Mexican Guarantee Trusts vs Traditional Security Interests: Are Cost Savings Worth the Risk for Return?

Borrowers often push back when creditors require a Mexican guarantee trust (GT) as the primary security document in aircraft financing transactions in Mexico. They recurrently ask creditors to rely on less expensive, “more traditional” security structures such as an aircraft mortgage or pledge. Creditors are then confronted with the task of assessing whether a Mexican mortgage or pledge provides the same level of protection as the GT and, if not, whether waiving the GT due to costs is a reasonable and commensurate proposition given the additional risk that may be assumed by the creditor.

GTs may only be set up utilising an eligible Mexican regulated financial institution as the trustee. The pool of potential trustees for aircraft transactions is small and initial set-up fees are high. Trustees also charge expensive enforcement fees which are added to the borrower’s indebtedness if foreclosure occurs. It comes as no surprise that borrowers prefer a local law mortgage or pledge to avoid these costs altogether. Should financiers acquiesce?

GTs are created by contract and are governed by Mexican law. Under the typical GT structure, the settlor (ie, the borrower) will acquire the aircraft from the seller on the delivery date and immediately thereafter transfer title to the aircraft to the trustee via a bill of sale and/or contribution agreement. The trustee will hold title to the aircraft during the term of the loan as security for the repayment of the borrower’s obligations. The lender or collateral agent (in its capacity as “first beneficiary”) will have several rights under the GT, including the right to direct the trustee to sell the aircraft in an event of default and apply the proceeds from the sale towards the borrower’s indebtedness. Once all obligations secured by the GT have been paid in full, the trustee will transfer title back to the settlor. GTs are typically signed before a notary public in Mexico and registered with the Mexican Aeronautical Registry (RAM) and on the International Registry.

Although no form of security document is free from litigation risk, the GT has several advantages over a mortgage or a pledge. The benefits of the GT to creditors may be greater than any cost-related benefit resulting from using traditional security structures. Five GT advantages to consider are as follows.

With a GT, the fact that the aircraft is owned by the trustee will generally prevent the borrower from encumbering the aircraft. This reduces the risk of third-party claims and liens against the aircraft. In some circumstances, GTs have even been effective to protect creditors against aircraft liens that would otherwise have a super priority status in Mexico (eg, unpaid taxes and labour law claims).

Although there has been some recent controversy in Mexican courts on whether the GT property is independent from the assets of the bankrupt debtor/settlor, the GT should generally hold as a bankruptcy-remote vehicle if adequately structured and drafted. This means that an aircraft secured by a GT would not be considered part of the borrower’s estate and the trustee would generally have the right to remove the aircraft from the bankruptcy estate and exercise its remedies outside the insolvency proceedings.

It is not possible to achieve bankruptcy-remoteness via a mortgage or pledge. Under those security documents, creditors would not be able to remove the aircraft from the bankruptcy estate. To exercise remedies, the creditor would need to first request confirmation from the court that it is a “recognised creditor”, establish its status as a “preferred secured creditor” and obtain permission from the court to repossess and sell the aircraft in accordance with the mortgage or pledge. If the creditor is able to successfully navigate these preliminary stages, it will then be permitted to sell the aircraft, but solely through court-conducted or court-supervised sales.

So long as minimum statutory requirements are met, Mexican law allows parties to the GT to freely agree on an out-of-court sale procedure in an event of default. This reduces the likelihood of a drawn out and costly foreclosure process that often occurs with mortgage foreclosures. Mortgage foreclosures require creditors to fully comply with the rules of Mexican civil procedure. This involves court-approved appraisals and auctions being publicised in newspapers. Initial bids must cover at least two-thirds of the appraised value and be accompanied by a 10% deposit. If no bids are submitted, creditors will face new auction rounds. Although pledge foreclosures may be more flexible in comparison with mortgage foreclosures, certain processes, such as those involving the determination of the sale price, may still be subject to court supervision.

The GT allows creditors to contractually designate the borrower/operator as a “depositary” of the aircraft (ie, the party with physical custody of the aircraft). In a default, the trustee may revoke the borrower’s status as the depositary and require the borrower to redeliver the aircraft to it. The borrower’s refusal to comply with this revocation order may have criminal implications for the borrower and its agents.

The GT allows creditors to make the trustee (not the borrower or operator) the registered owner of the aircraft before the RAM and International Registry. This diminishes the risk of the borrower holding itself out as having the power to sell, charge or otherwise encumber the aircraft.

Aviacsa, one of Mexico’s popular low-cost carriers, filed for bankruptcy in 2011. It owed USD30 million in fees and taxes and faced claims from over 3,500 employees. Twenty-six aircraft were at stake. Creditors holding GTs were able to remove their aircraft from the bankruptcy estate and commence foreclosure procedures within six months. Up until two years ago, anyone flying into Mexico City could still see some of Aviacsa’s other aircraft parked at their old hangar. So, one wonders, how were these other (now abandoned) aircraft secured?