Legal and Institutional Frameworks for Secured Lending

Moscow

December 2012

Antecedent Work on Reform

• EBRD critique and recommendations on Codification Committee’s 2010 draft amendments to Chapter 23 of Civil Code

• Identified positive changes in draft and numerous remaining deficiencies

• Developed proposed amendments to draft that is now before Duma (without those amendments)

Determine Approach to Reform• Amend existing law or replace? The question

needs to be considered

• Start by describing the desired end state, by whatever route it is reached

• At the highest abstract level, end state must fit core concepts of modern secured lending, to be addressed serially as:– Comprehensive coverage

– Functional approach

– Flexibility and autonomy of parties

– Simplicity

Comprehensive Coverage

• One set of rules for all arrangements in which an obligation (monetary or otherwise) is secured by a legal interest in movable property

• All types of:

– Parties – natural and juridical

– Legal forms of security

– Movable property

Functional Approach

• Not defined by narrow rules of specific legal forms of interest in movable property

• Concerned with what the transaction does, not what name we use for it

• Approach does not require abolishment of legal forms, only that they be treated with one set of rules with regard to coverage of this law

Flexibility and Party Autonomy

• Principally with respect to description of the obligation and property

• Also with respect to other terms of agreement such as definition of terms of default

• General idea is that parties should be free to frame their own agreements within broad scope of the law

Simplicity

• No requirements that are not necessary to core purpose of law

• Eliminate formalities, e.g. notarization of agreements

• Eliminate need for paper in registration

• KISS rule as guiding mantra

Legal Framework

Framework must have four major components – may be in different legal sources, e.g. CC, special law, regulation

• Creation of security interest

• Priority scheme and requirements

• Registration and registry

• Enforcement

Will address each in turn

Component 1 – Creation of Security Interest

• Parties make security agreement

• Agreement in writing – any tangible medium

• Parties set own terms – no unnecessary requirements in law

• Binding on parties upon conclusion of agreement – no registration required

A Security Interest May:

Secure one or more obligations that may:

• Be described specifically or generally

• Be monetary or non-monetary

• Be pre-existing, present or future; or a line of credit

Description of Collateral

• Description may be specific or general; may include future collateral

• Must reasonably identify collateral

• “All equipment” or “all accounts receivable” is sufficient description

• Purchase money exception – specific description necessary

Types of Interests Covered

• Pledge

• Chattel mortgage

• Sale with retained title

• Installment seller’s right to re-take

• Finance lease

• Other interest in movables that secures an obligation

Types of Movables• Equipment• Inventory and raw goods• Cash-flows (receivables & secured sales

contracts)• Intangibles and documents (e.g.

securities, warehouse receipts, instruments, contract rights, intellectual property, etc.)

• Crops and livestock• Fixtures – movables fixed to real estate• Consumer goods• Cash & deposit accounts• Minerals and timber to be severed from land

Attachment (Effectiveness between Parties) of Security Interest

Attachment relates to making the security interest enforceable between the parties

Three requisites:

• Security agreement signed by debtor

• Secured party has given value

• Debtor has rights in the collateral (not necessarily ownership)

A security interest attaches to proceeds of original collateral

Attachment of Security Interest(legal enforceability)

Attachment

Signed

agreementand

Value given by

secured partyand

Debtor has rights

in collateral

Continuity of Security Interest

• General Rule: Security interest continues in collateral even if sold, leased, licensed or otherwise disposed

• Exceptions are laid out in Law

Component 2 – Priority Scheme

• General principle – priority determined by when security interest is made transparent, e.g. by registration, possession or control

• Exceptions:

–Purchase money

–Proceeds

–Purchase in ordinary course of business

Perfection a/k/a Completion or Third Party Effectiveness

• Perfection means optimization of secured creditor’s rights against third parties

• Generally achieved by making security interest transparent

• Requires attachment and means of perfection

• Four means of perfection:– Registering notice in registry

– Possession

– Control

– Automatic (purchase money, proceeds)

Priority Rules

Priority

General rule:

First to:or

Purchase

Money

exception

or

Ordinary

Course

exception

or

Consumer

Goods

exceptions

orMiscellaneous

exceptions

Register or Perfect

Priority Is Against Following:

• Buyers of collateral

• Unsecured creditors

• Other secured creditors

• Lessors of equipment

• Bankruptcy liquidator

• Other interests (government and judgment liens, etc.) if politically possible to include in law

Special Priority Provisions Facilitate MSME and Agricultural Financing

• Purchase money security interest has priority over security interest in a class of movables; enables business to use second financer for purchase of a specific asset

• Interest in crops, growing or to be grown has priority over interests in the land

• Interest in crops or livestock for costs of production has priority over a general security interest in crops or livestock

Component 3 – Registration and Registry

• Secured party registers only a notice, not the security agreement

• Notice includes only:–Debtor name or identification number

– Secured party name and address

–Description of collateral – general or specific

• No formalities required – notice does not create rights; it only publicizes the interest

Purpose of Registry

• To give notice of the secured creditor’s interest in the collateral

• To establish the secured creditor’s priority by time of registration of the notice

Core Tenets of Registry

• Notice registration

• Unified as to types of movable property and types of legal interests

• Centralized – geographically and structurally

• Observe international best practices

24

• Accuracy – capture exactly information presented

• Speed – speed of registration and searching

• Accessibility – any time, from any place

• Cost effectiveness – fees cover costs of operation; not general revenue source for government

• Simplicity – reduce risk of error and encourage use

• Limited to purposes of registration – give notice and establish priority

• Rule-based decision-making – no bureaucratic discretion in registration and searching

Registry Best Practices

Form of Registry• Electronic registry – web-based

• Accessible to all via internet

• Automated acceptance or rejection

• Reliable, fully automated search process

• No unnecessary formalities for registration

• Uniform treatment of notices of all types

• Automated fee payment system

• Secure from tampering and corruption

Component 4 – Enforcement

• Secured creditor has immediate right to possession of collateral

• Self-help or expedited judicial action

• Secured creditor may dispose of collateral in commercially reasonable manner

• Distribution of proceeds in priority order

• Secured creditor has fiduciary duty to debtor and other claimants, including notice