Contributed By Zürcher Odio & Raven
The economy in Costa Rica has showed low growth, a high unemployment rate, a fiscal deficit that reached 7% of the gross domestic product (GDP) by the end of 2019, and a downgrade of the risk rating of the Costa Rican sovereign debt.
The reduction in economic activity caused by the deceleration in domestic demand and in the exports of goods and services has led to a reduction in tax revenue and, consequently, an increase in the fiscal deficit, which could lead to further downgrades in the risk ratings of the country's sovereign debt, complicating the financing of the deficit.
The Central Bank has reacted by reducing the monetary policy interest rate, as a measure to lower interest rates in the financial system and thereby reduce the cost of loans to borrowers. The government has also continued its efforts to reduce the fiscal deficit, by trying to consolidate the implementation of the tax reform enacted in 2018 to different economic sectors, which has reduced individual and corporate income.
These factors have affected the lending market by causing a credit stagnation and increased delinquency.
The COVID-19 pandemic has adversely affected domestic consumer rates and investment decisions in many economic sectors. The government's actions to reduce the impact have included an increase in spending, which finally increased the fiscal deficit that the government itself has been trying to resolve in the last few years.
Initially, the government urged the banking system to voluntarily take actions to mitigate the impact of COVID-19 by granting credit facilities and moratoriums, and restructuring loan terms and conditions to clients. Certain funds were unlocked by the Central Bank to grant commercial loans to borrowers in order to reduce the pandemic's negative impact.
The economic impasse of national lock-downs, travel restrictions and unemployment have impacted the economy and the forecast for the upcoming months. The temporary suspension of labour contracts and the reduction of wages and labour hours were also allowed as exceptional measures to minimise the economic effects.
The Congress also approved a moratorium for certain taxes (income, VAT and customs) in an effort to keep the economy moving forward. Additionally, the government has provided financial aids to individuals that have been economically affected by the pandemic, which have been mostly funded with public debt.
The impact has been devastating to the loan market, mostly through voluntary moratoriums by lenders to their borrowers and debt restructuring.
The high-yield market has not played a significant role. Even though small and medium enterprises are still receiving great government support with the purpose of encouraging internal production, challenges caused by the fiscal deficit, the international money market trends and COVID-19 are increasing the spreads and reducing the demand for credit. Other financing terms and structures remain similar.
Due to the deceleration of the economic environment and the imposition of restrictions for lending (including commissions and interest rates caps, and lending limitation to certain borrowers) caused by new regulatory rules, which has affected all lenders in general, the increase in alternative credit providers (other than banks) that was witnessed over the last few years has ceased.
Banking continues to be the main source of financing for both domestic companies and individuals, so maintains a central role in the economy.
The regulatory authorities continue to make efforts to review the existing procedures in order to reduce costs. Under these efforts, the Central Bank has developed a local transfer platform to allow transfers of funds using mobile phone numbers free of charge (known as “Sinpe Movil”), which has grown significantly during the last year.
Additionally, there has been certain activity from fintech companies, even though there is a lack of special regulation for them. Most such companies are required to comply with AML regulations and are intended to provide services to licensed financial entities.
Several tax and regulatory developments have occurred of late and significantly affected the loan market, with the purpose of avoiding the increase in costs and the restrictions on accessing international loans that would occur if the country was included on a list of nations that need to be supervised due to the lack of a process for implementing measures to prevent money laundering and the financing of terrorism. As a consequence, the government has worked hard to strength the legal, regulatory and institutional framework, with the adoption of rules aligned with international standards.
These measures have been also promoted by the government's interest in becoming a member of the OECD. In fact, in May 2020, Costa Rica was invited to join as the 38th member of the organisation, as soon as the country has taken the appropriate steps at the national level to accede to the OECD Convention, and deposited its instrument of accession with the French government, the depository of the Convention.
As part of the efforts to become a member of the OECD, foreign banks have been allowed to establish a branch office and conduct banking activities in the country without establishing a separate local entity, but subject to obtaining a licence from the regulatory authorities. The branch office shall be subject to local regulation and supervision from the regulatory authorities. This reform intends to make it easier for foreign banks to compete in the local market, and to offer more financing options to borrowers.
A new factoring law was enacted to regulate the factoring business and to provide more standard and safer rules for the parties.
Moreover, a legal reform was approved by which all legal entities and other legal structures settled in the country (regardless of their nature), including administrators of the resources of third parties, non-profit organisations and private trusts, must declare their final beneficial owners before the Costa Rican authorities at the Register of Beneficial Owners.
A reform to the Consumer Protection Act was recently enacted, which limits the interest rate that can be charged in a loan (usury law) and also restricts the lending of money to certain borrowers and creates some reporting obligations to local and international lenders operating in Costa Rica in relation to the terms and conditions of the loan products. Failure to comply with this law may result in economic fines for lenders and prison sentences for lenders' legal representatives.
A law that limits the amount of commissions that can be charged by service providers on the processing of transactions that use payment devices and the operation of payment card systems was also approved and entered into effect, to promote the efficiency and security of such systems, and to guarantee the lowest possible cost for the affiliates. In the short term, the Central Bank will publish the first maximum commission amounts allowed to be charged. Based on this law, the activity of payment service providers will be affected depending on the regulation to be approved by the Central Bank. There is a high interest in limiting the commissions charged by digital platforms. The regulation sets the following obligations for payment service providers that operate in Costa Rica:
Failure to comply with this regulation may result in economic fines ranging from USD7,500 up to USD150,000, plus the reimbursement of all amounts received in excess.
There are no specific requirements or procedures that banks and non-banks must follow in order to be authorised to provide financing to a company.
However, lenders must comply with certain criteria in relation to their clients, such as financial solvency and the provisions established in the Consumer Protection Act. Additionally, licensed financial entities must review the credit score and perform a loan-to-value analysis as determined by the Regulation SUGEF 1-05.
Foreign lenders are not restricted from granting loans in any way.
There are no restrictions on the granting of security or guarantees to foreign lenders. Foreign lenders receive the same treatment as local lenders, although foreign lenders must obtain a local identification number in the Public Registry in order to register their guarantees.
There are no restrictions, controls or other concerns regarding foreign currency exchange. The Organic Law of the Central Bank of Costa Rica authorises entering into contracts using foreign currency, and even allows foreign lenders to enforce payment on such currency when obligations should be paid abroad, or if the origin of the resources is abroad.
Borrowers must comply with the use of proceeds approved by the lenders. There are no other restrictions.
Agents and trusts are recognised concepts in Costa Rica. Guaranty trusts were commonly used to secure loan transactions in favour of foreign and local lenders due to their capacity to include assets of different natures, and for their low registration costs. Unfortunately, a tax bill was enacted in 2012 that eliminated the tax exemption for registration costs, except for those guaranty trusts created to secure loans for local banks.
Assignment and assumption agreements are valid in Costa Rica. In order to transfer the associated security package, the principle that applies states that the accessory rights follow the principal. Therefore, when the loan is transferred, the security package must be transferred as well. Participation agreements are also valid and are frequently used.
Even though it has been relatively unknown in Costa Rica, debt buy-back by the borrower or sponsor is permitted. Clearly, it is an important mechanism to enable borrowers to deleverage with a discount and, for financial sponsors, to mitigate eventual default in payment of their companies in a much less expensive way than providing equity to their companies.
It is important to confirm that there are no impediments or negative covenants that may prohibit the use of debt buy-backs. Also, there might be tax implications that should be taken into consideration, due to the income generated between the amount paid and the outstanding amount.
Unfortunately, the capital markets are not well developed in Costa Rica, and are seen mostly as debt markets. Almost all development comes from the excessive participation of the public sector as issuer, limiting the resources available for the private sector. For this reason, share transactions represent less than 1% of total transactions annually. Even though there are publicly held companies, an important number of them have been deregistered as authorised issuers, due to the high costs and the regulatory burdens.
In public acquisition transactions, it is mandatory in Costa Rica to carry out a public acquisition offer (OPA), which involves, among other things, a process of regulatory authorisation before the Securities Supervisory Agency (Sugeval), obtaining the shareholders’ approval, and issuing guarantees covering 100% of the tender offer.
This leads to a problem when the buyer is financing the OPA due to the fact that lenders are not willing to finance before closing. In order to avoid this inconvenience, most publicly held companies execute deregistration processes prior to negotiating an acquisition.
The mechanisms are quite different when it comes to the acquisition of a private company, which involves mergers, stock purchases, asset purchases and recapitalisations. In these events, it becomes normal to negotiate long-form documentation for acquisition and financing agreements. It is common to incorporate provisions regarding the buyer’s financing representations, tending to confirm the existence of financial commitments for closing, as well as references about the enforceability of the financing, that there has been no event that would prevent the financing, and that the full amount of the financing will be funded at closing.
It is usual to observe provisions about the seller’s financing representations, such as using best efforts to achieve financing.
Finally, certain transactions require antitrust clearance from the Commission for the Promotion of Competition (Coprocom). It is important to mention that, in this procedure, it is quite normal for Coprocom to request a copy of the acquisition documents.
Interest, commission and other financial expenses charged to foreign lenders are subject to a withholding tax, which ranges from 5.5% to 15% (an exception is made in favour of multilateral development banks, or bilateral or multilateral non-profit development organisations). Payments of principal are not subject to any withholding tax.
As part of the fiscal adjustments, Value Added Tax is in place (known as IVA in Spanish, and as VAT in English), as an indirect tax levied on the consumption of all goods and services in the country by all individuals and entities, at a general rate of 13% or, in some events, at 4%, 2% or 1%. Capital gains are also taxable.
The Consumer Protection Act limits the interest rate that can be charged in a loan. Each semester, the Central Bank should publish the applicable maximum interest rate. It also restricts the lending of money to certain borrowers and creates some reporting obligations for lenders operating in Costa Rica about the terms and conditions of the loan products. Failure to meet these obligations may result in economic fines for lenders and prison sentences for lenders' legal representatives.
Real estate, vehicles, inventory, stock shares, certificates of deposit, accounts receivable and other movable assets are among the most common assets typically available as collateral. Guarantee agreements are required to grant priority rights.
Regarding real estate, vehicles and other movable property, guarantee agreements must be granted before a notary public and stated in a public deed, which will then be duly filed and registered before the Public Registry.
Such registration procedure takes up to two weeks. Costs are approximately 0.50% for mortgages and 0.15% for pledges, based on the loan amounts. However, trusts are exempt from stamp duties and transfer taxes, as long as they secure banking operations in favour of local banks.
Non-possessory movable guarantees require the completion of an electronic form, which must be filed at the Movable Guarantees System. This procedure may take a few minutes, and its registration cost is approximately USD10. Possessory movable guarantees do not require this procedure.
Non-compliance with the aforementioned requirements will lead to the loss of priority rights.
The Law of Movable Guarantees allows the creation of floating charges and universal security interests over present and future movable property. Unless otherwise agreed, the movable guarantees extend automatically to all derivatives or attributable movable property. Derivative movable property is understood as that which can be identified physically from the original encumbered property, including but not limited to the proceeds of crop products, while attributable movable property is that which comes from the sale, exchange or pledging of the original encumbered property, such as cash, money deposits in financial institutions and investment accounts, and also new inventory, equipment or appliances resulting from the encumbrance, transformation or substitution of movable property of the original obligation, independently from the amount or sequence of these encumbrances, transformations or substitutions. It also includes the proceeds received from insurance policies, as well as any other right of compensation given by loss, damage caused to the property and dividend payments.
Intercorporate guarantees are valid in Costa Rica. Typically, cross-stream guarantees are a very common way to acquire adequate credit support for economic groups, allowing them to obtain less restrictive financing at lower costs.
The only way for a target to acquire its own shares is to purchase them from profits deriving from a legally approved balance, meaning they shall be paid for from outstanding profits, and not from guarantees or securities given for such purpose. Any disposition taken stating the opposite shall be taken to be invalid. An authorisation from the shareholders' assembly is also required to enable the acquisition of own shares of stock, and the law restricts any purchase surpassing 50% of the total amount of stock capital of the company.
The target is not restricted from granting guarantees or security, nor from providing financial assistance when it is acquired by a third party.
Domestic companies and individuals are not restricted from granting security or providing guarantees to lenders.
The board of directors or shareholders of companies, as applicable, must approve all transactions related to the constitution of mortgages or securities when the assets are equal to or above 10% of the company's total assets. The law requires this approval in order to protect the minority partners.
Lenders are required to execute release agreements, which should comply with the same formalities and procedures as the ones used to create and perfect the security packages.
The first to file and perfect rule prevails in Costa Rica, so a perfected security interest has priority rights over an unperfected security interest. When there is more than one perfected security interest over the same security package, the security interest is ranked according to priority in time of filing and perfection, which entails its registration before the National Public Registry. Subordination agreements are valid, and the priority over a security interest can be contractually varied. Notwithstanding the above, subordination provisions that could adversely affect other creditors will not survive the insolvency procedures of borrowers incorporated in Costa Rica.
Security interests are typically obtained from mortgages, guaranty trusts, pledges and movable guarantees. The perfection of the security interest is achieved by recording it at the Public Registry.
In order to enforce a security interest against other creditors, the security interest must be properly created and perfected. Lenders can enforce the collateral in the event of a borrower’s default under the loan agreements, with failure of payment being the most common and reasonable event of default accepted by the courts. The enforcement of collateral by other events of default could face some obstacles, such as a review by the courts in order to determine the substance of the enforcement. The appropriation by the lenders of the collateral (“pactum commissorium”) is prohibited. Upon the occurrence of an event of default, lenders can request a public sale of the collateral by filing a foreclosure claim before the courts (in the case of mortgages, for example), or before a notary public, sworn broker or trustee if it has been agreed and accepted by the debtor in the guarantee deed (in the case of guaranty trusts, pledges or movable guarantees, for example).
The law sets forth a priority list that specifies the order in which different creditors with a security interest on the same asset must be paid from the proceeds gained from the foreclosure. This list is also applicable in the event of bankruptcy and insolvency.
Loan agreements with provisions relating to the governing law of the contract will be upheld in Costa Rica. However, security packages over property located in Costa Rica must be governed by local law, in which case such provisions are not acceptable. Consequently, claims related to such security packages must be filed before the Costa Rican courts and resolved pursuant to local law.
A judgment validly obtained under the laws of a foreign court or an arbitral award will be enforced by a Costa Rican court without a review of the merits thereof, following the exequatur procedure provided in the Civil Procedure Code. The exequatur petition must be filed at the Supreme Court and shall comply with the following requirements:
Foreign and local lenders receive the same protection under the law. Bankruptcy/insolvency proceedings usually affect the ability of any lender to enforce its rights under a loan or security agreement, given that such enforcement might be attracted by the bankruptcy/insolvency process together with other creditors. Additionally, the enforcement of certain events of default – other than the lack of payment – could affect the lender’s ability to enforce its rights and the collateral when such events do not adversely affect the creditor’s interest in a real and tangible manner. In such case, the importance of such event could be subject to a review by the courts in order to determine the merit of the enforcement.
There are two legal procedures in place to rescue or reorganise a company with financial problems.
Firstly, the Judicial Procedure for Administration and Reorganisation for Judicial Intervention is a pre-emptive procedure for companies that are in a surmountable financial crisis, where closure would cause harmful social effects. A specialised court of justice determines the admissibility of this procedure, which is requested by the debtor or any creditor.
Secondly, under the Judicial Procedure for Pre-Emptive Agreements, the debtor proposes a payment agreement to its creditors. A specialised court will decide whether the company is suitable for such agreement, or if bankruptcy must be declared.
There is also a special administrative procedure established only for financial entities, handled by SUGEF. This Administrative Procedure in Case of Financial Instability Situations is also a pre-emptive procedure, and is imposed when a financial institution exhibits an instability as provided for by SUGEF. SUGEF appoints a comptroller that will take charge of the financial institution, according to the rules of the Organic Law of the Central Bank of Costa Rica. This intervention is temporary and cannot exceed a one-year term.
Due to some inconvenience and an increase in cases in recent years, there is a legislative initiative under discussion at the Congress to entirely reform the above procedures in order to update them in simpler formats in favour of the creditors.
The impact of insolvency takes two major forms. First, any collection procedure must be brought to the same court where the bankruptcy proceeding is being held, which is known as Jurisdiction Attraction (Fuero de Atracción), unless it is a procedure with a privilege over a specific collateral, and its public sale has been duly set. This could also delay the collection process. The second major impact is that a new appraisal of the security package must be made, even though both parties may have agreed a different base amount in the loan agreements. This aspect may result in the security package being less desirable for public sale. Other impacts that may be experienced include the following:
The period that applies to the processes in question also has to be taken into consideration, being three months before the request for bankruptcy, which may be extended to six months if there is enough evidence of prior bankruptcy. This means that every act made by the debtor during this period may be considered to be defrauding the creditor. In addition, a bill aiming to improve the bankruptcy process was recently put before the Congress and is still pending approval.
Creditors are paid in the following order:
There is no concept of equitable subordination or similar in Costa Rica.
There are various risk areas. First, if a collection process has to be filed before the bankruptcy court in order to be initiated, this will cause a probable delay in the collection process and in all the other procedures against the debtor that have already been filed in other courts.
In addition, a new appraisal of the security package must be made, even though both parties may have agreed a different base amount in the loan agreements.
Other risks could include the suspension of interest charges on the obligations, meaning that any interest charge shall cease at the time the bankruptcy is declared, with the exception of creditors with privilege over a specific collateral, and depending on the outstanding balance left from the public sale.
Finally, the principle known as par conditio creditorum is also applied for creditors that do not have a privilege over a specific collateral (also known as common creditors), which depends on the liquidation of the remaining assets, in order to distribute the outstanding amount between them, and may suffer a loss if the cash is insufficient. All losses are proportional between all common creditors.
The concept of project finance has been known in Costa Rica for more than 20 years, particularly after the enactment of the Concessions for Public Works and Utilities Law, and has been used in the public sector for transportation infrastructure (roads, ports and airports) and power generation. It has also been used in the private sector for large real estate development projects, particularly in the commercial and tourism markets.
Despite not being a well-known or frequently applied concept, the urgent need for financial and administrative instruments to undertake large public infrastructure projects in Costa Rica has led to an increasing amount of project finance in the country.
Public-private partnerships (PPP) are known but are not used as frequently in Costa Rica as they should be. Although there are no legal obstacles for these types of contracts to be executed under regular existing contract-related legislation, Costa Rica has no specific legislation regulating these types of contracts, with the exception of some regulations at a lower level than the law and one specific law that allows the creation of corporations between municipalities (the local or county government) with the private sector, known as Sociedades Públicas de Economía Mixta (SPEM). However, there are exceptions in some sectors for special types of contracts, such as the power generation sector, which is regulated by a special law, or the public works and services concessions law that even permits private initiatives or unsolicited proposals for contracts where concession-type contracts are used.
Despite this, Costa Rica has significant experience in public-private co-operation contracts with a clear distribution of risks between the contractor and the State, primarily in the roads, ports and airports sectors, and there is a current project of this type in the railroad sector. In addition, there are now cases of public buildings, particularly hospitals, where, along with construction, tenders are opened for equipment, maintenance and, in some cases, the operation of the units.
In Costa Rica, government permission is not required to undertake a project finance transaction, nor is there any special administrative registration. However, the administration must prepare and hold bidding rounds for public works projects and public works with utilities.
The terms of reference for the bidding round or the contract between the administration and the contractor usually regulate the kind of financing required for the construction and operation of the works, and that is where project finance is structured.
Except in PPP projects, the nature of which mean alternatives may be possible, the structuring of the project – including matters related to financing – is developed by the public administration, while the private subjects interested in the contract only intervene through objections to the terms of reference by which, in some cases, it is possible to suggest other sources of financing for consideration under the tender documents.
Projects developed under the concept of “project finance” are found in the public works and utilities sector in Costa Rica.
In the power generation sector, the Costa Rican Electrical Institute (ICE) is responsible for undertaking such projects.
In the transportation sector, including roads, ports and airports, the Ministry of Public Works and Transportation is the regulator, although other State bodies also participate in these types of projects, including the National Concession Council, the Atlantic Coast Port Authority (JAPDEVA), the Costa Rican Institute for Pacific Ports (INCOP) and the Civil Aviation Technical Council (CETAC).
The development of such projects has recently begun in the public buildings sector for State Universities and some Costa Rican Social Security Administration (CCSS) hospitals and health centres.
Companies that participate in project finance projects are typically created and used exclusively to execute and administer the project, but this aspect is usually regulated through the terms of reference for the contracts and therein lies the importance of participating at this point in order for the State to be able to adequately structure these businesses.
In these cases, the administration holds bidding rounds for the project and the tenders are awarded according to subjective bidder criteria, such as their experience and their technical, financial and environmental capability in projects similar to the project under tender. Accordingly, it is important to review these criteria to ensure that single purpose companies in the project will prove their experience and the technical and financial capacity of their parent companies.
In other cases, the parent companies use a subsidiary to participate in the tender, which bids directly or through a group of companies. The Costa Rican Administrative Contracts Law refers to such a group of companies as a “consortium", and the different companies comprising the consortium are jointly and severally liable for the administration. Consequently, this figure must be studied from the moment the administration writes the terms of reference, because the joint and several liability of the parent companies will generate issues for some of these parent companies.
In addition, in some cases, the terms of reference require the company thus created to have a minimum amount of capital duly subscribed and paid and, in other cases, single purpose companies have been requested to provide guarantees from their parent companies. This has primarily occurred in contracts for public works concessions.
In the case of private power generation for sale to ICE, the law stipulates that at least 35% of the capital stock subscribed and paid must be owned by Costa Rican individuals. There is no restriction on bank financing with regard to nationality.
Finally, the vast majority of project finance projects relate to public works and utilities involving assets within the public domain. Since they are affected by this regime, neither the public works nor the real property on which they are built may be used as guarantees in favour of banks or other creditors. Therein lies the importance of structuring them as project finance projects, whereby it is possible to use the contractor’s future income flows as a guarantee, and even to allow the use of project company shares as guarantees, which is usually done through guarantee trusts.
Banking loans and project bonds are the typical financing sources for project financings, and trusts are mainly used to structure the project and to secure such financings, as collateral. In some cases, there have been attempts to use pension funds and mutual funds through the stock market, but such attempts have not been successful, especially for the pre-construction stage and during construction, although it is legally possible to do this during the exploitation stage.
The use and exploitation of natural resources is highly restricted under the constitution, requiring special legal authorisation, and is usually undertaken by concessions granted under a legal framework.
Companies must comply with a broad spectrum of regulations regarding natural resources, public health, social security and occupational safety.
Because of their size and impact, the majority of project finance projects require the preparation and approval of an environmental impact study. The Technical Environmental Secretariat (SETENA), under the Ministry of the Environment and Energy, is the authority that confers environmental approval upon these types of projects.