Secured Transactions Reform - Facilitating the Use of Movable Collateral for Credit

1. SECURED TRANSACTIONS REFORM December 22, 2014

2. Reform Overview • Goal: To facilitate the use of movable property, including equipment, inventory, accounts receivable, livestock and other movable assets as collateral for loans and credit. • Why: To increase the availability and affordability of credit by increasing lender “certainty” that loans will be repaid on time and in full. Increased credit = more business activity = more jobs • Fact: Absent a modern regime, financial institutions are reluctant to accept movable property as collateral • How: Legislative changes that incorporate international best practices, establishment of an electronic registry and training.

3. Status of Reform Effort • Donor Assessments: World Bank, EBRD and other donors have evaluated existing legal and institutional frameworks governing secured transactions in Armenia and have recommended reform. • Government support: In March 2013, the Armenian Government reiterated its support for reform by enacting Decree No. 240-A “On the Improvement of Business Environment in Armenia” which identifies secured transactions reform as a priority. • World Bank Mission – Sept 2013: Technical assistance mission which included meetings with government authorities and private sector representatives regarding secured transaction practices in Armenia. • Preparation of Detailed Diagnostic and Reports: Experts prepared a detailed diagnostic evaluation of the existing legal and institutional frameworks and draft reports presenting their findings and conclusions for presentation to government. • Follow up mission November 11- 17, 2013: World Bank sponsored follow-up mission to draft law and finalize registry design

4. Summary of Mission Findings - Legal • Legal and institutional frameworks fragmented, incomplete and ineffective • Limited scope of regime excludes certain assets, types of debt and security interests • Complicated, formality-laden process for creation of security instrument • Limited and unclear priority provisions • Poor system of “publicity” of security interests • Enforcement process time consuming and expensive

5. Summary of Mission Findings - Registry

6. Proposed reform approach • Enact a legal framework that: • Comprehensively governs use of movable collateral • Covers all types of movable property; obligations and interests • Establishes clear and concise rules of priority of claims and means of perfection • Provides for efficient enforcement mechanisms • Establish an effective collateral registry that is accurate, transparent and cost-effective. • Build capacity of stakeholders to use law and registry

7. Legislative guidance - International Best Practices* • Modern legal framework needs to address: • New definitions and concepts • Creation of security interest • Priority scheme and requirements • Publicity of interests • Enforcement • Debtors rights

8. 1. Key Definitions and Concepts • Modern secured transactions regimes rely on new definitions and concepts. • Key definitions include: • “Security interest” and additional interests included in the secured transaction regime • “Collateral” and “Movable Property” • Key concepts include: • “Priority” • “Publicity” and “Perfection” • The following slides consider these terms in detail.

9. “Security interest” vs. “Pledge” • A “security interest” (other options “encumbrance” or “charge”) is a property right that secures an obligation. • The existing Civil Code provides for “pledge” also a property right … which ensures the performance of a monetary or other obligation” –unclear whether term pledge is broad enough to cover all interests. • If not broad enough important interests are left out of secured transactions regime, which makes the regime less useful

10. “Security interest” (continued) • “Security interest” introduces the concept of a “generic” property right, that secures an obligation. The term: • Subsumes all of the traditional forms of security in movable property • Broad enough to include Sale with retained title, installment sale with right to retake property, financial leases and other interests • Eliminates distinctions between various types of security interests

11. “Other interests” • In addition to security interests, modern secured transactions regimes typically include other rights solely for the purposes of publicity and determination of priority pursuant to the law. • Including other interests protects creditors from unknown liens and other obligations of the debtor. • Adds transparency and certainty to the lending process and encourages credit.

12. “Movable property” and “Collateral” • The term “movable property” is defined broadly to include “movable things of any nature, intangibles of any nature and fixtures.” • The term “collateral” is defined to include “present and future” assets. • Read together, these definitions are broad enough to cover: • Equipment • Inventory and raw goods • Cash-flows (receivables & secured sales contracts) • Intangibles and documents • Crops – growing, to be grown and harvested • Livestock – including offspring and products • Fixtures – movables fixed to real estate • Consumer goods • Cash and deposit accounts • Minerals and timber to be severed from land

13. “Collateral” - exceptions • Some jurisdictions decide to exclude certain types of collateral from the secured transactions regime due to the fact that the assets are already subject to a comprehensive regime. • Assets that have been excluded include: • Securities • Vehicles • The existing secured interest regime governing these assets needs to meet the publicity standards of the new system

14. 2. Simplicity of creation (and registration) Modern best practice is to simplify and expedite the creation of security interests, imposing no unnecessary burdens on the parties to the agreement. Minimal fees to encourage use. • “Creation”: all that is required to create a security interest is a written agreement signed by the debtor, which identifies the security interest and the collateral. No special terminology, forms or notarization required – such formality add unnecessary time and expense to process. • No other documentation: when interests are filed, no other documentation is required. • Registration: one way to “publicize” security interest against claims against third parties. Not required for creation of security interest. • Possession/control: other ways of creating security interests. Requires lenders to investigation status of

15. 3(a) “Priority” • “Priority” determines which lender has first rights in the collateral upon default. • Priority rules must be clear and precise so that a creditor can determine with a high degree of certainty the risk of granting credit. Priorities must also reflect business realities to encourage lending. • Basic rule: security interests and liens subject to a registered notice: 1) have priority over interests that are not registered; and 2) the priority determination is made according to the date and time of notice registration. • Priority by other means: international best practices recognizes priorities established by other means of publicity, including possession and control.

16. 3(b) “Super priorities” • “Super priorities” are special priority rules designed to encourage lending, by giving particular creditor’s priority over other secured creditors. Super priorities recognized by international best practices) • “Purchase money security interest”: takes priority over prior registered interests that might apply to the same property – special publicity rules apply • “Crops”: transactions such as the provision of seeds and agricultural services in connection with the growing of crops are given “super priority” over other interests, even if those other interests are perfected. • “Right of retention”: right of a person who provides value to property may possess property until the receipt of payment for value provided. Service/value is seen as benefit to secured party. (example – vehicle and equipment repairs) • “Commingled goods”: The draft law provides for security interest in goods that become commingled, such as agricultural commodities that are put into common storage.

17. 4. Publicity (registration, possession & control) • For a security interest or other interest to be effective against third parties (priority), it must be “publicized” in such a way that third parties know, or have to ability to discover, its existence. Means of “publication” depends on type of asset. International Best Practices • Established means of “publicity” or “perfection”: best practices recognize different ways of “publicizing” an interest based on the type of asset: registration of notice (non-possessory interests; possession (cash and other assets) and control (bank accounts). • Establishment of on-line “notice” registry: the establishment of an on-line registry is essential to the reform. Facilitates ease of registration, unifies interest into one registry, immediate publicity and establishes certain types of priorities. • Public access: The registry should be accessible to the public – ideally access should be from any location, by any person at any time.

18. 5. Enforcement • Enforcement against collateral upon default of the debtor must be quick and cost-effective. Rules on the seizure and sale of collateral should protect both creditor and debtors • Enforcement Principles • Secured creditor has immediate right to possession of collateral • Self-help or expedited judicial action • Secured creditor may dispose of collateral in commercially reasonable manner • Distribution of proceeds in priority order • Secured creditor has fiduciary duty to debtor and other claimants

19. SECURED TRANSACTION REFORM – ARMENIAN PERSPECTIVE

20. Proposed Solutions The Reform is implemented in two components: • LEGAL REFORM – AIMED AT BRINGING THE LEGISLATION GOVERNING SECURED TRANSACTIONS CLOSER TO INTERNATIONAL BEST STANDARDS, • REGISTRY REFORM– AIMED AT CREATING A LEGAL AND TECHNICAL BASIS FOR CREATION AND OPERATION OF THE UNIFED ON-LINE REAL TIME REGISTRY OF SECURED RIGHTS IN MOVABLES

21. Legal Reform 1. Amendments to the Civil Code • Introduce new concept of “secured right” , which is defined as a “property right of the creditor in the property or property right securing the implementation of an obligation”. • Allow the description of the collateral to be both specific and generic, • Stipulates registration as the only form of “perfection” of secured rights, • Establish rules for determination of priorities in the collateral on “first come, first serve ” basis, i.e. the preference to receive satisfaction from the value of the collateral belongs to the creditor having first registered its secured right in the collateral.

22. Legal Reform 2. The Law On Registration of Rights in Movable Property (the Registry Law) • Stipulates the types of movables and property rights in movables subject to registration in the unified electronic registry of secured rights, • Sets the procedure of registration of secured rights (including liens or as defined in the Law – “the limitations”) in movables, • Envisages the Agency responsible for running the registry (including maintenance, etc.), • Regulates the legal status of rights in movables registered in the respective registries before the enactment of the Registry Law.

23. Legal Reform 3. Amendments to the other laws/legal acts • Amendments to the Law on Taxes - stipulating the necessity for Tax Authorities to register the tax liens/limitations in the registry of secured rights to get priority right in the movable property, • Amendment to the Law on Compulsory Enforcement of Judicial Acts – prescribing the Compulsory Enforcement Service to register the judicial/other liens/limitations in the registry of secured rights to get priority right in the movable property, • Amendment to the Criminal Code of RA – stipulating criminal liability for destroying or damaging or hiding the collateral, as a result of which the creditor incurred significant losses.

24. Registry Reform Existing Registries • State Committee of Real Property Cadastre • Republic of Armenia Police • State Registry of Legal Entities • Ministry of Economy • General Department of Civil Aviation • Ministry of Agriculture • Ministry of Transport and Communications • Central Bank of Armenia, Registry of Joint Stocks • Central Bank of Armenia Government Bonds

25. Registry Reform Main Issues • Registries are fragmented • Registries do not cover all types of assets or transaction types • May require registration in more than one Registry • Paper based • Limited access to Registry Information • Available only to certain parties • Restricted to office hours

26. Registry Reform Principles of International Best Practices • Effective Publicity of Security Interests • View registered Security Interests in Chronological Order • Publicity Best Achieved by Registration, • Failure to Publicize = No Effect Against Third Parties, • Simple System for Registration and Searching, • Fast and Inexpensive System, • All Information Public and Accessible to Everyone, • Database Secure From Error, Abuse and Fraud • Registry Operated and Managed as Transparent Public Service

27. Registry Reform • The Registry of Secured Rights in Movables is a unified internet based, online, real time and publicly accessible electronic registry , • The Registry is run by the authorized agency within the structure of the Ministry of Justice, • The registration of all types of secured rights(including limitations) in to be done in the unified registry, • The only exceptions are securities and vehicles, the secured rights over which are registered in other registries. However, the information on secured rights registered in these registries should be displayed also in the unified registry

28. Registry Reform • All the registrations are to be done electronically by submitting the required information to the registry on line and be certified by the digital/electronic signature of the person making the registration, • If the person does not have an electronic signature, the only way to make registration of the secured right is to resort to the notary’s office. • The following identifications are to be used for making a search in the registry: • In case the debtor is an individual – the ID details or Public Services Number (PSN) or the number of the certificate on non receipt of PSN, if the debtor is not a RA citizen – the name, passport details, • If the debtor is a RA legal entity – the name and the registration number, and in case of foreign legal entity – the name and the TIN (if available) of that entity.

29. THANK YOU