MEXICO’S CURRENT SECURED FINANCING SYSTEM:
THE LAW, THE REGISTRIES AND THE NEED FOR REFORM
MEXICO’S CURRENT SECURED FINANCING SYSTEM:
THE LAW, THE REGISTRIES AND THE NEED FOR REFORM
John M. Wilson-Molina [ B.A., State University of New York at Buffalo; J.D., University of Arizona-College of Law. For suggestions and comments you may contact John Wilson-Molina via internet e-mail at jwilson@Infosel.net.mx]
The United States’ economy is more credit dependent than any other society in the world. The consumer and commercial loans generated, by our credit dependency, fall into two basic categories: secured and unsecured. [ Mark E. Rozkowski, Business Law: Principles, Cases, and Policy at 574, (2nd ed. 1989). In most types of transactions, creditors will prefer to be secured, since secured creditors enjoy "substantial advantages" over unsecured creditors when the debtor encounters financial difficulties. Id. See discussion infra.] As consumers we are more familiar with unsecured loans; although, we frequently engage in both types of transactions. In an unsecured transaction, the creditor lends money, or extends goods or services on credit, but does not obtain an express right or interest in any of the debtor’s property. [ Richard E. Speidel, Et Al., Sales and Secured Transactions at 40, (5th ed.1993); An unsecured creditor has no claim on any specific collateral of the debtor. James J. White & Robert S. Summers, Uniform Commercial Code §24-2 at 112, (3rd. ed. 1988).] Credit card debts, for example, are unsecured. If the debtor fails to pay the credit card debt, the creditor --not having any right to the debtor’s property whether or not it was purchased with the credit card-- would have to sue the debtor in court. [ William B. Davenport & Daniel R. Murray, Secured Transactions at 1 (1978).] Only after suing, obtaining and executing a judgment, will the creditor obtain rights in the debtor’s property. [ Id. In the present case, the creditor would obtain rights in the debtor’s assets only if the creditor obtains and executes a judgment. The creditor would then be obligated to have a court official (usually a Sheriff) seize property of the debtor. Only after these steps have been followed, and the goods sold at a judicial sale, would the creditor be paid from the proceeds of the sale of these assets. Id.]
Alternatively, a secured loan creates a definite right in a debtor’s property; and, in case of default, the creditor can enforce said right against the assets of the debtor. [ U.C.C. §9-102 (1994); A secured loan creates an express interest in property; namely, the right to repossess an asset of the debtor in default and the right to take the asset ahead of other persons with claims against the debtor in question. Richard E. Speidel, Et Al., Sales and Secured Transactions at 42 , (5th ed.1993); Creditors subsequently use part five, §§ 9-501 to 9-507 of the U.C.C Article 9 (1994), which governs the process by which a creditor can convert the property of the debtor into its own. Id, at 75.] Common examples of secured loans, at the consumer level, are car loans and home mortgages. Most car loans are usually secured by an express interest in the vehicle itself, called a security interest. [ Automobile financing is usually accomplished through Purchase Money Security Interests ("PMSI") pursuant to U.C.C. §9-107 (1994). ] Once having obtained a security interest in the car, the creditor can perfect its security interest ensuring an enforceable right against the debtor, and also against third parties. [ Speidel, supra note 2, at 62. A perfected security interest will usually put the creditor in a superior position to other creditors with claims against the same property. Id.] This advantage reduces the creditor’s exposure, reduces the borrower’s interest rate and is a major catalysts to modern lending--incentives which favor securing consumer and commercial transactions alike. [ Rozkowski, supra note 1, at 573-76. As the result of several factors present in commercial financing, the creditor desires more than merely the debtor’s promise to pay. This creditor desires additional security to satisfy the obligation if the debtor defaults, ussually translating into some sort of security interest in the debtor’s assets. Id. at 576.]
In Mexico, however, the legal devices used in secured lending are remains of Roman Law mechanisms not well suited to modern-day financing. [ Boris Kozolchyk, What to Do About Mexico’s Antiquated Secured Financing Law, 12 AZ J. Intl. & Comp. L. (1995).] Therefore, creditors cannot avail themselves of the added confidence provided by a properly functioning secured financing system. [ Id.] This deficiency makes credit in Mexico both expensive and difficult to obtain.
This essay will summarize the essential features of a secured financing system, [ This note will use Article 9 of the United States U.C.C. as the primary example of a secured financing system. However, the note sill integrate elements of the Canadian Personal Property Securities Act [hereinafter "PPSA"], and the European Bank of Reconstruction and Development Model Law on Secured Transactions [hereinafter "EBRD Model"].] examine why secured financing is not common in Mexico, and analyze existing Mexican secured financing law--pointing out the principal strengths and weaknesses of each existing mechanism. The essay will also study how to use present Mexican law to obtain a result closest to that desired under a modern secured financing system. Finally, will analyze the Mexican registry systems, [ Registration, as known in Mexican legal terminology, or filing as it is more commonly known under Article 9 and the PPSA, is a central feature of any secured financing system. Kenneth W. Clarkson et. al., West’s Business Law: Text, Cases, Legal and Regulatory Environment 600-03 (5th ed. 1992); Rozkowski, supra note 1, at 642-54; Speidel, supra note 2, at 136-78. The notice requirement, so that third are parties put on notice of the existence of present security interests, is an extremely important feature of secured financing. John F. Munger, Rights and Priorities of Secured Creditors of Personalty in Mexico, 16 AZ L. Rev. 767 (1974).] pointing out how problems with the Mexican registries --which are heavily concentrated on pure real estate financing and not commercial financing-- can contribute significantly to the inadequacy of the present secured financing regime.
Some commentators suggest that personal property secured financing law in Mexico resembles the U.S. system before the enactment of Article 9 of the Uniform Commercial Code (hereinafter "UCC" or "Article 9"). [ William H. Hawkland, and Alejandro M. Garro, Committee on Secured Transactions: Introductory Note From the Reporters, Academia Puertorriquena de Jurisprudencia y Legislación 3-21 (1989), establishing that most civil law jurisdictions use a complex system of various personal property secured financing mechanisms to achieve poorer results than those accomplished under UCC Article 9. See also Dale B. Furnish, Mexican Law on Secured Transactions, in Doing Business in Mexico § 37.01 (SMU ed., 1987).] This analogy stems from a Mexican system composed of, what these scholars refer to as, a "crazy-quilt" of varying devices. Conditional sales contracts, differing types of pledges, and even mortgages are used in Mexico to accomplish personal property secured financing. [ Id.] These mechanisms are consonant reminders of those replaced by Article 9 in the early fifties. [ Speidel, supra note 2, at 41. Article 9 substituted the un-ending web of secured financing mechanisms developed through ingenious commercial and legal practice with one basic security device and one body of law. Id; See also, Victor Levine, Secured Loans, 1946 A.B.A. Sec. Leg. Ed. Prac. L. Inst. 1-30, defining a vast array of pre-article 9 security devises, including the pledge, chattel mortgage, conditional sale, trust receipt, guaranty, etc. Id. See also Grant Gilmore, Security Interests in Personal Property at 5-250 (1965), and Davenport- Murray, supra note 3, at 3-7 (1978).]
After the great depression, prevailing commercial practices in the United States clamored for a tool which would allow securing commercial loans with personal property. [ The term "Personal Property" is used to indicate assets other than real estate, and will be used interchangeably with the term "Movable Property" throughout this note.] In response, the National Conference of Commissioners on Uniform State Laws and the American Law Institute worked tirelessly on the creation of a body of law permitting personal property security devices; [ Richard Duncan, Et. Al., The Law and Practice of Secured Transactions: Working with Article 9 , at §1.01 (5th ed. 1991).] these efforts were intended to clarify the rules governing secured loans. [ Id.] Initial results gave birth to various acts recognizing and legalizing the commercial practice of securing loans with personal property, in a number of jurisdictions. [ Id. Among these acts we find the Uniform Trust Receipts Act, the Uniform Conditional Sales Act, the Uniform Warehouse Receipts Act, the Uniform Sales Act, the Uniform Bills of Lading Act, etc. Id. See also Gilmore, supra note 15, § 9.1 at 288 (1965): and Speidel, supra note 2 at 48-55. ] The vast array of options available for secured transactions, however, led to common law problems and great diversity in the validity, recognition and enforcement of those devices. [ Gilmore, supra note 16, at 299.] Eventually, exceptions to the general rules multiplied and different States developed varying requirements for complying with the security devices. Needless to say, the law at this point-in-time became extraordinarily complex. [ Duncan, supra note 17, at §1.01[2]. ] The main objective of these acts --to reassure asset based lenders that their transactions on personal property were secure-- was lost in this complex multiplicity of legal mechanisms. [ Id.] Once again, interstate business was confronted with non-uniformity and uncertainty. [ Id; See also Gilmore , supra note 15 at 288.]
Efforts to bring uniformity in this area of law consolidated after World War II and culminated in the 1950s when Article 9 was proposed. [ Duncan, supra note 17, at §1.01[2]. ] Article 9 creates a unitary method for the entire country, [ Gilmore, supra note 15, §10.1 at 295.] whereby all of the previous devices are condensed into a single mechanism: the "security interest." [ Id . Article 9 is a completely comprehensive mechanism which covers every possible secured transaction on personal property. Id.] Article 9 [ Article 9 has not yet been reformed to integrate modern computer technology in the code’s notice sections and is therefore somewhat outdated.] has provided confidence to commercial financiers for almost half a century, and allows commercial lending to take place as we know it today. [ Dr. Heywood Fleisig, Address at Mexico-United States-Canada Meeting on Commercial Relations (Mar. 17, 1995), (audio tapes available at Instituto Catastral y Registral de Sonora [Registry and Assessor Institute of Sonora], Hermosillo Sonora Mexico. Dr. Fleisig was Advisor to the World Bank for private sector lending in Latin America and is now Director od Research for the Center for the Economic Analysis of Law.]
In order to understand what is demanded of the present Mexican legal mechanisms, it is first necessary to understand the main functions of a personal property secured financing system. For this purpose this essay uses a condensed summary of existing secured financing systens including the UCC, the CanadianPPSA and the EBRD Model Law, with special emphasis on six key concepts: 1) the necessity of a charge on after-acquired property; 2) the automatic encumbrance of proceeds; 3) the need for a purchase money security interest: a device that allows a debtor to gain credit even though he has encumbered the entirety of his current and future-acquired assets; 4) the protection of ordinary course buyers; 5) the need for a quick and inexpensive enforcement mechanism; and, 6) the need for proper notice of encumbered assets. [ These six basic concepts are the staring point to an understanding of Article 9, the Canadian Personal Property Security Act and the European Bank of Reconstruction and Development Model Law on Secured Transactions.]
A central feature of Article 9, the PPSA [ The Canadian Personal Property Security Act is closely modeled after UCC Article 9. However, since the PPSA was developed after the advent of computer technology, the Canadian system for giving notice is much more advanced than its UCC counterpart.] and the EBRD Model Law on Secured Financing, [ The European Bank of Reconstruction and Development (EBRD) drafted the model law and proposed its text in 1994. ] provide an automatic extension of the security interest from the original collateral to property acquired by the debtor after the creation of the security agreement. [ U.C.C. §§ 9-203, 9-204(1).] This is important since the lender’s security interest over the original collateral is of little use when this collateral is designed to be replaced in the ordinary course of business--such as in inventory financing. [ Ronald C.C. Cuming, Harmonization of the Secured Financing Laws of the NAFTA Partners, a paper prepared for the Seventh Biennial Conference of the International Academy of Commercial and Consumer Law. Saint Louis University, Saint Louis, Mo., August 27-31, 1994.] Under the UCC and the PPSA, as long as the debtor replaces the original collateral, the lender [ To establish priority over collateral subject to a security agreement, the lender must perfect her security interest. The concept of perfection primarily concerns granting notice to third parties, who might also be interested in obtaining some type of interest in the same collateral. For purposes of this note, assume that filing or registration, although certainly not the only method, is the applicable step in achieving perfection. See, Model UCC, §§ 9-301 - 9-312.] will have a valid security interest in subsequent replacement collateral. [ Cuming, Supra note 29, at 14.]
Under Article 9, the PPSA and, to a lesser extent, the EBRD model, proceeds include whatever is received upon the sale, exchange, collection, or other disposition of the collateral. [ U.C.C. § 9-306 (1). Money, checks, deposit accounts, and the like are "cash proceeds." All others are "noncash proceeds." Id.] This concept allows a security interest to continue in the collateral notwithstanding a sale, exchange, or other disposition, and in any identifiable proceeds received by the debtor. [ U.C.C. § 9-306 (2).] Inventory financing manifests the importance of this automatic extension. As mentioned in sub-section D infra, a secured party’s right in the inventory is subordinated to a buyer in the ordinary course. [ See discussion paragraph D infra.] Therefore, the original security interest grant’s adequate protection to the secured lender only if the interest extends to the proceeds of the sale of the collateral. [ U.C.C. § 9-203 further states that the right to proceeds exists automatically, whether or not a specific provision including proceeds is contained in the security agreement. Id. § 9-203 (3). ] Additionally, the secured party will have a continuously perfected security interest in the proceeds--if the interest in the original collateral was properly perfected. [ Id. § 9-306 (3). However, a security interest in proceeds becomes unperfected ten days after the debtor receives possession of the proceeds unless: (1) a filed financing statement covers the original collateral and the proceeds are collateral in which a security interest may be perfected by filing in the office where the financing statement covering the collateral has been filed, or (2) a filed financing statement covers the original collateral and the proceeds are identifiable cash proceeds, or (3) the security interest in the proceeds is separately perfected within this ten day period. Id.]
As we have seen, a secured lender should have priority over the debtor’s after-acquired property and proceeds. Granting these two rights to the secured party, however, may tie a debtor to credit stemming exclusively from an individual secured lender and potentially limit the debtor’s ability to receive credit from other sources. The PMSI feature alleviates this problem by creating an exception to the principle of prior tempore prior iure, allowing a party second in time become first in right. [ James J. White & Robert S. Summers, Uniform Commercial Code at 1138 (1988). See also, U.C.C. §§ 9-312 (3) - (4).]
The main reason for the PMSI mechanism is that the debtor needs protection from a secured creditor who is unwilling or unable to provide additional funds. [ White, supra note 41, at 1138.] If this debtor is able to procure additional financing for a new line of goods, notwithstanding the prior interest, the PMSI will provide this new creditor with protection over previous secured creditors with respect to the financed goods, without affecting the priority of the previous secured creditor. [ Id.]
A buyer in the ordinary course of business [ See U.C.C. § 1-201.] takes free of a security interest created by his seller even though the security interest is perfected and even though the buyer knows of its existence. [ Id. § 9-307 (1).] This exception is designed to protect consumers who purchase the seller’s inventory, which in turn secures a loan from a creditor, from the secured party’s right to reposess the goods from a third party purchaser . [ See discussion in subsection B supra , explaining the rationale for a security interest in inventory extending to the proceeds of the sale. Thereby permiting the ordinary course buyer to take free of the encumbrance. See also U.C.C. § 9-307 & White supra note 39 at § 24-13.]
A secured financing system must allow for quick and effective methods of execution on the secured property in case of default. Article 9 provides that the creditor may repossess the collateral to satisfy the outstanding deficiency on the loan. Repossession of the collateral may occur through the courts, [ Repossession through the court system is often expensive and time-consuming and is thus seldom used.] or through "self help" repossession. [ U.C.C. § 9-503. Self help repossession under the UCC is authorized only if it can be accomplished without a "breach of the peace," which generally occurs if the debtor protests, the creditor breaks into the debtor’s property to get the collateral or if the creditor uses actual or constructive force while repossessing.] Once the secured party has possession of the goods, the secured party may elect either resale or strict foreclosure. Strict foreclosure consists of keeping the collateral and abandoning any deficiency claim. [ U.C.C. § 9-505, official comment 1. In case of consumer goods U.C.C. § 9-505 establishes that if the debtor has paid sixty percent of the sale price, the secured party may not retain the consumer goods in lieu of the debt.] If the secured party chooses resale of the goods, the resale must be commercially reasonable. [ U.C.C. § 9-504. The proceeds obtained from the sale shall be applied first to the reasonable expenses caused by the repossession and the sale of the goods and then to satisfy all secured debts in order of priority. Id.] Additionally, if on default the collateral consists of accounts receivable or instruments, the secured party simply notifies the obligors to make payment directly to her. [ U.C.C. § 9-502.]
A secured financing system must provide notice of the rights created in encumbered collateral. If proper notice is not provided, subsequent purchasers or lenders may believe that the debtor’s goods are free and clear of encumbrances; and, relying on the lack of notice, they may purchase or lend against the collateral. The most effective method for avoiding this problem is providing notice by the filing a financing statement at the proper location. Under Article 9, the filing objective is generally satisfied by requiring that a secured party be perfected before such party can claim priority over competing claimants (purchaser or subsequent secured parties). A secured party will be deemed perfected when the security interest has attached and all applicable steps for perfection have been taken. [ U.C.C. §§ 9-303(1), 9-203 (1) and (2). Bradford Stone, Uniform Commercial Code at 386 (1995). The steps to be taken in order to achieve perfection are: 1) filing a financing statement pursuant to U.C.C. § 9-401 et. seq. U.C.C. § 9-302(1), 2) filing or registration pursuant to statutes other than the U.C.C. (for example, State certificate of title acts or statutes or treaties of the United States), 3) taking possession of the goods (for example in case of a pledge), 4) in some cases, such as in the case of consumer goods, the security interest is perfected automatically and no further steps are necessary to achieve this objective.]
In Mexico, a combination of factors influence the resistance to change in secured financing law. For example, capital is relatively scarce, the existing law does not satisfactorily secure loans on personal property, economic driving forces are only now requiring greater inflow of capital, and cultural values have often impeded borrowing except on real property. [ Alejandro Garro, Security interests in Personal Property In Latin America: A Comparison With Article 9 and a Model For Reform, 9 Hou. J. of In't'l L. 157 (1987); Kozolchyk, supra note 9, at 2-5.] It is therefore easy to understand why, up ‘til now, the Mexican lending community has not pursued personal property as valuable collateral for commercial loans. However, the North American Free Trade Agreement (hereinafter "NAFTA") [ North American Free Trade Agreement [ Tratado de Libre Comercio de America del Norte ], Dec. 17, 1992 Can-Mex-US, 32 I.L.M. 289 (hereinafter referred to as NAFTA).] has propelled Mexico into an era of increasingly sophisticated economic demands, [ Laura Patterson, A New Era Under Free Trade , The Christian Science Monitor, Dec. 12, 1993, p.13.] requiring increasingly sophisticated economic laws.
Mexico’s current laws and registry system are ineffective and contribute to scarcity and unreasonable rates for commercial credit. [ Fleisig, supra note 27; Kozolchyk, supra note 9, at 2. The average cost of commercial and consumer loans in Mexico is often three or more times greater than in Canada or the United States; Id.] The possible impact this disparity can have is of paramount importance. Under the NAFTA, Mexican enterprises will be competing on an equal basis with U.S. and Canadian enterprises which have access to cheap and more abundant credit, putting the Mexican enterprises at a competitive disadvantage. [ Kozolchyk, Supra note 9, at 2. The impact of this credit cost differential on the NAFTA’s long term success and on Mexico’s ability to develop its internal and external markets is quite significant. For example, small to mid-sized businesses in Mexico will not be able to compete with Canadian or U.S. enterprises who pay much less for their credit. Id.] Part of the reason that credit is cheaper for U.S. and Canadian companies is that--in cases where a mortage or a personal gurantee is not viable--lenders can secure their loans with the debtor’s personal property, [ John E. Rogers & Adrian Z. Arriola, Reforming the Lending Policy, Business Mexico, Jan./Feb. 1995, at 1; Fleisig, Supra note 27.] reducing exposure to extensive loss upon default. [ Id. The price of a loan is determined by its own risk. Therefore when the risk is reduced, so is the price of the loan. Id.; In the U.S. security interests in personal property are obtained through Article 9 of the UCC, and In Canada they are obtained through the Personal Property Security Act (PPSA).]
A system that does not have the legal mechanisms, for creating and enforcing security interests on personal property efficiently, will have higher interests rates to compensate. [ Rogers, Supra note 46, at 1. In Mexico, the higher risks in creating and enforcing liens has a direct effect on the interest rate of the loan. Id.] Therefore, credit rates will be more expensive in Mexico because the legal system does not allow for loans secured with personal property [ Fleisig, Supra note 27.] with the same efficiency as the other NAFTA partners. [ See, generally, Furnish, Supra note 13; See, also, John F. Munger supra note 12.] Mexican companies are therefore competing with a hand tied behind their back if they do not have access to cheaper credit. [ Kozolchyk, Supra note 19, at 1.] Conversely, if Mexico adopts a satisfactory secured financing law, it is predicted that the country’s GDP can increase by two percent or more. [ Fleisig, Supra note 27.]
As previously mentioned, in Mexico we are confronted with a virtual smorgasbord of secured financing mechanisms to choose from. Choosing among these, however, may cause indigestion--especially if we choose the wrong one. The devices available under Mexican law include the Civil Pledge, the Civil Pledge Without Dispossession, several Commercial Pledge variations including a Bailment Pledge, Avio and Refaccionario Pledges, Banking Pledges, Pledge of Invoice, as well as Consignments, Conditional Installment Sales Contracts, Mortgages, Industrial Mortgages, Financial Leases and Guarantee Trusts.
The commercial pledge [ Ley General de Titulos y Operaciones de Credito [General Law of Instruments and Credit Operations, hereinafter "GLCIO"] art, 334 (i)-(vii).] closely resembles the Roman Pledge which traditionally requires that goods securing a loan be delivered to the lender. [ Id. arts. 334-346 (1994). The civil pledge, used in consumer transactions, allows the lender to retain an interest in the pledged property while the debtor retains possession, through registration. However, anything less than actual delivery is not recognized in commercial pledges. Torres Oscar , Semanario Judicial de la Federacion V Epoca, Tomo CXIII 943, Sept. 29, 1952. See also, Furnish, Supra note 13, at 37-04.] This type of credit works well in situations where the debtor, in an effort to raise capital, is willing to relinquish possession of the goods. [ Jose Maria Abascal Zamora, Consideraciones Acerca de la Posesion de los Bienes Muebles en la Prenda, at 16 [Considerations Concerning Possession of Pledged Personal Property], Boletin Mexicano de Derecho Comparado , Nums. 40, 41 y 42, UNAM Instituto de Investigaciones Juridicas. ] It is easy to see that there would be no great inconvenience wrought by dispossession when the pledged goods are leisure or luxury items--such as jewelry. [ Id.] However, a traditional pledge [ The traditional pledge dates back to Roman law. The pignus, or delivery of possession to the lender was the only possible way of constituting a pledge. Munger, Supra note 12, at 782.] will not work when the debtor must retain possession of the goods to continue commercial operation. Therefore, when pledged goods are necessary for the livelihood of the debtor, delivery of possession to the creditor will impair the debtor's ability to conduct business and therefore hinder her ability to repay the loan. [ Alejandro Garro, Security interests in Personal Property In Latin America: A Comparison With Article 9 and a Model For Reform, 9 Hou. J. of In't'l L. 157 at 172 (1987).]
For example, in the financing of inventory and equipment, it is imperative that the debtor retain the goods for use and sale. Therefore, it is necessary to overcome the problem presented by this inherent dispossession. [ Id.] To achieve this, we find some exceptions used by lenders to set up non-possessory security interests in personal property. [ Furnish, Supra note 13, at 37-14.] Furthermore, when these legal mechanisms fail, ingenious lawyers attempt to manipulate and interpret existing law to best accommodate their secured financing needs. [ This assertion comes from observing numerous pledge and conditional sales contracts drafted by different law firms in Mexico. Such contracts, take the language in the applicable codes and attempt different interpretations in order to achieve personal property secured financing. For example, one contract attempts the registration of a commercial pledge, even though the relevant provisions do not provide for such registration. Another contract takes language in the code providing for a third party depositor for the pledged goods, and grants possession of the goods to an officer of the debtor enterprise. These contracts are taking ambiguous language or omissions in the law to attempt commercial lending secured by personal property.]
The special regime of avio and refaccionario credits [ GLICO, supra note 55, arts. 321-333.] establish a significant exception to the traditionally required dispossession. [ Furnish, Supra note 13, at 37-17.] However, these loans are limited in scope and application: "they are especially designed to be used by production enterprises." [ Cervantes Ahumada, Titulos y Operaciones de Credito [Instruments and Credit Operations] 286 (1986). This limitation seems excessively restrictive to many practicing attorneys. For example, in inventory financing it would be impossible to use either the avio or refaccionario mechanisms, since nothing is produced. However, interviews with several Mexican lawyers engaged in commercial financing shows that in practice these types of credits are frequently used in non-production enterprises . Some scholars allow for this same interpretation by taking a broad all-encompassing view of production enterprises; arguing that what is produced is the sale. Rodrigez y Rodriguez.] The historic purpose of these loans was financing start-up costs, and continuation of operations of agricultural and mining enterprises. Refaccionario credits are used to prepare the enterprise for production, while avio loans are used for the "immediate process of production." [ Ahumada, supra note 65, at 286]
1. Traditional Use of Avío and Refaccionario Loans
There is some difference of opinion as to whether the avio and refaccionario mechanisms are in fact limited to production enterprises. Some scholars propose that this limitation is obsolete and not valid, while others prefer the traditional more conservative approach. [ Rodriguez y Rodriguez, supra note 65.] It is therefore important when attempting to finance non-production enterprises, such as inventory based sellers, to establish whether it is legally possible to use these mechanisms in creating a secured loan.
Under the traditional approach, the underlying purpose for refaccionario loans is financing the start-up costs of an agricultural or industrial enterprise, including the financing of construction costs and financing the purchase of equipment and machinery. [ GLCIO, supra note 55, art. 323 (1994). Refaccionario loans may also cover financing tax liabilities, administrative expenses, or previously incurred expenses, as long as these have been incurred no longer than one year from the execution of the contract. Id.] Avio (or Habilitacion) loans finance the continuation of an agricultural or industrial enterprise already operating or ready to begin operations. [ Ahumada, supra note 65, at 289.] The use of avio loans is limited to the acquisition of raw materials, salary payments, and direct indispensable business operation costs, [ GLCIO, supra note 55, art. 321.] and must be applied to the direct and immediate process of production. [ Id.] Payment of both these loans was to be immediately upon the harvest, exploitation of the mine, or sale of the manufactured goods, [ Id. at 286 .] and may presently require complete repayment upon the sale of each generation of goods.
In order to illustrate the difference between the avio, which is applied to the immediate process of production, and the refaccionario loan, which is applied to the preparation, it may be helpful to resort to examples: 1) The owner of an agricultural enterprise requires capital for digging irrigation canals, and preparing the lands for planting. This requires a refaccionario credit since it will be used to prepare the land. However, once the land is ready for production, the borrower will require an avio credit to purchase seeds and labor for the actual farming; 2) In order to prepare for the production process, the owner of a shoe manufacturing industry requires a refaccionario loan for the acquisition and installation of machinery. Once the machinery is installed, the debtor will require an avio credit for the purchase of raw materials and payment of salaries.
2. Monitoring Requirement
When using these mechanisms, a lender is required to oversee that the loan is used for the precise purpose stipulated in the loan agreement. The law establishes that if the funds are used for a purpose not expressed in the loan agreement, the lender risks losing its security interest against the borrower and third parties. [ GLCIO art. 327.] Therefore, in each of the examples provided above, it would be incumbent on the lender to ensure that the avio loan proceeds be utilized precisely in the production process, while the loan proceeds from a refaccionario credit be used only in the preparation for production.
3. Notice
Irrespective of the traditional notion of the pledge, the avio and refaccionario mechanisms allow the debtor to retain possession of the goods purchased with the loan. The GLCIO expressly provides for debtor's retention of possession, [ GLCIO, supra note 55, at art. 329.] since the debtor will be considered the "judicial depository" of the items pledged. [ Id.] In addition, the avio and refaccionario mechanisms require a recording before the Public Registry of Property and Commerce; [ Id. art. 326. See registry discussion in section VI infra.] and the pledge will be valid against third parties only upon registration, and only from the hour and date of such registration. This feature closely resembles notice provisions contained in Article 9, the PPSA and the EBRD Model. [ Id.]
4. Proceeds vs. Frutos y Productos
Under the Commercial Code, avio credits are secured with the raw materials, acquired materials, and with the fruits and products obtained with the loan, even when these are future-acquired or pending. [ Id. art. 322.] Refaccionario credits are secured with the real property, machinery, instruments, movable goods, and with the fruits or future products, pending or obtained. [ Id. art. 324.]
It is not clear that the "fruits and products" wording of the Mexican Commercial Code is meant to encompass proceeds, as this term is understood under Article 9 or the PPSA. [ Under model UCC § 9-306, "proceeds" includes whatever is received upon the sale, exchange, collection or other disposition of collateral or proceeds. See discussion of proceeds, section III (B) supra.] Taking into consideration the wording, and the historical context of the avio and refaccionario, it may be possible that "fruits and products" is limited to actual physical conversion of the original collateral (e.g., the transformation of apple seeds into apples), and does not encompass other types of transformations of the collateral (e.g., the transformation of inventory into accounts receivable).
For example, it is known that copper ore can be the direct product of an avio loan for the purchase of dynamite and the labor used to extract the ore. However, the question would be whether the encumbrance would extend to the cash or accounts receivable generated by the sale of the ore? The planting and harvesting of cotton provides another example of the problem. Cotton can be the direct fruit of avio and refaccionario loans for preparing the field and the purchase of seeds. Again, the question is obvious--will the cash and accounts receivable, and even garments produced with the cotton, be considered fruits or products of the loans? The answer to these questions is not very obvious under Mexican law. We should keep in mind that reform in this area of the law could clarify this matter if it integrates the features of a secured financing system discussed in section III of this essay.
5. Priority
In terms of priorities between the avio and refaccionario credits, article 328 of the GLCIO establishes that properly registered avio pledges have priority over refaccionario pledges; and both have priority over subsequently registered mortgages. [ GLCIO, supra note 55, at art. 328.] The law also establishes that an avio or refaccionario lender will have preference over all subsequent creditors, with the exception of dominion creditors and previously recorded mortgage creditors. [ Id. art. 333.] The preference established will not be extinguished by the transfer of possession, of the pledged goods, to a third party. [ Id.] It is therefore important to recognize that avio and refaccionario credits will not function in the same manner as a purchase money security interest, as described in section III (c) of this essay.
As previously discussed, the historical use of the avio and refaccionario pledges has been exclusive to production enterprises. It would therefore appear that sale and distribution of goods at the wholesale or retail levels could not be financed with these mechanisms. However, as mentioned above, some Mexican attorneys have used these types of credits for inventory financing. This raises problems of whether the priorities and securities created under the refaccionario and avio would be upheld in litigation. [ The Supreme Court has sometimes held that avio and refaccionario pledges, constituted over non production enterprises, to be valid. Directo 2293/1954. Ma. del Refugio Alvarado (1956).]
1. Non-possessory Pledge:
Mexican attorneys use Article 334 subsection IV of the GLCIO, to create a non-possessory pledge in favor of a lender. [ Jorge Barrera Graf, Tratado de Derecho Mercantil [Merchantile Law Treatise] (1977), at 331.] This type of transaction requires that the debtor give possession of the goods to the lender, at least symbolically. [ GLCIO, supra note 55, art. 334(IV).] The lender, in turn, chooses a depository for the pledged goods. [ Id.] When the transaction requires that the debtor retain possession of the goods, the lender will designate the debtor, or an agent of the debtor, as the depository. This type of operation works, for example, when a bank (lender) provides a loan to a business enterprise (debtor) for the purchase of goods. The debtor then pledges the goods to the lender as security for the debt. Since, however, it is necessary for the debtor to retain possession of the goods --for use or sale in the business enterprise-- an arrangement confined to these parameters will not work. Therefore, under the provisions of subsection IV of Article 334, the lender chooses someone with close ties to the debtor as depository for the goods--usually either the president, or owner of the enterprise.
A problematic issue raised by this transaction is that article 334 IV expressly requires that the goods be at the disposition of the lender. The language and structure seem to indicate that the depository mentioned is to be some type of warehousing agreement where the lender designates a party or business to keep the goods given in pledge until the debt is cleared. [ Mantilla Molina, Derecho Mercantil [Mercantile Law] (1970).] This proposition may be confirmed by the content of subsection V of the same Article. [ Id.] Here the code requires that when the goods given in pledge to a lender are to remain in an establishment of the debtor, such goods must be at the disposition of the lender (as in Subsection IV), and the keys to the establishment (or of a field warehouse) were the goods are located must be surrendered to the lender. [ GLCIO, supra note 55, art. 33(V).]
The language of the two aforementioned subsections raises the question: whether the goods are really at the disposition of the lender when the depository is, for all practical purposes, the same person as the debtor? An extension of this problem is: whether the goods can be considered at the lender's disposition, not only when she does not have actual possession, but also when the debtor intends to use and in many cases dispose of the goods given in pledge? The answer to these questions is not clear and may therefore limit the use of this non-possessory device.
2. Filing Requirement:
Further indications that these provisions are not intended for the creation of non-possessory pledges are found in the Commercial Code. The Code follows the traditional dispossession method and does not expressly require the registration of a pledge [ Id. arts. 334-346. An exception to the non-registration rule is found in the Avío and Refaccionario credits discussed in §V(B) Supra.] considering that the lender would usually have actual possession of the pledged goods, and would not need to give notice to third parties via registration. [ Munger, Supra note 12.] However, many Mexican lawyers go beyond what appears to be the intent of the Commercial Code and imply a common-usage registration. It is argued that even though the Commercial Code does not require registration, it is so widely understood that in order for a non-possessory pledge be valid against third parties, the pledge must be registered in the Public Registry of Property and Commerce. [ The commercial code allows the use and custom to be recognized as lawful avenues for the creation of law. GLCIO, arts. 2, 11, 308.]
A possible explanation, for the acceptance of the registration principle in the Commercial Code, is that the Civil Code requires registration for pledges granting the lender judicial [ Real possession entails that the lender have the goods at her disposal. Judicial possession is established when the lender and the debtor agree that the goods be at the disposal of a third party, or when the goods are left at the disposal of the debtor. Codigo Civil para el Estado de Sonora [Civil Code for the State of Sonora], art. 3200.] possession. It can be argued that if the Commercial Code is used to create a non-possessory pledges, emulating those possible under the Civil Code, then this use adopts the Civil Code filing requirement through the principal of customary usage. [ Rodriguez, Supra note 65, at 20. Customary usage may be as effective for creating law as any other form. In Mexico there seems to be the possibility of creating law, at least in this narrow area of secured financing, through usage. It is logical that in order for a non-possessory pledge to be effective against third parties it must be registered. And, even though, there will always be uncertainties because this requirement is not established by the Commercial Code, most Mexican attorneys feel confident that registration is required by this principle. Id.]
The fact that the Commercial Code does not, at least expressly, require that pledges be recorded creates a series of problems. There exists the possibility of a valid non-possessory pledge in the form of a secret lien. Additionally, one can foresee cases where the legitimacy of a creditor's priority may be attacked on the basis that, since it is not required, a customary-usage registration is invalid.
3. Proceeds:
Article 335 of the GLCIO establishes that in rem rights of the pledge will follow the pledged good, even when the item is substituted for other goods as long as the substitutes are of the same quantity, quality and species as the original goods. Arguably, this provision could be analogized to the proceeds provisions of Article 9 and the PPSA, and some lawyers have taken this position. It is doubtful, however, when AZTECA S.A. de C.V. (a fictional debtor) sells copper ore on credit, that copper ore and cash or accounts receivable will be considered of the same species as the ore. Furthermore, it would be unwise to believe that article 335 of the GLCIO provides for a security interest in generations of collateral subsequent to the original goods. Especially since, this provision does not cover replacement collateral in the wide encompassing fashion that UCC Article 9 would. [ The avio and refaccionario pledges may be exceptions to this. Although the language and historical purpose of these loans may limit attachment to products and not proceeds.]
Article 335 may, however, become a very important provision in inventory financing. This provision provides that the secuurity interest attach from one set of goods to another set of goods if they are fungible or of the same species. [ GLCIO, supra note 55, art. 335.] For example, AZTECA (our debtor) sells copper ore --pledged in favor of the non-possessory lender-- and, after this sale, AZTECA replaces its inventory with similar copper ore. In this case, Article 335 may be a mechanism by which a lender may create a floating lien on inventory. However, the question of whether this mechanism can be used to attach to the proceeds of the sale of inventory, remains doubtful.
Additionally, it is not clear what happens between the period of time when the good is converted into cash and the cash reconverted into inventory. For example, AZTECA sells the copper ore and receives cash. This enterprise then takes the cash to purchase additional copper. It appears that under these facts, once the copper sold by AZTECA in the first instance is replaced with the new copper, the pledge extends to this later good. However, it is not clear whether the creditor has any right over the cash before the purchase of the new copper, or whether the lender has a pledge, at all, when the original copper ore is never replaced.
Some Mexican lawyers argue that the definition of fungible is very broad, and that as long as the original collateral and the second good have the same replacement monetary value, they will be considered fungible. [ Instituto de Investigaciones Juridicas, Diccionario Juridico Mexicano.] Even though it is widely accepted that color televisions and accounts receivable are not of the same species, they may be considered fungible if they have the same debt covering value. [ Article 763 of the Civil Code for the Federal District of Mexico states, Movable goods are fungible is they can be replaced by others of the same species, quality and quantity. Movables will be considered fungible if they have the same debt liberating power ("poder libratorio"). This means that if good # B will pay or secure a debt to the same extent as good # A, it will be considered fungible, if it is of the same quantity, quality and species.] In practice, contracts are drawn with provisions that appear to encompass proceeds from the sale and use of the original collateral. [ This assertion stems from the examination of dozens of commercial contracts, from various Mexican law firms.] However, it seems that the provisions of law used to validate these procedures are unclear at best, and at worst scenario not intended for the purpose.
4. Description of the Goods:
As mentioned before, non-possessory pledges are recorded for priority over third parties even though the law does not expressly require or authorize such action. However, when registering pledges in general, we are confronted with a very strict and specific description of the collateral. [ GLCIO, supra note 55, art. 337.] This provision requires a declaration expressing receipt of the goods given in pledge, including the data necessary for their identification. [ Id.] This requires a description that identifies the good given in pledge in an "indubitable" manner, and has been compared to pre-UCC serial number test for identifications.
Such a detailed description may render the pledge unworkable for creating the floating lien described above, and raises questions as to whether we must identify all goods, over which the lender has a pledge, at the time of registration. For example, AZTECA engages in the sale of appliances. For this purpose, AZTECA receives a loan from a lender BANCO for the purchase of inventory. BANCO, in turn, wishes to secure the debt with a bailment pledge. Under this scenario, the parties could create a contract whereby AZTECA retains possession by having Cuauhtemoc (AZTECA’s president) named depository of the pledged goods--which will remain at AZTECA’s place of business. Additionally, the parties to this transaction would want to avail themselves of article 335 so that replacement inventory, of the same appliance species, would be automatically encumbered by the pledge.
However, we are confronted with the indubitable identification requirement that the serial number of the appliances be registered. Therefore, when AZTECA sells an appliance with a particular number, the registration covering this item will no longer be valid. [ Article 337 only mentions this specificity requirement for subsections I, II, III, V and VI of Article 334, and may be another reason for the use of subsection IV for the creation of non-possessory pledges.] Therefore, for the pledge to attach to the proceeds, the original registration must somehow identify the collateral at the outset. If not, third parties will be unable to verify the encumbrance over replacement goods or proceeds; unless the registered instrument is continuously amended to reflect the serial numbers of the replacement goods. [ The practical dificulties for registration will be analyzed in § VI infra of this essay.] Therefore, the lender with not have priority over third party lenders and purchasers in reference to the second (or subsequent) generations of the original collateral.
Yet another method for creating a non-possessory pledge is outlined in Article 69 of the Law of Credit Institutions. Here it is provided that a pledge may be granted by a Mexican banking institution, [ Under the national treatment provisions of the NAFTA, this privilege must be extended to U.S. and Canadian banks within fifteen years of the treaty’s inception.] for the acquisition of durable consumer goods. [ The definition of durable consumer goods is not clear. The apparent definition encompasses goods that are not consumed by ordinary usage. Under Mexican law there does not appear to be a bright line rule governing characteristics of the goods or the length of time that they must last. Rodriguez, supra note 65, at 331.] This type of pledge requires that the invoice, [ Retention of the invoice appears to reserve title for the lender. Rodriguez, supra note 65, at 331.] which must be annotated with the proper descriptions, [ The annotation is required to say that the goods are reserved in title of the lender. Id , at 335.] be delivered to the lender. Upon completion of these requirements, the goods will be at the control of the debtor as depository. [ Law of Credit Institutions, art. 69.] Under this Article, the lender may not contest the debtor's possession of the goods as long as she is complying with the loan agreement. [ Id.] However, in case of default, the lender will automatically be allowed to repossess under a summary judicial mechanism. [ Id. This procedure is referred to as a Jucio Ejecutivo Mercantil.]
1. Limited to Mexican Banks:
A limitation to the Article 69 pledge is that its use is reserved exclusively for Mexican banking institutions. This requirement prohibits sale creditors or asset based lenders from creating a non-possessory pledge in this form, limiting them instead to the use explained above under article 334 of the GLCIO. The distinction is significant because Article 69 creates a pledge mechanism that legally authorizes the non-possessory pledge. This new mechanism would eliminate the problems that may be inherent in trying to validate a non-possessory pledge under the principal of common usage. [ See, supra § V A. See also supra notes 94-96, and accompanying text.]
2. Secret Lien:
Article 69 of the Law of Credit Institutions, like article 334 of the GLCIO, has no provision requiring the registration of the pledge. [ See, these provisions generally.] This is a curious problem since this Article expressly creates a non-possessory pledge, and it is understood that in order for the lender to have priority against subsequent lenders and purchasers, the pledge must be registered in order to avoid the creation of a secret lien. Therefore we encounter the problems mentioned before, concerning whether registration must in fact be carried out, and whether such registration is valid. [ See, Supra § 5V A.]
The first paragraph of Article 69 states that these pledges must be constituted in the same manner provided for in the GLCIO. Many feel that this provision necessarily confers the common usage registration requirement of the Civil Code and then transferd to Article 334 upon Article 69 pledges. However, it is also possible that the common usage registration requirement extends to all non-possessory pledges, and would do so regardless of the above provision.
Another possibility is that, since the lender retains title through the annotated invoice, there is no need for registration. [ For additional concerns that might lead to decide not to register, see, infra § VI and accompanying text.] However, this raises the additional concern as to whether the third party lender or purchaser must ask for the invoices of any goods in which she may want acquire interest. [ Mexican case-law gives no legal significance to the invoice. Therefore, it is curious that Article 69 of the LIC attempts to use retention of the invoice in lieu of filing notice.]
Article 67 of the LIC provides a mechanism which creates mortgage-type rights on personal property. However, this mechanism has two major limitations. The primary problem is that the use of the industrial mortgage, like the banking pledge, is limited to financial institutions. That is to say, asset-based lenders, equipment and inventory wholesalers, and other possible lenders will not be allowed to utilize this specialized mechanism. A second problem is that the industrial mortgage stems from the traditional concept of a real estate mortgage. Therefore, a loan secured by an article 67 mortgage is usually expected to be secured primarily with real property.
1. Security Interest:
The provisions of Article 67 provide that the industrial mortgage will encumber the "complete unit" of an industrial, agricultural or service enterprise. In summary, the law provides that the mortgage will extend to all assets of the firm including the concession or license, or both, as well as all real estate and personal property utilized by the enterprise in its operations. Additionally, the mortgage may also encumber all money in the current account and the firms’ accounts receivable and all credits in its favor originated by the business operation.
2. Non-Possessory Feature:
The industrial mortgage provides that the encumbrance over the assets of a firm shall not prejudice this firm’s ability to use, dispose of and substitute the assets of the firm in the ordinary course of business. Additionally, authorization for such disposition from the lender will not be required, unless expressly convened by the parties in the loan document. Furthermore, the lender or mortgagee under this Article must permit the operation, use and exploitation of the assets in accord with the expected ordinary use of each. When dealing with a service oriented enterprise or a public service concession, the mortgagee must permit the disposition of the assets which permits the most efficient rendering of the services performed. However, under this law, the mortgagee can oppose the sale or additional encumbrance over the assets and can oppose mergers with other companies if such action will jeopardize the security of the mortgage.
3. Must the Mortgage Include Real Estate:
Even thought the industrial mortgage must include all assets of an enterprise, it is not absolutely essential that the mortgage include real property. (Although we should keep in mind that currently most of these mechanisms do encumber real estate.) The industrial mortgage without a lien on the real property would most likely occur in two different scenarios. For example, let us assume that AZTECA S.A. is financing its operations with an industrial mortgage from BANCO. Let us further assume that AZTECA does not own the real property in which the enterprise is located, and instead is leasing its facilities. In this case, the parties could still engage in a valid industrial mortgage. However, instead of procuring a lien over the real property on which the enterprise is located, BANCO would encumber all of AZTECAS’s movable assets and accounts. In terms of real estate, the lender would only encumber the leasehold interest.
Under a second scenario, let us assume that AZTECA S.A. owns the real property subject to an existing and perfected real estate mortgage in favor of BANCO DOS. However, AZTECA attempts to obtain additional funds from BANCO in order to finance its operation and start-up costs. Under this fact pattern, an industrial mortgage between AZTECA and BANCO would be possible. However, it would be advisable to obtain a valid subordination agreement from BANCO DOS, agreeing to renounce all rights on the firm’s movable and intangible assets. This is especially important considering that often times true real estate mortgages glom-on to moveable assets of the debtor, even those that aren’t incorporated as fixtures but merely located on the premises encumbered by the real estate mortgage. Realistically though, considering lending policies under Mexico’s current economic struggles, it would be difficult to find a bank which would subordinate and take a secondary position over an asset of its debtor. However, if the value of the real estate secures the mortgage so that the primary mortgagee bank feels properly secured, a subordination agreement may be possible.
Additionally, a borrower may have trouble keeping current on its mortgage payment because of income problems. Assuming the bank will not benefit from foreclosing, it may be advantageous for the bank holding the real-estate mortgage to subordinate to a second bank in order to bring in new capital. This action may allow the debtor to solve cash-flow problems and therefore keep current on the original mortgage.
F. GUARANTEE TRUST
The Fideicomiso de Garantia ("guarantee trust") is composed of what we could call two separate elements. One is the trust or the fideicomiso itself, and the other is the security mechanism. The trust is generally formed according to general principles of mexican trusts law and the security device used is generally a mortgage-type interest in real estate. However, the security device may also include, to a lesser extent, personal property.
1. The Trust in General:
In general terms, in Mexico, much like in other common and civil law countries, the trust mechanism can be used in many different ways. Some scholars have stated that the trust concept is limited only by the imagination of the legal profession. The only legal limitation is established in the GLCIO Article 346 which states: "The trust is limited only to a determinable lawful use." Other scholars have stated that the trust has no intrinsic purpose itself. Instead, this mechanism is relegated to effectuating a second purpose which can be separated from the trust itself. [ Carlos Felipe Davalos Mejia, Derecho Bancario , at 409]
The parties to a fideicomiso de garantia include: 1) the Fideicomitente-- debtor/trustor; 2) Fideicomisario--lender/beneciary; 3) Fiduciario--Trustee which will always be a Mexican financial institution.
In general, under the guarantee trust, the trustor secures the preferential payment of a loan. The fideicomiso de garantia is created by transfering the legal title (el Dominio) from the trustor to the trustee. Subsequently, if the trustor defaults on the loan, the trustee will be obligated by the trust intrument to sell the colatteral and pay the beneficiary. Any residual amount must be returned to the trustor. However, some trust mechanims establish that upon default, title to the trust property reverts automatically to the benefiary, who will enjoy full use of the property. Furthermore, this mechanism can be used to guarantee obligations other than repayment of a loan, such as timely delivery of shipment, the return of a negotiable intrument etc.
2. Enforcement:
The main benefit to the fideicomiso de garantia is that it is possible to execute on the collateral without having to resort to the judicial system, at least theoretically. To this effect, case law establishes that, given the legal nature of the trust, judicial intervantion is not necessary in the enforcement proceedings. As mentioned, the trustee is the legal title holder to the goods and is entrusted with realization of the expressed obligations and rights of the parties. (Fideicomiso, no es necesaria la intervencion de un organo jurisdiccional para la realizacion del fin, A.D. 45/77, informe 1977, segunda parte, pag. 36). A similar case states that since the guarantee trust transfers title of the goods to the trustee, this party is obligated to sell the goods when the trustor or third party defaults on the underlying obligation. Furthermore, the proceeds of the sale will be used to pay the beneficiary. (Fideicomiso en Garantia, concepto de, A.D. 45/77, Sala Auxiliar, septima epoca, vol. semestral 97-102, septima parte, pagina 107).
In summary, the guarantee trust is a practical alternative in this respect to the real estate mortgage --or perhaps even other personal property security devices-- since it bestows upon the trustee the power to execute on the security. However, the parties must expressly establish this execution power in the trust instrument in painstaking detail.
At first glance, it appears that the guarantee trust is a device which reduces court involvement in the repossession and sale of the collateral. However, in reality, the trust has created more litigation than one would anticipate, and is at times more difficult, expensive and time consuming than repossession via the Juicio Ejecutivo Mercantil. For example, the trust may undergo a legal analysis in the courts to determine whether this provision was voluntarily agreed upon by both parties, or whether it was a provision of adhesion (similar to an unconscionable contact analysis under U.S. law). [ Commercial Code , Article 78.] Furthermore, Dr. Davalos Mejia postulates three theories for this unanticipated litigation: 1) the issue of whether the guarantee trust is a legal purpose as proscribed by Article 346 of the GLCIO; 2) the issue of whether the guarantee trust is a mechanism which can transfer legal title or whether it only transfers temporary title; and, 3) the issue of whether it is possible for the trustee to act as a judicial body when it is not.
3. Security Device:
Most of the transactions involving a guarantee trust entail the use of real property as collateral. However, this does not expressly exclude the use of personal property as security. Although, using personal property creates the same problems as the commercial pledge.
First of all, the guarantee trust with personal property would entail that the goods be placed in the immediate possession of the trustee. This, in effect, is tantamount to the dispossession required by the pledge, and will not work in situations where the trustor/debtor requires retaining possession of the goods, such as in the financing of inventory or manufacturing equipment. Alternatively, although guarantee trusts with real property must be registered, there is nothing in the law which requires the registration of fideicomiso de garantia con bienes muebles. Therefore, we also encounter the fact that a guarantee trust with personal property creates the possibility of a secret lien. In practice some of these trusts have been registered. However, a third party would not be required to consult the registry in order to determine whether there is a lien over the subject mobile goods.
The main function of a registry system, regardless of whether it deals with real or personal property, is the protection of rights in property. [ Article 47, Ley No. 143, Catastral y Registral del Estado de Sonora (Law of Assessment and Registration for the state of Sonora).] This is accomplished by putting the world on notice of the existence of interests in the property in question. As an underlying observation we see that there is a basic distinction between the substantive law which creates the property right, and the registry law which protects it. Inevitably, this distinction has led to the frequent assertion that registry systems are natural complements to the underlying substantive law. This statement, however, incorrectly subordinates the role of registries and registry law to the antecedent substantive property law. Those who wish to properly use secured financing mechanisms must realize that the underlying legal mechanisms and principles are of little use unless third parties can rely on a properly functioning registry system. If the Public Registry does not give effective notice of these rights in property, any antecedent legal rights of parties who have acquired, or are interested in acquiring, rights in property, will be to no avail. Mexico must implement and preserve a registry system that protects the legal mechanisms which create property rights, since the value of these rights is greatly undermined if the registries do not function correctly. [ Registration is a matter of state law and therefore may vary from jurisdiction to jurisdiction. However, to the extent that Sonoran law may serve as a representative example of registry law generally, we hope that it will be helpful in pointing out some issues that should be addressed.]
In keeping with this commitment, Sonora along with other states, including Baja California, Chihuahua, and the Federal District is dedicating considerable effort to the modernization and computerization of the land registration system. In the area of personal property, however, most registries remain underdeveloped and require a renewed commitment to the preservation of property rights. Until recently, we have not encountered many transactions that require us to analyze critically the registration process as it relates to personal property interests. Although, the modernization of the Mexican economy, coupled with an increase in the value of personal property as collateral for commercial loans, is forcing us to address the need to protect the rights of parties who take non-possessory interests in personal property.
The typical registry systems are divided into separate sections, one of which is solely devoted to personal property transactions. Filings in this section are of relatively minimal significance. Until recently the total number of personal property registrations has been fairly modest and continues to represent only a fraction of the total registrations. For example, in the registry for the Federal District which encompasses football fields of real property transactions, the filing for personal property comprise only a small wall along the back corridor.
Currently, the bulk of registrations over personal property goods do not arise from commercial transactions. They are primarily the registration of auto loans, fixtures subject to an all-encompassing mortgage primarily concerned with the underlying real estate, and avío and refaccionario credits. [ We should recognize that these categories are not mutually exclusive. It is possible that refaccionario credits are used in creating the majority of the all-inclusive mortgages. However, it is also possible that these mortgages are created under Article 67, the industrial mortgage provision of the Law of Credit Institutions . The lack of distinction between the types of registered documents makes it difficult to determine what legal mechanisms were used in creating the non-possessory interest.] Most of the transactions registered in the personal property section are civil transactions between a banking institution and a consumer and the current registry system is designed, almost exclusively, to protect the rights created by these types of transactions. The main concern in registering these interests are evidentiary and procedural. However, we begin to encounter problems when we are confronted with parties who are interested in creating rights in personal property in connection with commercial financing. In attempting to accommodate and protect these rights, it has become apparent that existing Registries are not always up to the task.
First, it should be pointed out that this deficiency does not stem entirely from the registry system. As mentioned before, the prevailing commercial culture, and the existing law, do not require the registration of these rights in all instances. Therefore, if not all rights in personalty must be recorded--and, as a result, those who are interested in acquiring rights in personalty are not required to consult the Registry in order to determine whether there are existing interests in the same property--it is of little importance that the current registry system does not provide adequate notice. This is not an argument to justify the current state of the registry system. Instead, it is an invitation for simultaneous reform in the underlying substantive law, the commercial practice, and the registry system. If all three function in harmony, the rights of those with interests in personal property in commercial transactions will be protected as effectively as the Registries currently protect civil transactions and real property rights.
To illustrate the current registration process, and some of its deficiencies, lets conduct an imaginary trip through a personal property registry in a Mexican State: Sonora. For the purposes of this illustration, we will use a refaccionario pledge which, to be effective against third parties, must be registered pursuant to Article 326 of the GLCIO. [ See also, Article 3457, Civil Code of Sonora.] Let us assume that Banco S.A., a commercial bank, has made a loan to AZTECA S.A., our fictional commercial borrower, for the purchase of machinery. As collateral for the loan, Azteca has in turn given the machinery in pledge to Banco whose representative now appears at the Registry office to register the pledge contract.
First, we can observe that contracts requiring registration usually make no distinction between commercial and civil transactions. This lack of distinction is therefore carried over to the registration process which does not make any distinction either. Furthermore, the registered documents do not usually indicate which legal mechanism was used to create the rights in the property. Avío and refaccionario loans are the exceptions since the loan contracts usually refer expressly to these mechanisms. However, transactions creating rights in personal property will not usually indicate whether they are commercial pledges constituted under Articles 334-346 of the GLCIO, a pledge created under Article 69 of the LIC, or civil pledges created under the applicable provisions of the Civil Code for the state in question. [ The vast majority of the documents registered are form contracts that do not identify the type of legal mechanism used. These form contracts only contain collateral descriptions, debtor information, and payment criteria. It is not clear whether this ambiguity is intentional or not. However, an apparent advantage to the registration of a document that does not expressly establish which legal instrument was used, is that it may be possible to argue for the application of the most favorable mechanism. For example, it is probably safe to assume that all automobile transactions will qualify under article 69, of the Law of Credit Institutions because most banks that grant loans on an automobile pledge will probably retain the invoice as title to the automobile, and as the main guarantee against the sale or subsequent encumbrances of the same automobile. However, these same contracts would also appear to comply with the requirements of the civil pledge, under the Civil Code of the state in question.] Additionally, as noted previously, registry law requires that the personal property have precise characteristics that serve to identify it in an indubitable manner and that such characteristics be set forth in the registered document. [ Article 81, Ley No. 143, Catastral y Registral del Estado de Sonora .]
Once the refaccionario loan document has been presented at the front desk of the Registry, a Registry official will determine whether the pledge agreement has been ratified, [ Article 48, Ley No. 143, Catastral y Registral del Estado de Sonora , requires that all private contracts be registered.] either by a notary public or a public broker. If it has, only the signature of either the notary or the broker will be required for the registration of the document. If it has not been ratified by either of these public officials, the official at the Registry can perform this operation for a fee, [ Article 3466(III), Civil Code of Sonora, establishes the ratification requirement for all private documents.] assuming the contracting parties are present to sign the document. Once ratified, the pledge agreement will be stamped with a chronologically-assigned inscription number. For the purposes of this illustration, we will assume that the pledge contract between Banco and Azteca has been assigned #54321.
The refaccionario pledge will then be submitted, in numerical order, to one of several qualifiers who will evaluate the validity of the contract. The law establishes eight criteria any one of which, if not met, could lead to the rejection of a document submitted for registration. [ Article 69, Ley No. 143, Catastral y Registral del Estado de Sonora and Article 3470, Civil Code of Sonora. Article 82, Ley No. 143, Catastral y Registral del Estado de Sonora and Article 3468, Civil Code of Sonora, further establish criteria for registration of personal property interests.] This evaluation will include a verification that pledge #54321 complies with the legal requirements established by the various laws, codes, and regulations that might apply to the given transaction. [ Article 3471, Civil Code of Sonora, establishes liability on behalf of the Registry if customary qualification procedures are not followed which results in a loss to a party to the registration.] However, the evaluation in this respect is necessarily limited in scope and it remains incumbent upon the contracting parties to ensure compliance with applicable law. Therefore, the actual evaluation encompasses primarily the verification of the signature ratification, consistency of loan amounts and other terms throughout the document, and an overall inspection for any significant mistakes. [ The same qualification procedure is followed in both real and personal property transactions.]
The process of evaluating a pledge may take as little as a couple of hours but, depending on the Registry workload, may not be completed for several days, with the average evaluation taking two to three days. [ Article 3473, Civil Code of Sonora, establishes liability on behalf of the Registry for willful or unjustified delay in registering.] Once the evaluation has been completed and it is determined that the document is fit for inscription, document #54321 will be registered.
For the purposes of this illustration, it will be assumed that Banco S.A. presented the refaccionario pledge on March 1, 1997 at 8:00 a.m. All required parties appeared before the registrar who ratified the document and then stamped the contract with a chronologically-assigned number. The pledge agreement then proceeded to the Registry's evaluation department. Assuming that the terms and provisions of the contract passed the qualification, based on the average time to qualify such documents, the pledge contract would be registered on March 3, at 1:00 p.m. Once it has been registered, the pledge will be effective against third parties from the date and time stamped on the contract when it was presented, March 1, 1997, 8:00 a.m. [ Article 63, Ley No. 143, Ley Catastral y Registral del Estado de Sonora, Article 3472 Civil Code of Sonora, and Article 3017 Civil Code for the Federal District.]
The potential disparity between the date of registration and the date of validity could lead to problems. For example, a third party, Caballero S.A., a retailer of used machinery, may be interested in purchasing all of Azteca’s machinery. To illustrate the problem presented by the time gaps, assume that Caballero makes an inquiry at the Registry on March 2, 1997 to determine whether there are any encumbrances on file covering Azteca’s machinery. Assuming the pledge was not approved and registered until March 3, Caballero S.A. will be inclined to rely on the fact that its inquiry, made the day before, did not turn up any encumbrances. Based on its findings, Caballero will purchase Azteca’s machinery. However, as explained, Banco's security interest in the machinery will be considered valid from the date of presentation. Therefore, Caballero’s rights to the pledged machinery will be subordinate to the prior interest even though Caballero relied on what appeared to be an appropriate inquiry.
If the approval of a pledge contract is delayed at the evaluation stage of registration, for any reason, under this scenario the potential problem would be exacerbated. If the difference between the time of presentation and the time of registration is more than a few days, it may lead to a greater probability that subsequent searches will fail to uncover the existence of valid liens.
If the pledge in this example does not meet one or more of the registration criteria, it will be returned to Banco without being registered. Currently there is no charge for documents that are refused. However, as part of the overall reform of the registry system, payment will be required at the time of document presentation and not at the time of registration. Therefore, when a document is returned after evaluation, [ Article 3469, Civil Code of Sonora, establishes the possibility of a judicial appeal for rejected documents. This article is rarely used since only an extremely small percentage of all documents submitted for registration are ever rejected.] there will be a charge for the evaluation service provided.
Registration is a two-part process. First, the documents are integrated into portfolios and filed numerically by inscription number. The second step requires that the debtor’s name be entered into an alphabetical index. Consequently, when an interested party conducts an inquiry by debtor name [ When the debtor's name is likely to activate numerous entries, additional information such as residence or tax-payer identification number may be required to further assist in obtaining the correct records.] she will be given a list of inscription numbers which she will then take to the file room for retrieval and inspection of all applicable portfolios. Of course, documents may also be requested by inscription number if the searching party happens to have this information. Finally, the original documents, signed by the registrar and containing the inscription date and number, will be returned to the registering party. [ Article 66, Ley No. 143, Ley Catastral y Registral del Estado de Sonora, Article 3476, Civil Code for Sonora, and Article 3018 Civil Code for the Federal District.]
In this example, Azteca S.A. would be entered into the alphabetical listing of debtors. The annotation next to the debtor's name will contain the inscription number. It will be assumed that refaccionario #54321 will be filed in a portfolio containing inscription numbers ranging from 54300 to 54350. It is now assumed for the purposes of continuing this illustration that Caballero S.A. appeared at the registry on March 4, 1997 knowing only that it wished to purchase Azteca’s machinery. The Registry official would therefore conduct a search under Azteca S.A. which should reveal all inscription numbers under this debtor name. [ There is a relatively small administrative cost for each debtor search conducted. This fee is set at a predetermined amount and is not based on the number of inscriptions that are activated by the debtor's name.] Caballero would then take this list of numbers to the file room where it would request that the clerk locate the portfolios containing the applicable inscription numbers. Presumably, if all goes well and Caballero's search includes inscription #54321, it will find that Banco has a refaccionario pledge on the machinery that Caballero was considering purchasing.
Currently, encumbrances on personal property are kept in a card catalogue index. However, in anticipation of the computerization of the index, the card catalogue system has not been consistently updated. Therefore, the only way to access recorded liens on personal property, with complete certainty, is by inscription number. Apparently, the registration number is the only way to access currently recorded personal property liens. It is not possible to access a lien by debtor name because, in anticipation of the computerized index, there has not been a constant update of the card catalogue system. However, since the computerized index system is not yet functioning for personal property liens, it is not possible to access a lien which has been recorded since the abandonment of the card system. Furthermore, it will not be possible to access a lien on personal property until the adoption of the computer index. Additionally, it has not yet been determined whether the computer index, once it is fully operational, will resume at the date that the card index system lapsed, or whether the computer index will include only those registrations made after it is functioning.
In contrast, as part of the current reform efforts, encumbrances on real property are computerized. This represents a great improvement that will eventually include the computerization of the entire index system. Once this system is installed, it will be possible to access the debtor name which will reveal any encumbrances on both real and personal property. Additionally, the data base, via a debtor-name search, will access basic information such as a description of the collateral, the loan amount, and payment terms. As part of the long-range goal of this reform, documents will be accessed in their entirety via a computer index. However, the original documents will continue to be integrated and filed in portfolios as outlined above.
There are no hard-and-fast rules as to the place of registration with respect to personalty. [ However, the place of registration would not matter to the lender since a registration in any of the registries in the state would be effective throughout the state.] Liens on personal property are frequently registered at either the debtor's residence, the lender's residence, the location of the goods, or the place where the contract was executed. [ Article 82 subparagraph (II), Ley No. 143, Catastral y Registral del Estado de Sonora , requires that the contract be registered in the jurisdiction in which the contract was executed. However, this requirement is primarily aimed at assuring that the registered document is properly ratified and is not particularly concerned with designating a geographic location for registration.] However, it seems that the location of the registration may be set voluntarily by the parties to the transaction. [ Since commercial lending secured with personal property is not particularly common at this time, there is not much need for third parties to have notice of any existing security interests in the movables. Consequently, there has not been much impetus to establish rules concerning the appropriate place to register.] Apparently it is very common to register only in the jurisdiction where the lender's place of business is situated. [ Two factors may influence the decision concerning whether to register at the lender's place of business. First, the location of the lender is usually the location where the contract was executed, and even though Article 82, subparagraph (II) of the Law of Assessment and Registration for the state of Sonora is primarily for ratification purposes, it does require that the document be registered where executed. Second, and probably most influential, the lender's residence is probably the most convenient location to register. Another factor that may influence this decision is that it does not matter where the contract is registered. The lender will not be penalized for registering in a location that is unlikely to be searched since any registration appears to be universally valid. See discussion below.]
Furthermore, a State’s registry system is frequently divided into judicial districts, or municipalities as they are commonly known. Each of these districts has its own Public Registry. [ Article 3453, Civil Code of Sonora, establishes that the state government will determine the location of registries within the state. Sonora has opted to employ existing judicial districts for the location of its registries. Most states in Mexico are divided similarly into judicial districts, municipalities or an equivalent geographic designation, each of which has a Public Registry designated to accept registrations within its boundaries.] Currently, each of the municipal registries is autonomous and is not linked in any manner to the other municipal registries.
Returning to the illustration, assume that Azteca S.A. is incorporated with its principal place of business in Daztlan. Furthermore, assume that Azteca received its loan from Banco S.A.'s Guaztlan subsidiary. This factual pattern would present a practical dilemma to Caballero S.A., an Iztlan corporation, which is interested in purchasing Azteca's machinery. Logically, Caballero would want to determine whether there is an existing interest in Azteca's machinery by consulting the registry in Daztlan. However, Banco registered its interest at the registry in Guaztlan. Therefore, a search made in the Daztlan registry would not turn up Banco's lien.
This is a significant problem since a properly recorded interest in personal property will be valid throughout the State, and perhaps throughout the Country. Assume, for example, that Caballero purchases Azteca's machinery in reliance on the fact that the search in Daztlan did not disclose the existence of Banco's lien. Once again Caballero's rights will be subordinated to Banco's even though Caballero appears to be a bone fide purchaser. Theoretically, Banco might register in all the registries in the State thus reducing the probability of this type of problem since it is frequently possible to register in all registries under one registration fee. However, this cumbersome step does not seem necessary since a single registration by Banco produces the same legal effect as sixteen. [ A potential problem created by nation-wide validity of registrations is the possible encouragement of careless registration practices, or registration at the most convenient location even though it may not be the best place to register in order to give notice to third parties.]
This problem will be remedied once the registries are reformed, since these registries plan to create central data bases containing electronic inscriptions of the transactions recorded at all satellite offices. Once this is accomplished, a direct line from each of the municipalities to the central data bank will exist. [ Even though there will be a direct link between each of the municipalities and the central data bank, there will be no link among the municipalities themselves.] Therefore, any interested third party will be able to determine whether a particular debtor has any liens of record in the entire state by a single consultation at the central data bank. [ There will be a modest fee for this consultation. Additionally, it will be possible to consult the central data base from each of the satellite offices. However, because this consultation will have to be made via telephone, there could be delays in processing search requests.] Under this new system, Caballero, instead of having to search all the satellite registries, will have to consult only one.
These reforms will solve the problem within the state. However, a validly registered lien on personal property is not only valid throughout each state, apparently it is valid throughout Mexico. [ The very idea of nation-wide registration validity without a system which links the country's registries together seems incomprehensible and creates enormous potential for fraud and abuse. However, it must be remembered that not much lending secured by personal property now takes place in Mexico. Moreover, a purchaser of the encumbered goods would probably ask to see the invoice ( factura ) of the good to be bought. Since a secured lender in Mexico would retain possession of this invoice, the borrower could not transfer the item until the lender is completely paid off. Consequently, the subsequent buyer would be put on notice that the seller does not have complete ownership of the goods.] Therefore, if Azteca moved the machinery to another state and Vaquero de Sinaloa S.A. wished to purchase the item there, presumably it would consult the registry within a municipality in Sinaloa. Needless to say, this would be a futile endeavor as this consultation would not produce notice of Banco's lien in the other State.
Pursuant to registry law, the cost of registration is usually a uniform fee for both real and personal property transactions. For example, 0.35% [ It may be helpful to think of this fee as $3.50 for every $1,000.] of the total amount of the loan. Additionally, there is a flat transactional charge plus a 15% education tax on the amount of the registration fee. In some states there is a ceiling on the amount of the registration fee. In other words, the cost is calculated as the lesser of a percentage of the loan amount or some maximum level. However, some states have no upper limit and the fee is calculated as on a percentage basis regardless of the amount of the transaction. For example, if the loan for the credit sale of machinery between Azteca and Banco were a total of N$XX (approximately US $1,000,000), the registration fee would be approximately N$XX (approximately US $3,500). [ The exchange rate was based on rates listed in the Diario Oficial de la federación on XX date .]
Although this fee may be acceptable, or at least less objectionable, with valuable real property and with lower-cost consumer (or civil) loans, the relatively high cost of registration in commercial personal property secured transactions may dissuade parties from registering their interests. In fact, the cost of registration may contribute to the rather modest number of registrations in any given state covering personal property.
In comparison with other countries which have efficient, effective and reliable laws for the creation of security interests in personal property, as well as the registry systems to accommodate this type of financing, Mexico is not overflowing with credit, especially credit secured with goods as volatile as personal property. Therefore, since most of the lending community has not reached a point where it will consider engaging in this type of lending, there has not been a constant pressure to institute reform in this area.
However, since the recent devaluation and ensuing recession, credit has been harder to obtain than before, and the credit available is very expensive. This creates problems for business enterprises which require financing for the acquisition of personal property, mainly in the form of inventory and equipment. Conversely, manufacturers and asset-based lenders cannot sell their goods on credit to these enterprises because of the uncertainties inherent to the present legal and registry systems. Implementation of legal mechanisms which integrate the principal features of a properly functioning secured financing mechanism will go a long way to helping alleviate these problems.
Additionally, lenders and borrowers interested in engaging in secured lending must chose a mechanism with incredible scrutiny in order to ensure that they are employing the mechanism that best suits the fact pattern of a particular transaction. México must recognize that many companies now feel the need for security mechanisms on personal property; a trend which is apparent from the current interpretation of the present legal regime. This need is especially important since under the NAFTA, Mexican manufacturers, wholesalers and retailers are now competing with U.S. and Canadian firms which do avail themselves of the asset maneuverability and cheaper credit that Article 9 of the U.C.C. and the Canadian Personal Property Security Act provide. An action which will confer a further competitive advantage on goods coming from the North.
This illustration is meant to be an invitation for us to be cautious in our financing practices, as well as consider solutions to the obstacles presented to those parties interested in commercial financing secured with personal property. We must consider it a point of departure for a discussion that will lead to the protection of rights in personal property, the same type of protection that is currently provided to parties with interests in real property.
Copyright National Law Center for Inter-American Free Trade 1997