Large scale distribution of goods and services requires the availability of reasonably priced credit for manufacturers, producers, wholesalers, retailers and consumers. For borrowers in the emerging entrepreneurial class, access to credit depends on their ability to pledge their productive assets as loan collateral. As a result, a balance must be struck between the debtors' need to use such assets to their fullest income-generating potential and their creditors' need to seize and sell the collateral quickly and inexpensively in the event of default. A legal system which successfully balances these interests will, to the extent allowed by purely economic considerations, keep interest rates at an affordable level.
In the United States and Canada this challenge has been met through legal systems which permit borrowers to collateralize loans by granting creditors a nonpossessory "security interest" in productive assets. Third parties (creditors and purchasers) are protected by the notice provided by a simple filing (or registration). This filing effectively alerts everyone to the acquisition of a creditor's interest in the assets remaining in the debtor's hands. So successful are these nations' systems of filing that thousands of security interests, representing millions of dollars in loans, are registered in Canada and the United States every day. While Mexican law provides various forms of non-possessory liens in personalty, including conditional sales and certain types of pledges, they are not designed for use in a modern commercial setting to finance and secure, for example, a merchant's inventory or his accounts receivable. In fact, registrations of personal property secured transactions in Mexico City, one of the world's largest cities, amount to no more than a handful per day. It is not surprising then that the average cost of commercial and consumer loans in Mexico is often three times higher than in Canada or the United States.
The impact of this credit cost differential on NAFTA's long-term success and on Mexico's ability to develop its internal and external markets is quite significant. For example, how can Mexican small to mid-size businesses compete with Canadian or U.S. merchants who pay much less for their commercial credit? And if commercial credit is prohibitively expensive and unavailable to the Mexican merchant, what credit terms, if any, can he extend to his customers? Finally, how can a Canadian or U.S. investor open a manufacturing plant or a distribution center in Mexico if, as a result of the inadequacies and uncertainties of Mexican secured transactions law, its home bank is unable to secure the loan needed to finance the start-up costs using assets located in Mexico?
A. Cultural Attitudes
Commerce, and especially money lending, were not among imperial Spain's and colonial Mexico's favorite occupations. Mercantile and intellectual endeavors were regarded as typically Jewish or Arab occupations and were therefore under constant scrutiny as to their usuriousness. While popular suspicions toward merchants and moneylenders still abound, many of the imperial and colonial prohibitions and restrictions disappeared once Mexico gained its independence and especially after it enacted the 1917 Constitution. Moreover, Mexico's central banking law has for generations encouraged the extension of commercial and consumer credit through a highly complex system of banking and financial institutions which NAFTA has now opened to U.S. and Canadian lenders. If cultural attitudes are increasingly more receptive to the modernization of commercial and consumer credit, what continues to stand in its path?
B. The Contrasting Legal Models of Securing Transactions
1. The self-liquidating transaction--UCC model
While official attitudes toward commerce and credit have changed in Mexico, the legal mechanisms chosen to implement the central banking policy of making credit more available have largely failed in their mission. To trace the roots of this failure, it is first necessary to understand the function and operation of security devices such as conditional sales and pledges without debtors' dispossession of the collateral, as well as of the public registries where these transactions are recorded.
Mexico's central banking policy, with respect to commercial lending, is the same as the one first introduced by the Bank of England in the 18th Century. This policy drew a sharp line between real estate and commercial lending. The former was associated with long-term loans secured by identifiable, "immoveable" property, i.e., the borrower's land and buildings. Commercial lending, on the other hand, was associated with short-term loans secured by "moveable" and "self-liquidating" collateral, such as crops and raw materials, which are sometimes difficult to identify and constantly change shape and hands, but still provide the means to repay the loan.
This commercial/real property distinction deeply influenced United States central banking policy as well, especially that of the Federal Reserve Act at the beginning of this century. Commercial lending was entrusted mostly to commercial banks and factoring companies. Such loans were collateralized by a seemingly endless variety of "moveable" property: equipment, fixtures, inventory, accounts receivable, equity and debt securities, checking accounts and special deposits, documents of title such as warehouse receipts and bills of lading, intangible property such as trademarks, copyrights and patents, and so on. Real property secured lending was eventually entrusted to savings and loan associations and insurance companies. These loans were collateralized by immoveable property such as land and buildings.
Commercial law implementation of this policy in the United States was carried out by the enactment of the Uniform Commercial Code (UCC) a decade or so after the conclusion of World War ll. This code, on which the Canadian Personal Property Security Act (PPSA) is based, has fostered the development of the world's largest and most active commercial and consumer credit markets. It did so by shaping rules inspired by the following key principles of the contemporary commercial lending marketplace:
2. The Mexican real estate financing law model
Instead of adopting these principles, Mexican law allowed the rules governing real estate secured financing in Mexico to control personal (or "moveable") property secured transactions. Predictably, Mexican secured financing mechanisms have failed in their mission to promote the availability of commercial credit.
One of these real-estate-inspired principles assumes that realty is the most valuable form of property and that any other property is "accessory" or "subsidiary." Accordingly, the "accessory" (personal property and fixtures) follows the fate of the "principal" (real property). Thus, even though creditor A, for example, files a personal property security interest covering fixture X on January 1, 1994, a real property filing on January 15, 1994 involving the premises where X is located will take priority over the earlier personal property filing. The same principle prevents the creation of a security interest in any collateral until the loan has been extended. In this case, the loan is deemed the principal transaction and the creation of a security interest its accessory. This means that a creditor cannot, even with the debtor's consent, ensure the priority of its claim to the collateral by registering its interest before the extension of the credit.
Another principle arising from real property's historical pre-eminence is the assumption that the most protective, and therefore most sought after, right for purchasers and creditors is that of ownership. Several sub-principles flow from the notion of ownership supremacy. One is that the law is much more protective of a purchaser or creditor who is able to exhibit a formal "title" to the collateral, such as a public or private deed of sale, mortgage or entrustment (fideicomiso). Another is that possessory rights are protected only when the purchaser or creditor proves his adverse possession by judicially accepted evidence.
The preeminence of ownership means that he who does not have ownership rights, or who cannot prove that his rights are derived from someone who is an owner, cannot be a party to a secured transaction. Unlike the UCC rule which states that "title to collateral is immaterial," title to Mexican collateral is quite material and must be proven in a historical or chronological fashion.
The implications of this principle as they relate to the operation of a commercial, or personal property, registry are very significant. First, it means that a registration concerning personalty must identify the collateral in detail, much as it does with metes and bounds in real property recordings. In addition, the registry must provide historical information concerning the personal property's chain of title. Obviously, such a registry would be unworkable where the collateral is changing, ephemeral or untraceable such as a department store's inventory, a magazine publisher's accounts receivable, or money on deposit in a checking account.
Consequently, a creditor's right to follow or pursue the economic value of the collateral, or those goods, products or proceeds that replace it, is lost as a result of an inability to prove a continuous chain of title leading to the new collateral or the proceeds. In short, a registry founded on real property law principles must per force be a registry of collateral, regardless of the difficulties in tracing title or in identifying the collateral, and for this reason cannot accommodate most forms of personal property.
In the modern commercial world it is easy to see that the financing of commercial and consumer transactions is done by parties who, according to the principles of Mexican real property law, are not "true" owners. Imagine, for example, the following transaction, which will likely typify the NAFTA trade: A Mexican factory manufactures small refrigerators, but the raw materials and parts are subject to a pledge in favor of its bank in Mexico. Once produced, the refrigerators become collateral for another bank that financed the factory's inventory. Then the factory sells the refrigerators to a distributor in the United States. The U.S. distributor obtains financing for the purchase from its local bank which issues a letter of credit naming the Mexican manufacturer as beneficiary. The U.S. bank requires a security interest in the refrigerators while they are in transit. The distributor-importer complies by having the manufacturer endorse a negotiable bill of lading obtained from the carrier of the refrigerators. While in transit, fifty refrigerators are sold to a retailer who makes a down payment and identifies the fifty refrigerators he purchased. When the refrigerators arrive at a U.S. port, the importer-distributor does not have the money to pay either the carrier's freight or the bank's loan. Who owns the fifty refrigerators? And, regardless of who owns the refrigerators, who can claim possession from the carrier whose freight remains unpaid?
If real property law standards were to apply, it would be very difficult to answer these questions. From a purely possessory standpoint, however, each person in the chain, including the captain of the vessel whose freight remains unpaid, would have a right to the retention or use of the refrigerators, or to the realization of their market value. For the law of commercial secured transactions to succeed, each one of these interests must be acknowledged, prioritized in a rational fashion and required to provide a simple yet effective form notice to other creditors and purchasers.
President Zedillo, while still a candidate, noted the importance of transforming Mexico's real property lending mentality to a commercial lending mentality. In a speech to Durango entrepreneurs he pointed to the need to promote "changes in the commercial bank mechanisms that facilitate loans to small and medium-size firms." President Zedillo added that such loans must be evaluated in light of their commercial feasibility and intrinsic value, and not on the basis of the "real property mortgages that the owner of the firm was able to provide. . ." This is indeed a correct characterization of the problem and a helpful enunciation of policy.
The implementation of this policy requires the enactment of laws providing for the creation, perfection (notice) and priority of security interests in a form likely to attract the widest range of commercial loans at real interest rates comparable to those in Canada and the United States. As proven by the Canadian and U.S. experience, a unitary security interest which contains the common denominator of the creditor's and debtor's right of possession is a much more workable approach than that of security interests predicated upon ownership, or a mixture of ownership and possessory rights.
Accordingly, a security interest in movables (should be characterized in Mexico) as the creditor's right to possession of the collateral based on the terms and conditions specified in the security agreement or by law. As a consequence of the conveyance, in the event of default, the creditor would be able to repossess the collateral, either by peaceful, extra-judicial means, or judicially by means of a truly summary action. Such a creditor would not need to: a) prove the effectiveness of the loan-pledge agreement in court; b) file an action for the recision of the security agreement; c) undergo the procedure for the execution of judgments or of highly liquid rights ("execution" procedures or procedimientos de ejecucion). Predicated upon a valid filing, endorsement of a document of title or acquisition of physical control over the collateral, a secured creditor's action would be possessory in nature and, as such, resemble "possessory interdict" proceedings which are common in civil law countries for the quick preservation or recovery of possession.
Finally, this system should be harmonized with those in Canada and the United States as well as the laws of other countries entering into free trade agreements with NAFTA countries. Harmonization will require not only changes in the respective countries' substantive law but also in their recording systems. The ultimate goal should be an electronic network that would allow a bank in, say, British Columbia, Canada to check, via a remote computer link, the registries of Guadalajara or Monterrey, Mexico prior to considering a loan to borrowers in those jurisdictions or with assets located there.
Thanks in large measure to the work of Professor Ronald Cuming of the University of Saskatchewan and Director of the Secured Financing Project at the National Law Center for Inter-American Free Trade, Canada has become the world's leader in electronic commercial registries. Moreover, current legislative efforts to modernize secured transactions law and filing systems in the United States are moving in the direction of Canada's model. It is hoped that Mexico, as well as other Latin American countries, will soon join that network.