Law Of Mongolia On Pledges Over Movable Property And Intangible Property.

14 September, 2015

1.     INTRODUCTION

Obtaining finance has been a concern not only for small and medium enterprises, but also for large Mongolian conglomerates. In most conventional loan arrangements, lenders, whether domestic or international, require security from borrowers to secure repayment. In theory all types of property in Mongolia can be used as security, including tangible and intangible property. However, in practice, there are only limited cases where security can be perfected.

Historically in Mongolia there has been no way to perfect a pledge taken over movable property. As such, in Mongolia security over movable assets is governed by contractual terms only. For this very reason, banks and financial institutions in Mongolia prefer to take land, buildings and minerals licences as collateral due to the comparatively well-developed registration system.

According to the IFC, whilst in the developing world 78 percent of the capital stock of a business enterprise is typically in movable assets such as machinery, equipment, or receivables, and only 22 percent is manifested by immovable property, financial institutions are reluctant to accept movable property as collateral.[1] Likewise, the lack of a registration system in respect of security over movable assets (save for minerals licences and shares of joint stock companies) has limited the ability of business enterprises in Mongolia to obtain financing secured by movable assets.

Creating a legal environment for pledges over movable and intangible property with clear priority rules and a reliable registration system can be beneficial to the development of the private sector by increasing the amount of credit available at economically beneficial rates. Realising the importance of the benefits to the economy and private sector, the Parliament of Mongolia has passed the relevant legislation to create a legal environment in which movable property can be more effectively used as collateral. The new legal developments are discussed below in detail.

2.    THE MIPP LAW

On 2 July 2015, the Mongolian Parliament approved the Law of Mongolia on Movable and Intangible Property Pledges (the "MIPP Law") and the Law of Mongolia on the Implementation of the MIPP Law (the "Implementation Law").  The purpose of the MIPP Law is to address the issues discussed above and stimulate Mongolia's access to capital.  The MIPP Law will come into force on 1 September 2016.

The scope of the MIPP Law covers the relationship arising either contractually or by operation of law between a pledgor and a pledgee with regard to pledges over movable and intangible property.  In addition, the provisions relating to the registration and order of priority under the MIPP Law will apply to the rights of a financial lessor and assignee and any lien or right of retention under a hire-purchase agreement, and pre-emptive rights of sellers under a sale and purchase agreement. Pledges concerning mineral licences however, are not within the scope of the MIPP Law. The Implementation Law is retroactive and pledge agreements executed prior to the entry into force of the MIPP Law can be registered within a six month period following the entry into force of the law (i.e. until February 2017).
Noteworthy measures introduced by the MIPP Law include:

1. specific measures on creating, perfecting and enforcing security over movable and intangible property;
2. a detailed regulation on pledges over certain assets, claims and receivables;
3. clearer order of priority among creditors;
4. creation of an online registration system; and
5. provisions on the management of pledged property between the contracting parties such as its transfer, use, insurance, damage and destruction.

3.     LEGAL FRAMEWORK FOR PLEDGING MOVABLE AND INTANGIBLE PROPERTY



3.1    Creation of a Pledge



Pledges can be created either by way of written agreement between the interested parties or by operation of law.  Pledge agreements must be executed in written form and must contain certain mandatory provisions.  For pledges created by operation of law, only the provisions in the MIPP Law relating to the perfection mechanism and the order of priority shall apply.

According to the MIPP Law, security interests can be created over existing or future property that is capable of transfer, including all types of shares, securities, claims, all types of scientific, literary and cultural works, inventions, industrial designs and models, trademarks, utility models and other movable property and intangible property. "Movable property" includes all property other than land, buildings and other property that cannot be used for its purpose if separated from land.[2]  Finally, property that is not capable of transfer or which cannot be exchanged for cash pursuant to law may not be used as collateral.



3.2    Perfecting a Pledge



Pledges can be perfected either (i) by way of transferring the pledged property to the lender's possession; or (ii) if the pledged asset is not so transferred, then by way of registering a notice of security interest with the new online registry.



A pledge created by operation of law may also be perfected by registering a notice of security interest with the registry. 



The MIPP Law further provides for specific perfection methods for bank accounts, vehicles, and property purchased under certain financing arrangements.  



3.3    A Modern Registration Mechanism



The MIPP Law mandates the General Authority for State Registration ("SRA") to create an electronic registration system for security interests in movable and intangible property ("Pledge Registry"). Unlike the existing registration system in place for pledges over immovable properties and minerals licences which is paper-based, the MIPP introduces a new electronic notice-based registration. Under the new registration system, a notice of security interest is registered online with the registry. A notice must contain certain information such as the names and addresses of the parties, the security period, and description of the pledged property.  It is expected that the new registration will eliminate the need for documents to be submitted and the Pledge Registry will not verify the legality of the transaction.



It is intended that the Pledge Registry will be accessible to the public through an online search function administered by the SRA.

The onus on registration sits with the pledgee, but requires written approval from the pledgor.  During the security period, the parties are free to extend, alter or de-register the security interest subject to notification.

 

The MIPP Law also allows a notice of security interest to be registered prior to the execution of a pledge agreement.  Thus, registration of the notice in advance gives additional comfort to creditors that no priority security interest in respect of that property may be registered following registration of such notice.



Stamp duty is payable on registration, but this is a flat fee and not based on the value of the secured assets or secured obligations.  The stamp duty payable is set out in the table below:

 

Table 1: Stamp Duty on Registration

 

  

3.4    Order of Priority



The priority of claims in the event of multiple creditors is an important concern.  The MIPP Law sets out two guiding principles.  Firstly, secured creditors take priority over unsecured creditors.  Secondly, claims of secured creditors shall be ranked in the chronological order of their date and time of registration.  All else being equal, security interests that were registered earlier prevail over other claims and rights.  However, exceptions may apply for certain types of security arrangements where other creditors take priority over secured creditors.  These exceptions include leasing arrangements, and pledges over livestock and grain products.



The MIPP Law gives parties the freedom to negotiate and change the order of priority.  In addition, the MIPP Law provides specific provisions on the order of priority in certain circumstances where property belonging to different persons becomes inseparably interconnected or intermixed.



3.5    Pledge Enforcement



The MIPP Law sets out detailed regulations on enforcement of security.  Upon the occurrence of an event of default in relation to the secured obligations, the pledgee must issue a notice to the pledgor requesting its remedy within a certain period of time. The period during which the pledgor is requested to remedy the default must be no less than 14 days (if not longer).  Should the pledgor fail to comply within the prescribed period, the pledgee may proceed to enforce its security, which must also be reported to the Pledge Registry.

 

In certain respects, the MIPP Law provides simplified and expedited procedures if the parties have commenced legal proceedings to enforce the security. For example, under the new regime, it would be possible for a pledgee to demand possession of the pledged property from the pledgors in the event of enforcement. If such request is not complied with, the pledgee may file a claim to the court to issue an order for possession within seven days of submission of the claim.



In terms of methods to dispose of the secured property and recover the amounts owed, the MIPP provides for three options: direct sale, auction or market sale.  In any event, the MIPP Law obliges the pledgee to choose the most cost-efficient method.  Certain types of security interests, such as pledges over bank accounts and certain securities, can be enforced without undertaking judicial proceedings.  The order of allocating proceeds from a disposal of pledged property is also clearly set out in the MIPP Law.



At any time prior to a disposal of the pledged property, the pledgor has the right to recover the pledge property provided that it has fully discharged the secured obligations and compensated the pledgee's costs and losses arising from enforcement of the security.



4.    CONCLUSION

 

The below table highlights the main differences pre-and post-introduction of the MIPP Law.



Table 2: Movable Property Pledges – Before and After

 

 

It remains unclear exactly how under the MIPP Law the registration process and ancillary matters will be implemented in practice.  The mechanics are subject to further regulations to be issued by the SRA.

Although the MIPP Law provides a legal framework where extra-judicial enforcement is permitted, it remains to be seen whether in practice creditors can enforce their security without having to go through a judicial procedure.

In summary, the MIPP Law is certainly a welcome development.  By creating a mechanism for taking, registering and perfecting security over movable and intangible property, the MIPP Law provides improved legal protection and transparency for creditors, potentially better access to financing for borrowers and may assist in reducing the costs of financing in Mongolia.

For further information, please contact:

Chris Melville, Partner, Hogan Lovells
chris.melville@hoganlovells.com