Secured Transactions

and Collateral

Registries Concepts

Brett Coleman and Everett WohlersApril 3, 2015

Agenda for Session

The need for and consequences of a

modern secured transactions reform

Legal framework for secured transactions

Registry type and best practices

Integrated with the foregoing topics, a brief

comparison with the new Armenian laws

What is the Problem?

Private firms (especially SMEs) do not have access to credit

Banks are unwilling to lend, or lend only

at high rates because of high risk

Risk is due to lack of security for lending

on which lender can rely:- SME’s do not generally have sufficient immovable

collateral

- Movables are not accepted as collateral

Percentage of firms indicating access to finance is

NOT a problem (WB Enterprise Surveys)

Ranking of Problems 2008 and 2013

COLLATERAL GAP

Source: World Bank Enterprise Surveys

Mismatch between assets owned by companies

and collateral required

44%

34%

22%

Vehicles/machinery/equipment

Accounts Receivable

Land / Real Estate

73%

27%

Land / Real Estate Movable property

Capital Stock of Firms Collateral Taken by FIs

Heart of the Problem

Banks will not lend to SME’s secured by

movable collateral because of high risk

High risk is due to:

- No assurance of priority against other

interests

- Unreliable and slow enforcement against

collateral

What is the Answer?

1. Adopt a legal framework that:

- Comprehensively governs use of movables as collateral

- Covers all types of legal interests that secure an obligation

- Covers all types of movable property –tangible/intangible, present/future, fixtures, proceeds

2. Develop an effective collateral registry that is accurate, transparent and cost-effective.

Where Has It Been Done?Countries as diverse in size as China (1.7 million)

and the Marshall Islands (58,000)

Advanced economies such as US and Canada to

conflict-affected countries such as Afghanistan

Regions with most reforms

- East Asia – China, VN, Cambodia, Laos, Singapore

- Pacific – NZ, Australia and most small island nations

- Latin America – Mexico, Honduras, Guatemala et.al.

- Central Europe – nearly all, with Romania and Albania

earliest

- Middle East – Afghanistan and Palestine, with many ongoing

- Africa – Ghana and Liberia, with many ongoing

Variable Effect

Access to finance 8 percentage points

Access to a loan 7 percentage points

% of working capital

financed by banks

10 percentage points

Interest rates 3 percentage points

Loan maturity 6 months

10

RECENT IFC STUDY OF IMPACT OF

SECURED TRANSACTIONS REFORMS

Study also shows that the impact of introduction of

secured transaction laws and movable registries on

access to finance is larger among smaller firms.

•PROMOTES CREDIT DIVERSIFICATION

• INCREASES MARKET COMPETITION

•REDUCES THE COSTOF CREDIT

• INCREASES ACCESS TO CREDIT, REDUCING THE RISK OF CREDIT

- Underserved MSMEs and women entrepreneurs

- Promotes risk management, prudent lending

-

- Better

interest rates

- Move from informal to formal financing

- Cost savings for businesses

- Credit risk diversification: immovable and movable

- Sector diversification in the portfolio

- Development of industries (factoring and leasing)

- NBFIs

BENEFITS OF A MODERN SECURED

TRANSACTIONS SYSTEM

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Content of Laws

What reformed secured transactions laws

generally include

- Creation of security interest

- Priority scheme

- Registration and registry

- Enforcement

Variations in Armenia laws

Creation of Security Interest

Security interest is a right in movable

property that secures an obligation

Parties make security agreement

Agreement in writing – any tangible

medium (example: exchange of e-

mails)

Parties set own terms – no

unnecessary intrusion of bureaucracy

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

Must reasonably identify collateral

“All equipment” or “all movable

property” is sufficient description

Armenia Law Differences

Conditions of creation and scope of

obligations subject to secured right are

not detailed

Though new CC Ch. 14.1 permits

collateral to be described either

specifically or generally, it mandates

specific description when it is possible to

do so

Types of Interests

Pledge/mortgage of movables

Sale with retained title

Installment seller’s right to reclaim

upon default

Finance lease

Consignment

Any other legal interest in movables

that secures an obligation of any type

Armenia Law Differences

Pledge remains separate in CC from

secured right

Other types of interest are not addressed

in provisions on secured right or

registration, e.g. right of seller in sale with

retained title, right of installment seller to

repossess if not paid, right of a finance

lessor, et.al.

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

Priority Scheme

General principle – priority determined

by when security interest is

transparent, a/k/a “perfected”

Exceptions and special rules:

- Purchase money (acquisition finance)

- Proceeds (temporary)

- Purchase in ordinary course of business

- Rules for right of retention, fixtures,

accessions and commingled goods

Armenia Law Differences

New CC Ch. 14.1 determines priority rank

only according to time of registration; it

does not provide for other means of

transparency, i.e. possession or control by

secured creditor

New CC Ch. 14.1 does not set out

exceptions or special rules for right of

retention, fixtures, accessions or

commingled goods

Armenia Law Differences (continued)

The most consequential difference is in Article 18

of the Law on Registration of Secured Rights

It provides that a person who buys an asset subject

to a secured right takes it free of the secured right

The intent was to permit a buyer who buys an asset

in the ordinary course of business of the seller

(debtor) to take it free of the secured right

The lack of the “ordinary course of business”

qualification is a major hole in the law; it means that

the secured right is defeated by any buyer, not just

one buying from a merchant’s inventory

Priority Is Against Following:

Buyers of collateral

Unsecured creditors

Other secured creditors

Lessors of equipment

Other interests (government and

judgment liens, etc.)

Bankruptcy liquidator

Special Priority Provisions to Facilitate

MSME and Agricultural Financing

Purchase money (acquisition) security

interest has priority over security interest in

a class of movables; enables business to

use a 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 livestock24

Armenia Law Differences

New CC Ch. 14.1’s version of purchase

money special rule does not require

purchase money creditor to register

notice to acquire priority over prior

interests

New law does not provide special rules

for priority of security rights in crops or

livestock

Registration and Registry

Secured party registers only a notice, not the security agreement

Notice includes only minimum information to inform a third party of potential existence of an interest in particular movable property; i.e. identifies the debtor, the secured creditor and the collateral

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

No other purpose (does not establish

validity of the agreement, value of the

collateral or the obligation, or other fact)

Core Tenets of Registration

Notice registration

Unified as to types of movable

property and types of legal interests

Centralized – geographically and

structurally

Observe international best practices

Electronic, web-based system

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Registry Best Practices

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

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Form of Registry

Electronic registry – uses best practices

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

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Notice Registration

Secured party registers only a notice, not the

security agreement

To be effective, notice must include:

- Debtor name or unique identification number for

indexing and searching

- Secured party name and address

- Description of collateral – general or specific

- Duration if not set by law

No formalities required – notice does not

create rights; it only publicizes the interest

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Armenia Law Differences

Does not limit debtor indexing to one criterion

Requires specific description of collateral

Provides for attachment of documents

Requires disclosure of excessive information,

e.g. unnecessary information on secured

creditor, legal form of right in collateral, etc.

E-signature of applicant

Provides for electronic transfer of data from

other registries which are not notice registries

and which may not have compatible data

Form of Registry

Electronic registry – uses best practices

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

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 –applies in liquidation and pre-liquidation enforcement

Secured creditor has fiduciary duty to debtor and other claimants

Armenia Law Differences

Neither the Law on Registration of Secured

Rights nor the new CC Ch. 14.1 provides rules

for enforcement of secured rights

Article 70 of the CC provides the sequence of

distribution of the proceeds of liquidation

- It gives first priority to satisfaction of pledges, but it

does not mention secured rights

- A claim based on a secured right, then, would fall into

the fifth priority for “other creditors”

- The priority based on registration sequence of

secured rights, then, appears to be limited to non-

liquidation enforcement

Demonstration

For those who are interested, a demonstration

of a live registry system will follow the last

session of the conference.