Volume 6, Number 9, Page 1

Proposed Revisions to Mexican Secured Financing: Part One of Two

By John Wilson

NAFTA opened Mexico’s domestic market to duty-free access for goods from the United States and Canada. Yet, while U.S. and Canadian businesses have access to abundant and inexpensive credit, Mexican businesses are either unable to obtain credit, or subject to excessively high interest rates. NAFTA also opened Mexico’s borders to most types of direct foreign investment. Yet, U.S. and Canadian investors remain hard-pressed to finance their Mexican business operations.

The source of both problems is the inadequate legal nature of Mexico’s secured financing law. Designed to meet the needs of an agrarian economy, the law has changed little since the early part of this century. The few changes that have come have been in non-uniform, piecemeal fashion.

After years of ignoring Mexico’s pressing credit problems, on April 7, President Zedillo submitted the Federal Law of Credit Guarantees (“Ley Federal de Garantías de Crédito”) to the Congress. This proposal attempts to create a Civil Law analogous to Article 9 of the Uniform Commercial Code (“UCC”) and so provide the legal certainty and flexibility necessary for creditors and debtors to engage in modern secured financing practices. Unfortunately, this proposal falls well short of its objectives.

The proposed law does recognize some features essential to secured financing reform and is therefore a small step in the right direction. The proposal attempts to create a framework that would: 1) extend to after-acquired property and proceeds; 2) secure future advances; 3) create purchase money security interests; 4) protect ordinary course buyers; 5) provide summary enforcement procedures; and, 6) require public notice of security interests via perfection by filing. However, the proposal regulates these principles in an ineffective manner and will not provide the desired legal certainty and flexibility necessary for a sustainable secured financing market.

The following, part one of a two part series, will define why the proposal falls short of allowing for modern secured financing practices. Part two, to appear in the next issue of the Trade Report, will analyze the proposal’s deficiencies in regard to present Mexican law and general guarantee principles, and its interaction with international trends and reform projects.

After-Acquired Property and Proceeds

A security interest in after-acquired property and/or proceeds, by nature, encumbers future goods. Therefore, parties to a transaction do not know the exact attributes of the future goods assimilated by the security interest. Consequently, at the time of creation and perfection of a secured transaction, the proposal must permit the parties to describe original and future collateral in general/generic fashion. The proposal allows general/generic collateral descriptions exclusively for blanket/universal liens. For all other secured transactions, the proposal requires specific (indelible) collateral descriptions — similar to pre-UCC serial number tests. This requirement negates security interests over categories of collateral such as inventory, equipment, accounts receivable, etc. Instead, the proposal forces the parties to encumber all of the debtor’s present and future goods, or to encumber them on a one-by-one basis.

Indelible descriptions also cannot work with fungible goods or secured lines of credit. Fungible goods are characterized by their generic nature; these can only be described in similar generic manner. Secured lines of credit allow a debtor to draw from funds made available by the creditor; the goods purchased with these funds then act as collateral to secure the creditor’s loan. This collateral, however, does not exist at creation and perfection, and cannot be described indelibly at that time. The proposal thereby de facto excludes any non-universal future lien and any security interest over general-natured collateral.

The proposal does not provide an alternative to perfection by filing. However, filing is unsuited to perfect a security interest in some types of collateral— such is the case with many instruments and documents. After-acquired property and, especially, proceeds often include these types of goods. Consequently, the proposal will either exclude a security interest in these types of goods or, more likely, create disputes between the secured creditor and third parties that acquire interests in this type of collateral.

Purchase Money Security Interests (PMSI)

The proposal uses traditional title-retention rules for the purchase money feature. This approach may function with equipment sales, which the proposal segregates from the mass of future encumbered goods. However, the proposal does not account for the relationship between PMSI and inventory collateral, and does not limit proceeds stemming from a PMSI to traceable cash proceeds. Moreover, the proposal does not require that a PMSI inventory creditor provide notice to a previous inventory financier. Consequently, the proposal will cause constant disputes between original secured parties and PMSI creditors.

Future Advances

The proposal allows the parties to agree that a secured transaction will cover future advances. Under the proposal, the amount due at the time of default, which may include future advances, will be the amount of the secured obligation; seemingly, this rule is equivalent to “value” given. However, the proposal does not reconcile this feature with civil law notions requiring that any obligation be a sum certain at creation of the security interest. The proposal, also, does not provide notice to third parties that a security interest may cover additional collateral purchased with future provided funds. The present legal framework does not solve this problem. Instead, present law neglects future advances by regarding them as new obligations. New obligations require new and separate creation and perfection actions. These present law rules may render future advances inoperable under the proposal.

Ordinary Course Buyers (OCB)

The proposal also attempts to provide protection to ordinary course buyers by excluding a creditor’s interim right over goods sold in the debtor’s “preponderant” activity. This language is not equivalent to the common law concept of “ordinary course of business” and becomes problematic if we consider that Mexico still subscribes to an ultra vires analogue. This corporate law rule forces incorporators to use broad boilerplate language or “general purpose” clauses that allow a corporation’s “preponderant” activity to include everything mentioned in the boilerplate text or anything not proscribed by the general purpose clause.

Under a properly functioning reform effort, an OCB takes free of a perfected security interest only if the seller is in the business of selling the type of goods acquired by the buyer. Here, the sale of a debtor’s equipment would not qualify as an ordinary course sale. However, the present proposal protects a buyer who purchases equipment if the debtor’s articles of incorporation include the sale of such goods.

Additionally, the proposal does not require that ordinary course buyers give new value for the purchased goods. Consequently, the proposal may allow a secured debtor to provide goods to a previous creditor, in payment for a debt, thereby circumventing the objective of a secured transaction.

Furthermore, the proposal does not regulate the volume of goods purchased. The general rule of thumb for determining an OCB is that the quantity of goods purchased is for the OCB’s own use or the OCB is acting as a normal consumer. Under a properly functioning reform, a third party who purchases a disproportionately large quantity of the debtor’s inventory would not qualify as an OCB. The present reform, however, will protect a buyer who purchases a secured party’s entire collateral base, thereby undermining the policy objectives of OCB protection.

Enforcement

Although the proposal attempts to provide an extra-judicial enforcement procedure, in practice, this procedure will probably take a couple of months. Based on current Supreme Court rulings, it is likely that the Court will rule even this protracted procedure as unconstitutional. Part two will analyze this feature in more depth.

Filing

The only perfection method provided by the proposal is registration/filing at current registry offices. This is very problematic considering that current registry law and practice is rife with problems.

Registries require the filing of entire transactional documents, not financing statements. This practice renders pre-filing inoperable, does not allow one filing to cover several transactions and reduces transactional privacy.

Registered documents undergo a strict qualification procedure whereby a registry official determines the legal validity of the contract. This practice may take several days and creates a time-window where a document may be perfected yet unsearchable. Qualification also allows a registrar to second guess the parties’ intent and places them in a position of making determinations that only a court should make.

Registries require indelible (serial number) descriptions of encumbered collateral. This practice obstructs transactions that intend to cover after-acquired property and proceeds.

Registries use collateral criterion indexes instead of debtor indexes. This practice requires searching parties to consult the registry with serial numbers, for each piece of property, at hand. Moreover, this practice limits the use of inventory financing and fungible goods, and makes searching overwhelming and complicated.

The proposal requires filing of a security interest at the jurisdiction where the goods are located. However, local registries are not linked with other local registries or state registries (there is no federal registry) making it impossible to discover a filing in any office other than the locality in which the filing took place.

Finally, the cost of registration is a percentage of the total loan amount. This practice makes filing prohibitively expensive—approximately $4000 for each million dollars of the transaction.

Conclusion

Although the proposed Federal Law of Credit Guarantees recognizes several modern principles necessary for secured financing reform, its text fails to create a framework in which these principles can function. Rewriting this law in order to foster flexibility and increase legal certainty will open a new secured credit market essential for Mexico’s international competitiveness and the long term sustainability of NAFTA.

[Part two of this brief analysis will discuss other conflicts with Mexican law as well as the proposal’s lack of interaction with international agreements and secured financing reform projects.]

John Wilson is an attorney with the National Law Center for Inter-American Free Trade.