Guarantees under Mexican law and the Covid-19 pandemic

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Daniel Del Río Loaiza

Basham, Ringe y Correa, Mexico City

danieldelrio@basham.com.mx

Pedro Said Nader

Basham, Ringe y Correa, Mexico City

psaid@basham.com.mx

In recent years, the Mexican lending market has grown significantly, with lenders seeking special measures or specific legal instruments to secure financing transactions as the financial market carries an inherent volatility. However, the current pandemic caused by the Covid-19 virus has had a direct impact on the Mexican economy. The ability for companies and individuals to meet their respective credit commitments in a timely manner has been largely impacted with the fall of the national economy resulting in greater economic instability.

In this regard, Mexican legislation provides for two general types of guarantees: personal guarantees and real guarantees. On the one hand, personal guarantees are directly assumed by a specific person. On the other hand, real guarantees are created over specific assets aimed at reinforcing the legal position of the lender. These in turn, may attribute to the lender a security right, ownership of an asset, title to an asset or temporary possession of an asset.

Creating and perfecting security interests

Under Mexican law, a security interest is perfected when all the applicable steps required have been taken when the corresponding security agreement is executed. In this regard, formalisation before a public notary and registration before the appropriate public registry of property and commerce (Registro Público de la Propiedad y de Comercio) is necessary when dealing with real property.

On the other hand, with regards to personal property, registration in the Mexican Sole Registry of Moveable Property (Registro Único de Garantías Mobiliarias) will be required in order to ensure and preserve the priority of the security interest being granted before third parties.

Types of guarantees under Mexican law

In accordance with the above, under Mexican law, personal and real guarantees are divided as follows.

Surety bond

An agreement whereby a guarantor (obligor) assumes an obligation in favour of a creditor to pay in the place of the debtor, in the event that the debtor defaults with its payment obligation. In this regard, bonds may be contracted with duly licensed and registered insurance companies or may be granted by any interested third party.

Pledge

A pledge agreement provides a personal property right to secure the payment of an obligation as well as the preferential right to such payment. A pledge may be granted without transfer of possession, which means that the pledged property may remain with the pledger to use in the regular course of business. In case of a breach by the debtor of the obligations secured by the pledge, the creditor may sell the pledged assets, following the required proceedings established by Mexican law, and apply the proceeds to the payment of the secured obligations.

It is important to consider that pledges are usually granted through assets that may be easily sold or disposed, like:

• equipment;

• vehicles;

• machines;

• merchandise;

• accounts receivable;

• money; or

• shares of stock.

However, given the current sanitation emergency, interested parties willing to enter into pledge agreements should consider that many sectors have dropped prices on assets or even changed their pricing to Mexican pesos, diminishing their current market values.

Mortgage

A mortgage grants a creditor (mortgagee) a right over property, whose possession remains with the mortgagor, to be paid out of the proceeds of the disposition of the property in the event of a failure to comply with the obligations being secured.

A mortgage creates a security interest over real estate assets but can also be granted over personal property attached to real property and over businesses or ships. Mortgages may be granted unilaterally, meaning that the mortgage may be granted by the mortgagor without the mortgagee’s participation.

As mentioned above, many sectors have dropped their prices; the real estate market is no exemption. Demand has dropped, and structural changes to the Mexican economy have created a long-lasting effect. Furthermore, large mortgage lenders have suspended mortgage payments, as well as provided total or partial deferral of interests and or principal payments for up to four months, with the possibility of an extension for a further two months, as financial stability and economic growth are key players when it comes to mortgage lending.

Guarantee trust

This type of security interest is an agreement whereby a settlor transfers the title of the real or personal property to a trustee to be held as security for the repayment of a debt or to secure compliance with an obligation owed to the creditor or beneficiary, though the debtor may continue in possession of the property held in escrow. Only banks, insurance companies, guarantee companies, special purpose financial institutions or public bonded warehouses (as escrow agents) and certain other financial institutions may act as trustees.

If the fair market value of the property held in escrow falls to such an extent that the property will no longer cover the principal of, and interest on, the secured debt, the obligor may transfer additional property to cover the shortfall or the creditor may accelerate the debt by so notifying the obligor, either judicially or through a public attester. Generally, the trustee will only act after receiving instructions from the creditor or beneficiary. In brief, the guarantee trust implies the payment of fiduciary fees which payment should be covered as negotiated by the parties.

Equipment or operating loan

By virtue of this type of agreement, a debtor is obligated to use the exact amount of the loan for the acquisition of raw materials and/or equipment as well as for the payment of wages, salaries and direct expenses required for the day-to-day operation of the business.

This type of loan is secured by the raw materials or equipment acquired with the loan proceeds or the products or manufactured goods resulting therefore.

Financing loan

The legal nature of a financing loan allows for multiples uses, such as:

• to purchase tools, farming implements, cattle, instruments, fertiliser or breeding stock;

• to develop farms or raise crops – either seasonal or permanent;

• to open land for cultivation; and

• to purchase or install machinery, and construct or develop working equipment necessary to carry out the debtor's day-to-day business.

This type of loan is secured, simultaneously and separately, with the assets and the products and proceeds, whether future, pending or already obtained, of the business for which the loan was obtained.

Joint obligor

A debtor who is jointly and severally liable with others for the performance of an obligation, which may be enforced by the creditor to pay its entire amount, with the right of reimbursement against the other obligors for their respective share of the obligation. A joint obligor should be well known, possess a good reputation and adequate management or individual with the financial capacity to repay for the payment.

Under Mexican law, joint obligations are those in which several debtors or creditors, or various creditors and debtors, so that each and every creditor may ask the debtor to pay the obligations in full. Joint and several liabilities are a comprehensive, mandatory and unitary creditor relationship with all the joint debtors, which sometimes may also be facing a plurality of debts.

Further to the above, there are different types of liability partnership that should also be considered, such as:

• Active joint and several liability: fully corresponds to each and every one of the creditors, and any which may claim and receive the full benefits of an obligation. Once a debtor pays one of such creditors, it in turn is released from its obligations with respect to the other creditors.

• Passive joint and several liability: every debtor is obligated itself to comply with the obligations, so that the creditor may require the fulfilment of a given obligation from any of such debtor. Once it has been carried out by one of the debtors, the other debtors are released from their obligations before the creditor.

Additionally, there will be active joint and several liability, when two or more creditors have the right to demand, each in itself, the total performance of the obligation; and passive joint and several liability, when two or more debtors have the obligation to report, each in itself, in full, the benefit due.

Therefore, two types of relationships are distinguished; the first is the apparent relationship, which refers to the relationship between creditors and debtors, and the second is the underlying relationship, which refers to the relationship between the co-creditors and/or co-debtors once the payment has been fulfilled. It should be noted that joint and several liability is not to be implied; it results from the law or the will of the parties.

The extinction of both the active and passive joint and several liability occurs once the payment made to one of the joint creditors fully extinguished the debt. Additionally, a substitution, compensation, consolidation or remission of rights made by any of the joint creditors, with respect to any of the joint debtors of the same class, extinguishes an obligation.

Each of the joint creditors or all jointly and severally may require all or one of the joint debtors the total or partial payment of the debt. If the joint creditors require the totality of the debt from one debtor, which in turn is or becomes insolvent, the joint creditors may require the fulfilment of the obligation from a different debtor or all of the joint debtors. If the joint creditors only required the partial fulfilment of the obligation, or allowed for the separation of the debt with respect to one or several of the joint debtors, the creditors may still require the remainder from the other joint debtors.

Conclusion

The Covid-19 pandemic has generated a direct impact on the security interest market in Mexico, as many credit institutions and individuals will lack the capacity to calculate and anticipate market fluctuations and their corresponding financial outcomes. The level of uncertainty has brought economies to a complete stop. As such, securing financial transactions has become a cumbersome issue.

Nevertheless, to the extent the government reactivates the economy, all interested parties wishing to secure financial transactions should carefully consider all possible scenarios that could derive from the Covid-19 pandemic. Interested parties should always consider that, when securing financial transactions, it is best practice to provide mechanisms that guarantee the compliance of an obligation. This is why guarantee agreements are an important part of Mexican legislation since, as it has been previously demonstrated, these types of guarantees have the advantage of speeding up and facilitating the process for the granting of loans by financial entities or even supporting the compliance of different types of obligations that may be generated at the time of entering into an agreement.

Nevertheless, achieving a secure financial transaction will depend on the asset(s) in question and the current financial market conditions at that time.

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