DLA Piper Mexico, S.C.
Throughout this article we will explain how the trust is an efficient tool to secure finance transactions, including for infrastructure projects, in Mexico. We will first explain the main characteristics of a trust, its nature and types of trusts, among other fundamental aspects of a trust. Subsequently, we will analyze the benefits and advantages of the trust as a method to secure financing obligations related to infrastructure projects.
- GENERAL OVERVIEW AND MAIN CHARACTERISTICS OF A TRUST.
The Mexican Trust. The Mexican Trust (fideicomiso) is an agreement whereby an individual or legal entity, whether domestic or foreign, transfers and assigns the property of certain assets or rights for a lawful and specific purpose, for its own benefit or for the benefit of a third party, entrusting the realization of such purpose to a trustee. The trust is governed by Mexico’s General Law of Negotiable Instruments and Credit Transactions (Ley General de Títulos y Operaciones de Crédito) (the “Law”). Since it is an agreement expressly regulated by law, there are certain mandatory provisions that must be contemplated. Nevertheless, the trust is distinguished for being one of the legal figures with greater flexibility and room for operation.
Parties to a Trust. A trust or fideicomiso – generally – consists of three parties: (i) the settlor (fideicomitente), (ii) the trustee (fiduciario), and (iii) the beneficiary (fideicomisario). The settlor or settler will transfer the title of assets and/or rights (e.g., real estate, movable assets, collection rights, shares or equity interests, etc.) to a trustee which is generally a Mexican bank but there are other financial institutions authorized to act as trustee under Mexican law. The trustee will hold title of such assets, oversee the compliance of the specific purposes of the trust and follow the instructions of the settlors and/or beneficiaries tending to the fulfillment of the aforementioned purposes. Finally, the beneficiary of a trust is the party that stands to benefit from the assets and funds in the trust. In finance transactions, the beneficiaries are the financial institutions or entities granting the relevant financing.
Trust Formalities. Pursuant to article 387 of the Law, a trust must always be executed in writing and must follow the same formalities required for the transfer of the assets that will be contributed to the trust. In practice, the best example of this requirement is the real estate trust. Considering that in Mexico the transfer of real estate must be documented through a public deed and registered in the Public Registry of Property; therefore, a real estate trust must comply with the exact same formalities corresponding to a real estate transfer.
Types of Trusts. The Law does not specifically limit the diverse types of trusts which may exist; however, the most used are described below:
- Management or Administration Trust: A settlor transfers to the trustee certain assets and rights for the trustee to keep, safeguard, manage and, based on certain terms and conditions, including, if applicable a cashflow waterfall, transfer them in favor of the settlor or in favor of a third party.
- Management and Source of Payment Trust: A settlor transfers to the trustee the ownership of the collection rights in its favor derived from agreements entered into, generally with its customers, e.g., leasing agreements, services agreements, construction agreements, supply agreement, among others. The funds derived from the collection rights are deposited in the trust accounts and the trustee administers them. Usually after running a cashflow waterfall set forth in the trust, the trustee repays the financing that the settlor has entered into with a financial institution in the dates established in the applicable loan agreement. Once such repayment has been made, the trustee delivers the remainder to the settlor.
- Security Trust: The trustee receives the property of assets and/or rights transferred and assigned to the trust to secure the fulfillment of an obligation by the settlor and in favor of the beneficiary. The principal advantage of the security trust is that in the event of default by the settlor, as borrower, in the applicable loan agreement, assets and rights could be sold in a non-judicial foreclosure procedure.
- Investment Trust: As its name indicates, the purpose of this type of trust is to invest funds transferred to it. This type of trust is widely used among entities and individuals as an investment tool; hence, in most of the cases the settlor and beneficiary are the same person.
Technical Committee. A trust agreement may contemplate a Technical Committee which is a collegiate body that is generally appointed by the settlor and in some cases by both the settlor and the beneficiary, to support the parties in complying with the purpose of the trust and to decide on specific matters that require a group of experts. Since there are no express provisions regulating this corporate body established in the Law, it is necessary to provide the Technical Committee with the relevant authorities to resolve unforeseen events in the fulfillment of the purposes of the trust. In practice, it has been proven that trustee institutions seek that the powers of the Technical Committee go in line with each purpose of the trust.
Term. In accordance with article 394 of the Law, the term of a trust cannot exceed 50 years. Further, trusts can be terminated due to different circumstances listed in article 392 of the Law, including but not limited to: (i) the fulfillment of the purposes for which it was established, (ii) because it becomes impossible to comply with the relevant purpose, (iii) by written agreement between the parties, and (iv) by revocation of the settlor (when the settlor has expressly reserved this right when creating the trust), among others.
- THE TRUST AS AN INSTRUMENT TO SECURE FINANCE TRANSACTIONS INCLUDING FOR INFRASTRUCTURE PROJECTS.
In this section, we will focus on the advantages of using a trust as a method to secure finance transactions, including for infrastructure projects. In Mexico, the trust has become a critical tool in securing finance transactions, including related to infrastructure projects. The trust agreement is a legal instrument that creates a separate entity for a specific project or investment. The trust is managed by the trustee, a neutral, independent third party, which holds legal title to the assets and funds, being responsible for administrating such funds and assets in the trust for the benefit of the beneficiaries. The trustee ensures that the funds and assets are used for their intended purpose, rather than diverted to others, and that the project is completed in accordance with the agreed-upon terms and according to the trust agreement.
Generally, any type of asset, movable (including intangibles) or immovable, all types of property, real or personal, could be transferred to a trust. In contrast to a pledge or mortgage, a trust is not restricted to certain types of assets. Due to this flexibility, trusts, particularly security trusts, have become extremely popular for project and structured finance. Infrastructure projects are typically large-scale, long-term investments that require significant capital outlays, and securing financing for these projects can be challenging. Trusts can be established to pool investment funds from multiple sources, thereby spreading the risk and increasing the likelihood of securing financing. Additionally, trusts can provide a framework for managing and allocating the funds, ensuring that they are used efficiently and effectively.
In finance transactions, including infrastructure projects, a security trust can be used to hold assets as collateral for a loan or bond issuance, and ensure the timely and effective completion of the project as planned, while providing certainty to lenders, governmental entities and investors as to the use of funds and repayment of the relevant financing. Security trusts are also used to secure financing for real estate projects. In these cases, the trustee holds title to the property on behalf of the beneficiary until the financing is repaid. This provides security for the lender and allows for the transfer of title to the borrower once the financing is paid off.
In Mexico, the use of trusts has become increasingly common in the context of public-private partnerships (PPPs), used by commercial and development financial institutions to secure and mitigate the risks associated with financing large infrastructure projects, including the construction of highways, airports, hospitals, wind farms and solar parks, residual water treatment plants, penitentiaries, pipelines and ports. In PPPs, trusts also play a critical role in securing the necessary funding and attracting private investment in infrastructure projects. Under a PPP, a company invests in a public infrastructure project, which usually requires financing, and shares in the risks and rewards. The funds invested by the company and disbursed by the lender are typically held in a trust and the trustee allocate them as the project progresses in accordance with the instructions received by the parties. This provides lenders and investors with the assurance that their funds will be used for their predetermined purpose and that the project is completed according to the agreed-upon terms and conditions applicable to the project, while also promoting transparency and accountability. For example, a trustee can hold funds in the trust until certain conditions are met, such as the completion of a project milestone or the issuance of a permit.
In addition, trusts can help to mitigate risks associated with infrastructure projects. Infrastructure projects are often complex and there are a range of risks that can arise during the construction and operation phases. These risks can include technical and construction risks, regulatory risks, and market risks. Trusts can be established to hold contingency funds that can be used to address any unforeseen risks that arise during the project. Additionally, trusts can provide a means of managing and mitigating risks associated with project completion and performance.
A key advantage of using a trust in Mexico is that, in general terms, it is bankruptcy remote. The transfer of ownership of assets or rights that were owned by the settlor in favor of the trustee isolates and minimizes the risks and losses, such as bankruptcy. In the event of bankruptcy of the borrower, the assets and rights the settlor transferred to the trustee are no longer owned by the borrower, and therefore, can be sold in terms of the rules agreed upon in the trust to repay the loan granted by the beneficiary, as lender.
Furthermore, trusts can provide greater flexibility and control over the management of assets. A trust can be adapted and customized to meet the specific needs and goals of the settlor and beneficiaries. For such purposes, a trust allows the parties involved to (i) include a range of discretionary powers for the trustee to provide a wide scope of action to the trustee, and therefore, greater capacity to adapt to specific circumstances, (ii) add or remove settlors, trustees and beneficiaries, as necessary based on the specific transactions and needs, (iii) replace the assets held by the trust to reflect changes in the needs and circumstances of the parties involved, among other advantages provided by the trust.
Additionally, trusts can provide a means of protecting the interests of all parties involved in infrastructure projects. Infrastructure projects typically involve multiple stakeholders, including lenders, project sponsors, investors and contractors. Trusts can provide a framework for managing and allocating the risks and rewards associated with these stakeholders, ensuring that all parties are appropriately compensated and protected. Additionally, trusts can provide (i) a non-judicial foreclosure procedure that may avoid lengthy and costly judicial proceedings, and (ii) a degree of privacy and confidentiality, as the funds and assets held in trust are generally not subject to public disclosure or scrutiny.
Trusts can also be used to protect lenders and investors in the event of default. In such cases, the funds and assets held in the trust can be used to repay lenders or investors, providing a measure of security that would not be possible in the absence of a trust agreement. In the event of default, as long as the foreclosure procedure established in the security trust agreement is followed (according to the guidelines of the Law), the trustee has the power and authority to sell the trust assets and the proceeds will be delivered to the beneficiary (creditor) as set forth in the trust.
Notwithstanding there are some exceptions, Mexican law does not allow lenders to seize or execute collateral without due process. As established in the Law, the beneficiary (creditor) under a security trust agreement might instruct the trustee to execute and sell the trust assets without employing the judicial system or obtaining a court order, by a non-judicial foreclosure procedure included in the security trust agreement; provided, however, that the Law requires compliance of the following conditions:
- notice by the beneficiary to the trustee specifying the default by the settlor (borrower) of the applicable secured obligations under the relevant loan agreement instructing to initiate the foreclosure procedure;
- notice by the trustee to the settlor;
- opportunity for the settlor to oppose the procedure by:
- repaying the outstanding aggregate of the loan;
- providing evidence of the performance of the purportedly breached secured obligations; or
- delivering a document evidencing that the applicable secured obligations were novated, or the term was extended.
Further, using a trust provides greater transparency and accountability. By appointing a trustee to manage the trust, the beneficiaries can retain a substantial degree of control over the assets and funds while also delegating certain responsibilities to the trustee. The trustee is responsible for ensuring that the funds are used in accordance with the trust agreement and the project’s objectives. This responsibility means that lenders and investors have greater visibility into how their funds are being used and can hold the trustee accountable if they are not satisfied with the management of the trust. This can be particularly beneficial for financial institutions, companies or individuals who want to maintain control over the assets and funds in the trust.
In summary, security trusts are a vital tool for securing finance transactions and infrastructure projects in Mexico, providing a wide range of advantages for financial institutions, companies and individuals operating in Mexico. In the event of default by the settlor, assets can be sold in a non-judicial execution procedure and provide enhanced flexibility, control, and asset protection. Finally, the use of trusts provides legal certainty and security to lenders, governmental entities and investors. Trusts can mitigate risks and ensure the success of complex projects, including the assurance that their funds will be used as intended. This has helped to build trust in Mexico’s financial system, further strengthening its investment climate. As Mexico continues to invest in its infrastructure, trusts will play a critical role in attracting the necessary funding to ensure that these projects are successful.