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Secured Lending Across Borders: Navigating the Complexities of International Transactions

As business becomes increasingly globalized, secured lending transactions frequently involve parties and collateral located in multiple jurisdictions. This presents unique challenges for lenders, who must navigate a complex web of choice-of-law rules and foreign legal systems to ensure their security interests are properly perfected and enforceable.

The Mandatory Choice-of-Law Rules: UCC Article 9

The starting point for any discussion of cross-border secured lending is the choice-of-law rules set forth in Article 9 of the Uniform Commercial Code (UCC). These rules are mandatory and cannot be altered by agreement between the debtor and secured party. The policy rationale is to provide certainty to third parties who may not be privy to the specific terms of a security agreement.

Under UCC § 9-301(1), the law of the jurisdiction where a debtor is located generally governs perfection, the effect of perfection or nonperfection, and the priority of a security interest. For registered organizations, such as corporations and LLCs, the debtor is located in its state of organization (UCC § 9-307(e)). However, foreign entities cannot be registered organizations under the UCC definition. Instead, the default rule for determining a foreign debtor's location looks to the debtor's place of business or chief executive office if the debtor has multiple places of business (UCC § 9-307(b)).

The Foreign Debtor Exception: UCC § 9-307(c)

This default rule is subject to an important exception for foreign debtors under UCC § 9-307(c). If the foreign debtor is located in a jurisdiction whose law generally requires public notice of security interests (e.g., through a filing system), the debtor is located in that jurisdiction for purposes of perfection by filing. However, if the foreign jurisdiction does not have a public notice system comparable to the UCC financing statement filing system, the debtor is deemed to be located in Washington D.C. In such cases, perfection by filing is accomplished by filing a financing statement in D.C.

The term "generally" in § 9-307(c) is not clearly defined. It is uncertain whether a jurisdiction's public notice system must apply to all types of entities and collateral to satisfy this standard. If there is any doubt, the prudent approach is to file both in the foreign jurisdiction (if it has some form of public filing system) and in D.C.

Effect of Perfection and Priority: Location of the Collateral

While filing for perfection is based on the debtor's location, the effect of perfection or nonperfection and priority are governed by the location of the collateral for tangible assets. This bifurcation of applicable law can lead to some tricky conflict-of-laws issues.

For example, suppose a Delaware corporation grants a security interest in equipment located in a foreign country. To perfect by filing, the lender would file a financing statement in Delaware. However, the law of the foreign country where the equipment is physically located would govern the effect of perfection and priority. The lender must look to that country's law to determine the relative rights of competing claimants and the impact of the debtor's bankruptcy proceeding, if any.

This highlights the importance of consulting with local counsel in the jurisdiction where collateral is located. Even if the lender has properly perfected under the UCC, a failure to comply with the foreign jurisdiction's requirements could leave the security interest vulnerable.

Special Considerations for Intangible Collateral

The rules become even more complex when dealing with intangible collateral, such as accounts, intellectual property rights, and securities.

For accounts where the account debtor is located in a foreign jurisdiction, the lender's UCC perfection by filing in the U.S. may not be sufficient to protect against competing claims. The UN Convention on the Assignment of Receivables in International Trade would provide greater certainty by looking to the law of the assignor's location to determine perfection and priority. However, the convention has not yet taken effect, as it still requires ratification by more countries.

Intellectual property rights present additional hurdles, as they are often governed by jurisdiction-specific registries and legal regimes. Perfecting a security interest in U.S. copyrights, for example, requires filing in the U.S. Copyright Office. But this filing would not necessarily perfect the security interest in foreign copyright rights, even if held by the same debtor. The lender may need to take additional perfection steps in each relevant foreign jurisdiction.

For securities and other financial assets, the choice-of-law rules depend on whether the securities are held directly or indirectly through an intermediary.

Directly held certificated securities are treated similarly to tangible collateral, with perfection and priority governed by the location of the certificates. Uncertificated securities are governed by the issuer's jurisdiction. This can be problematic when dealing with issuers organized under foreign law, as many countries do not recognize the concept of a UCC-style non-possessory security interest in uncertificated securities.

Indirectly held securities are subject to the Hague Securities Convention, which preempts the UCC choice-of-law rules for securities held with an intermediary. Under the convention, perfection and priority are governed by the law of the securities account agreement, provided the relevant intermediary has a qualifying office in that jurisdiction. One wrinkle is that if the account agreement does not specify a governing law, the convention points to the law of the intermediary's jurisdiction.

The Role of Foreign Counsel and Contract Drafting

Given this dizzying array of choice-of-law rules and variations in national legal systems, the importance of engaging knowledgeable foreign counsel cannot be overstated. Local counsel can advise on the specific perfection and priority rules in their jurisdiction, as well as any quirks or pitfalls to be aware of.

For example, some countries may not recognize self-help remedies that are permitted under the UCC. Attempting to enforce a security interest through self-help in such a jurisdiction could expose the secured party to liability, even if the loan documents purport to choose U.S. law.

On the contract drafting front, the panelists emphasized the need for clear and thoughtful governing law and forum selection clauses. While the UCC's mandatory choice-of-law rules will often trump contractual provisions for perfection and priority, these clauses can still play a vital role in determining the law applicable to issues like attachment, enforcement rights, and certain remedies.

New York law, in particular, is a popular choice for commercial transactions due to its well-developed body of case law. Under N.Y. Gen. Oblig. Law § 5-1401, parties can select New York law to govern their contract even if the transaction has no reasonable relationship to New York, provided the transaction value exceeds $250,000. This can provide valuable predictability, at least when litigating in New York courts.

However, secured parties must be cautious about relying too heavily on contractual choice of law when dealing with foreign counterparties and collateral. If a dispute ends up in a foreign forum, that court may disregard the parties' choice of New York law in favor of local mandatory rules or public policy considerations. This underscores the need to structure transactions with an eye toward enforceability in all relevant jurisdictions.

Conclusion

Cross-border secured lending transactions require careful navigation of a complex set of choice-of-law rules and foreign legal regimes. Lenders must take a proactive, multi-jurisdictional approach to perfecting and enforcing security interests, with a particular focus on the location of the debtor and the collateral.

By understanding the nuances of the UCC Article 9 choice-of-law framework, and engaging experienced counsel, lenders can structure transactions that are enforceable across borders. Even the most carefully crafted loan and security documents may face challenges when put to the test in a foreign bankruptcy or insolvency proceeding.

As global commerce continues to expand, the demand for cross-border secured lending is only likely to grow. By staying abreast of developments in this area and employing a creative, jurisdiction-sensitive approach, experienced attorneys play a vital role in facilitating these transactions and helping their clients manage risk in an increasingly interconnected world.