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Protecting a lender's rights

Protecting a lender's rights

T RADITIONALLY, Cambodians look to their friends and family to raise capital to start

their own businesses. However, with a growing trust in the banking sector, many Cambodians

are also looking to financial institutions to raise capital to start new business

ventures or expand old businesses.

Many lenders, whether private individuals or financial institutions, will not grant

a loan to a borrower unless the borrower puts up collateral in exchange. Collateral

is property, whether real or personal, owned by the borrower and in which the lender

takes certain rights ("security interest" ) in the property.

Such rights are primarily the right of a lender to sell the collateral if the borrower

fails to repay the loan. In Cambodia, the collateral is normally real estate or personal

property owned by the borrower. The lender does not obtain automatic ownership of

the collateral property in the event the borrower defaults on the loan payments.

A loan contract is considered void if there is an agreement to allow a lender to

take automatic ownership of the collateral upon default by the buyer.

Personal Property as Collateral

For lenders who accept personal property as collateral for a loan, the contract must

be in writing and the lender must take possession of the property in order to secure

its interest and to ensure enforcement of the loan contract. Lenders should also

be aware that possessing the collateral does not mean the lender may use or take

profit from it. The lender merely holds the property until the loan is paid off or

sells it should there be a default by the borrower. While the lender is holding the

collateral, it must take reasonable care of the property. The lender is liable for

all damages caused by its own fault.

Real Estate as Collateral

Before a lender takes Cambodian real estate as collateral, it should investigate

the land to confirm its ownership and to determine whether there are any liens and

any other encumbrances on the land. Under Cambodian law, land may only be used as

collateral by one creditor or group of creditors at one time. Therefore, it is very

important to determine if the real estate is subject to existing security interests

before granting a loan.

Theoretically, all lenders may register their security interest in land by filing

a security agreement (the contract between the lender and borrower allowing a lender

rights in the land in exchange for a loan from the lender) at the relevant Sangkat,

Khan and Land Offices. However, in practice, most individual lenders only file at

the Sangkat level in order to minimize their potential tax liability and costs at

the Khan and Land Office levels. It is not clear whether a Cambodian court will accept

this practice as sufficient to protect the lender's interest in the land. Under Cambodian

law, filing at all three levels must be completed in order for a lender to secure

its interest in the land.

As an additional protection, the lender should take possession of the Title Deed

or Title Certificate (Ownership Certificate) to the land to ensure that the borrower

is unable to transfer the land to a third party during the period of the loan contract.

Conclusion

In Cambodia there are currently only two ways to notify a third party of a lender's

security interest in a borrower's property: The first is to take physical possession

of the property and the second, for real estate, is to file the security interest

at the relevant government offices. Even though possession of personal property is

the best protection for the lender, it is not the best or most efficient way to maintain

dynamic movement of Cambodia's economy and its small businesses.

Most small businesses do not have land to pledge as collateral, but may have "business

properties", such as inventory, equipment, accounts receivable, etc., which

could be used as collateral for a loan. These properties are essential to the functioning

of a small business, and therefore, cannot be handed over to the lender. To assist

small businesses in obtaining loans for their businesses, a central filing system

should be put in place in order to register and protect a lender's interest in secured

property. Doing so would contribute to the dynamic growth and development of Cambodia's

economy.

Of course, establishing a central filing system to register security interests requires

human resources, time, and money (all of which Cambodia lacks at this moment). However,

in the future Cambodia must find the means to establish such a filing system, since

the success of Cambodia's economy will most likely depend on the continuing existence

and expansion of the small business sector.

- (Ratha L. Panh is an associate in the Phnom Penh office of Dirksen Flipse Doran

& Le.)

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