The Mexican legal system is profoundly different from those of the United States and Canada. Where Mexican legal institutions are rooted in the Roman civil law tradition, common law dominates the US, except to some extent Louisiana, and all the provinces of Canada except Quebec.

Mexico has embraced its role in the global economy and has adopted specific legislative reforms to encourage free market access. The basic legal framework remains substantially unchanged, however, and newcomers accustomed to doing business in a common law jurisdiction note substantive and procedural differences in basic legal transactions in Mexico. Some will find the civil law formalism nettlesome. Others will find it refreshing to do business in a less litigious culture.

Different secured lending mechanisms are provided in Mexican statute, which has been recently reformed to improve the position of lenders and stimulate credit transactions after the Mexican economic crisis of the mid-nineties. Lenders are encouraged to consult with local counsel to develop structures for particular projects.

Form of collateral

Real property

Transactions involving real estate or immovable property in Mexico concern interests in land and the constructions thereon, fixtures and in rem rights.

Items permanently affixed in real property may also be regarded part of the latter (affixed items that may not be detached without damaging the property, such as fish tanks, bee hives or other similar breeding places, affixed machinery inherent to the exploitation thereof, electronic devices and accessories forming part of the building, ducts and sewage systems to distribute liquids or gases to or from a property, telephone and telegraph fixed lines).

Items deemed to be part of real estate are regarded movable property whenever detached from the real property (unless the value of such items has been considered in the granting of a security interest to a third party).

The following security interests can be granted over real property:

Mortgage (hipoteca). The real estate mortgage is perhaps the most widely used form of security for transactions involving immovable property. A debtor or a third party executes a mortgage instrument, naming the creditor as the mortgagee and giving the creditor the right, in a default situation, to be paid out of the proceeds of sale of such property subject to the order of priority set out by law. The standard real estate mortgage applies to the immovable property identified in the mortgage instrument. Certain industrial mortgages are available to Mexican banks (and, in some states, to other Mexican or foreign lenders as well). This provides the lender with security over all the assets of a business (including immovable property). A mortgage securing a debt above a minimum threshold value (which is determined by local law and varies from state to state) must be in writing and executed before a public notary. The mortgage instrument, which should describe the property being encumbered and the term of the mortgage, must be registered in the appropriate real property public registry office to be effective against third parties. Other registrations are required depending on the type of property being encumbered. (For example, registration in the Aircraft Registry, Maritime Registry, Railroad Registry and International Registry – under the recently passed Convention on International Interests in Mobile Equipment and the Protocol to the Convention on International Interests in Mobile Equipment on Matters Specific to Aircraft Equipment, Cape Town Convention). Special authorizations may also be required for aircraft or regulated activities, including telecoms and other industries.

Guarantee trust (fideicomiso de garantía). Under a guarantee trust agreement, a debtor transfers title in certain assets to a trustee as security for compliance with an obligation. All types of assets can be placed in trust (that is, immovable property and tangible or intangible movable property). Only Mexican banks and other financial institutions can act as trustees. Recent amendments to the General Law of Negotiable Instruments and Credit Transactions (Ley General de Títulos y Operaciones de Crédito) (LGTOC) have improved the benefits of guarantee trusts, the use of which has increased recently. Guarantee trusts increase the costs of asset management relative to other security options, but they can provide control and other advantages for the lender that are not otherwise available. Guarantee trusts must be executed in writing. A guarantee trust over immovable property must be executed before a Mexican notary public and the trust instrument must be registered in the appropriate real property public registry office to be effective against third parties. Guarantee trusts over movable property securing a debt above a minimum threshold value (about $90,000) must also be executed before a public notary (and the trust instrument should be registered in the appropriate public registry office). Other registrations, authorizations and actions can be required depending on the assets being placed in trust.

Movable property

Movable property refers to property with mobility. Rights and actions related to such movable items and, in general, all items not regarded as immovable property, are also regarded as movable property. It includes intellectual property rights, machinery and equipment and trading stock and securities.

The following security interests can be granted over movable property:

Pledge. There are three basic types of pledge. First, the possessory pledge (prenda mercantil). Here the pledgor (a debtor or a third party) transfers possession of the movable asset to the lender (or a third party for the benefit of the lender) to hold as security for compliance with an obligation. This pledge is commonly used to pledge stock of a private company, for instance, where the lender takes actual possession of endorsed stock certificates. A possessory pledge must be executed in writing. Special requirements apply depending on the type of asset, for example: delivery of bearer instruments to the lender or a third party; delivery and endorsement of registered instruments and registration in the special registry ledger (such as shares of a private stock corporation); delivery of non-negotiable instruments and notice to the underlying debtor, if applicable; delivery of pledged assets to the lender or third party; registration of the pledge in the case of credit on equipment or credit on repairs.

Second, the non-possessory pledge (prenda sin transmisión de posesión). Possession and operation of the assets here remain with the pledgor. This type of pledge includes the possibility of creating a floating or generic pledge over all present and future movable assets of a business. This security was introduced recently in the amended LGTOC and is particularly useful when control and operation of the pledged assets is to remain with a borrower or pledgor during the term of a loan. Floating or generic pledges can be created over the entire business (save for immovable property) or over specific types of assets, as required. A non-possessory pledge must be executed in writing. A non-possessory pledge securing a debt above a minimum threshold value (about $90,000) must be ratified before a public notary and the resulting instrument registered in the pledgor's commercial file of the appropriate commercial public registry to be effective against third parties. Special requirements apply to this type of pledge including: rules to appoint an appraiser to appraise the pledged assets; events allowing for debt acceleration, (for example, the borrower breaching an agreed collateral ratio). Other registrations, authorizations and additional actions may be required depending on the assets being pledged.

Third, the securities pledge (prenda bursátil). This is a pledge over securities traded in the Mexican stock exchange. Securities are deposited in an account at the SD Indeval de CV, Institución para el Depósito de Valores (clearing agency). Recent amendments to the Securities Market Law (Ley del Mercado de Valores) allow for title in the securities to be transferred to the lender. The lender must return the securities to the pledgor after performance of the secured obligations (while complying with certain rules that apply to repurchase transactions). Periodic statements of account produced by the pledgor's brokerage firm must identify securities subject to a securities pledge. This type of pledge must be executed in writing and involves a foreclosure agent (ejecutor) and the transfer of the securities to an account at the clearing agency. A Mexican bank or brokerage firm (other than the lender) may be appointed as foreclosure agent and is responsible for selling the securities at market value if a default occurs.

Mortgage. Mortgages can also be granted over ships and aircraft.

Guarantee trust. Guarantee trusts can be created over movable property.

Commercial security

Commercial or quasi-security features and structures are also available and frequently used in Mexico to enhance a lender's position, which include the following:

Retention of title. A sales agreement with retention of title is commonly used in transactions involving real property or movable assets (for example, industrial machinery and equipment) through a registration procedure similar to that for immovable property. Title does not pass until the debtor has paid the purchase price in full. An attempt to sell the property in violation of the retention of title provision is void and gives the lender/seller the right to repossession and damages. A sale subject to rescission for failure to make timely payments is also available for sale transactions, where the acquisition price is payable in instalments but this does not have the same level of security as retention of title.

Letters of credit. For a foreign creditor, the letter of credit is a simple and reliable way to secure payment for sales of goods to Mexican buyers.

Promissory notes. The Mexican promissory note is often used to document credit operations in Mexican business practice. A foreign manufacturer may sell products on credit to its Mexican distributor, for example, in exchange for a series of notes in amounts that correspond to the wholesale price of the products plus interest. A Mexican promissory note must meet certain criteria.

Third-party guarantees. A creditor frequently requires a guarantee of payment from a third party (a natural person and/or a company). The Mexican guarantee can be executed on a promissory note or other negotiable instrument (an aval guarantee) and/or a separate agreement, depending on the financing. Additional (joint and several) obligors can also participate in all or some of the obligations assumed by the main debtor. Guarantee agreements governed by foreign laws can be used by Mexican guarantors with the previous review of local counsel.

Mexican bonds. The Mexican bond is sometimes used as a third-party guarantee of payment or performance in connection with a contractual obligation, such as a performance deadline in a construction contract. In practice, it may be subject to substantial limitations.

Pledge bonds. These are also commonly used to secure interests in commodities such as bulk goods located in Mexico. Only a duly licensed bonded warehouse can issue certificates of deposit and pledge bonds. Goods described in a certificate of deposit are physically stored in a facility controlled by a bonded warehouse or in transit. While goods are on deposit, the rights of a holder of the certificate of deposit are superior to those of other creditors unless a court orders a different order of priority. A pledge bond can be transferred with or without transferring title to the goods, but a bonded warehouse can only release pledged goods to the holder of both the certificate of deposit and the pledge bond. Such a creditor can file an enforcement action subject to commercial procedures.

Assignment. In general, credit rights under a commercial agreement governed by Mexican law can be assigned under an assignment agreement. The assignment must comply with notice and other requirements. The assignment is not effective against the debtor unless the debtor is given notice. Notice of the assignment is not effective against third parties until the date the assignment takes effect by law, determined according to the type of credit.

Other structures. These are available and frequently used in Mexico to enhance a lender's position, including sale and leaseback and factoring transactions. Escrow accounts are also common to some type of financing, involving accounts in Mexico or abroad.

Risk areas

There are some types of assets over which security cannot be granted or is difficult to grant in Mexico. Certain personal assets cannot be encumbered. These include allowances for food, a family's estate, clothing and furniture, machinery, equipment or instruments required for an individual's main activity, and employee wages.

Assets in regulated or protected industries may require additional actions for a security interest to be created or perfected (for example, additional filings or authorizations).

Assets in the public domain as set out in Mexican law are non-transferable and cannot be encumbered (for example, property owned by the government, Mexican airspace, interior waters, territorial waters, ports, dams, archaeological and artistic monuments, and so on).

Future assets can be pledged, placed in a guarantee trust or included in an industrial mortgage. Enforcement is dependent on the asset coming into existence and on compliance with any formalities for the creation and perfection of the security.

Intangible and fungible assets can be encumbered by a pledge, an industrial mortgage or a guarantee trust.

The concept of unlawful financial assistance is not recognized in Mexico. However, fair consideration, corporate benefit, arms-length transactions and related concepts are relevant, particularly in insolvency situations. The granting of downstream security interests by a parent company to secure a loan to its subsidiary would generally be valid.

Ownership and possession (not the mere enforcement or holding of a security interest) can attract liability under environmental laws. Under environmental laws and regulations, owners and occupiers of real property with soil contamination are jointly and severally liable for remediation, irrespective of any recourse they may have against the polluter, and any administrative, civil or criminal liabilities.

Commercial debt market

Subordination of debt is possible although not specifically regulated by law. Subordination of debt can be set out in an inter-creditor agreement between the senior and junior creditors (of the subordinated debt). For practical purposes, the borrower can be notified of the subordination in certain circumstances.

Secured debt is traded in Mexico. Securitization transactions have recently taken place in certain industries (for example, in the housing and credit card industries) in which receivables are assigned to special purpose vehicles (generally Mexican trusts), which then issue securities and offer these to the public.

Enforcement and insolvency

Security interests are ancillary to the main obligations (usually repayment) being secured and therefore can only be enforced if the borrower defaults on such obligations.

In an insolvency situation, the creditor must first obtain a credit recognition resolution from a court before it can enforce its security. When no agreement on a rescue plan is reached and insolvency is declared, the receiver is responsible for enforcing the security and repaying the secured creditors with the proceeds.

Different enforcement proceedings apply depending on the type of security. In general, enforcement is limited to the public sale of secured assets to repay the creditors with the sale proceeds. Private sales are allowed in special circumstances but must be sanctioned by a court. Where sale proceeds are insufficient for repayment in full, the creditor can request the court to secure additional assets, if available. Within the context of insolvency proceedings, the lender becomes an unsecured creditor for any balance remaining unpaid after enforcement.

Acts, including granting security, carried out to the detriment of creditors are generally void. These include: (i) acts carried out before an insolvency declaration that are knowingly committed to defraud creditors; and (ii) other acts presumed to be carried out to the detriment of the creditors, such as transactions at too low a value, debt remissions, and payment of debts not yet due.

Any act done within 270 calendar days preceding the insolvency declaration is subject to review. The court can extend this period if requested by any creditor, the conciliator or the receiver (síndico) before a credit recognition order is made.

The order of priority for payments on the borrower's insolvency is as follows:

• Wages and severance payments owed for the two years preceding the borrower's insolvency declaration.
• Expenses to preserve the bankrupt estate (for example, management costs).
• In the case of individual borrowers, singularly privileged creditors (for example, for funeral expenses and creditors for illness expenses).
• Secured creditors (holding mortgage and pledge security interests), if all required formalities have been complied with.
• Labour claims (other than above) and tax claims.
• Creditors with special privilege (as set out in Mexican commercial law, for example, bonded warehouses).
• Unsecured creditors (all other creditors not mentioned above).

If the required formalities have not been complied with, secured creditors are treated as unsecured creditors. Also, secured creditors become unsecured creditors for any balance remaining unpaid after their secured assets have been realized.

Cross-border considerations

Acquisition restrictions

Real estate mortgages and guarantee trusts can be granted to foreign lenders. Industrial mortgages are generally limited to Mexican banks but are available to foreign lenders in certain states. Certain restrictions or additional requirements may apply for a foreign person to acquire direct title over immovable property when enforcing the security. For example, direct acquisition of land by foreigners may be restricted if it is located within the so-called restricted zone (a girdle 100 kilometres-wide along the northern and southern borders and 50 kilometres-wide along the coastline). Foreigners can only acquire a beneficial interest for residential use of real property located in the restricted zone through a Mexican trust. For non-residential use of real property in the restricted zone a governmental authorization is required before the acquisition.

Security over movable property can be granted to foreign lenders in any of the forms set out above. Certain restrictions or additional requirements may apply for a foreign person to acquire direct title over movable property when enforcing the security (for example, when foreign investment participation is restricted).

Exchange controls

There are no exchange controls in Mexico.

Governing law and jurisdiction

In general, Mexican law governs security interests over assets located in Mexico and any controversies must be resolved by Mexican courts.

Taxes

Registration duties and notaries' fees are payable in connection with the granting of security interests, but stamp duties or other charges are not payable. Transfer and value-added taxes are assessed on enforcement. Notarial fees and registration duties differ from state to state and in some states are quite expensive (particularly where registration duties are based on the value of secured debts). This may be particularly problematic in the case of immovable property. Strategies to minimize costs need to be evaluated on a case-by-case basis with local counsel.

Recent reform

Mexican law concerning guarantee trusts and non-possessory pledges was reformed in 2000 and 2003 to improve the position of lenders and stimulate credit transactions after the Mexican economic crisis of the mid-nineties. This has benefited the local market and foreign lenders in cross-border transactions. The passing of the Cape Town Convention, which will become effective November 1 2007, poses a big challenge to financing and security structures for aircraft equipment in Mexico and is expected to provide benefits to industry participants. Implementation particulars are still under discussion and will be tested in the near future.

Author biography

Juan Carlos Machorro Santamarina y Steta Machorro is a partner with Santamarina y Steta and has been with the firm since 1990, becoming partner in January 2002. He has degrees from the Universidad Iberoamericana (1994) and New York University (1997). His practice takes in general corporate and financial areas, including mergers and acquisitions, syndicated lending, banking, project finance and infrastructure projects. Machorro previously worked with Brown & Wood LLP (now Sidley LLP) in New York and is fluent in English.