Designing the Foreclosure of Security Interests

Summary

SUMMARY

The binding force of contract, and of obligations in general, hinges upon the ability to enforce against a debtor's assets. The same applies to security interests, which are designed to enhance obligations in favour of particular creditors. This paper takes the aforementioned realization to its logical and practical endpoint: what are the exact and practical means of enforcing (secured) obligations, and how can these processes be optimized, from a law and economics perspective?

The legal systems analysed in light of this question are Belgian and US law, both for movable and immovable property. The analysis proceeds along two general tracks. One is the creation of an efficient incentive framework, to counter moral hazard, both on the side of the creditor and of the debtor, by looking into the benefits of centralizing enforcement with a neutral and properly incentivized third party. The second track deals with the reduction of transaction, search and uncertainty costs, and uses current developments in the market and the law to identify strengths and weaknesses that can immediately be dealt with in practice.

The ultimate goal is to provide an enforcement mechanism that allows for cost-effective market access, and, through transparent procedures, conveys free and clear title to the asset to the ultimate buyer.

KEYWORDS

Security; foreclosure; insolvency; seizure; auction

INTRODUCTION: GENERAL PRINCIPLES OF ENFORCEABILITY OF BLIGATIONS

OBLIGATIONS REQUIRE PREDICTABLE, EFFECTIVE AND EFFICIENT ENFORCEMENT

Without enforcement mechanisms, there would be no binding obligations. Indeed, if compliance cannot be imposed, then the obligatory nature of a contract is quite elusive, and will be a function of the counterparty's good will rather than a matter of reliable certainty. Much like the contractual obligations themselves, their enforcement will be inextricably linked to the party that assumed them. Once the necessity of access to enforcement mechanisms is established, the question becomes how these mechanisms can be optimally designed. From the very outset, the problematic nature of forced execution on the person in civil matters automatically refocuses attention on that party's assets.

Taking the matter of effective enforcement one step further, be it along the same lines, one can think about how obligations can be strengthened beyond the minimum level of bare enforceability.