SECURED FINANCING OF U.S. BASED LOANS IN MEXICAN TRANSACTIONS ENHANCED BY THE USE OF MEXICAN TRUST AGREEMENTS (FIDEICOMISOS) by Rebeca Pérez-Serrano INTRODUCTION In December 2005, Sheppard Mullin provided legal advice on two major transactions in Mexico: the acquisition of a Mexican subsidiary of Pulte Homes, Inc., by a leading Mexican real estate developer and its U.S. partner; and the financing of the acquisition of a controlling interest of thirteen airports in Northern Mexico by Ingenieros Civiles Asociados. These transactions shared two integral components: that financing was provided by a U.S. lender and the use of Mexican trust agreements (fideicomisos). In the first transaction, a trust agreement implemented certain buy-out and voting agreements between the buyers/controlling equity holders and key executives/minority equity holders; in the other, a trust was created to hold the collateral (shares) acquired by the borrower/purchaser for the benefit of the lender. These two recent transactions underscored the fact that Mexican trust agreements are being used in U.S. based secured financed transactions as a supplement to traditional secured financing mechanisms in Mexico. OVERVIEW OF COMMONLY USED SECURED FINANCING MECHANISMS IN MEXICO 1 In addition to obtaining, where available, a U.S. parent Guaranty of the Mexican borrower (or a personal Guaranty from a high net worth individual), traditionally, U.S. lenders financing Mexican transactions have used one of the following mechanisms to perfect their security interests under Mexican law: MEXICAN MORTGAGE A mortgage is an agreement whereby a debtor/mortgagor grants in favor of a lender/mortgagee a right over real property, the possession of which remains with the mortgagor. If the debtor defaults, the lender can petition the appropriate court to compel the sale of the mortgaged property and apply the proceeds of the sale to the payment of the debt. A mortgage can be extended to cover improvements and fixtures affixed to the real property. In order to notify third parties of the existence of the mortgage and to perfect it, a Mexican notary public drafts the mortgage in the form of a public deed (escritura pública) and records it in the Public Registry of Property where the real property is located. MEXICAN PLEDGE A pledge is an agreement whereby a debtor/pledgor grants to a lender/pledgee, a security interest over personal property to secure the payment of an obligation. The debtor may or 1 In Mexico, there is no equivalent to an Uniform Commercial Code financing statement. The following list includes some of the most commonly used secured financing mechanisms in Mexico and is not comprehensive. 1
may not retain the possession of the pledged property. In the case of default by the debtor, the lender can petition the appropriate court to compel the sale of the pledged personal property and apply the proceeds to the payment of the secured obligations. MEXICAN GUARANTY TRUST AGREEMENT A guaranty trust agreement is a trust where the debtor/settlor transfers the ownership of certain property to a Mexican bank 2 which acts as trustee or fiduciary ( fiduciario ), in order to secure compliance with an obligation owing to the creditor/beneficiary. In the event of default on the underlying obligation, the trustee will proceed with the sale of the trust property in a private auction and apply the proceeds to the payment of the secured obligations, as provided in the trust agreement. Because of the enforcement issues relating to the foregoing secured financing mechanisms in Mexico 3, U.S. lenders are increasingly favoring the use of a number of variations of the guaranty trust agreement to provide enhanced protection and control over the collateral. The variations of Mexican guaranty trust agreement include: TRUST AGREEMENT WHERE THE LENDER IS DESIGNATED AS THE FIRST BENEFICIARY OF THE TRUST ( LENDER S TRUST ) In a Lender s Trust, the Settlor transfers title to the collateral, either real or personal property (the Property ), to the Mexican trust (the Trust ). The Trustee or Fiduciary is a Mexican financial institution. The First Beneficiary of the Trust is a U.S. lender/creditor and the Second Beneficiary of the Trust is a borrower/debtor subject to a Credit Agreement governed by U.S. law. Note that a Second Beneficiary often is the same entity as the Settlor. While the parties to a Lender s Trust can contractually set forth any rights and obligations permissible under applicable Mexican law, a Lender s Trust may include some of the following terms: RIGHTS OF THE FIRST BENEFICIARY Authorize the Second Beneficiary to use and possess the Property until such authorization is revoked pursuant to an event of default under the U.S. Credit Agreement. Pay or instruct the Trustee to pay any Property taxes or expenses to maintain the Property in the event that the Second Beneficiary fails to do so. Keep control over the Property until all the obligations under the U.S. Credit Agreement have been paid in full. Instruct the Trustee to sell the Property in a private sale in the event of default by the Second Beneficiary under the U.S. Credit Agreement. 2 In Mexico, only banks and certain other financial institutions may act as trustees. Article 350 of the General Law of Instruments and Credit Operations. 3 Some of the enforcement issues include: expensive litigation, the complexity created by the interplay of Mexican and U.S. remedies, where the exercise of a remedy in Mexico may affect a remedy in the U.S. or vice-versa, and the enforcement of Mexican judgments in the U.S. or the enforcement of U.S. judgments in Mexico. 2
Appoint a substitute First Beneficiary. This may be used to syndicate the underlying loan. THE SECOND BENEFICIARY Possess and use the Property subject to the First Beneficiary s rights to revoke such possession and use in the event of default under the U.S. Credit Agreement. Pay applicable taxes, utilities and any other costs or expenses associated with the possession and use of the Property. Receive proceeds from the operation of the Property. Appoint, with the consent of the First Beneficiary, a substitute Second Beneficiary. THE TRUSTEE Act upon instructions of the beneficiaries consistent with the terms of the Lender s Trust. Receive a fee for its services (as set forth in the Lender s Agreement). Be indemnified and held harmless by the beneficiaries in connection with the performance of instructions given by them. TRUST AGREEMENT FOR THE DEVELOPMENT OF REAL ESTATE IN MEXICO ( DEVELOPER S TRUST ) A Developer s Trust is a trust agreement used to develop residential real estate (the Real Property ) located in Mexico s restricted zone 4. If the underlying purchase and sale agreement provides that the purchase price is to be paid in installments by the buyer, the Developer s Trust will also establish rights and obligations, as among the various parties, with respect to the payment of those installments. The parties to a Developer s Trust are the Settlor acting as seller, delivering the Real Property to the trust which holds the fee title to the Real Property. The Trustee or Fiduciary is a Mexican financial institution. The First Beneficiary of the Trust is the buyer/developer. The Second Beneficiary of the Trust may be also the seller of the Real Property or another party designated by the Settlor. Again, while the parties to a Developer s Trust can contractually set forth any rights and obligations permissible under applicable Mexican law, a Developer s Trust may include some of the following terms: RIGHTS OF THE FIRST BENEFICIARY (BUYER/DEVELOPER) Use and develop the Real Property, e.g., subdivide the property, submit the Real Property to a condominium regime. Pay applicable taxes, utilities and any other costs or expenses associated from the possession and development of the Real Property or instruct the Trustee to do the same. Instruct the Trustee to sell certain parcels to third party 4 The restricted zone covers 100 kilometers inward from international borders and 50 kilometers inward from the coastline. Mexico s Foreign Investment Law restricts direct ownership of land for residential purposes in these areas by non-mexican nationals. 3
buyers. (Note that this right may be limited by the rights remaining with the Second Beneficiary). Appoint a substitute First Beneficiary, with the consent of the Second Beneficiary. THE SECOND BENEFICIARY (SELLER/LENDER) Allow the First Beneficiary to posses, develop and subdivide the Real Property, reserving the right to revoke the same upon default in the payment of the purchase price. Procure and provide utilities for the Property (e.g. road access, energy, water and sewage). Set forth transfer restrictions on the subdivided Real Property, pending payment of the purchase price. Instruct the Trustee to sell the Property in a private sale if the First Beneficiary defaults on its obligations under the underlying purchase and sale agreement. THE TRUSTEE Act upon instructions of the beneficiaries consistent with the terms of the Developer s Trust. Constitute a condominium regime on the Real Property following the First Beneficiary s instructions. Allow the First Beneficiary to subdivide the Property, market and sell individual lots. This right may also be limited by the right of the Second Beneficiary. Transfer title to individual lots to third party purchasers following the First Beneficiary s instructions. Receive a fee for its services (as set forth in the Developer s Trust). Be indemnified and held harmless by beneficiaries in connection with the performance of instructions given by them. FINAL CONSIDERATIONS APPLICABLE TO THE LENDER S TRUST AND THE DEVELOPER S TRUST The trust agreement must be executed in the presence of a Mexican Notary Public in the form of a public deed (escritura pública) and recorded with the Public Registry where the property transferred to the trust is located. The Tax effects relating to the transfer of the property to the trust must be carefully analyzed and reviewed by tax advisors familiar with both U.S. and Mexican tax laws. Generally, a transfer of property to the trust is deemed a taxable sale when the following occur: the settlor (i) irrevocably transfers the property to the trust, (ii) is not the beneficiary of the trust and (iii) does not reserve the right to reacquire the property from the trustee. Other tax issues for consideration may include whether the creation of a Mexican trust by a U.S. corporation creates a permanent establishment in 4
Mexico, thus subjecting the U.S. settlor to Mexican taxes, settlor s ability to depreciate property transferred to the trust and tax incentives available for certain trusts 5 that meet requirements of Mexican tax laws. The rights and obligations of the First and Second Beneficiaries in the event of default of the main agreement, whether its is a purchase and sale or a credit agreement, should be carefully drafted and properly reflected in the trust agreement. These include without limitation, notice, opportunity to cure, private sale or auction outside of court of the property by the Trustee, distribution and payment of the sale proceeds to satisfy any outstanding obligations. The trust agreement should contain governing law, conflicts of law provisions, and jurisdiction and dispute resolution provisions, whether the parties choose to go to court or submit to binding final arbitration. Because Mexican law governs Mexican trusts, the beneficiaries in a Mexican trust frequently choose to enter into a Beneficiary Rights Agreement (usually governed by U.S. law). These agreements establish certain provisions with respect to the trust, the ownership, construction or development (if any), administration and maintenance of the property transferred to the trust and the resolution of disputes between the parties. The Beneficiary Rights Agreement provides that in the event of any conflict between its terms and provisions the provisions of the trust agreement, the terms and provisions of the Beneficiary Rights Agreement shall govern and control. CONCLUSION The use of various forms of Mexican trust agreements by U.S. based lenders in secured financing transactions in Mexico has increased notably. This use will continue to develop as these trust agreements provide U.S. lenders enhanced security and control over the collateral in the event of default by the debtor and flexibility to buyer/acquirer with respect to the use of such collateral property. For more information on secured financing in Mexico and Fideicomisos please contact: Jerry J. Gumpel or Rebeca Pérez-Serrano Sheppard Mullin San Diego/Del Mar, California office (858) 720-8900, Julie Ebert Sheppard Mullin San Francisco office (415) 774-3202, Juan M. Trujillo Sheppard Mullin New York office (212) 332-3814, or Luis Rubio of Rubio Villegas y Asociados, S.C. Mexico City 011-52-55-5242-0700. We thank Luis Rubio for providing information on the structure of the Lender s Trust. 5 Such as Fideicomisos de Insfraestructura y Bienes Raíces or FIBRAs. 5