The following is a summary of the procedures for granting loans and creating and perfecting a security interest in real property located in Mexico, as well as foreclosure procedures, focusing on the laws of Mexico.

When U.S. entities make a loan, the loan may be secured . . . → Read More: Issues for U.S. Lenders Financing Individual Real Estate Purchases in Mexico]]>

In General:

The following is a summary of the procedures for granting loans and creating and perfecting a security interest in real property located in Mexico, as well as foreclosure procedures, focusing on the laws of Mexico.

When U.S. entities make a loan, the loan may be secured by real property located in Mexico by means of (a) mortgage (hipoteca), or (b) guarantee trust (fideicomiso de garantía). Mexico has a well developed legal and judicial system, under which both mortgages and guaranty trusts are valid and enforceable, provided the documents are properly prepared. There are, however, significant differences between mortgages and guaranty trusts in terms of the manner, cost and/or timing of creating, perfecting, assigning, or foreclosing on these two types of security interests. Some of these differences are discussed below. First, however, this article will review similarities for loans regardless of whether they are secured by mortgages or guaranty trusts.

Under Mexican law, mortgages and guaranty trusts can secure not only real property, both also improvements, fixtures and new construction on the property. For both mortgages and guaranty trusts, there is no legal difference between the rights of a U.S. lender and the rights of a Mexican lender.

Ownership of Real Property by Non-Mexicans:

Mexican law prohibits non-Mexicans (including Mexican legal entities owned by non-Mexicans) from directly owning residential property in the “Restricted Zone, which is all land within 100 kilometers (about 62 miles) from the borders and 50 kilometers (about 31 miles) from the beaches. Non-Mexicans can acquire only indirect ownership of residential property in the Restricted Zone, and may do so only by having title held by a Mexican trust for the beneficial use of the non-Mexican buyer. Current law allows trust agreements to provide for trusts to be created for an initial term of up to 50 years, subject to renewal for an additional 50 years upon the request of the beneficiary.

The trust is established by a trust agreement executed between the seller of property and the trustee, with the non-Mexican “buyer” as beneficiary. In addition, a U.S. mortgage lender (“Lender”) (and an assignee of its loans) can be beneficiary(ies), if provided for in the trust agreement. The terms of the trust agreement establish the rights of the beneficiaries, and provide that the beneficiaries are entitled to the use, enjoyment, products, and benefits of the property, including proceeds from selling the property. The terms of the trust agreements therefore can affect the value of the property. The trust agreement for each property must be carefully analyzed to determine exactly what are the legally enforceable rights of the beneficiaries (including the Lender and, if applicable, assignees of the Lender’s loans).

Under Mexican law, only certain Mexican financial institutions can act as trustees, and they must be authorized by the Ministry of Foreign Affairs to act as a trustee for real estate in the Restricted Zone. The trustee holds legal title to the property in its name, but only as trustee acting on behalf of the trust’s beneficiary(ies). Legal actions with respect to the property (including sales and transfer of ownership following foreclosure) can be taken only by the trustee or a Mexican court. There can be delays and/or transaction costs involved in having a trustee act with respect to the property.

Non-Mexican buyers must also agree to submit themselves to the jurisdiction of the Mexican legal system for any dispute regarding the property, and under the penalty of forfeiture for noncompliance, not to invoke the protection of their government in matters regarding the property. This is known as the “Calvo Clause.” Before the transaction may be completed, the non-Mexican purchaser must notify the Ministry of Foreign Affairs that he or she agrees to the Calvo Clause, and the Ministry must register the purchase and issue a permit for the trust and for the non-Mexican beneficiary(ies) beneficial interest in the trust. The Lender (and any assignee of its loans) will not be able to resort to U.S. courts to resolve issues regarding ownership of, or security interests on, Mexican property. Such issues must be resolved in Mexican courts.

Notaries:

A Mexican notary public (“Notario”) is a special attorney appointed by the government with exclusive jurisdiction over property transfers and liens (including mortgages and guaranty trusts). Mortgages and guaranty trusts must be approved and processed by a Notario before they can be recorded in the Public Registry. Therefore, the timing and cost of closing loans and selling/securitizing loans depends in part on the Notario’s fees and time to process and record documents. It will be important for the Lender to locate cooperative and responsive Notarios so as to obtain expeditious processing and recording of the documents in every area of Mexico in which the secured property is located. Furthermore, the Lender should be aware that the Notario does not represent any of the parties to a transaction; rather, he or she represents the interests of the government and secondarily, the transaction itself. Although a Notario may use a document drafted by the parties, the Notario will use his or her own judgment regarding the document’s compliance with Mexican law. The Notario will also document the value of the property to be used for capital gains tax purposes.

Transfer Tax and Capital Gains Tax:

Upon the transfer of real property, the following taxes are due: a property transfer tax (2% of appraised value) and tax on capital gains generated by the sale. Various techniques have been used in some Mexican real estate transactions to try to lower or avoid the transfer tax and/or capital gains tax. These include establishing an artificially low value on the property.

Title Reports and Title Insurance:

Various U.S. title companies also currently provide title insurance for owners and lenders for Mexican real property. The availability, scope of coverage, and cost of Mexican title reports or title insurance is beyond the scope of this article.

Due diligence:

Proper due diligence should be conducted regarding each property, including but not limited to (a) title matters, (b) existing liens and encumbrances, and (c) zoning, subdivision compliance, infrastructure, and current and future availability of sewer, water and electricity service.

Loan Agreements and Promissory Notes:

Regardless of whether a mortgage or guaranty trust is used, it is normally advisable to have the borrower execute a loan agreement and a bilingual promissory note enforceable in both the U.S. and Mexico. The best practice is for the loan agreement to be executed in English and Spanish with concurrent jurisdiction in Mexico and the United States. This allows the creditor to pursue remedies in both countries in the event of default. To be enforceable in both countries, the loan agreement must comply with both Mexican and U.S. law. The borrower must also execute a Spanish language security instrument (i.e., the mortgage or guaranty trust). Together with the bilingual promissory note or notes in favor of the creditor, this documentation allows the creditor, in the event of a default by the borrower, to file a lawsuit through a summary judicial proceeding in Mexico, whereby the creditor is entitled to obtain a preliminary attachment on the Mexican property.

Possession/Eviction:

Mexican law requires a judge’s order for a debtor (or other person in possession of the property) to be forced to deliver real property to the creditor. Thus, the lender may be required to obtain a court order to evict and obtain possession, even after foreclosure.

Foreclosure:

The foreclosure procedures for mortgages and guaranty trusts differ in some significant respects. In general terms, the mortgage foreclosure procedure, because it must proceed in court, is in theory generally expected to be more time consuming and costly than the non-judicial foreclosure procedure permitted for guaranty trusts under Mexican law. However, the non-judicial foreclosure process provided by law for guaranty trusts has not yet been fully tested and upheld by Mexican courts, nor has it been utilized to any significant extent by Mexican bank trustees. The cost and time required to foreclose on a mortgage or guaranty trust can vary depending on a number of factors, and are therefore difficult to estimate. This difficulty is enhanced by the lack of available historical data on recovery rates, costs and time delays regarding foreclosures on Mexican real estate. This is especially true in the case of non-judicial foreclosures of property secured by guarantee trusts. The amount recoverable can also vary significantly based on the market for real property in Mexico, which can be affected by all variables that affect real estate markets in the U.S., as well as aspects unique to Mexico (such as currency exchange, political and social stability, safety concerns, and anything else that affects the market for Mexican property)

Different federal and/or state laws apply to mortgages and guaranty trusts:

While guarantee trusts are generally governed by Mexican federal law, which is the same throughout Mexico, mortgages are generally governed by state laws which vary as to certain aspects of the perfection, assignment, and foreclosure process. These variations may make using a mortgage preferable to a guarantee trust, or vice versa, depending on the state in which the property is located.

Mortgages (Hipotecas):

The mortgage is perfected against third parties by filing the Public Deed at the Public Registry of Property within the jurisdiction of the mortgaged property. Priority is determined by recording dates. Assignment of secured party’s rights in mortgages is governed by state law, which must be examined for each state in which the property is located to determine how to properly assign the mortgage if the Lender’s loans are sold or securitized.

Foreclosure of a mortgage must be done in court. Although there is a special “summary” judicial procedure available for mortgages, such proceedings may, depending on the particular circumstances, last from six months up to three years or more before a creditor receives payment. Attorney’s fees for these types of lawsuits are commonly 20% of the amount received by the creditor plus any expenses incurred.

Securitization and financing:

A number of risk factors can significantly impact the potential sale or securitization by the Lender of loans secured by Mexican real property or the ability of the Lender to obtain financing on favorable to terms to fund to its loans and operations. Among other things, such factors (or investors’ perception of such factors) could increase the difficulty or cost of selling or securitizing the Lender’s loans or obtaining financing, and/or decrease the profitability of selling or securitizing the loans, and/or even result in the Lender being unable to sell or securitize its loans or obtain financing. Some, but not all, of such risk factors that can affect the potential sale or securitization of the loans are mentioned herein, but this is not, and is not intended to be, a comprehensive or exhaustive review of such factors. In addition, although this is changing, there is not yet an established secondary market in the U.S. for investing in loans secured by Mexican real estate.

The National Law Center for Inter-American Free Trade (NLCIFT), located in Tucson, Arizona, is preparing to launch a pilot program for securitization of real estate assets in Mexico that entails collaboration between the public and private sectors to promote economic development along and near the U.S.-Mexico border and to facilitate the cross-border flow of goods and services. A feasibility study by the Center will address the reforms needed to occur to facilitate placement of securitization in the U.S. secondary market, with a particular emphasis on two key border states in Mexico, i.e., Baja California and Sonora. The proposed work of the Center in the area of securitization will provide greater certainty and security to U.S. lenders to the Mexican market for tourism construction and later for low and middle-income housing in those two Mexican states and the rest of Mexico and ultimately throughout Latin America.

This proposed work, thus, has an economic development component via increased access to more affordable credit to finance much-needed low and middle-income housing, an export enhancement component for the United States with respect to construction materials and services, etc., and a job creation component for the United States (construction and related supply industries, banking and credit sectors, etc.) and also for construction and banking in Mexico and other parts of Latin America. The feasibility study will address the three main categories of reform required: 1) transactional (standardization of transactional documentation); 2) substantive legal (modernization of the legal framework for securitization); and 3) institutional (modernization, strengthening and reorganization of public registries). The Center will be working in close cooperation with officials in Mexico, including at the State of Sonora’s Instituto Catastral y Registral del Estado de Sonora (ICRESON) and the Secretariat of Infrastructure and Urban Development in Baja California.

This article is based on my experiences as a real estate lawyer representing U.S. investors in Mexican tourism projects, including marinas, since 1997.

The article starts from the broadest perspective — that of Mexico’s national tourism policy, next focuses on a particular federal agency, Fonatur, and then discusses . . . → Read More: Marina-Related Tourism Development in The Sea of Cortes]]>

INTRODUCTION

This article is based on my experiences as a real estate lawyer representing U.S. investors in Mexican tourism projects, including marinas, since 1997.

The article starts from the broadest perspective — that of Mexico’s national tourism policy, next focuses on a particular federal agency, Fonatur, and then discusses particular projects in the Sea of Cortez and Baja California Sur.

NATIONAL POLICY

On the national level, throughout various presidential administrations in Mexico, including the historic change in the presidency from the PRI party to the PAN in 2000, tourism development has remained one of the highest priorities of the Mexican government. This is understandable in light of the fact that tourism consistently ranks among the top three sources of revenue flowing into Mexico. The other two are sale of petroleum and remittances from Mexicans living abroad. In addition, Mexico is the third most popular tourist destination in the world and would like very much to become second.

FONATUR

One of the most important ways the Mexican government has invested in promoting tourism is through Fonatur, a government agency founded in 1973 which selects and develops new resort areas on a massive scale. Examples of such developments are Cancun, Loreto and Los Cabos.

Key to these developments is the concept of public-private partnerships. Obviously the Mexican government cannot on its own provide the massive amounts of investment necessary. Its chosen role is to be the sparkplug, to get things going and attract private investment. What Fonatur typically does is to acquire the land, create a master plan, build key infrastructure such as roads and utilities and then sell off locations to private developers. At the same time, the government’s goal is to create sustainable, well-planned, coordinated projects rather than helter skelter development. Therefore, the privately built facilities, whether hotels, golf courses, condominiums or marinas, must conform to the development guidelines established by Fonatur and must be approved by Fonatur as well as other relevant government agencies, for example, the Mexican environmental protection agency in the case of an environmentally sensitive area.

ESCALERA NAUTICA

Every year Fonatur announces its five or six top priority projects. Since 2001 one of these top priorities has been the Escalera Nautica, or “nautical stairway,” surrounding the Sea of Cortez, also known as the “Golfo de California.” The importance of this project was reaffirmed once again by President Felipe Calderon Hinojosa upon taking over from President Fox at the end of last year and by Secretary of Tourism Elizondo upon his reappointment by President Calderon. The plan calls for 22 full-service marinas along both sides of the Sea of Cortez, 10 of them new. Of the 12 existing, seven are to be improved and five have been judged adequate. The 10 new marinas will be located on sites with natural shelter, or bays, a feature the peninsula has in abundance. Five of these are to be in Baja California, three in Baja California Sur, and one each in Sonora and Sinaloa. The reason it is called a “stairway” is because the idea is to be able to go by boat from one marina to the next in one day, or a distance of approximately 120 nautical miles. Visionary Arizona developer Donald Diamond, a longtime yachtsman and Mexico aficionado, decades ago dubbed this concept the “string of pearls.”

Fonatur’s market studies indicate that once completed, at least 52,000 American boat owners will set sail to those destinations and a good number will permanently moor in the various marinas. The Sea of Cortez, because of its climate, sheltered configuration and unusual natural beauty, is one of the best places in the world for boating. Fonatur estimates that 76,400 boats will be cruising Baja coastlines by 2010 and that by 2014 there will be 5.4 million nautical tourists. Fonatur actually first began thinking about the Escalera Nautica in the 1970’s. In 2001 a compact among the federal government and the four affected states, Sonora, Sinaloa, Baja California and Baja California Sur, was signed in La Paz, B.C.S. with President Fox signing for the federal government. I was honored to be invited to the signing ceremony.

The Sea of Cortes is extraordinarily environmentally sensitive. Jacques Cousteau once called it the world’s aquarium. It harbors unique species of acquatic life found nowhere else. Therefore Marina and associated real estate development will be subjected to close scrutiny by the authorities, will probably take longer per project and will have to be done in more carefully than in other less protected regions. Since there is no choice as to adhering to high standards of sustainability and protection, development in the Sea of Cortes will by necessity set a new, higher standard for the entire world. This can only benefit both Mexico and the development community.

PRIVATE DEVELOPMENT

As with the other Fonatur-sponsored developments I have mentioned, the long term goal of the Escalera Nautica is to attract private investment on a massive scale. You may ask, is boating an activity important enough to justify such a project? The answer is “not by itself.”

That is why the basic concept of the Escalera Nautica project is that each marina will become a focal point for private development on the surrounding land. The hotels, condos, stores, restaurants and homes which are expected to be built as the result of the attraction of the marina are in turn expected to create jobs and generate other much-needed revenues for the state and local areas. The feasibility of this concept has already been shown in the private sector. Numerous private master-planned projects are, or would like to be, anchored by a marina. For example, the magnificent Puerto Los Cabos development of Eduardo Sanchez-Navarro, now under construction in San Jose del Cabo, is anchored by a 550-slip marina. It will also feature a world-class marina complex, two signature golf courses designed by true legends of the game, and an array of five-star hotels. It embraces a unique tropical nature preserve, miles of white sand beach, a traditional village with fresh fish and farmers’ markets, and a variety of ownership opportunities. (Description taken from developer’s materials).
The advantage for a private developer of participating in an Escalera Nautica location is that the basic marina infrastructure, in many cases, will already be built, at government expense. This infrastructure includes dredging the basin as well as extensive, and very expensive, breakwaters and other protection from waves, tides and storms.

As an example of how challenging it can be to build the necessary infrastructure, in constructing the marina at Puerto Los Cabos, which is a totally private project and not part of the Escalera, three breakwater structures are being built. Once the excavation progressed the basin filled up with primarily fresh water from the existing water table. Although this was visually impressive, the engineers knew they still had a long way to go, using dredging, to remove further material and achieve the necessary depth. The basin would only be opened to the sea during the last phase, when the temporary lake would finally be connected to the tides and salt waters of the Pacific. This could take place only when the breakwaters were ready to absorb the wave action that would otherwise make the passage impossible.

Extensive underwater sonar surveys had already taken place, as well as computer modeling, to determine the best placement for the three breakwater structures. It was known that a submarine canyon near the proposed entrance could be used as a natural advantage for the approach to the marina, and this was incorporated in the final placement of the breakwaters (also known as jetties).

Actual construction of a “rubble mound” breakwater involves three different sizes of rock. Medium sized rocks were used first (1-3 feet in diameter), which were brought in by dump truck from a nearby quarry site. Once the medium rocks were in place, smaller rubble was dumped in to help lock them in place and to allow construction vehicles to drive further out on the structure. The process was continued until the largest cap rocks, some over 30 tons, were put in place by crane. These cap rocks will absorb most of the energy from ocean waves (including hurricanes) before they get to the medium rocks that form the nucleus or core.

Even before construction began, a continual convoy of dump trucks was employed to bring in the thousands of tons of rocks that would comprise the jetties. These trucks ran 6 days per week for 8 months just to keep up with the quantities needed to finish the largest private breakwater ever built in Mexico. (Description taken from developer’s materials).

CONCLUSION

Many have expressed frustration with the seemingly slow pace of development of the Escalera Nautica. There are of course reasons for this, including the way government functions as compared to the private sector as well as the need to reassure the environmental community regarding massive development in such a sensitive area.

Nevertheless, the basic idea of the Nautical Stairway is such a great one that it is probably inevitable. Without waiting for the Escalera to be completed, Narciso Agundez, the dynamic governor of the State of Baja California Sur, is planning to build a series of major cruise-ship terminals along the Pacific coast of that State, each of which will undoubtedly spark development in the surrounding area. This exciting project will be a joint public-private venture.

And as often happens, when government reaches a barrier, the private sector steps in. This activity will succeed in creating, if not a full public-private partnership, at least a mix of public and private initiatives that, taken together, will transform the economic and touristic role of the entire region surrounding the Sea of Cortes.

The second home real estate market involving U.S. purchasers in Mexican coastal areas like Puerto Peñasco is strong and healthy. Continued rapid growth is anticipated for economic and demographic reasons we are all familiar with. From the standpoint of an attorney . . . → Read More: When Do I Get My Bank Trust?]]> Growing Pains in the Expanding Mexican Real Estate Market

• Mark B. Raven, Esq.

The second home real estate market involving U.S. purchasers in Mexican coastal areas like Puerto Peñasco is strong and healthy. Continued rapid growth is anticipated for economic and demographic reasons we are all familiar with. From the standpoint of an attorney active assisting buyers and sellers in Mexican real estate transactions, however, there still exist certain legal areas where improvement is needed if the market is to become more secure and user-friendly for American buyers. One of these problem areas is the timing of the Mexican bank trust.

This article will first explain certain key points about the Mexican bank trust and then talk about the timing issues that can create problems and yet are little understood. Finally, I will share some ideas for improving the present unsatisfactory situation.

Part One. The Mexican Bank Trust.

As many readers are already aware, foreigners cannot hold title in their own names to residential real estate in the so-called “restricted zone”, comprising a 50-kilometer strip along the entire coast of Mexico, the entire Baja, as well as within a 100-kilometer strip along the border.

In order to overcome this restriction, Mexico has devised a system whereby legal title is held in the name of a Mexican bank or other fiduciary institution as trustee for the benefit of the foreign owner. The foreign owner/beneficiary has the economic rights that come with ownership, but technically the rule against foreigners holding title to residential property in the restricted zone has been observed. This system of bank trusts has worked well for many decades. Currently the trust term can be 50 years, with a 50-year renewal.

What many people do not understand, however, is that putting a property in trust with a Mexican bank is not an automatic “no-brainer.”

Mexican trustee banks are not so different from trust banks in the United States in that they are well established, risk-averse, solid and conservative. They are highly regulated and act with the deliberation and attention to detail one would expect from fiduciary institutions charged by law with safeguarding other people’s money. Accepting a property in trust means taking on the responsibility and liability of administering the trust for the benefit of the beneficiary in accordance with the law.

Before a Mexican trustee bank can or will accept a property in trust, therefore, it must make sure the property complies with all legal and regulatory requisites. Prominent among these are the developer’s compliance with governmental land use regulations such as zoning, environmental, subdivision registration, development plan approval and completion of promised improvements.

It should be noted that Mexico has meaningful land use laws and regulations, which are basically comparable to those in the U.S. For Puerto Peñasco subdivisions, these laws and regulations are primarily administered by the State of Sonora through S.I.U.E., a state agency located in Hermosillo.

Until these subdivision and land use requirements have been fulfilled, the developer cannot get a “clean bill of health” from the State and municipal authorities, which includes an official permit to sell lots or condominium units. Without proof that the necessary governmental authorizations have been obtained, the Mexican trustee bank will not act as trustee for a development project. The issue for many developers is that meeting all of the above requirements costs money and takes time. In many cases the developer may not have enough money or enough time to comply, or is not willing to spend the money. The developer may be unhappy with the delay caused by the need to complete the approval process before selling to the public. Although most reputable developers will start the process and try to follow it to conclusion, at the same time most want to start selling before the process is completed. Unfortunately, in the real world there is little or no enforcement by the government and therefore sales can start without the necessary authorizations and without a bank trust.

To sum up, the business needs of the developer to make as much money as soon as possible collide with the legal requirements of the government and the trustee banks, and the developer’s needs win out.

Part Two. Timing Problems.

You may ask, “How can this be?” How can the developer sell a unit without a bank trust in place if the U.S. buyer is not legally allowed to own the unit except through such a trust? The short answer is that the buyer does NOT own the unit. Even though the buyer signs a contract with the developer and makes a substantial down payment, usually at least 30%, the buyer has only a promise that he or she will obtain ownership later, after the trust is put in place. This will happen only when the developer finishes all of his homework and the trust bank feels secure in taking on the trust. Until then the legal owner of record remains the developer. If you conduct a title search of the property in the Public Registry the buyer’s name will not appear.

The developer will counter that in the meantime, during the sometimes, long period before the trust is put in place, the buyer is given full use of the property. That is true, but the buyer seldom realizes the risk he is running during this period of “suspended animation”. For example, if the developer were to run into financial difficulties and find himself, unable to complete the work necessary to obtain final governmental and trustee bank approval so that his buyers can obtain their bank trusts, the buyers might not get their trusts for a long time. Without a trust, it is virtually impossible to sell or finance the property. Perhaps, as has happened in the past, buyers will have to settle for getting their trusts without the development ever being finished as promised. Worse, the developer’s creditors might have legal rights superior to those of the buyers. This is because the buyer’s interest, as explained above, is based on a private promise from the developer, not a deed recorded in the Public Registry. A buyer might decide to assume these risks in a given situation, but in my experience most are completely unaware that these risks even exist, let alone why.

Part Three. How to Improve The Situation?

Stronger governmental enforcement would clearly help, but given the enormous financial demands on the Mexican government, how likely is it that the protection of unwary U.S. buyers will take priority over the basic needs of their own people?

I personally believe that the best remedy at present is increased education of buyers. That is in fact the essential reason I wrote this article and formed ICS (International Consulting Services). If enough U.S. buyers refuse to pay money for a property unless at the same time they obtain ownership through a duly recorded bank trust, developers will be forced to stop “putting the cart before the horse” and will feel the pressure to comply with all government and trustee bank requirements before starting to sell.

It would also help enormously if a buyer without a trust and with only a “promise of trust” could at least have his or her property interest formalized by a Mexican Notario Publico and recorded in the Public Registry. This would give legal notice of ownership interest to all third parties, including potential competing claimants. As of this time, Notaries in Sonora are not willing to formalize such contracts, but this is an area where legal reform is long overdue. If the law really does not authorize Notaries to formalize such contracts and allow the contracts to be registered, the law should be changed.

Finally, there are contractual protections that an experienced attorney can often negotiate on behalf of the buyer.

It seems to me that the problem discussed in this article is the kind of “growing pain” that is experienced when the legal and business infrastructure in a region has not yet caught up with the rapid, unprecedented growth in real estate demand. I intend to do all I can personally to contribute to a solution that strikes a better balance between the goals of developers and the needs of buyers.