REFORMS TO LEGAL PROVISIONS GOVERNING MEXICAN SECURED CREDIT

A) Introduction

The long awaited legal reform to provide lenders with greater guaranties and thus ensure Mexican borrowers access to credit, much publicized by Mexican financial authorities, was finally passed by Mexican Congress, albeit not as a new Federal Guarantee Law, but rather -thankfully, as otherwise a new law would not be coherent within the existing legal framework- as a patchwork of reforms to the existing General Law of Credit Instruments and Operations (Ley General de Títulos y Operaciones de Crédito, ‘GLCIO’), Commercial Code (Código de Comercio, ‘CC’) and Law of Credit Institutions (Ley de Instituciones de Crédito, ‘LCI’). Such patchwork of reforms was finally published in the Mexican Official Gazette of the Federation on May 23, 2000 and entered into force on the following day. Making sense of the significance of these reforms and the legal framework thereby modified will only be possible after a brief survey of the problems faced by creditors until now.

However, before entering into a brief review of the former legal framework, it is interesting to examine how President Zedillo viewed the need for his original proposal to create a Federal Guarantee Law. The avowed purpose was indeed manifold, because the evils it sought to solve were many. President Zedillo stated that the former legislation was obsolete, and that the perfection of security interests was thus subject to "slow and costly" procedures with inadequate public registries and cumbersome formalities. Mechanisms to guarantee swift payment to creditors were, to say the least, substantially hampered. Mr. Zedillo’s proposed legislation intended to give the market the choice between working with the previous legislation and the new legislation, embodied by such Federal Guarantee Law, thus having his new ‘creature’ coexist cheek by jowl with the unreformed GLCI and CC. Fortunately, Congress evidently decided that reforms to the existing legislation, however inelegant these might turn out to be, were indispensable, and thus appropriately grafted the provisions contained in Zedillo’s proposal into the existing legislation.

Indeed, perfecting security interests in Mexico has until now faced more than its fair share of problems, some of which are briefly discussed below:

To pick a start, it should be stated that there were no self help remedies in Mexico. Most repossession of personal and real estate property subject to liens or perfected security interests had to be obtained by the creditor through a court order. In addition, if the creation of a security interest was allowed by law, the interest had to be registered in a Public Registry of Property and Commerce, and/or the creditor had to take possession of the pledged collateral. The above notwithstanding, the greatest impediment to ensure creditors the repayment of a loan was –and still is- the legal provision whereby employees of an indebted party have absolute precedence over any other creditor (Article 2989 of the Mexican Civil Code for the Federal District and Article 113 of the Mexican Federal Labour Law), a provision which could only be circumvented by having the borrower assign certain assets guaranteeing the loan to a trust, which implies certain not insignificant costs which are described below.

Some points concerning the intricacies of the Public Registry of Property and Commerce should be made. Pursuant to Article 18 of the CC, in every judicial district of Mexico a Registry of Commerce should be established alongside with -when possible- the local Registry of Property. Thus, there was more than one Public Registry of Commerce and one Public Registry of Property in each state of the federation, although not always one per each judicial district. As the purpose of the Registry is to give notice to third parties of the acts registered therein, the effect of such notice was limited to the jurisdiction where a pledge had been registered, thus limiting the scope of the notice to a certain jurisdiction and geographical area. A borrower could thus circumvent the effect of the pledge by simply disposing of the pledged property in another jurisdiction to a third party acting in good faith who could in turn oppose the creditor’s rights thereon. Maximum protection was afforded only by registering the pledge in all jurisdictions, a supremely costly and ultimately overwhelming procedure. Further, only public documents may be recorded at the Registry, that is, documents issued either by Mexican public notaries, public brokers or by Mexican courts. Finally, as there were no self help remedies, a creditor could only enforce the pledge following authorization granted by a court of law after a lengthy judicial procedure, which could result in the borrower having no assets for the creditor to foreclose on.

As mentioned above, by setting up a trust, in which the trustee may only be a Mexican financial institution pursuant to Mexican law, a borrower can assign to the trust certain assets and borrower’s rights to receive future payments pursuant to a contract. However, setting up a trust implies substantial notaries’ and trustees’ fees, and such trust can only be set up for individual contracts and would thus be terminated upon termination of such contracts.

As for mortgages, a perfected mortgage is fully enforceable against good faith purchasers, but not against previous mortgages over the same real property and back-pay of employees of the borrower. Again, there were no self help remedies, and thus a creditor would have to follow a special mortgage procedure (juicio especial hipotecario) which would take between 6 and 18 months, and only then enable the creditor to obtain the payment of the loan from the judicial sale of the property.

To conclude, recovery time could be considerable, protection against fraud was not easily obtained and only through an expensive and cumbersome trust could the creditor avail himself of protection against employees of the borrower.

1. The Guarantee Trust

As stated above, the setting up of a trust is the only means to ensure that a creditor’s claim may have priority before borrower’s employees’ claims for back pay, but until these reforms this was a costly structure mainly because the structure could be used only for a single transaction. The new legal structure is descriptively called a ‘Guarantee Trust’ (‘fideicomiso en garantía’), and may be used in various different operations (Article 397, GLCIO), as the beneficiary of the trust (the creditor) may be appointed upon creation of the trust or at a later date. Thus, a borrower who in its normal course of business executes successive credit transactions with one or more creditors may create a single trust to be used as the structure with which to obtain and adequately secure multiple loans. There may be two or more simultaneous beneficiaries, but an order of precedence among same or a percentage of the assets assigned to the trust must be appointed for each beneficiary by the borrower. Alongside with this provision and in order to protect the borrower’s interests provide for a flexible use of the trust, Article 398 establishes that a beneficiary must notify the trustee through public notary or public broker of the payment of the credit guaranteed with a specific guarantee trust, so as to extinguish the obligation in such creditor’s favour, being otherwise liable for damages.

The reforms have been commended for incorporating the market concept of 'floating assets'. Indeed, the borrower may keep the material possession of assets assigned to a trust (Article 405), as it may use such assets to produce other assets (which in turn will be assigned to the trust), or even sell such assets, whereby the proceeds of the sale shall be transferred to the trust by operation of law. Notwithstanding the above, the parties may expressly state that borrower will not thus use the assets assigned to the trust (Article 402).

Further, Article 408 specifically allows for a blanket description of the assets assigned to a trust whenever borrower uses such assets to perform its main corporate purpose (Article 454). So ingrained in Mexico is the reluctance to accept blanket descriptions of assets that the reforms even go the length of establishing that the officers at public registries may not suspend or deny recording of blanket liens if such blanket liens describe assets generically as provided by Article 454.

Various reforms were made to the CC whereby the overall supervision of one single Public Registry of Commerce will be governed by the Ministry of Commerce (Article 18, CC), and offices of the Public Registry of Commerce in every jurisdiction will be electronically interconnected, while a central base will be set up by said Ministry in which all data collected by the separate offices of the Registry of Commerce will be stored. Discrepancies shall be cleared based on the data stored in the centralized data base, save proof to the contrary (Article 20, CC). In all, these and other relevant reforms should ensure an up to current international or UCC standards means of inspecting liens and encumbrances on guarantees, and enable potential creditors to carry out a due diligence process availing the creditor with certainty as to the borrower’s creditworthiness at a certain point in time. Thus, when Article 410 of GLCIO establishes that all acts whereby trusts are incorporated, modified, extinguished and assigned must be recorded at the Public Registry of Commerce (and in the Public Registry of Property in the case of real estate), this becomes more than a hollow obligation, as it would appear that finally creditors will be ensured easily available publication of registrations, validity of notice to third parties, and thus allow them to oppose their claim against any and all.

It must be borne in mind that these reforms were designed not only to give greater certainty to creditors, but also to ease the access to credit among erstwhile reluctant borrowers, who have not been the traditional recipients of credits nor have been previously considered by potential creditors as creditworthy, mainly because recovery was uncertain. It is for this reason that Article 412 embodies a protection for borrowers which may not be waived by the parties, indeed, creditors may only recover credits by the sale of the assets assigned to a guarantee trust, and above the value of said assets the obligation to the creditor will be extinguished by operation of law. This protective provision may be considered as appropriate in asset based loans, but would otherwise seem to violate a legal principle whereby an accessory obligation should be incidental to a principal obligation, and not the other way around; in other words, the guarantee trust should be accessory to the principal obligation derived from the loan agreement between creditor and borrower, and therefore extinguishment of the accessory obligation should not imply extinguishment of the principal obligation. For example, a borrower could establish a guarantee trust to further allow a creditor to perfect a security interest on a credit granted before the creation of the trust. In the event of the borrower's unfulfillment of the credit terms by means of any event of default, the borrower could trigger foreclosure by the creditor on the assets assigned to the trust, and thus have him fall into the 'trap' of the provisions of Article 412, unwittingly having the credit extinguished by operation of law and loosing further legal recourse to obtain repayment from the borrower. To counterbalance this protection, creditors are ensured rights to regularly inspect the assets (Article 406, section II), have the credit mature in advance or have the borrower assign additional assets to the trust in case assets should diminish in value (Article 404). Thus, it may be argued that a creditor who will have taken the appropriate and diligent measures to value and regularly inspect the assets assigned to a trust should not feel the brunt of the protective measure described above.

 

2. The Pledge without Transmission of Possession

Any obligation as well as all rights and assets of the borrower may be pledged in this new legal mode as a pledge ‘without transmission of possession’ (Article 352), by which the GLCIO means that only exceptionally will such pledge be left in the possession of the creditor or an appointed third party (Article 346). No further ordinary pledge or guarantee may be perfected against the assets thus pledged. The pledge will have full effects opposable against third parties upon its recording at the Public Registry of Commerce (Article 366).

As a peculiarity of this pledge, the reforms state that, when the borrower is entitled to make partial payments, the pledge will be proportionally diminished, although creditors' rights have to be adequately guaranteed beforehand (Article 349). Further, although Article 367 expressly states that borrower’s employees will have preference over the creditor in connection with credits owed to same employees, and in addition (much as in the guarantee trust, see above) creditors may only recover credits from the proceeds of the sale of the assets pledged, and forego any amount owed to them in excess of the proceeds thus obtained (Article 379), self help remedies are finally available to creditors.

In connection with the ordinary mercantile pledge, before these recent reforms were enacted, there was and is a means for the creditor to obtain possession of the pledge and to avail himself of a self help remedy. Indeed, the creditor under the mercantile pledge is not able to recover the assets pledged as collateral, but rather only the cash product received following the collateral's judicial sale, unless the borrower consents in an ancillary agreement executed following the execution of the pledge agreement that the creditor obtains the property of the pledge in presence of an event of default (Article 2883 in conjunction with Article 2886 of the Civil Code for the Federal District applicable to the entire Republic in Federal matters, and therefore applicable to the GLCIO as a federal law).

Under the recent reforms, a set of provisions were grafted into the CC with an additional Third Chapter 'bis' to the original Third Chapter, under the heading "Of the Procedure to Execute the Pledge without Transmission of Possession and the Guarantee Trust". Herein I shall refer both to provisions contained in Chapter I concerning the extrajudicial procedure to execute collateral and to provisions in Chapter II regarding the new judicial procedure to execute same.

Briefly stated, the extrajudicial procedure implies that creditor may require payment by serving notice to the borrower through a public notary or a public broker. Thereupon, and saving borrower's opposition to this procedure, which would trigger the new judicial procedure described in Chapter II, creditor may immediately acquire possession of the assets pledged (Article 1414 bis 1, CC) and proceed to the sale thereof in the presence of a judge or the same notary public or public broker (Article 1414 bis 17, section II).

It is impossible at this stage to estimate with any degree of certitude how efficient, measured in terms of time consumed, will the new judicial procedure be. Suffice it to say that the provisions concerning the terms for borrower to comply with judicial instructions towards the delivery of the pledged assets to the creditor are brief, albeit always in full compliance with borrower's constitutional rights, and that the means whereby the court will enforce its provisions are sufficiently harsh to ensure their prompt observance. It may indeed be -facetiously- argued that, under the previous unreformed legislation, creditor and borrower could reach an agreement outside court that for all intents and purposes would work as well as this new extrajudicial procedure. As it is not hard to surmise that within the very near future these new provisions will be put to the test, it should be possible to measure their efficiency by various means, not least among which the increased granting of credits to borrowers formerly considered as not being credit worthy.

4. Conclusion

Although it is indeed too early to have a balanced estimate of how these reforms will operate in the Mexican market, and even though there is little save the text of the reforms to go on, it is reasonable to expect more legal certainty for creditors, who should thus feel encouraged to grant more credit at possibly lower interest rates. Indeed, President Zedillo's original proposal argued that honorable borrowers were made to pay for delinquent borrowers through increased interest rates.

The reforms governing the Public Registry of Commerce and the registries of property will allow creditors to have a clear and precise overview of the collateral offered by a potential borrower, and ensure that their lien on such collateral will be opposable against other potential creditors of the borrower. Further, the new mercantile pledge 'without transmission of possession' and the guarantee trust should ensure that creditors will now be able to establish blanket liens, have access to self help remedies and, if things should come to a legal 'tug of war', ensure prompt and effective judicial assistance and redress of wrongs.

It has been argued by some critics to the reforms that measures such as those contemplated in Articles 379 and 417 (the extinguishment of the credit obligation upon execution of the assets pledged or placed in the guarantee trust) will render these new provisions unpalatable to potential creditors; indeed, some critics grimly state that the reform was stillborn. It has also been claimed that the so-called self help remedies are insufficient and laughable.

Confidence in the effectiveness of these reforms will be measured by both credit granted by foreign financial institutions and suppliers of goods and services, and Mexican creditors, both financial institutions and other intermediaries. Actual reliability will only be apparent after such reforms are put to the test. It may be estimated that, within possibly three to four months following the publication of these patchwork of reforms, the public notaries and public brokers will have a story to tell, while the courts should be churning out justice within six months following publication. Time, as the saying goes, will tell.