In the ever-increasing globalized economy, U.S.-based lenders must be prepared to structure loans to domestic borrowers with operations and assets located outside the U.S., as well as their foreign subsidiaries and affiliates. As a larger percentage of small and middle market domestic companies venture into foreign countries in order to capitalize on opportunities presented abroad, so too must lenders adapt to the reality that having foreign operations and assets is no longer a trend among only large U.S. companies.
Providing loans secured by assets located in foreign jurisdictions, however, requires asset-based lenders to address issues that are either not present or are easier to navigate in wholly domestic loans, including those related to enforceability of liens in a specific foreign jurisdiction, the manner in which to place liens on assets located in foreign countries, and perfection and priority of the security interest in such foreign assets. While the issues present in cross-border, asset-based loans are not insurmountable, they should be addressed on the outset of the due diligence process.
Lenders considering making a cross-border, asset-based loan must identify which jurisdiction’s law will govern the creation of security interests in a specific asset. The type of collateral at issue will often determine the governing jurisdiction. For example, when taking a security interest in shares or other equity interests in a foreign company, the laws of the jurisdiction under which the company issuing the shares or equity interests is organized dictates the form and the requirement of the pledge agreement, including any specific language needed to comply with local laws to make the pledge enforceable.
Taking a security interest in accounts receivable requires lenders to identify the owner of the inventory whose sale gives rise to the accounts receivable, since the laws of the jurisdiction in which that owner is formed will influence the process required to take such a security interest. Security interests in equipment, inventory and real estate are usually governed by the laws of the country where such assets are located. Once lenders identify the jurisdiction(s) that will impact the proposed transaction, they can work with local counsel to identify threshold issues that affect deal structure, including whether they can take a particular security interest at all.
Since the laws of various countries do not allow borrowers to grant certain types of security interests, understanding what can and cannot become part of the collateral package early in the diligence process will provide lenders with critical data they need to underwrite the loan and decide on its terms. For example, the laws of certain countries, including China, Brazil and Spain, either prohibit or restrict the ability of borrowers to grant security interests over future assets. In some foreign jurisdictions, blanket liens — a single security device granting a lien on substantially all of the company’s assets, which are typical in the U.S. — may either be prohibited entirely or are only available to local lenders or local borrowers. Even in instances where lenders’ transaction structures do not seem to violate any local laws, particular grants of security interests may nevertheless be deemed unenforceable. For example, in Germany, borrowers cannot grant security interests in assets that are not transferrable, such as copyrights, and a German court may hold the security interest invalid if it deems that there was a material over-collateralization at the time when a security interest was granted.
Once lenders understand the assets of their borrowers over which they can and cannot take a security interest, they will need to ensure that they properly attach their security interests to the property to be collateralized. Many countries do not have uniform procedures for taking a security interest in assets, such as those set forth in the Uniform Commercial Code (UCC) in the U.S. Instead, multiple statutory and common law schemes govern liens and security interest in particular foreign assets.
In common law jurisdictions, such as the UK, the preferred method of establishing the lien and its perfection against third parties is for secured lenders to take physical control of the goods. Civil law countries, such as France and Germany, typically require the collateral to be described in the applicable documents or filing forms with much greater specificity than that which is required under the UCC. For goods, this may mean a detailed description that includes identifying marks or serial numbers. In certain countries, such as China, India and South Africa, the granting of security interests in favor of foreign lenders, and even the making of loans by foreign lenders, can require approval by a special governmental body or a central bank.
Perfection, Priority of Interests
In addition to determining how they will properly attach their security interests in foreign assets, lenders must ensure that the security interests are properly perfected. While, with some exceptions, the concept of “first in time” is the general rule when it comes to the priority of security interests, in many countries there is no central filing or registration system for certain types of property. For example, the liens on accounts receivable, inventory and equipment are not filed or registered in Germany, where lenders must instead rely on representations of the borrower that no superior liens exist.
In many European countries, perfection and priority of security interests in inventory are complicated because of the retention of title rights, which do not appear in lien searches. Retention of title — a vendor retaining title to the goods until the purchase price is paid in full — results in unpaid vendors being able to assert claims against goods sold to borrowers that are superior to the claims of lenders. To mitigate this issue, lenders can identify which vendors have contracts with the borrower that contain retention of title clauses and attempt to get the vendors to waive such rights. Some lenders address perfection issues related to accounts receivable and inventory by requiring the borrower to create a subsidiary located in a jurisdiction with more favorable laws relating to perfection of liens and then transfer the accounts receivable and inventory to that newly formed subsidiary.
Foreclosing on Interests
Having properly attached and perfected security interests in assets located outside the U.S. may not sufficiently enable lenders to foreclose on their security interests. For example, in Brazil, foreclosure of a security interest depends on the underlying agreement being notarized in its place of execution and registration of the agreement, together with the sworn translation into Portuguese, with the appropriate Registry of Deeds and Documents in Brazil. In addition, in order to be enforceable, the relevant agreement cannot be contrary to Brazilian public policy, national sovereignty or good morals. Brazil strictly prohibits automatic foreclosure, and provisions to that effect in the loan documents are void under Brazilian law. Similarly, in China, a security document may not contain a clause providing that the ownership of the mortgaged/pledged property will be transferred to the mortgagee/pledgee when the debtor fails to repay the due debt; thus, foreclosure provisions, without a court procedure, are invalid.
As a broader segment of U.S. companies expand their operations and asset base abroad, lenders must confront such realities and deal with them effectively, notwithstanding the array of considerations that, unlike in wholly domestic loans, must be taken into account in cross-border, asset-based loans. Doing so will enable lenders to not only remain competitive with existing and prospective borrowers, but also explore new areas of investment with potentially higher risk-adjusted returns and diversify their strategic activities, thereby reducing their dependence on specific lines of business and particular customers.
Iryna Ivashchuk is a partner at Berger Singerman. Ivashchuk focuses her practice in general corporate transactions and complex real estate and financing matters, assisting clients in domestic and cross-border deals. She advises clients from all over the world on formation and capitalization of various entities, private securities offerings, and joint venture transactions, as well as acquisitions and dispositions of real and personal property and businesses, asset-based financing, leasing and real estate development.
David K. Black is an associate at Berger Singerman. Black assists clients with corporate transactions and commercial real estate. Black counsels closely-held companies, as well as entrepreneurial organizations and individuals.