Implementing the reform

Pages61-84

Page 61

A successful reform of the law of secured transactions requires a modern law and a modern filing archive. The law must be passed, and the filing archive implemented. How does a task manager achieve this?

Among the most important tasks is to build a persuasive case for the reform. The more persuasive that case is, the stronger the position of the donor or international financial institution in the country dialogue will be and the easier it will be to get agreement on the reform. The key to reaching a voluntary agreement on reform with the government is a law and filing system that seem reasonable to the interested parties. Both the economic and the political approach of the reform must therefore be well justified.

A good place to set out the detailed case for reform is the diagnostic study. Its analysis can be reinforced by commentaries in the draft law giving the motivation, legal background, and economic logic underlying the drafting strategy. The full package-the diagnostic study, draft law, and proposed filing archive-will need to be defended in a training and public awareness program that addresses people's concerns, well founded and otherwise. Putting this package together will require a team of lawyers and economists, including both local and international experts.

So task managers face challenges on several fronts. They must understand the legal issues well enough to make informed judgments about the quality of the diagnostic study and the legal changes being proposed by an international expert in secured transactions law. They must supervise the interaction between the lawyers and the economists on the team or supervise the firm that supplies the lawyers and economists. They must be prepared to explain and defend the reform, throughout project preparation and later, to key stakeholders in the country-often in the absence of the experts on their team. And they must supervise the foreign and local teams that will assist in this explanation and defense.

Page 62

Carrying out the diagnostic study

A good reform begins with a good diagnostic study. A good study identifies legal barriers to using collateral. It also distinguishes problems in access to credit attributable to laws from those with other causes-and links those legal problems to their legal roots.

Some diagnostic studies simply list the legal problems in current law. That approach limits their effectiveness. A study that merely identifies a legal constraint-without explaining its economic importance-will be less convincing to key stakeholders. Diagnostic studies need to carefully walk stakeholders through the economic problems arising from the present legal framework, explain the potential economic impact of reform, and show that a solution is feasible within the country's legal and institutional framework. They also need to address public policy problems that arise in derogating (amending or repealing) contradictory laws.

Diagnostic studies are aimed at two broad audiences-legal readers and nonlegal readers. Nonlegal readers-economists, most donor staff, many local officials, local banks and businesses-are accustomed to thinking about constraints on access to credit that stem from economic causes. A good diagnostic study must convince these readers of the economic importance of the legal constraints.

Nonlegal readers may not immediately understand the potential economic impact of relatively obscure legal provisions. Should the law require a precise description of the goods taken as collateral? Should the law permit the borrower to sell the collateral? Should the law provide for the automatic continuation of the security interest in the proceeds of the sale or other disposition of the collateral? Should government tax claims have superpriority? To keep nonlegal readers engaged, the diagnostic study should explain as early as possible why technical details such as these can have an enormous impact on the effectiveness of the secured transactions system and thus on access to credit.

Legal readers-local practicing lawyers and government officials trained as lawyers-have somewhat different needs. Stakeholders trained in the local law will typically have a general understanding of the importance of a framework for secured lending. But they also will often believe that their country already has such a framework. The diagnostic study must therefore convince these readers that the legal problems in access to credit are not just simple differences in Page 63 approach but differences with great economic importance. Discussing the potential economic gain from reform is important because changing established laws and legal practices always incurs costs. Legal readers, often more sensitive to such costs than other stakeholders, will be more willing to accept that their country should pay those costs if they expect a large economic gain.

The question of economic gain from different legal alternatives weighs heavily on judicial decisions and can influence judicial rulings on constitutionality. So it can be helpful for legal readers if a diagnostic study explains the economic merits of different drafting solutions, giving estimates of the potential gains from different approaches. For example, "this approach will exclude accounts receivable, which represent about 10 percent of business assets."

A good diagnostic study has four key inputs:

* An initial legal assessment based on a preliminary examination of local law that gives the field team some guidance about what to look for in the field interviews.

* Field interviews that investigate the effect of current law on access to credit by sector, including information on the terms of loans and the role of collateral in determining those terms.

* A legal analysis that elaborates on the initial legal assessment, building the microeconomic chain of causation from legal defect to observed characteristic of the credit market. This analysis, following the field interviews, should cite all relevant laws, points of conflict, and internal inconsistencies and identify the economic impact of each shortcoming. Local lawyers, identified by referral or through the field interviews, should be brought fully into this process.

* An economic analysis of the likely impact of reform. This should link the legal defects to what is observed in the credit market, assess the role of alternative explanations, and provide some rough guidance on the likely economic impact of the reform.

Initial legal assessment

The first step in the diagnostic study, an initial legal assessment of the existing laws governing secured transactions, will point to the questions that the field team should ask in the field interviews. This assessment requires help from both a local secured transactions lawyer and a foreign lawyer with expertise in secured transactions law (typically about 5-10 staff days from each). In addition, indicators relating to secured transactions from the World Bank Group's Page 64 Doing Business project can provide a good initial survey of problems (see the discussion of this data source in chapter 6).

The local lawyer should identify the fundamental secured transactions laws and related laws that affect their operation. These laws typically include the bankruptcy law, the homestead and exempt property provisions, the code of civil procedure, the banking laws, and consumer protection laws. But the local lawyer should have enough expertise in the debt collection process to identify any additional laws that are relevant. A good example is the family law in Ukraine that prohibited eviction of any family with a child under the age of 12. This law, clearly a significant constraint on using real estate as collateral, would not rank high on the list of laws that foreign experts would check. Good local lawyers will flag such issues. The local lawyer should also report the local view on the main problems in the debt collection system and options for reform.

The local lawyer will rarely be able to identify all the problems in the underlying laws, however, because the local lawyer will typically have had no training in foreign legal systems that allow effective use of movable property as collateral. Once the local lawyer has found the laws and competent translations and submitted the local view on the source of problems, the diagnostic task therefore passes to the foreign lawyer.

The foreign lawyer needs to check the law for important potential problems in each stage of the secured transactions process-creation, priority, publicity, and enforcement of a security interest. This initial assessment should cover all the material discussed in chapter 3 of this book. But a skilled foreign expert will identify many more problems than are set out in that chapter and should report on whatever else looks important based on a reading of the law. (This book sets out only some of the important problems; most textbooks on secured transactions run 300-500 pages in length.) And of course all these problems must be covered in the proposed law.

The initial legal assessment should produce a list of specific legal problems and their likely economic consequences. An example of the desired specificity: "The pledge law gives priority to the first lender secured by the crop in the field, but the warehouse law gives priority to the warehouseman. Therefore, we would expect to see no loans secured by crops in the field because of the risk of loss of...

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