Professor Henning is a member of the Uniform Law Commission, the American Law Institute and the American Bar Association where he is active in the Business Law section. He also is a member of the U.S. State Department’s Advisory Committee on Private International Law and serves on the U.S. Delegation to Working Group VI of the United Nations Commission on International Trade Law which has developed a model secured-transactions law for developing nations.
Your research focuses on Sales and Secured Transactions. How does adoption of Modern Secured Transactions Laws assist developing nations in their economic growth?
My two primary research areas are – Sales of goods or what is commonly called movables and Secured transactions which is the use of the movables as collateral to secure obligations.
Secured transactions are available to enterprises of all sizes. The largest international corporations use them; the smallest micro-enterprises can make use of them so it is a very important financing tool. What a secured transactions law does is allows them to borrow money and use their work in process as collateral so if they default on the loan and unfortunately what will happen is the creditor will use the court and take over that inventory—the work in process and sell it and pay themselves back. But assuming that the business does well, of course, the loan is repaid and business grows. And the same cycle can repeat itself. And the largest international corporations use the same laws to obtain loan.
I was asked by the United States Department of State to serve on a United States Delegation to the UN Commission on International Trade Law. The particular assignment was to create a model law that could be adopted by developing nations in order to encourage secured lending and the model law is not an international convention that every country would sign up to; it is not a treaty. It is a law that each country can decide for itself whether to adopt and if a country decides to adopt a law like this then it really needs to be adapted to the local legal environment. So it is not going to be adopted in precisely the form in which it was drafted anywhere. There are a number of principles on which useful secured transactions laws should be based.
A number of countries have out of date secured transactions laws or perhaps almost no law in this area at all. I know Nepal adopted secured transactions law in 2006, and it has been in the process of creating a registry for publicly filing notices of secured transaction.
There are some basic ideas for what I call a modern secured transactions law:
First of all, it should be relatively easy to create rights in collateral on behalf of the lender. It should not be a long complicated process, it should not be highly regulated, it should be a simple matter of contract law. So that if you want to borrow money from me to buy a piece of machinery and I am a bank by a simple contract you should be able to grant me security rights in the machinery that you are going to acquire.
The second thing is that for me as a lender, to be secured, I need to know that my collateral is going to be there if you default. And so I need to have third party effectiveness i.e. if you borrow money from someone else, and use the same machinery as collateral, or if you sell it to someone, I need to know that my rights in your machinery will be superior to the rights of the other lender, or to the rights of the buyer. And in order to do that, the transaction has to be transparent. There has to be something publicly filed so that another lender or buyer dealing with you can search a registry under your name and they will find a notice that I have registered. So when I as a lender make this loan and take my security rights in your collateral, I register a notice in a public searchable database and what that does is allows third parties like other lender or buyer to learn about my interest. And when they learn about my interest, they are probably not going to enter into that transaction with you. One of the key factors of any modern secured transaction regime is the existence of publicly searchable registry into which notices of secured transactions are entered. And they are typically entered by the name of the borrower so that third parties who want to deal with the borrower can find out about the interest of the earlier lender.
The third aspect of it is there has to be a right that courts will enforce to take the collateral and be able to sell it in a fair manner if there is a default in the line of obligation.
There are more principles but broadly stated it is the ease of creating the security right, it’s a registry system for notifying third parties to the existence of the security right and it is the ability to realise on the collateral in the event of default.
George Orwell famously said—All animals are equal, but some animals are more equal than others. But the rule of law is fundamental to democratic order. Can law be egalitarian in nature—advocate for decentralisation of power? Be equal to say employers and employees, rich and poor, powerful and powerless, developed and underdeveloped nations? Or is it just a utopian thought?
The powerful always have advantages. What the rule of law can do, if it is carefully followed, is to at least level the playing field so that the less fortunate, those who are trying to start a business, those who are trying to pull themselves out of poverty can have access to the same rules and laws, and the same advantages that the wealthy are using to create their corporate structures. I think rule of law is important is creating an egalitarian society.
I understand under Nepal’s new constitution, there are seven provinces, and of course, there are many local governments below that level, and this is new. Unites States has been using a federal system for a long time, I don’t want to suggest that the way we do things can be transported here. I don’t want to suggest that we are doing better. We have made many mistakes but we are at it for 200 years. And this is new in Nepal. One thing that Nepal might consider is having vehicles for the provinces to consult with each other and if the provinces can work together, and adopt and harmonise their laws in some of these areas—that will be a way of pulling some authority away from the centre.
One thing that I think is valuable about the process we use at the Uniform Law Commission, when we undertake a project, the first thing we do is spend a couple of years studying. In that study we reach out to every group that we can think of that may be affected in a serious way by our law. If some provision might go into our new law, we want the beneficiaries to have their input in it and thereby find ways to accommodate each other. From studying to drafting a law, we create a committee with a chair, a reporter (someone from academia who does research for the group), members of the commission and stakeholders. Everything we do has to be open to comment. No member of the commission is allowed so much as to allow one of the stakeholders to buy them a drink and we live by that.
It is said that legal systems that provide strong legal protection for investors have permitted the development of sophisticated financial markets. Could you elaborate on it?
When you are talking about financing any business, the financing often consists of a mix of debt and equity. The debt/loans can be in a healthy business up to 80% of the capital that the business uses may be borrowed and 20% or so may consist of the equity. In different businesses the percentages will differ. But when we are talking about the borrowing aspect, we are usually talking about secured finance, secured transactions laws. When we are talking about equity interest, what we are talking about is the ability of investors to acquire ownership interests in the business and if it is a privately held business, say it is a corporation, then for a private corporation, what we call in US is a closely-held corporation, then it is the matter of the invest or injecting money into the corporation but in return obtaining shares of ownership interest. If we are talking about a publicly traded corporation, then the shares will be bought on the publicly traded markets. And that is how the ownership interests will be acquired. But in any event, the entity raises money through the sale of shares of its ownership. So it really raises money for its operation in two ways: 1. Through the sale of its ownership interests and 2. Through borrowing typically on a secured basis using its assets as a collateral. And there has to be strong markets in both areas. If you are talking about the publicly-traded company, there has to be a security exchange in which there is confidence that the shares when bought will actually be made available, that there is no fraud underlying. Investors who invest through a market place have to have confidence in the integrity of the market place.
Tell us about your visit to Nepal.
My visit to Nepal is to work with Samriddhi Foundation to advance their mission but to do it in a way that involves my law students in the United States. We are working on an understanding under which I will teach a class of only a very few students perhaps four to five students and they will work with Samriddhi and in turn Samriddhi will ask them for help in research in certain areas. It can be in any of the areas of interest and need of Samriddhi and then my students will do the research. I will be in charge of the class in the United States but my students will be working with the team of Samriddhi. At the end of the course, they will have written reports that will be helpful for Samriddhi in its work here advancing civil, political and economic freedom.
What objective(s) of Samriddhi will this collaboration serve?
We talked about three possible research areas: 1. Commercial laws that currently exist here. The extent to which those laws are efficiently operating or the extents to perhaps which amendments or modifications might be necessary, the extent to which certain laws that would be helpful from the standpoint of Nepal’s economy but that might not exist here. In the areas of commercial laws, we could be talking about my areas of research—sales and secured transactions. But we will also be talking about Entity laws—the laws that govern the creation of corporations and other types of business entities. We are also discussing laws that promote electronic contracting so that instead of requiring a piece of paper and a manual/physical signature, the law will recognize and enforce electronic documents coupled with electronic signatures. Allowing contracts to be entered into by the exchange of digital documents and digital signatures without the necessity for physical documents and physical signatures.
Commercial law is a whole network of laws that support transactions and facilitate doing business. It’s the law that supports the creation of entities to engage in business, and to some extent, it also allows disputes to be settled in ways that are efficient and inexpensive. There are many countries where arbitration is used as a means to avoid the court in solving disputes in a quicker and less expensive system, the laws in those countries provide that the decision of the arbitrator will be enforced by the court as if it was the judgement of the court. So that parties get involved in arbitration knowing that that’s the end of it.
From my talks with Samriddhi while arbitration can be used in Nepal, the decision of the arbitrator cannot be enforced as the judgement of the court and therefore you could go through arbitration but at the end of the arbitration, one of the parties doesn’t accept the findings of the arbitrator, then you may have to go onto the court. What that does is discourages the use of arbitration and forces more disputes into the court system.
Commercial laws include facilitating transactions, facilitating the creation of entities, facilitating the resolutions of disputes, and it is one of the areas where we think my students can do research on existing Nepali laws and existing laws elsewhere and help Samriddhi come up with sort of an understand of what laws here might be useful or what existing laws might be amended or modified, to help their mission, which of course, is economic freedom and economic growth.
My students might do a comparative study of many federal countries—US, Canada, Mexico, Australia. Federal systems are not in the majority of the countries but are quite common around the world. It might be helpful for my students to research the extent to which the provincial units, not just in the US but in many countries, are able to create vehicles to cooperate in the development of law. And in so doing might inform Samriddhi of ways in which consistent with the Nepali culture and the development of Nepal’s new constitutional system the provincial units could cooperate and work together.
It is a way of helping to assure that federalism really works.
From the United States’ perspective, we started 200 plus years ago with only the provincial units and they created the federal government and they created a very weak federal government. And over time, our federal government has gained more and more power and has now a very strong central government. To me, federalism means vesting the states with the power to push back against the federal government and to maintain their own spheres. The states are of course subject to the central authority, but it’s important that they be able to maintain their own sphere.
The larger and more powerful the central government, the less economic and civil freedom there is in a country. The more power that can be pulled away from the central government, the more opportunity it is for the people at the lower level to influence the development of the law, the more channels they have to access the people in power.
As Nepal develops its federal system, obviously it will have to find its own way, and determine what power must remain at the center and what powers can be devolved down to the units and I think that is what Nepal is trying to explore. And it’s a good opportunity for an organisation like Samriddhi to gain ideas about how other countries, not just the United States but other countries around the world, operate within a federal system and determine how lessons learnt elsewhere can be translated into cultures and needs of Nepal.