead, his counsel raised several legal technicalities in submissions, arguing that:

• 1. The factoring agreement was invalid because it was not stamped or registered.
• 2. The personal guarantee was unenforceable because the specific liability figure only appeared on the first page, whereas the directors only signed the final page.
• 3. The banking documentation was contractually defective due to a minor typographical error in an early facility letter.

• 1. Whether an invoice factoring agreement requires statutory stamping or registration to be legally enforceable.
• 2. Whether a personal guarantee is legally binding under the Law of Contract Act if the guarantor only signs the final execution page and not every individual page of the document.
• 3. Whether the Plaintiff sufficiently proved the allegations of corporate fraud regarding the direct collection of factored invoices.

1. Enforceability of Factoring Agreements: An invoice factoring agreement does not involve immovable property or mortgages, meaning it is not subject to compulsory registration. Furthermore, it is not a registrable instrument under the Schedule to the Stamp Duty Act; hence, a lack of immediate stamping does not invalidate the agreement or render it inadmissible.

2. Validity of Guarantees: Section 3(1) of the Law of Contract Act (Cap 23) strictly requires a guarantee memorandum to be in writing and signed by the party to be charged. Kenyan law does not mandate that a guarantor sign every sequential page of a contract. If clear intent to be contractually bound is demonstrated by an execution on the final signature page, the guarantee is valid and enforceable for the full amount stated within the body of the text.

3. Standard of Proof for Fraud: Fraud is a serious civil allegation that requires strict, clear, and unambiguous documentary tracing. Merely demonstrating that a client paid a company directly is insufficient to establish fraud unless the underlying specific invoices are produced to confirm they were legally factored to the bank at that precise time.

The High Court dismissed the claims of fraud (Prayer C) due to an insufficient paper trail. However, the court upheld the validity of the personal guarantee. Justice Havelock entered judgment in favours of Trans National Bank against the 3rd Defendant for the proven principal sums of KShs 23,611,616.70 and US$ 9,700.00, plus interest at a commercial rate of 17.25% per annum calculated from March 1, 2010.

The judgment provides useful clarity on how Kenyan banking law characterizes invoice account receivable factoring:

Commercial Purpose of Factoring & Definition: The court defines invoice factoring as a specialized business facility wherein a borrowing company assigns or sells its outstanding accounts receivables (unpaid customer invoices) to a lender (the bank or microfinance) in exchange for a fee or commission. This serves as an immediate liquidity mechanism, allowing businesses to bridge cash-flow gaps between generating an invoice and receiving delayed payments from clients.

The Mechanism of Security: Unlike traditional commercial lending, which relies heavily on physical collateral or standard overdraft protections, the primary security in a factoring ecosystem is the actual face value of the invoice.

Legal Assignment of Debt: When an invoice is factored, the underlying debt legally changes hands and belongs entirely to the bank. To execute this properly, the borrower must physically endorse the buyer’s copy of the invoice with a clear directive instruction, notifying the customer/debtor that payment must be remitted directly to the bank.

While factoring is a powerful instrument for financial inclusion and cash flow management in Kenya, with the factoring agreement being the primarily reference point for determined the rights and obligations of the parties. Before signing, it is imperative to ensure that the document clearly defines risk allocation, due diligence, costs, and the limits of the factor’s authority over you’re a business and the customers.

With many lenders and microfinance institutions in Kenya venturing into factoring and invoice discounting arrangements, the sector is likely to grow. This is supported by the enactment of the 2017 Act which recognizes receivables as security and provides a comprehensive framework for factoring and invoice discounting.