Over the last few years, Mexico has experienced a significant transformation in the political, economic, social and legal realms. Since the North America Free Trade Agreement (or Nafta) came into effect in 1994, economic growth in Mexico has been primarily driven by activity in the private sector, although the government still exercises an important influence in the economy. Nafta opened trade barriers, created new areas of opportunity for the private sector and allowed increased foreign investment, all of which resulted in the need to improve the Mexican legal framework applicable to commercial transactions.

The legal framework for secured lending, coupled with improved macroeconomic conditions and increased direct foreign investment in the real estate market, have prompted foreign financial institutions to finance the acquisition, construction and development of real estate in Mexico. Mexican financial institutions and borrowers have also benefited from the gradual decrease of interest rates, the growth in internal savings, the liquidity in the domestic financial sector, the liberalization of financial services and the stability shown by the economic indicators in Mexico.

At the same time, investments in housing, commercial and hospitality developments have significantly increased over the last few years, due primarily to the composition of the Mexican population (mostly aged under 30), modern consumer trends and Mexico's position as a tourism destination. The industrial sector has also shown increased activity, mainly in the northern region of the country. These trends are likely to continue.

Real estate investment trusts (Reits) and other foreign real estate investors have also been increasing their investments in Mexico in the commercial sector through the development of shopping centres and fashion malls, due mainly to the growth in the Mexican consumer and retail markets.

Ownership limitations

There are real estate ownership limitations in Mexico. The Mexican federal constitution governs ownership of lands and waters. It grants to the Mexican nation ownership of all land and water within Mexican territory and provides that the Mexican nation has the power to transfer ownership rights of properties to private individuals, creating private property. Article 27 of the Mexican federal constitution states that only Mexican nationals have the right to acquire land or obtain permits for the exploitation of mines and waters.

According to Mexican law, Mexican corporations that allow foreigners to participate in their capital must include an agreement, within their bylaws, under which foreigners agree to consider themselves Mexican nationals with respect to their investment and waive their right to request the protection of their government, under penalty, in case of failure to comply with the agreement, of forfeiture of their investment in favour of the Mexican nation. Also, the Mexican federal constitution contemplates a restricted zone in Mexican territory, which consists of the land or real estate within a 100-kilometre stretch along the borders and a 50-kilometre stretch along the coast. The ability of non-Mexicans to own real estate in this restricted zone is limited.

Mexican corporations that allow foreigners to participate in their capital may: (i) acquire real estate outside the restricted zone for any purpose; (ii) acquire real estate directly within the restricted zone but only for non-residential purposes; and (iii) indirectly obtain rights over properties within the restricted zone for residential purposes, by means of a trust.

Foreign entities or individuals may: (i) acquire properties outside the restricted zone as long as they obtain an approval from the Mexican Ministry of Foreign Affairs; and (ii) indirectly obtain rights over properties within the restricted zone for all purposes (including residential purposes), by means of a trust.

Secured lending framework

In 2000, certain amendments to commercial and banking laws became effective. Those amendments related to: (i) the perfection and enforcement of security interests; (ii) the introduction of the pledge without transfer of possession; (iii) the enactment of special rules applicable to guaranty trusts; and (iv) the introduction of rules for the enforcement and foreclosure of these pledges and guaranty trusts. These amendments aimed to improve the legal framework for secured lending, to encourage banks and other foreign and domestic financial institutions to increase their lending activities.

In 2003, Congress enacted a few additional amendments to these laws. The amendments eliminated a provision enacted in 2000 under which, if the proceeds derived from the sale or foreclosure of the collateral pursuant to a pledge without transfer of possession or a guaranty trust were not enough to pay the secured obligations, the debtor was discharged of its obligation to pay any shortfall, and the creditor had no further recourse against the debtor. This non-recourse provision made lenders reluctant to use the guaranty trust or pledge without transfer of possession as a means to create a security interest.

Collateral packages: mortgages v guaranty trusts

Mexican law states that all matters related to real estate in Mexico are governed by Mexican law. Therefore documents relating to the creation and perfection of security interests must also be governed by Mexican law.

One of the most important challenges is to set up a collateral package that would allow lenders to obtain repayment with the collateral in an expedited process in case of default.

In Mexico, the traditional option used to create a security interest on real estate is the mortgage (hipoteca). A mortgage is a lien created on real estate properties (as opposed to movable properties) that provides a security interest on the mortgaged assets in favour of the creditor, subject only to the rights of mandatory preferred creditors (for example, workers and the tax authorities). The mortgaged assets comprise land, improvements and fixtures and they remain in possession of the mortgagor. Mortgages must be created in respect of real property specifically determined, and in most cases (but depending on which state of Mexico the real estate property is in), the mortgage includes: (a) the natural accessions of the mortgaged property; (b) improvements made to the property by the owner; (c) moveable objects permanently incorporated into the mortgaged property by the owner that cannot be removed without damage to the objects or property; and (d) new buildings built by the owner on the mortgaged land. A mortgage must be granted in writing before a Mexican notary public and recorded in the Public Registry of Property of the jurisdiction where the mortgaged properties are located. Fees must be paid, which vary from jurisdiction to jurisdiction. Mortgages (and related foreclosure procedures) are governed by the civil code and the civil procedural code of the state where the mortgaged assets are located. Foreclosure under a mortgage requires a judicial proceeding, which includes public auctions based upon appraisals made by independent appraisers.

Under a guaranty trust (fideicomiso de garantia), the debtor transfers to a Mexican bank, as trustee, title to real estate or other assets, which will conform the collateral. Guaranty trusts created in respect of real estate must be recorded with the Public Registry of Property of the jurisdiction in which the properties are located and fees must be paid, which vary from jurisdiction to jurisdiction. The amendments of 2003 clarified that title to the trust assets is held by the trustee. The parties may agree for the debtor or any third party to maintain the physical possession of the trust assets. Guaranty trusts may be in effect for up to 50 years. Only Mexican banks can act as trustees of real estate trusts.

The main advantage of a guaranty trust, compared to a mortgage, is that the parties to a guaranty trust can agree to a non-judicial foreclosure procedure, through which the trustee would sell the trust assets to satisfy the secured obligations.

However, using a guaranty trusts involves the payment of trustee's fees, which are not payable in the case of mortgages. Most lenders in cross-border transactions have concluded that the cost of these fees is not significant after weighing the benefits of the guaranty trusts.

Lastly, if bankruptcy proceedings are initiated by or against the borrower, there are arguments to indicate that assets that are properly transferred to a security trust may be maintained outside the bankruptcy procedure of the borrower. However, this has not been tested in court.

Imported know-how

Title insurance is not required by law in Mexico and real estate brokers are not required to offer title insurance in real estate transactions. Generally, title insurance is not used in Mexico in transactions where the purchaser and the lender are Mexican. However, due to increasing participation of foreigners in acquisition and financing of Mexican real estate, and the presence of international insurers who offer owner's, lender's and leasehold policies in respect of Mexican real estate, the practice has evolved towards the use of title insurance. Title insurance will cover risks against loss of the property, sustained or incurred due to, among others: (i) communal land (propiedad ejidal); (ii) prior liens; (iii) invalidity of documents filed with the corresponding public registry of property; (iv) any prior effective preventive notice affecting the property; and (v) if an American Land Title Association (ALTA) survey is provided to the title company, discrepancies, encroachments, restrictions and contiguity issues.

As the participation of more sophisticated players in the lending and acquisition markets increases, and the use of title insurance in Mexico becomes more common, Mexican counsel have been challenged to specialize in title policy commitments, pro forma policies, surveys, and title policy and related endorsements. The market is also requesting the use of professionals (such as surveyors) knowledgeable in the ALTA standards for surveys and title policies.

Recently, as volumes of mortgage lending by foreign originators have increased, and as Mexican real estate-backed loans have found their way into the foreign securitization markets, it has become necessary in Mexico to follow the basic standards for ALTA surveys and title policies. In a typical cross-border financing transaction involving Mexican real estate that will be securitized abroad, several issues must be addressed:

A survey of the property must be provided to the title company, and must be prepared and signed by a professional surveyor that understands ALTA standards. The survey report should include a general and legal description of the property, the surveyor's conclusions regarding property area, boundaries, encroachments (if any), overlaps, easements, access, contiguity (if more than one parcel), discrepancies with title documents, photographic evidence of the property, and a walk-through plat of the property (including improvements and buildings). The survey report must also include a certification signed by the surveyor indicating that the survey was made in accordance with the Minimum Standard Detail Requirements for ALTA Land Title Surveys.

The title company should provide a title commitment showing the requirements and exceptions from coverage to its standard jacket title policy form and a pro forma title policy. In the typical process of property due diligence, these requirements and exceptions from coverage may be removed and negotiated with the title company by providing appropriate documentation, such as payment of prior taxes, release of prior liens, compliance with zoning requirements, appropriate surveys, and owner's affidavits. Mexican counsel should be able to identify the documentation required for the title company to eliminate as many exceptions from coverage as possible. Depending on the title company, the form of title policy will vary slightly. However, the buyer and/or lender should ensure the title policy covers a matter that is particular to Mexico, that is, that the property is not located in or part of communal (ejido) land, which is land not susceptible of sale to members outside the ejido.

In addition to obtaining title insurance, lenders will commonly request additional coverage in title insurance, by the use of endorsements. Upon request, and if evidence of proper coverage is provided, the title company will issue an endorsement to cover risks additional to loss of title. Mexican counsel should be able to request the additional endorsement coverage, including endorsements regarding: access, survey, marketability, zoning, valid parcel, tax parcel, contiguity (if more than one parcel), forced removal, gap coverage, and additional insured (lender policy only).

The lawyer's role

The typical role of lawyers in real estate transactions has become more comprehensive. As well as traditional due diligence and title, other matters have become relevant such as title policy, surveys, environmental reports and zoning issues. Lawyers have increased their participation in the structuring of real estate transactions, driven by local and international tax matters, securitization issues, rating agency requirements and increased transaction complexity. Lastly, in connection with drafting legal documents and closing transactions, Mexican lawyers have been required to increase their participation and knowledge of securitization documents, escrow and cash management agreements and other practices of the US and international markets to keep up with recent trends and adapt to the standards and expectations of international participants. Other tasks for Mexican counsel include: (i) reviewing the corporate authority of a Mexican borrower and guarantor to enter into a loan transaction or real estate transaction, and to review powers of attorney of their representatives executing the loan, real estate and security documents; (ii) obtaining a certificate of liens that evidences the existence, or lack, of liens on the property to be purchased or mortgaged, and giving, where available, a preventive notice (aviso preventivo), which assures the purchaser or creditor (if they perfect the purchase or security interest within the time the notice is effective) preference over any other notation or registration made on the property that does not show up on the certificate of liens; (iii) drafting and negotiating the relevant transaction documents, including with the relevant trustee in the context of security trusts; (iv) closing the transaction and formalization before a notary public for further registration with the public registry of property of the jurisdiction where the real estate is located.

In the context of loans to Mexican entities that are to be securitized, the bylaws (estatutos) of the Mexican borrowers have to be amended to incorporate certain provisions applicable to special purpose entities. Amendments include: (i) a limitation of the corporate purposes; (ii) a requirement to obtain a unanimous shareholders vote to file a voluntary petition of insolvency; (iii) the appointment of independent directors that have the right to vote on certain matters; and (iv) the incorporation of certain separateness provisions (such as covenants to maintain separate accounts or not to commingle assets).

Real estate transactions in Mexico involving the transfer of ownership (including acquisition or transfer to a trust) or the granting of a mortgage must be in the form of a deed (escritura pública), executed before a public notary (notario público), and registered before the public registry of property of the jurisdiction in which the real estate is located (the registration process is handled by the public notary).

In Mexico, as opposed to other countries, public notaries must be licensed attorneys and have a special permit to act as notaries. Most notaries have obtained their licence after passing certain exams and other requirements. The deed granting title to real estate or evidencing a security interest will be effective against third parties as of the date of registration (so gap coverage is important within the context of a title policy and the filing of a preventive notice (aviso preventivo), where available, is recommended). The participation of the notary will include filing official certificates regarding background checks on the property, attesting to the execution of the transaction documents, certifying that the parties have the legal capacity to execute the relevant document, issuing the deed formalizing the transaction, making the relevant registrations in the corresponding public registry of property, the payment of relevant taxes and registration rights (with funds provided by the parties) and other required government notifications.

As real estate transactions in Mexico involving the transfer of ownership require the participation of a Mexican public notary, the fees of public notaries are regulated. However, these regulated fees are expensive, so in some case public notary fees may be negotiated with the public notary. When electing a public notary, the parties should be aware of the notary fees, registration rights, background check expenses, transfer taxes (if any) and any other fees or costs associated with the transaction.

Author biographies

Guillermo Pérez Santiago Ritch Mueller, SC Since 1998, Guillermo Pérez Santiago has actively participated in the real estate practice group at Ritch Mueller, SC. He regularly advises foreign lenders and investors in real estate financings and acquisitions. He has participated in several transactions that have been highlighted by several publications for their significance. Recently, he advised Bear Stearns, Citibank, Credit Suisse, JPMorgan Chase, Morgan Stanley and other foreign and domestic financial institutions in real estate finance transactions in Mexico. His practice also includes securities, mergers and acquisitions, banking and corporate finance. He has been recognized as a leading practitioner by various international publications, such as the International Financial Law Review, and has participated in several conferences and publications on asset securitization and real estate financing. He is also a professor of mergers and acquisitions and asset securitization at the post-graduate courses of the Escuela Libre de Derecho and is a former securities law professor of the ITAM Law School. Born in Guadalajara, Jalisco (1970), Guillermo Pérez Santiago obtained his law degree from the prestigious Escuela Libre de Derecho in Mexico City in 1995. He received an LLM degree from Duke University Law School in Durham, North Carolina, in 1998. He joined Ritch Mueller in 1991 and became partner in 2001. He also worked as a foreign associate with Davis Polk & Wardwell in New York. He is fluent in Spanish and English. Ricardo Gómez-Palacio Ritch Mueller, SC As one of the leading partners of the Ritch Mueller, SC real estate department, Ricardo Gómez-Palacio has represented Kimco Realty Corporation, the largest publicly traded owner and operator of shopping centres in North America in its investments in Mexico, as well as Credit Suisse, Morgan Stanley and other major financial institutions regarding Mexico asset-backed securitizations, and diverse funds and investors in connection with the acquisition, financing and development of high-end tourist destinations, resorts and condominiums operated by the most luxurious brands, such as the Four Seasons. Ricardo Gómez-Palacio has published in the International Financial Law Review, and has participated with the American Bar Association in cross-border conferences as a speaker. His practice also includes securities, banking and corporate finance, mergers and acquisitions, and aircraft finance. Born in Mexico City (1972), Ricardo Gómez-Palacio obtained his law degree from the National University of Mexico in Mexico City in 1997. He received an LLM degree from University of Texas at Austin (1998). He joined Ritch Mueller in 1995 and became partner in 2006. He also worked as a foreign associate with Simpson Thacher & Bartlett, LLP, in New York. He is fluent in Spanish and English.