By Alejandro Ortiz & Stephen Elison

Gardere, Arena y Robles, S.C. and Gardere Wynne Sewell LLP

One of the primary concerns of U.S. companies engaging in financing and lending transactions in Latin America is how to obtain a security interest similar to those security interests available to a lender in the United States for a comparable transaction.

In the United States, secured transactions are usually governed by Article 9 of the Uniform Commercial Code ("UCC") which applies to transactions intended to create a security interest in personal property or fixtures. Secured transactions not governed by the UCC may be subject to several other laws, including specific federal laws (e.g., Ship Mortgage Act of 1920) or state laws governing security interests in real property. Consequently, the United States offers a wide variety of possible security interests, such as purchase money security interest, escrow accounts, trusts, pledges, mortgages and liens to potential creditors.

Lenders have come to expect the following characteristics in connection with secured financing transactions in the United States:

1. Perfection. Perfection is the process by which the lender obtains maximum priority over the collateral against most, if not all, third parties.
2. Self-help Remedies. The lender has at its disposal the use of self-help remedies in the event the debtor defaults on its obligations. Such remedies may involve taking possession of the collateral without the intervention of the courts.
3. Security over Revolving Collateral. Under this concept, a lender in the United States is permitted to obtain a perfected security interest over future assets of the debtor, such as inventory and accounts receivable.

Although there have been recent minor developments throughout Latin America involving security interests, from a U.S. perspective, most Latin American countries remain unfriendly to creditors, particularly with respect to the use of self-help remedies and the ability to perfect a security interest in future assets, concepts which are virtually non-existent in Latin America. In Venezuela, for example, Article 542 of the Commercial Code and Article 1844 of the Civil Code provide that any covenant or clause that vests a creditor with the power to appropriate or otherwise dispose of collateral is void unless the collateral is cash. This rule is generally known as the Pacto Comisorio prohibition. Consequently, U.S. lenders have been reluctant to provide financing collateralized solely by assets in Latin America. Nevertheless, by utilizing various structures available within most Latin American jurisdictions, a U.S. lender often achieves an acceptable degree of security, permitting it to engage in credit facilities involving Latin America collateral.

The following is a brief summary of some of the mechanisms available in Latin America to obtain security interests in real property, personal property and accounts receivable. Because the information presented below is neither comprehensive nor country specific, we advise our readers to consult directly with us before undertaking any project in Latin America involving secured financing.

A. Real Property.

Mortgage. A mortgage (hipoteca) is perfected when the mortgage instrument is executed by a notary public and subsequently registered in a public, centralized registry. A perfected mortgage grants the mortgagee a preferential right, in the event of default, to obtain the mortgaged property before any other creditor, including creditors arising in connection with bankruptcy proceedings (except for certain preferential creditors). To enforce a mortgage, the lender must first seek a judicial foreclosure proceeding. Although a Latin American mortgage lacks the self-help feature common to U.S. mortgages, it nevertheless remains a predictable and reliable means of securing real estate loans certain types of financing arrangements.

B. Personal Property e.g. inventory and equipment

1. Pledge (prenda). The most common means of perfecting a security interest in personal property in Latin America is either by (i) giving physical possession of the pledged assets to the lender, or (ii) registering the pledge agreement at a centralized registry. Except for certain creditors, the lender has a preferential right over the pledged assets. The primary limitation on pledges on personal property, however, arises when the lender desires to obtain a pledge on revolving inventory or future assets. In Latin America, a pledge on revolving inventory or other future assets cannot be perfected until such assets exist and either the debtor has delivered physical possession of the assets to the lender or the newly existent assets are registered in the centralized registry. Until that time, the debtor only has a contractual obligation to perfect the pledge when the assets become existent. The contractual obligation, however, does not give the lender a preferential right over future assets. Furthermore, there are no self-help remedies available to the lender, but rather the lender must obtain court approval through a special judicial proceeding to enforce the pledge.
2. Purchase-money Loans (créditos de habilitación y créditos refaccionarios). This type of loan is generally used by a debtor (i) to acquire property or (ii) in connection with certain business expenses (e.g., inventory, paying salaries, direct costs associated with the trade or business of the debtor, etc.). A purchase-money loan is secured by such items as the inventory purchased and the end-products manufactured with such inventory. A purchase-money loan is perfected when it is registered with the centralized registry. Upon registration, the lender will have a preferential right over most other creditors with respect to the inventory and end-products obtained or produced as a result of the loan. In some countries such as Mexico, however, a creditor is entitled to recover the pledged asset (as opposed to proceeds from the sale of the asset) only if it has entered into an additional agreement in writing with the debtor subsequent to entering into the pledge agreement. Future property of the debtor such as inventory not purchased with proceeds from the purchase loan, is not automatically perfected under a purchase-money loan. In the event of a default by the debtor, the lender must obtain court approval through a special judicial proceeding to enforce the debtor's obligations.

C. Accounts Receivable

Generally, a pledge on accounts receivable is perfected in Latin America when the debtor gives the lender physical possession of the accounts receivable documents (invoices) and the loan debtor notifies his customer of the existence of the debtor's pledge. Future accounts receivable may not be perfected until they come into existence and the loan debtor separately pledges them to the lender. Until the specific accounts receivable become perfected, the lender does not have any preferential rights to the accounts receivable. In the event that the debtor defaults on its loan obligations, the lender remains without any self-help remedies and must obtain court approval through a special judicial proceeding to enforce the pledge agreement. The lender can arrange for amounts received as accounts receivable to be kept in escrow until all of the obligations of the debtor are fully satisfied. The rules applicable to a pledge of personal property are also applicable to pledges of accounts receivable.

Although a U.S. lender will, generally, have few opportunities to increase its protection under the above set of rules, under certain circumstances the lender may employ a trust as a means to strengthen its security interest. A trust might be useful if the debtor is scheduled to receive payments in connection with work to be provided in the future under a specific service or construction contract. To establish the trust, the debtor, lender and a trustee (usually a financial institution) must enter into a trust agreement through which the debtor assigns to the trust all of the debtor's rights to its existing accounts receivable, as well as the debtor's rights to receive future payments pursuant to the contract. If the debtor defaults under the loan, the lender is not required to seek a judicial determination to enforce the debtor's obligations, since the owner of the accounts receivable is the trust itself. Thus, the trustee could pay the lender immediately after the debtor defaults on its obligations.

D. Conclusion

As discussed above, a U.S. lender can obtain a perfected security interest in items such as real property, personal property and accounts receivable in Latin America. The lender must be prepared, however, (i) to use a variety of security devices available in the various jurisdictions, (ii) to forego the U.S. self-help remedies to which the lender may be accustomed in favor of a judicial proceeding to enforce the debtor's obligations, and (iii) to manage the ongoing "perfection process" that may be necessary to maintain a perfected security interest in revolving assets, such as inventory, or future accounts receivable.