One of the most promising international commercial developments in recent years has been the increasing adoption, especially by developing countries, of modern secured transactions laws. Because securities markets are often not well developed in these countries, financing tends to take the form of debt rather than equity. The ability of an enterprise to provide a lender with readily accessible collateral in the form of movable assets increases the enterprise’s access to credit. The World Bank, which strongly promotes secured transactions reform, has concluded that:
Laws governing secured credit mitigate lenders’ risks of default and thereby increase the flow of capital and facilitate low-cost financing. Discrepancies and uncertainties in the legal framework governing security rights are the main reasons for the high costs and unavailability of credit, especially in developing countries.
The lack of a modern secured transactions regime is especially harmful to micro, small, and medium-size enterprises (MSMEs). A World Bank report, referencing a survey conducted in more than 100 countries, found that collateral was required in more than 75 percent of all loans. It also found that movables typically comprise a large percentage of the assets of commercial enterprises generally and an especially large percentage for MSMEs. Without a modern secured transactions regime, movables are what the report calls “dead capital” because banks are usually unwilling to lend against them. The goal of the World Bank and other international agencies committed to reform is to increase access to credit by unlocking the value of movables.
As we shall see, there are several statutory models available for countries interested in reform, but they all share certain features:
- They permit the creation of a security right by contract and generally permit the parties to define their respective rights and obligations under the principle of freedom of contract;
- They permit a security right to be created in any transferable property interest, including an interest that is less than title (e.g., a leasehold interest in goods, a license of intellectual property), and the security right continues in the proceeds if the debtor disposes of its property interest;
- They have great flexibility, facilitating the creation of security rights in assets that will be held by the debtor pending default, assets that will be held by the creditor pending repayment, assets of a generic type such as all the debtor’s inventory, and assets to be acquired by the debtor in the future, such as new inventory that replaces sold inventory;
- They create a system for determining whether a security right is effective against a third party that acquires a property interest in the collateral, and the system provides super-priority for acquisition financing (an extension of value by a seller or lender that enables a debtor to acquire an asset); and
- They provide for the rapid enforcement of security rights in the event of default, largely through extra-judicial means.
At the core of the system for determining whether a security right is effective against third parties is a publicly operated, readily searchable registry that permits a creditor to provide notice of its security right. For example, if a creditor takes a security right in a farmer’s tractor as collateral for a loan, the right will be extinguished if the farmer sells the tractor to an innocent third party unless the creditor has registered a notice. It may do so by delivering to the registry a simple form indicating the farmer’s name, describing the tractor, and providing a limited set of additional information. The notice will be indexed in the registry’s database in the farmer’s name and anyone searching under that name will find it. If the creditor timely registers a notice, a third party that buys the tractor will take it subject to the creditor’s security right.
A recent study demonstrates the power of modern secured transactions regimes that employ collateral registries. The study compared access to bank finance before and after the introduction of such regimes in seven countries and found that:
[T]he introduction of registries for movable assets is associated with an increase in the likelihood that a firm has a bank loan, line of credit or overdraft, a rise in the share of the firm’s working capital and fixed assets financed by banks, a reduction in the interest rates paid on loans, and an increase in the maturity of bank loans.
As noted above, there are several templates available for reform-minded countries. No matter which model (or combination of models) is selected, the country will need to adapt the rules to fit within its framework of related laws and to meet other idiosyncratic needs.
One possibility is to follow the approach taken by the United States, Canada, New Zealand and Australia. In the U.S., secured transactions are governed by Article 9 of the Uniform Commercial Code (UCC). The UCC, which is state law, was widely adopted in the 1960s and has been periodically updated since then. The most recent major revision of Article 9 dates from 2001. Canadian provinces, beginning with Ontario in 1990, have each adopted a version of the Personal Property Security Act, which is loosely modeled on Article 9. New Zealand reformed its secured transactions laws by adopting the Personal Property Securities Act of 1999, and Australia followed with its Personal Property Securities Act, adopted in 2009 and effective in 2012. Malawi’s 2013 Personal Property Security Act was based on New Zealand’s law, and Jamaica’s Security Interests in Personal Property Act (SIPPA), also adopted in 2013 and discussed in more detail below, was influenced by the US/CA/NZ/AU model.
Another approach, and one which has been highly influential in Latin America, is based on the Organization of American States’ Model Inter-American Law on Secured Transactions. The model law, which was based on an assessment of best practices by the National Law Center for Inter-American Free Trade, was adopted by the OAS in 2002 and model collateral registry rules were adopted in 2009. The model law served as the basis for reforms in Guatemala, Mexico, Honduras, Colombia, El Salvador, Panama and Costa Rica. The Jamaican law referred to above reflects aspects of the OAS model law.
Yet another approach is based on the Model Law on Secured Transactions developed by the United Nations Commission on International Trade Law (UNCITRAL) and approved by it on July 1, 2016. The final version of the model law has not yet been published, but earlier versions, and a series of publications establishing the principles that underlie it, have influenced reform in numerous countries. Legislation based directly on the UNCITRAL model law has been drafted for consideration by Kenya, Zimbabwe and Ethiopia.
The reform movement has produced a number of striking successes. Mexico’s reform effort proceeded incrementally through a series of amendments to its laws over a 20-year period and has resulted in a very strong regime. In just its first year of operation, the Mexican Single Registry of Security Interests, known as RUG (for Registro Unico de Garantias Mobiliarias), received more than 45,000 registrations. There was a dramatic increase in volume following reforms in January and June of 2014, and by November of that year RUG had received more than 400,000 registrations. Well over 90 percent of the collateral reflected in the registrations secures loans of less the US$1 million, suggesting that MSMEs, which represent almost 99 percent of the businesses in Mexico, have been major beneficiaries of the new regime.
The 2014 adoption of Colombia’s Secured Transactions Law, based on the OAS model law, led to another success story. The Colombian Registry began operations in March of that year and by May, more than 11,000 registrations representing loans of more than US $5 billion had been registered, and by July the number of registrations had swelled to 57,000. The listed collateral included a wide variety of assets that were unlikely to have supported loans under the prior legal regime.
Another reform effort in the Caribbean has resulted in modern legislation, but has not yet yielded the kind of success experienced by Mexico and Colombia. Following a commitment made by the government of Jamaica to the International Monetary Fund as a condition of an Extended Fund Facility in 2013, Jamaica’s Security Interests in Personal Property Act (SIPPA) was enacted on Dec. 30, 2013, and went into effect on Jan. 2, 2014. The act has been underutilized compared to expectations, possibly due in part to lack of practical capacity in the banking sector to administer asset-based loans and inaction on the part of bank regulators with respect to adjusting capital adequacy guidelines and the like in light of the increased protection SIPPA provides for personal property security. There are, however, hopeful signs. The OAS has engaged in a capacity-building exercise with the government of Jamaica, and a review of the legislation required by the terms of SIPPA may lead to improvements.
In addition, the International Finance Corporation (IFC), part of the World Bank Group, is working with the government of St. Lucia to develop a new secured transactions law. The drafting is complicated by the country’s mixed common law and civil law heritage, but is likely to be completed within the next year or so. Inasmuch as banking regulation in St. Lucia is provided by the Eastern Caribbean Central Bank (ECCB), which is the central bank not only for St. Lucia but also for seven other states in the region (Anguilla, Antigua and Barbuda, Commonwealth of Dominica, Grenada, Montserrat, St Kitts and Nevis, and St Vincent and the Grenadines), it is possible that reform in St. Lucia may inspire similar reforms in the other states regulated by the ECCB. The IFC is also working with the governments of Trinidad and Tobago and Haiti on reform projects.
Other countries around the world have benefited from secured transactions reform. China adopted a new Property Law in 2007 and established a collateral registry. A study commissioned by the IFC evaluated the effects of the law on SMEs and found that of 250 entrepreneurs surveyed, 59 percent indicated that their businesses would have been severely impacted had they not had the access to secured loans that the law facilitated. The report also found that female entrepreneurs in particular were beneficiaries of reform. Among the many other countries not mentioned above that have either reformed their laws or are moving in that direction are Vietnam, Liberia, Rwanda, Sri Lanka, India, Cambodia, Philippines, Jordan, Lebanon, Azerbaijan and Belarus.
Secured transactions reform is not a magic elixir that can grow an economy overnight, and it is but one piece in the legal infrastructure any country needs if it wishes to have a thriving economy. It is a foundational piece of that infrastructure, however, and there is now sufficient data from a number of countries to demonstrate that it can have beneficial effects, especially as applied to MSMEs. Watch for many more countries to join the bandwagon in the coming years.