I. Changes to the Substantive Law of Secured Transactions Before 2014

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1 RECENT IMPROVEMENTS IN MEXICAN SECURED TRANSACTION LAWS Prepared by John E. Rogers, Francisco J. Pérez Ortega and Carlos A. Villegas Guillot 1 Introduction In the last few years, a series of changes in the Mexican laws governing secured transactions have made lending against personal property such as equipment, inventory and accounts receivable more attractive to lenders to Mexican companies. The changes have involved amendments to the substantive law of secured transactions, including the introduction of new concepts such as non-possessory pledges and guaranty trusts and the introduction of a central national registry for recording or registering secured transactions. Early this year, as part of the Mexican government s financial reform package of laws, the laws governing civil procedure and the enforcement of security interests granted by debtors against personal property were amended. The latest changes became effective in January While it is too soon to measure their effects, according to the legislative history the changes are intended to modify the commercial legal framework for the purpose of making procedures more efficient, provide incentives for the general population to have access to credit, and to benefit the development of business in our country. More recently, June 2014 amendments to the Mexican Commercial Code promise to make the central national registry a more reliable mechanism for recording secured transactions and alerting creditors to previously filed security interests. I. Changes to the Substantive Law of Secured Transactions Before 2014 Unlike the United States where all states adopted the Uniform Commercial Code (UCC), Mexico does not have a single comprehensive law covering secured transactions. Instead, several laws cover various types of transactions involving personal or movable property (bienes muebles). Thus, there is no single concept of a security interest in personal property but a variety of mechanisms set out in the Commercial Code, the General Law of Credit Instruments and Transactions (the Ley 1 John E. Rogers is a member of the New York bar and is Of Counsel to Strasburger & Price in Mexico City and New York. Francisco J. Pérez Ortega is a member of the Mexican bar and is a partner of Struck Palafox y Pérez Ortega, S.C., part of the joint venture Strasburger & SPPO, S.C. in Mexico City. Carlos A. Villegas Guillot is a member of the Mexican bar with offices in Mexico City and San Miguel de Allende, Mexico.

2 General de Títulos y Operaciones de Crédito or LGTOC), the Civil Codes of the various States of Mexico and the Credit Institutions Law. The concepts include pledges under the Commercial Code (the commercial pledge) and the Civil Codes (the civil pledge), the industrial mortgage, pledges of warehouse certificates (bonos de prenda), assignments of accounts receivable (cesiones de créditos), conditional transfers of negotiable instruments (reportos), the securities pledge (prenda bursátil), special security interests involved in the equipment credit called the crédito refaccionario and the operating credit called the crédito de habilitación o avío. Each of these models has limitations making it difficult for a creditor to determine which is the most appropriate for a particular lending transaction. 2 In 2000, through amendments to the Commercial Code and LGTOC, guaranty trusts (fideicomisos de garantía) were introduced, further expanding the types of security interests available to creditors. Perhaps most significantly, non-possessory pledges (prendas sin transmisión de posesión), allowing creation of blanket liens or floating liens on equipment, inventory, receivables and other revolving property also became available in This amendment may have been the single most important step in bringing Mexican secured transactions laws closer to those embodied in the UCC. Previously, security interests in many of the key categories of personal property could only be created (or released) by identifying each specific item of collateral listing separate items of equipment or specific accounts receivable for example. Under the 2000 amendments, property not yet in existence or owned by the debtor could be pledged as security, something that was previously impossible. The non-possessory pledge was now available to secure subsequently acquired property and property not in existence at the time the pledge was granted. Unfortunately, the 2000 amendments did not permit creditors to sue for a deficiency if the value of the property securing the loan was less than the amount of the debt. Additionally, creditors could not foreclose upon their security interests except through judicial proceedings unless the debtor did not contest the amount of the debt or whether it was due and payable. These limitations caused concerns among creditors about the effectiveness of the new types of security interests. These concerns, along with the Organization of American States (OAS) 2002 adoption of the Model Inter-American Law on Secured Transactions (the Model Law), led Mexican legislators to adopt further amendments to the LGTOC in 2003, eliminating the antideficiency limitation and providing for extrajudicial foreclosure although only to a limited extent and only in the context of guaranty trusts. Despite the advances that had been made since 2000 to modernize Mexican laws governing secured transactions, by the time the 2014 financial reform package was adopted, many creditors still had concerns about whether they could rely on collateral security they might require of debtors in Mexico. Creditors were concerns included: 1. Uncertainty about the most effective type of collateral to choose for a transaction. This uncertainty was caused by the multiple types of collateral available for transactions, in spite of the fact that the non-possessory pledge and the guaranty trust now seemed to be the broadest and most flexible types of collateral security. 2 Instead of relying on collateral security, some lenders to Mexican borrowers obtain a promissory note or pagaré from the borrower. The pagaré qualifies as a negotiable instrument under Mexican law because it can be enforced through executory or accelerated proceedings permitting the lender to obtain pre-judgment attachment of the borrower s assets. This approach is certainly simpler to document than obtaining collateral security, but does not give the creditor secured status.

3 2. The extremely limited availability of extrajudicial foreclosure. Extrajudicial foreclosure was not available for enforcement of any of the security types unless: the debtor did not contest the amount of the debt or whether it was due and payable (an uncertain proposition); the transaction used a guaranty trust (a somewhat expensive process, given the fees that likely to be charged by the trustee, required to be a licensed Mexican credit institution); or the debtor was notified of the foreclosure through a fedatario público (a public notary or corredor público), a time-consuming solution in some circumstances. 3. Doubts regarding the effect of a purchase money security interest. The effect of a purchase money security interest (PMSI) on an existing non-possessory pledge was not always clear, because the validity of the PMSI could depend on all of the personal property of the debtor having been previously pledged, or on the extent to which such property was used in the preponderant activity of the debtor. In addition, a PMSI could be adversely affected to the extent the debtor s property was subject to title retention mechanisms. On the other hand, since the PMSI creditor did not have to give notice to a pre-existing secured creditor, the existing creditor might make advances on collateral that could be subordinate to the superior lien of a later-created PMSI The good faith purchaser risk. Purchasers of personal property were subject to certain risks. If a debtor, in its ordinary course of business, sold property, that property could be subject to a pre-existing security interest if the purchase was outside of the debtor s preponderant activity, an ill-defined term. 5. Roadblocks to enforcement of a non-possessory pledge or a guaranty trust. Enforcement through a non-judicial proceeding or self-help could only occur if both debtor and creditor had contractually agreed to the use of the self-help remedy and there was no dispute between the parties over whether the amount or status of a debt at the time of default. The process also required that a fedatario (either a notary or a corredor público) send formal notice to the debtor to turn over the collateral and be present when the creditor took possession of the collateral to prepare an inventory of the transferred collateral. If at any time during this process the debtor raised a challenge, the process had to cease. 6. The delays inherent in judicial proceedings. If self-help were not available for any reason, enforcement required a judicial proceeding. These actions could take as long as two years or more to complete, because of possible delays resulting from various challenges that the debtor could institute, including the right to challenge any court decision by bringing a federal amparo proceeding questioning the constitutionality of the decision. Even when self-help is available via notification by fedatario, substantial delays could result from difficulties in locating and notifying the debtor. 7. Delays caused by the availability of appeals and amparo challenges. An accelerated enforcement procedure for the non-possessory pledge could potentially shorten the enforcement time to as little as a month, but the debtor could still raise time-consuming appeals or amparo challenges, meaning the value of the collateral could erode by the time the creditor eventually obtained possession. 8. The uncertainty as to the amount a creditor could expect to receive from the sale of collateral. The value of collateral subject to a foreclosed security interest was not determined by its market value in a public or private sale conducted in a commercially reasonable manner, as in the US under the UCC. Instead, the security agreement had to 3 See LGTOC Art. 358.

4 specify the method by which the value of the collateral was determined and/or designate an appraiser who would determine the value prior to sale. If the collateral did not sell at the initial appraised value, the permissible offer price was reduced by ten percent per week until the collateral could be successfully sold or adjudicated in favor of the creditor. 9. The difficulties of locating certain security interests in public registries. Some types of security interests, such as the guaranty trust, provide the potential advantage of being treated as outright transfers of title that would remove them from the bankruptcy estate of the debtor. This provided a distinct advantage to the creditor receiving any such transfer; but since these transfers generally did not need to be recorded or filed with any registry in order to be perfected, other creditors of the debtor could not determine the existence of these interests through any search in the public registries. II. Establishment of the Registro Único de Garantías (RUG) Until recent years, perfecting most Mexican security interests required filing or registering a notarial deed with the applicable security agreement in a public registry of commerce where the debtor maintained its domicile or, in some cases, where the property was located. This led to substantial uncertainty about where to file a deed and where to search for the existence of prior filings. Moreover, the quality, reliability and location of the various public registries differ substantially across Mexico. In 2009, the amendments to the Mexican Commercial Code established a central electronic registry for most types of personal property security interests the Registro Único de Garantías Mobiliarias or RUG. 4 This step was prompted in part by OAS s adoption of the Model Law, and the Legislative Guide adopted in 2008 by the United Nations Commission on International Trade Law. Shortly after the enactment of the Commercial Code amendments, in October 2009, the OAS adopted its Model Registry Regulations to provide the legal foundation for implementing and operating the registry regime contemplated by the Model Law. Financial institutions, public officials, fedatarios or any other party authorized by the Ministry of Economy can file electronically through the RUG website ( with immediate effect in the case of filings made by fedatarios. Anyone can use the website to search for filings made against any debtor. In September 2010, an executive decree implemented the 2009 Commercial Code amendments and clarified the operation of the RUG through the electronic system called the Integrated System of Registry Procedures (Sistema Integral de Gestión Registral). The new RUG system substantially advanced the creation of a single nationwide electronic system for registering personal property security interests. By providing a single electronic system for the entire country, the RUG is actually more advanced than the continuing patchwork of state registry systems operating under the 50 separate Uniform Commercial Codes in the US and the separate province-by-province filing or registry systems in Canada. Unfortunately, the amendments requiring the establishment of the RUG did not include transitional rules clarifying how prior state public registry filings would be handled. Since security interests set forth in those local filings could be superior to those filed in the RUG, prospective lenders against personal property still had to search local registries to determine whether any such filings had been made against the same property subject to the RUG filing. 4 See new Article 32 Bis 1 through 32 Bis 9 of the Commercial Code published in the Diario Oficial de la Federación on August 27, 2009.

5 Creditor reliance on the RUG was further limited by the fact that guaranty trusts, industrial mortgages and certain other kinds of security interests were not required to be filed or recorded in the RUG in order to have effects with respect to third parties. Industrial mortgages and guaranty trusts often involve real property as well as personal property, and creditors could conclude that recording the relevant document in a local real property registry would be sufficient to perfect the lien or security interest created in all such property against third parties. Even if a filing in the RUG might have been required for the personal property component of an industrial mortgage, for example, if there were no real property portion, the law did not clearly require a RUG filing for the portion relating to personal property. Although a creditor could require a debtor to represent and warrant that all liens or security interests affecting personal property had been filed with the RUG, the creditor had no easy way of verifying the representation or warranty. The creditor thus ran the risk that undisclosed prior security interests might take priority over those that the creditor filed in the RUG, if those prior interests were filed, for example, in a local commercial registry in the case of a guaranty trust or in a real property registry in the case of an industrial mortgage. III. Changes Enacted in the Financial Reform of January 2014 and June 2014 Changes A. Summary of the January 2014 Financial Reform In general. As a result of commitments made by the three main political parties in the Pact for Mexico (Pacto por México) adopted after the election of President Enrique Peña Nieto in 2012, the government has enacted a number of major reforms most notably in energy, but also in financial services, telecommunications, education, and labor law among other areas. The Mexican Congress passed and the president signed a number of legal reforms in the financial services arena that became effective in January 2014 upon their publication in the Daily Gazette of the Federation (the Diario Oficial de la Federación or D.O.F.). 5 The financial reform was intended to strengthen the Mexican financial system and encourage sustained economic growth, by promoting competition, generating additional incentives for financial institutions to provide more financing on better terms and conditions, and enabling them to have greater certainty in making and recovering loans. The amendments to various provisions of the Commercial Code, the LGTOC and the Organic Law of the Judicial Branch of the Federation were some of the most important aspects of the reform. Those amendments were designed to strengthen the legal framework for secured loans, facilitate their collection, and enforce collateral security for such loans in case of default in payment. Cash collateral. Amendments to the LGTOC allow creditors to enforce collection of cash collateral through extrajudicial means. If the debtor and creditor agree to terms that allow the creditor to take ownership of cash (up to the amount of the secured obligation) in the event of a default, there is no need to initiate a judicial proceeding or obtain a judgment. The debtor, however, must be entitled to preserve its rights to any amount of cash collateral exceeding the amount of the secured obligation. This extrajudicial enforcement mechanism in Article 336 Bis of the LGTOC represents an important innovation in the enforcement alternatives available to creditors, and a step toward establishing the kinds of enforcement options that foreign creditors are accustomed to having with respect to obligations secured by cash collateral. Provisional or pre-trial remedies. The provisions related to provisional or pre-trial measures available to creditors for enforcing collateral security in general have been reordered in commercial cases. Criteria applying to such measures have been established, increasing legal 5 D.O.F., January 10, 2014

6 efficiency and certainty in the collection of secured commercial obligations. The law clarifies the requirements for obtaining an order restricting the movement of individual defendants (radicación de personas) and an order for provisional sequestration or retención of assets In addition, once the applicable requirements have been satisfied, the court with jurisdiction in the case must approve the applicable provisional measure. It is also now possible to request the modification or revocation of the provisional measure based on intervening events, ending the possibility that the provisional measure may be challenged at any time. This change is an important advance for creditors since they now have access to the assets and can get them appraised and determine whether they are adequate to cover the amount of the secured obligation. If the value of the collateral is not adequate, the creditor will have the right to request additional provisional pre-trial measures or additional collateral security to cover any shortfall. Given that the amount of time previously required to enforce collateral security often led to a diminution of the value of the pledged assets, the new law significantly strengthens creditors rights. Federal district courts for commercial matters. Federal District Courts for Commercial Matters have been established with broad jurisdiction in commercial matters. Under Article 104 of the Mexican Constitution, federal courts and state or local courts have concurrent jurisdiction to handle commercial cases, but as a practical matter, the federal courts rarely handle such cases at the outset. The financial reform amendments contemplate that certain federal district courts will specialize in commercial matters. In order to allow better distribution of caseloads at federal, state and local levels, the existing concurrent jurisdiction will be maintained. The jurisdiction of the federal district courts will be clarified with respect to bankruptcy cases, commercial disputes in which the plaintiff has not chosen to commence the action before a state or local court, the recognition and enforcement of commercial arbitration awards and commercial class actions. Strengthening the financial system. Financial reforms also address areas other than those surrounding secured transactions. The changes seek to strengthen the Mexican financial system, and give greater legal certainty and security in all financial transactions. The reform includes strengthening of the corporate governance of financial group holding companies (through a new Law to Regulate Financial Groups) and reorienting the National Commission for the Protection and Defense of Users of Financial Services (CONDUSEF, its initials in Spanish). The latter will benefit users of the financial system by creating a bureau of financial institutions that will give users more information for making financial decisions. An arbitration system in financial matters will offer a new method of dispute resolution and increase fairness, speed, transparency, effectiveness and efficiency in the process. Multiple Purpose Financial Companies and General Bonded Warehouses will be subject to additional regulation and supervision. Finally, the government will ease the regulatory framework governing Development Banks to enhance the financial system and establish other mechanisms to streamline the market. B. June 2014 Changes Affecting the RUG The January 2014 financial reform package did not directly affect the RUG, but in June 2014, amendments to the Commercial Code and the General Law of Commercial Companies significantly enhanced the role of the RUG in the framework of Mexican secured transactions law. The amendments addressed one of the main concerns of creditors the fact that multiple juridical acts were not required to be recorded or filed in the RUG. 6 Under paragraph A of Article 32 Bis of the Commercial Code, personal property security interests expressly include not only the non-possessory pledge but also any ordinary commercial 6 D.O.F, June 13, 2014.

7 pledge in which the creditor does not have possession of the property, any pledge which is involved in a crédito refaccionario or crédito de habilitación o avío, and any industrial mortgage involving personal property. In addition, paragraph B of the Article now requires that the following must be recorded in the RUG in order to have any effect with respect to third parties: 1. In general, all juridical commercial acts by which any special privilege or right of retention with respect to personal property might be created in favor of a creditor that does not have possession thereof. 2. Financial leases affecting personal property. 3. Financial factoring contracts. 4. Commercial sales contracts for personal property in which the seller relinquishes possession but retains any ownership or rescission rights that can be exercised upon nonpayment of the purchase price. 5. Guaranty trusts involving any personal property. 6. Judicial or administrative rulings affecting personal property, including those involving attachment orders. 7. Any other analogous act, lien or charge affecting personal property that, directly or indirectly, can create a lien or security interest against property not in the creditor s possession. The breadth of this language seems to require that, in addition to the specific types of security interests listed, all bonos de prenda and purchase money security interests must now be filed in the RUG in order for the related security interests to be perfected against third parties. These changes should provide substantial additional assurance to creditors granting loans against personal property that their searches in the RUG will disclose all security interests, as well as attachments and other relevant acts that might have priority over the interests granted to secure such loans. Unfortunately, these changes did not address the problem created by security interests created (and recorded in local public registries) prior to the establishment of the RUG or, in the case of the types of security interests newly covered through the June 2014 amendments, prior to the effective date of the amendments. As a result, a creditor searching the record for previously filed security interests must consider the possibility that the debtor may have recorded security interests in local public registries prior to the establishment of the RUG or, in the case of the newly covered types such as the industrial mortgage or guaranty trust, prior to June 13, If that possibility exists, the creditor must search the local public registries where the debtor might have filed such security interests in addition to searching the RUG. C. Evaluating the Effectiveness of the Changes It is too soon to assess the overall effectiveness of the 2014 Financial Reform and recent changes in the RUG including whether the changes will improve creditors ability to enforce secured obligations or lenders willingness to extend new credit based on personal property collateral. With respect to the list of concerns set forth in part I of this article, however, we can come to some preliminary conclusions:

8 1. The multiple types of security interests remain unchanged, meaning that creditors must still select from the usual list of suspects. 2. Perhaps the most notable advance is in the area of extrajudicial foreclosure, even though the change is limited to cash collateral. 3. The concerns involving PMSIs appear unaffected by the January reform; but the June amendments to Article 358 of the LGTOC indicate that a PMSI s effect on third parties will probably depend not only on it being filed in the RUG but also on whether the property subject to the PMSI can be distinguished from the other property subject to the non-possessory pledge. 4. The good faith purchaser risk may have been clarified by the June amendments, insofar as the types of rights that may be filed in the RUG have broadened. It may now be advisable for a purchaser to search the RUG for any prior filing of rights related to the property to be purchased and to record its rights as purchaser in the RUG to give notice of the purchase to third parties who could subsequently seek to acquire rights to the property. 5. The reform does not give creditors greater rights for enforcement of a non-possessory pledge or guaranty trust through a non-judicial proceeding or self-help, except to the extent that cash collateral is involved. 6. Enforcement of security interests through judicial proceedings may become substantially quicker and more expedient because of changes in the Commercial Code providing additional pre-trial protective measures, including the right to appoint an appraiser of assets. Consequently, there will be fewer opportunities for delays of the proceedings. Cases that can now be handled by the federal courts may also be resolved more expeditiously, although it is too soon to know whether this will happen. 7. The risk of collateral losing value because of delays in enforcement proceedings has been reduced, because of the changes referred to in item 6 above, but the possibilities of appeals and amparo challenges remain unchanged. 8. The amount a creditor may receive in a foreclosure sale of the assets will still be determined by the appraised value not necessarily be the market value of the assets. 9. The June 2014 amendments to the Commercial Code have substantially reduced the risks of unrecorded or undisclosed security interests, since now virtually all types of security interests, including industrial mortgages and guaranty trusts, among others, must be filed in the RUG to be effective against third parties. These provisions should provide significant assurance to creditors that their searches in the RUG will actually disclose all relevant information. Nevertheless, the ongoing lack of transitional rules means that many creditors must supplement a RUG search with a local registry search, bringing the attendant uncertainty regarding which local registry or registries are applicable. These concerns will apply to security interests filed in local registries prior to the establishment of the RUG in 2009 or, in the case of industrial mortgages, guaranty trusts and other types of security interests newly subject to the RUG, those recorded before June 13, Although several creditors concerns were not addressed by the January 2014 financial reform or the June 2014 Commercial Code amendments, the changes that have been made suggest that Mexico intends to make ongoing incremental improvements in its laws governing secured transactions. We anticipate that this trend will continue and assuming that lenders continue to

9 comment on the remaining challenges there are likely to be further improvements in the future. In general, we believe that the amendments to the Commercial Code, the LGTOC and related laws enacted in 2014 represent an important step in strengthening and modernizing Mexican financial laws and institutions, a step that will foster much greater legal certainty and security in financing transactions in Mexico, from the perspectives of both creditors and debtors. For more information on the changes to Mexico s financial regulations, please contact: John E. Rogers, , john.rogers@strasburger.com Luis Fernando Gomar, , luis.gomar@strasburger.com Francisco J. Pérez Ortega, , fperezortega@sppo.mx Carlos A. Villegas Guillot, , cavilleg@prodigy.net.mx About Strasburger & Price, LLP One of the fastest growing law firms in Texas, Strasburger & Price, LLP stands ready to fill the full range of legal needs for Texas-based, middle-market companies, while also performing run the company work for national and international clients. The firm, which celebrates its 75th anniversary this year, has consistently been recognized as a premier Texas law firm, in both the courtroom and the boardroom. With experience in more than 30 practice areas, Strasburger attorneys provide legal advice to a variety of businesses from start-ups to Fortune 500 companies, both publicly and privately held as well as individuals and governmental entities. Strasburger has Texas offices in Austin, Collin County, Dallas, Houston, and San Antonio, as well as offices in New York City, Washington, D.C. and, as Strasburger & Price, S.C., in Mexico City. In September 2014, Strasburger commenced a joint venture with Struck, Palafox y Pérez Ortega, S.C. (SPPO). The Mexico City based joint venture operates as Strasburger & SPPO, S.C. For more information about Strasburger, please visit About Struck, Palafox y Pérez Ortega, S.C. A leading Mexico City-based law firm, Struck, Palafox y Pérez Ortega, S.C., provides high quality, personalized legal services in different fields of the law. The degree of specialization of its attorneys has given the firm a strong advantage when dealing with sophisticated and multi-jurisdictional matters, as well as with clients with interests that reach far beyond Mexico. For more information about SPPO, please visit About Carlos A. Villegas Guillot Mr. Guillot is a member of the Mexican bar with offices in Mexico City and San Miguel de Allende, Mexico. DISCLAIMER: Articles contained within this media release provide information on general legal issues and are not intended to provide advice on any specific legal matter or factual situation. This information is not intended to create, and receipt of it does not constitute, a lawyer-client relationship. Readers should not act upon this information without seeking professional counsel. ADVERTISEMENT NOTICE: This may constitute a commercial electronic mail message subject to the CAN-SPAM Act of If you do not wish to receive further commercial electronic mail messages from the sender, please send an to Strasburger@Strasburger.com and request that your address be removed from future mailings.