Securing Mortgage Loans to U.S. Citizens for the Purchase of Real Estate in Mexico

By: PATRICK J. KELLY & LUIS G. RESÉNDIZ

February 2006

I.  Mortgages on Mexican Real Estate, Foreclosures and Available Remedies

Lenders offering mortgages to U.S. borrowers for purposes of purchasing or refinancing real estate in Mexico will only do so if they have reasonable assurances that they have adequate remedies in the event the borrower defaults in payment, and that those remedies are enforceable under Mexican law. In other words, lenders using real estate in Mexico as collateral for loans want to make sure that they can foreclose, recover and resell the real estate to satisfy the loan in the event that the borrower fails to comply with the terms of the loan. The purchase, sale, transfer or foreclosure of Mexican real estate is subject to Mexican law. Lenders cannot rely on enforcing a mortgage on Mexican real estate through the use of laws and/or courts in the United States.

Until recently, foreigners purchasing real estate in Mexico had to finance their purchases out of personal asset or borrow against U.S. based assets. The lenders did not rely upon the Mexican real estate as collateral for the loan.

There are two methods currently used in Mexico to secure mortgage lending. The first involves having the debtor execute a mortgage on the real estate. The mortgage is entered into pursuant to Mexican law,  executed in a public instrument in front of a Mexican Notary Public and is recorded in the public registry of property where the real estate is located. The execution of the mortgage in a public instrument limits the borrower’s defenses with respect to the validity of the instruments and its recording and puts the public on notice that the debt constitutes a lien on the real estate.

The second method used to secure credit extended to purchase Mexican real estate is to require the borrower to enter into a Mexican trust arrangement (fideicomiso), under the terms of which, title to the real estate is held in the trust, and a Mexican financial institution acts as trustee. Under the terms of the trust, the lender and the borrowers are appointed beneficiaries. The crucial terms of the loan to the borrower are incorporated in the trust document, as is the actual title to the real estate. The trust agreement authorizes the lender as the primary beneficiary of the trust to instruct the trustee to sell or transfer the real estate to a third party (i.e. the lender or a third party purchaser) in the event of a default by the borrower in the repayment of the loan. The trustee, the lender and the borrower can negotiate the terms of default, the process for notifying the borrower of default, any opportunity to cure, and the transfer or sale of the real estate out of the trust. While the borrower may avail herself of the right to challenge the existence of an event of default by commencing a lawsuit in Mexico, the procedure available to the lender by virtue of using the trust allows the lender to have a remedy that is potentially quick, inexpensive and effective in providing for the summary transfer of title to the lender, or to a third party purchasing the property.

Whether the lender chooses to require a mortgage filing in Mexico, or requires the creation of a trust, the lender will also have the borrower execute a promissory note that is subject to the laws of the U.S. jurisdiction in which the lender is located, and that is subject to enforcement in the courts of that jurisdiction. This structure allows the lender to enforce remedies with respect to the real estate in Mexico, where the real estate is located, and enforce remedies on the promissory note in the courts of the United States, if the lender elects to proceed against the note, but not the real estate. In some cases, lenders are requiring that the promissory note be secured by assets in the U.S. to secure some percentage of the loan in addition to the lender being named as the primary beneficiary under the Mexican trust.

II.  Mexican Foreign Investment and Trust Law

Pursuant to Mexico’s Constitution, foreigners cannot hold title to Mexican residential real estate located within 50 kilometers of the coast or 100 kilometers of the border (the “Restricted Zone”). However, pursuant to Mexico’s Law of Foreign Investment, foreigners can purchase residential real estate in the Restricted Zone through a trust. The trust is formed contractually between the seller (trustor), the purchaser (beneficiary) and a bank (trustee) to provide the beneficiary with beneficial use and enjoyment of the real estate for a term of 50 years. The bank trustee holds title to the real estate for the buyer’s benefit. The trust may have multiple beneficiaries and can be renewed for additional 50-year terms. The beneficiary may, through the trustee, lease, sell or transfer the real estate at any time. The trustee cannot encumber or transfer the real estate without the instruction and approval of the beneficiary. The trustee real estate is kept separated from the trustee’s other assets so creditors cannot encumber or otherwise affect the real estate. For foreigners accustomed to having direct title to real estate, this arrangement may seem suspicious, but trusts are common, have been in use for this purpose for at least 30 years, and are relatively easy to use.

The trust agreement sets forth the terms under which the trustee may take action with respect to the real estate held in the trust if the beneficiary does not comply with the terms of the trust.  In the case of a trust being used to secure a lender’s interest in the real estate, the lender simply becomes the primary beneficiary of the trust, having beneficial title to the real estate for purposes of securing the loan, while the buyer becomes the second beneficiary and has the right to have possession of, and use the real estate as long as there is no default in the terms of the loan agreement. If the buyer/debtor desires to sell or transfer the property, she must obtain the lender’s permission, which permission will not be unreasonably withheld as long as the secondary beneficiary is not in default under the loan agreement and/or the proceeds of the sale will be applied to satisfy the loan. Lenders and borrowers can incorporate into the trust agreement many of the essential terms that are present in mortgages. Once the loan is paid off, the lender and borrower amend the trust to terminate the lender’s beneficiary status and to make the borrower the primary beneficiary. Even though a trust is not required for foreigners purchasing real estate in the interior of Mexico (i.e. outside of the Restricted Zone), we recommend the lender still require that the borrower  establish the trust to secure the loan.

III.  The Mechanics of Enforcement of Secured Interests and Mortgages in Mexico

The real importance of how debt is documented becomes apparent when it is time to enforce the debt. Trust arrangements, according to Mexican law, give the lender-beneficiary the ability to summarily request the trustee to sell the real estate in the event the buyer-debtor defaults. The proceeds of the sale are then applied to cover the amounts owed to the lender, and the remainder, after deduction of the lender’s expenses in enforcing its remedies, is delivered to the debtor. If the debtor offers no resistance regarding the sale of the real estate, this method allows the lender to sell the real estate and recover its money quickly.

If, however, the debtor objects to the sale of the real estate and files a lawsuit trying to prevent the sale, the trust method, while still a powerful tool for the lender, will not result in a transfer or sale of the real estate in immediate satisfaction of the loan. A few examples of arguments commonly raised by debtors (many times without real merit) include claims that the trust agreement is void, that the lender has to prove in court that the debtor is in default, and that the trustee failed to comply with formalities necessary to proceed with the sale of the real estate. Even if the borrower files a lawsuit, it may be possible for the lender to obtain the trustee’s cooperation in transferring the real estate. It is possible, however, that the trustee might refuse to transfer the property until there is a resolution of the borrower’s claims, even though pursuant to the terms of the trust and applicable Mexican law the trustee should proceed with the sale. In these cases, it might be necessary for the lender to go to court to obtain a court order to force the trustee to proceed with the sale.
Mexican law provides various types of “special”, more expeditious trials for different types of actions. The lender must, however, meet certain requirements to have access to such “special” proceedings. For purposes of enforcing debt secured by a mortgage on real estate located in Mexico, the most common proceedings would be the “foreclosure trial,” the “summary mercantile trial,” and the “ordinary mercantile trial.”

1.  Summary Mercantile Trial

A Summary Mercantile Trial allows the lender to place liens on the debtor’s property, and garnish assets of the defendant right at the outset of the litigation. The lender may pursue this type of action if the lender’s claim is based on, among others, (i) a public document or (ii) commercial paper. In addition, the defendant has limited defenses. The Summary Mercantile Trial has the shortest duration. In the event the defendant fails to answer the complaint within 5 days after service of process, the court will enter judgment for the lender. The prevailing party generally recovers attorney’s fees, and there are very few appeals that are capable of suspending the trial.

2.  Ordinary Mercantile Trial

An Ordinary Mercantile Trial is a default proceeding for controversies arising out of business deals or between business people. The lender has to obtain a favorable judgment not subject to further appeals before the lender may place liens on the defendant’s property. The defendant may raise all defenses she thinks appropriate, and the proceedings may last a year or several years before all appeals are exhausted. There are many appeals and other actions that are capable of suspending the trial. The lender has the burden of proving its case, even if the defendant does not answer the complaint, and the prevailing party does not always gets attorney’s fees.

3.  Foreclosure Action

The main purpose of the Foreclosure Action is to foreclose on a mortgage. The lender must attach to its complaint the documents showing a valid and existing mortgage which is usually, the so called “first testimony” of the public document executed before the Notary Public. The Foreclosure Action is a very useful proceeding if the value of the land mortgaged is enough to cover the debt or the debtor has no other assets. It is a fairly expeditious proceeding that is difficult to suspend. If the lender has correctly documented and registered its mortgage, the proceeding could be concluded within 6 months if the debtor does not resist. If the debtor does resist, the proceeding could take from 6 months to several years.

IV.  Brief Summary of the Laws and Credit Instruments Relevant to Lending in Mexico

A.  Most Relevant Laws

1. Civil Code:  Provides the default rules for most of the questions not addressed by the parties in the Loan Agreement.
2. Commercial Code:  States some general rules applicable to commercial loans.
3. General Law of Commercial Paper and Credit Transactions:  Sets forth the requirements that must be met in order to consider a document Commercial Paper (most important (i) Promissory Notes and (ii) Checks). This law also provides rules that are applicable to various specific types of loans. This law also provides the general legal framework for trust agreements.
4. Monetary Law of the United States of Mexico:  Sets forth the rules to determine what currency or exchange rate must be used when repaying loans in foreign currency.
5. Credit Institution’s Law:  Contains the rules applicable to operations performed by financial institutions, including trust agreements.

B.  Specific Credit Instruments

1.  Promissory Notes

Article 170 of the General Law of Commercial Paper and Credit Transactions states that a promissory note must contain the following:

(i)  The word Pagaré (Promissory Note) within the text of the document. In the absence of the word Pagaré, the document is not considered a promissory note.

(ii)  An unconditional promise to pay a specific amount of money. The interpretation given to this requirement is only that the promise to pay must not be conditioned. It is possible to stipulate a variable interest rate but the principal must be certain. It is possible to stipulate the amount in foreign currency, but the creditor cannot force the debtor to pay in the currency stated; the debtor may always pay in Mexican pesos. The exchange rate to be used to calculate the amount due would be that in force at the time of payment if the debtor received foreign currency when she executed the promissory note, or that in force at the time she executed the promissory note in the event that she received Mexican pesos.

(iii)  Name of the person to whom payment shall be made:  Absence of this requirement will void the promissory note as such. The note cannot be made payable to bearer.

(iv)  Place and time of payment. If the place of payment is missing, the law presumes the note is payable at the maker’s domicile. In the event the time of payment is missing, the note will be payable on demand. If the note provides various payment dates, it shall be considered payable on demand.

(v)  Place and time in which the note is executed. Omission of either of these requirements shall void the promissory note as such.

(vi)  Maker’s signature.

2.  Mortgages, Security Interests, and Guarantees

a.  Mortgage

Typically, mortgages must be granted on public documents executed before a notary public. Also, any agreement restricting a debtor’s freedom to further mortgage her property is void. All mortgages must be recorded before the Registry of Property having jurisdiction over the real estate being mortgaged. The creditor’s preference is established in a similar form as in a race-notice jurisdiction (lack of knowledge of pre-existent mortgages or liens and must record first).

b.  Security Interest

The assets over which the security interest is granted must be particularly described (unless the security interest is being granted over the business as a “business unit” pursuant to a Production Loan). The law provides that the creditor should retain possession of the assets given as security. However, such rule can be modified by the parties and in reality it is usually the debtor who retains possession. The law states several obligations for the creditor who retains possession. Customarily, security interests are recorded before the Registry of Property having jurisdiction over the debtor.

c.  Guarantees

Guarantees are not widely used because of the existence of otherwise convenient legal figures, such as:

(i)  The “aval”: Anyone signing a document meeting the requirements of commercial paper (promissory notes, checks, etc.) who is not the maker (or an endorser) will be considered an aval. The aval’s signature must be within the same document or in a piece of paper thereto attached. The aval has the obligation to pay in full the obligation of the maker (or on the behalf of whom she is signing as aval). The aval’s obligation remains even if the obligation secured is void for any reason. The holder of the commercial paper may sue the maker, the aval, or both; the holder does not have to try to collect first against the maker.

(ii)  Co-debtor or joint-debtor (obligado solidario): Consideration problems are basically non-existent under Mexican law; therefore, it is very common to have all of those “participating” on the debtor’s side to sign the loan documents as co-debtors, as opposed to having them sign guaranties. The reason is to avoid the technicalities and difficulties of a guaranty, that is, having to draft a document in which the guarantor renounces all the protections conferred to him by the law, most importantly, the guarantor’s right to force the creditor to exhaust all its remedies against the debtor before enforcing the guaranty. A co-debtor will have the same obligations as a debtor.

C.  Other General Considerations

The interest rate provided by law for commercial loans that is applicable in the event the parties do not stipulate one themselves is 6%. In addition, debtors may not be forced to pay in currency other than Mexican pesos, provided that if the debtor received foreign currency, then the exchange rate for repayment would be the exchange rate applicable at the time the debtor pays the loan. The validity of commercial paper issued outside of Mexico is governed by the laws of the country where it was issued. However, when a commercial paper is payable in Mexico, it must comply with the requirements of Mexican law.