Investors looking to buy Mexican real estate should make sure they fully understand the title registration process before handing over a penny to the seller. Many foreign investors have lost everything because they failed to ensure that the title was properly registered before paying off the seller. For more on this, read the following article by attorney Christopher McDonagh from JD Supra.
It is all too common for buyers of Mexican real estate to pay all or a significant part of the purchase price before receiving properly registered legal title or Mexican bank trust (fideicomiso) rights to the property. Many buyers mistakenly believe they are fully legally protected because they have a signed (but unregistered) “purchase contract” or “promise of trust agreement.” Some buyers might believe their rights to the property are protected because they have been given possession of the property or were told by the seller or real estate agent that a “closing” has occurred and that the property belongs to the buyer at the time the seller signs a purchase contract or promise of trust agreement. Other buyers (for example, buyers making installment payments of the purchase price under the purchase contract or seller-carryback promissory note) understand the seller won’t transfer title until the purchase price is fully paid, but might not fully appreciate the risks to their rights to the property while the seller retains title.
In reality, there are significant limitations on the buyers’ legal rights in these situations, and such buyers may risk losing any legal claim to the property. In the worst case, the buyer could also lose up to all the money invested. This is possible, because buyers do not establish ownership of Mexican property until they have properly registered legal title or Mexican bank trust rights to the property. Until that time, the buyer’s rights are essentially to have a contractual promise by the seller that it will transfer the property to the buyer. If the seller has good and marketable title (or Mexican trust rights) to the property and authority to convey such property, and if the buyer complies with its obligations under the contract (such as paying the entire purchase price), then the buyer has a valid and legally binding contractual right to the property enforceable against the seller. However, the buyer’s right, if unregistered, is not effective against claims to the property by third parties.
A key fact that many buyers do not fully appreciate is that under Mexican law (as in most, if not all, U.S. states), in order to be effective against third parties, an interest in real estate must be registered in the public registry for real property in the jurisdiction where the property is located (the “Public Registry”). Without a registered title or trust, the buyers’ rights can be trumped under Mexican law by claims by third parties, especially if those third party rights have been registered in the Public Registry. In other words, if you don’t have a registered title or trust, you don’t own it, even if you’ve paid for it.
How can this situation arise? It is possible under Mexican law (as under U.S. law) for more than one person to have a legally valid claim against the seller. The seller might have entered into purchase contracts with more than one buyer. The seller might have voluntarily allowed a lien to be placed on the property, such as a lien in favor of a lender. Or a lien might be imposed by a Mexican court to satisfy a judgment or imposed by Mexican law (e.g., for unpaid taxes or labor or social security claims). The seller might go bankrupt. Or, if the seller dies before the title transfer is legally completed and registered, the seller’s estate or heirs may have claims to the property.
Under any of these circumstances, Mexican law generally provides that the party whose rights prevail is the party that has first registered those rights in the Public Registry. The first in time, the first in right. (By the way, the same generally holds true throughout the U.S., which is why real estate transactions in the U.S. are almost exclusively structured so that the purchase price is not released to the seller until the deed from the seller is registered in the applicable public registry.)
Consequently, if a buyer does not yet have rights to the property registered in the Public Registry, the buyer’s claim to the property itself could be lost to anyone with a valid, prior registered claim to the property. If there are competing claims and none of them are registered, then the buyer’s best protection may be to be the first to register those rights. Otherwise, the buyer would have only one of competing unregistered claims, and face uncertain, costly and time consuming litigation in Mexico, just to have a chance of having the buyer’s rights to the property validated by a Mexican court.
If the buyer loses any legal right to the property itself, the buyer will likely still have a valid legal claim against the seller to return money received from the buyer. However, if the seller is unwilling or unable to voluntarily return the money, the buyer may be left in a difficult position. Even with a valid legal claim, it might be an expensive, difficult and/or long process to successfully obtain a judgment to recover the money. Furthermore, any judgment obtained is only as good as the extent to which the buyer can actually collect from the seller, and the net recovery will be reduced by attorneys’ fees and court costs unless those can be recovered as part of the judgment. Finally, even if a lawsuit is not required in order to have the seller acknowledge the debt, the current economic crisis increases the odds that the buyer may not be able to collect the full amount from the seller and/or might have to incur further expenses or delays in bankruptcy court.
The only certain way to eliminate such risks is to formalize the buyer’s ownership of the property through a properly registered legal title or Mexican bank trust. A non-Mexican cannot acquire direct title to property in the Restricted Zone (i.e., within the area 100 kilometers from the Mexican border, 50 kilometers from the beach, and all of Baja). However, non-Mexicans can acquire full rights to use, rent and sell property in the Restricted Zone by having title to the property transferred to a Mexican bank trust of which the buyer is beneficiary. The trust can be created for an initial term of up to 50 years, which is subject to automatic renewal for an additional 50 years upon the request of the beneficiary. If the property is already in a Mexican bank trust, the buyer can have the beneficiary rights assigned to the buyer. Title to non-residential property in the Restricted Zone can also be legally held by a Mexican corporation that is wholly owned by non-Mexicans. Non-Mexicans can acquire direct title to property outside the Restricted Zone. Mexican citizens can directly own title to property throughout Mexico. In all these instances, these rights can be formalized and registered, so as to be effective against third parties, only through a public deed (escritura pública) that is protocolized by a Mexican notary public and registered in the Public Registry. Without a duly protocolized and registered public deed, the buyer’s rights are essentially limited to a claim to the property against the seller, but not against third parties.
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The risk of third party rights prevailing over those of unregistered buyers are significantly increased in the current economic environment. Of particular concern now are Mexican developers or sellers whose projects have stalled due to lack of financing, or who are (or might become) bankrupt or have liens on the property that might be foreclosed on by the seller’s lenders. Here are some existing or possible scenarios involving buyers who have paid all or part of the purchase price, but not yet received a properly registered title or trust (“unregistered buyers”). We have assisted clients in some of these situations and others are likely to arise in the near future.
Foreclosure by seller’s lender
All buyers understand the risk that if they borrow money to buy a property and the lender puts a mortgage on the property, the lender can foreclose on the property if the buyer defaults on the loan. However, not all buyers understand that their property may also be subject to foreclosure by the seller’s lender, if the seller has allowed a mortgage or other lien to be placed on the property. Whoever holds registered legal title to the property can allow a mortgage or other lien to be placed on the property. The buyer cannot prevent such liens until registered title is transferred to the buyer or the buyer’s trust. Once a lien is in place, it can be removed only by the lienholder (e.g., the lender) or a Mexican court. Often, a developer has borrowed money to finance construction of the property and the developer’s lender has a lien on the entire development (typically through a master trust or mortgage). Even though an unregistered buyer has paid the entire purchase price, or is current on making installment payments, the developer’s lender can still foreclose on the property if the developer defaults on the developer’s loan.
Unregistered buyers should be concerned of this risk anytime a seller has allowed or may allow a lien on the property. This is especially true in the current economic circumstances where developers might have difficulty meeting their payment obligations to their lenders, investors, employees, contractors, suppliers or others who might already have liens (or be able to place a lien) on the property. Unfinished developments are of particular concern, especially if there are construction delays that often are signs of financial difficulty. This is currently the case with a number of developments in Rocky Point and other areas of Mexico.
If there is a lien on the buyer’s property or entire development, the buyer cannot obtain title or trust rights to its property until the seller’s lender releases the buyer’s particular property from that lender’s mortgage lien. Typically, even though the buyer has a written contractual promise from the developer to transfer title to the buyer, this is not binding on the developer’s lender, and the developer will be unable to release individual properties without the lender’s authorization. Unfortunately for the buyer, if the developer is in default on its loan, a lender may legally refuse to release property from its lien and may even be able to foreclose on the development, thereby possibly terminating the rights of buyers to any property to which the lender’s lien applies. The buyer can thus have their property rights “frozen” or possibly terminated by a lienholder of which the buyer might not even be aware.
Seller’s bankruptcy
Similar problems can result if the seller goes into bankruptcy before the buyer has received a registered title or trust. In that case, the buyer may suddenly find that instead of being an owner of Mexican property, the buyer is simply one of a number of unsecured creditors of the seller looking to recover in a Mexican bankruptcy court what is likely to be a mere fraction of the buyer’s investment
Litigation over who owns the property
If a lawsuit is filed in Mexico contesting ownership of a development or specific property, an unregistered buyer might be unable to obtain registered title or a trust until the lawsuit is concluded. It is possible the buyer could lose all rights depending on the outcome of the litigation. A buyer is in a much stronger position if he or she obtains registered title or a trust before such a lawsuit is filed. However, the buyer should be aware that, depending on the circumstances, if a Mexican court rules that the seller did not have legal title, then the buyer could lose the rights to the property despite having registered title or a trust. That risk is one reason, among others, that we recommend that buyers consider obtaining title insurance that they can enforce against a well-established and well-financed title company.
Possible solutions
Fortunately, we have had some success in such circumstances in obtaining the release of the buyer’s property from the lien of a developer’s financing source and the completion of the transfer of registered ownership to the buyer’s trust. One example is reaching an arrangement with a developer and its lender for the following to occur on the same day: our client, the buyer, pays all or part of the remainder of its purchase price directly to the lender; in exchange for this payment the lender releases the lien; the developer gives our client an irrevocable power of attorney and letter of instructions to enable our client to have its trust formed and registered; and the buyer pays any remainder of the purchase price to the developer when the buyer’s title or trust is actually registered. If the buyer’s property is not yet fully constructed, the buyer should be very cautious about paying any more money directly to the developer or lienholder until construction is complete. However, the buyer might safely agree to deposit all or part of the remaining purchase price in a secure escrow account in the U.S. until construction is complete. These approaches are more likely to succeed where the lienholder and developer have an incentive to agree to the procedure, such as receiving the remaining purchase price from the buyer. If the buyer has already paid the entire purchase price, the lienholder or developer might be more reluctant or require a different incentive.
Another scenario is where the buyer is still making installment payments of the purchase price under the purchase contract or seller-carryback promissory note. Often the seller/developer has sold the note to someone else to whom the buyer makes the rest of the payments. In these cases, the seller/developer has been fully paid but retains title in order to guarantee payment to the note holder. The typical arrangement is that the seller won’t transfer title until the note is fully paid. Buyers in this circumstance should be aware that their rights to the property are subject to the risks described above until title is registered in their name (or in their trust). If buyers cannot immediately pay off the loan, it may still be possible to have title transferred now from the seller/developer and thus eliminate the risks discussed above.
Conclusion
Unless buyers of Mexican property have legal title or Mexican bank trust (fideicomiso) rights registered in the Public Registry, they risk losing any legal claim to the property and the money they have invested. Given the current economic situation, the risks are increasing, and include foreclosure by sellers’ lenders, seller’s bankruptcies, and litigation regarding over who owns the property. Buyers without registered ownership rights are therefore well advised to formalize and register their ownership rights as soon as possible.
Mark Raven and Chris McDonagh are partners in the law firm of Raven, Clancy & McDonagh, P.C. in Tucson, Arizona. Mr. Raven is licensed to practice law in Arizona and New York. Chris McDonagh is licensed to practice law in Arizona and California. They have represented clients in numerous Mexican real estate transactions in association with Mexican counsel.
Mark Raven, a graduate of Yale Law School and a member of the Arizona State Bar since 1970, focuses his legal practice in real estate, corporate and international business transactions. He is a Certified Real Estate Specialist under a specialization program administered by the State Bar of Arizona. Mr. Raven has served as developers’ counsel in connection with numerous large-scale commercial real estate projects located in both Arizona and Mexico. Mr. Raven has extensive experience in working with U.S. companies and individuals promoting economic development in Mexico, and has collaborated closely with Mexican local, state and federal government agencies in public-private partnerships and other collaborative efforts involving the Mexican government. Mr. Raven can be reached at (520) 798-5224 or mraven@ravlaw.com.
Chris McDonagh focuses his legal practice in real estate, financing, corporate and international business transactions. Mr. McDonagh received his J.D. in 1994 from The University of Southern California Law Center, where he was Associate Editor of the Southern California Law Review; and his Master of Laws degree in International Trade Law in 2004 from The University of Arizona James E. Rogers College of Law. He is also a member of the Financial, Business and Legal Services Committee of the Arizona-Mexico Commission. Mr. McDonagh can be reached at (520) 798-5233 or cmcdonagh@ravlaw.com.
This article was oiginally posted on JD Supra.
