Which Security Measure Is the Safest for Banks When the Collateral Is Future-Formed Property?

INTRODUCTION

In credit-granting activities, particularly for loans financing construction projects, housing purchases, machinery and equipment acquisition, or production expansion, banks are often required to accept future-formed property as collateral. This type of property does not yet exist at the time of contract execution or has not yet come under the ownership of the borrower, but is expected to be formed at a later stage.

Taking security over such assets entails significant risks, including difficulties in asset description, valuation, establishment of ownership upon completion, potential conflicts over priority rights with other creditors, and complications in enforcement upon the borrower’s default. Therefore, a critical question arises: which security measure provides the highest level of safety for banks when the collateral consists of future-formed property?

This research analyzes the current legal framework, examines practical risks, evaluates available security measures, and proposes a model of a “secure collateral package” in compliance with Vietnamese law.

I. LEGAL FRAMEWORK GOVERNING FUTURE-FORMED PROPERTY

1. The 2015 Civil Code

• Article 294: Future obligations may be secured; once the obligation arises, the security agreement does not need to be re-executed.
• Article 295: Secured assets may include existing property or future-formed property.

These provisions constitute a crucial legal basis allowing banks to accept collateral that has not yet been formed.

2. Decree No. 21/2021/ND-CP on Securing the Performance of Obligations

This Decree provides detailed regulations on:

• Methods for describing future-formed property in security agreements;
• Registration of security interests over property not yet in existence;
• Procedures for enforcement of collateral upon default;
• Rights and obligations of the secured party during the formation and completion of the collateral.

3. Sector-Specific Regulations on Housing and Projects

• Circular No. 26/2015/TT-NHNN: Governing mortgage and release of mortgages over off-plan housing at credit institutions.
• Decree No. 95/2024/ND-CP, guiding the 2023 Law on Housing: Regulating conditions, scope, and procedures for mortgaging future-formed housing, and clearly specifying cases where such mortgages are permitted in favor of credit institutions.

4. Registration of Secured Transactions

• Mortgages over future-formed property must be registered with the National Agency for Secured Transactions Registration (Ministry of Justice) to be effective against third parties.
• Such registration determines priority rights in payment in the event of disputes or enforcement.

II. MAJOR RISKS IN ACCEPTING FUTURE-FORMED PROPERTY AS COLLATERAL

1. Ownership Risk

As the property does not yet exist or is incomplete, the borrower lacks documents evidencing ownership, making it difficult for banks to demand transfer of rights or to enforce the collateral later.

2. Asset Description Risk

If the collateral is not clearly and specifically described in the mortgage agreement, registration may be rejected or the security interest may be declared invalid in dispute resolution.

3. Priority Conflict Risk

A single asset may be mortgaged to multiple creditors before it is formed. Failure to register promptly may result in the bank’s security interest ranking behind other creditors.

4. Enforcement Risk

Assets under construction, not yet completed or not eligible for transfer, may significantly delay enforcement, causing financial losses to the bank.

III. ASSESSMENT OF SECURITY MEASURES AND THEIR DEGREE OF SAFETY

Based on current law, the following measures are commonly applied and arranged in ascending order of safety:

1. Registration of Secured Transactions

(Mandatory and most critical measure)

• A prerequisite for effectiveness against third parties;
• Earlier registration results in higher priority;
• For future-formed property, detailed description in accordance with Decree No. 21/2021/ND-CP is essential.

→ Although not an independent security measure, registration is the cornerstone that ensures the legal validity of all other measures.

2. Mortgage of Receivables or Contractual Rights

Particularly effective for:

• Off-plan housing sale contracts;
• Construction and equipment supply contracts;
• Accounts receivable.

Advantages:

• Receivables arise earlier than physical assets, enabling faster enforcement;
• Easier valuation and registration.

3. Cash Flow Control via Dedicated or Escrow Accounts

Banks require borrowers to channel all project revenues into accounts under the bank’s control.

Benefits:

• Reduces the risk of fund dissipation;
• Enables monitoring of asset formation progress;
• Enhances debt recovery before enforcement becomes necessary.

4. Step-in Rights Upon Default

Commonly stipulated in project finance agreements.

Upon default, the bank may:

• Replace the project owner in management;
• Appoint a project management unit;
• Collect payments directly from project customers.

This measure is particularly effective for real estate and construction projects.

5. Third-Party Guarantees or On-Demand Guarantees

Primarily including:

• Parent company guarantees;
• Payment guarantees issued by other institutions.

Advantages:

• Creates an independent repayment source;
• Significantly reduces credit risk.

Disadvantages:

• Dependent on the guarantor’s financial capacity and willingness to perform.

IV. THE SAFEST SECURITY PACKAGE FOR BANKS

No single measure provides absolute safety. The optimal solution lies in a combined security package, comprising:

1. Legal due diligence of the project
   1. Verification of land use rights, construction permits, progress, and legal documentation.
2. Mortgage of future-formed property with detailed description
   1. Accurate identification of location, technical specifications, and distinguishing features in compliance with Decree No. 21/2021/ND-CP.
3. Immediate registration of the secured transaction
   1. Ensuring instant effectiveness against third parties.
4. Concurrent mortgage of receivables
   1. Enhancing security and accelerating debt recovery upon default.
5. Establishment of escrow or dedicated accounts
   1. Allowing bank control over project cash flows.
6. Step-in rights upon default
   1. Preserving asset value before deterioration.
7. Requirement of guarantees from the borrower or parent company
   1. Providing a final layer of protection.

V. RECOMMENDATIONS FOR LEGAL IMPROVEMENT

1. Introduce mechanisms for early establishment of priority rights over future-formed property, similar to those in developed jurisdictions.
2. Standardize enforcement procedures for incomplete or non-transferable assets to shorten recovery time.
3. Strengthen the secured transactions registration database, enabling centralized searches by banks.
4. Improve regulations on project cash flow management to better protect lenders’ interests.

CONCLUSION

Vietnamese law permits the use of future-formed property as collateral; however, such assets entail significant risks relating to ownership, asset description, priority rights, and enforcement upon default.

No single security measure is absolutely safe.
The highest level of protection for banks is achieved through a comprehensive security package, including:

• Mortgage of future-formed property (with detailed description),
• Mortgage of receivables,
• Registration of secured transactions,
• Cash flow control via escrow accounts,
• Step-in rights upon default,
• Third-party guarantees.

The proper combination of these measures in compliance with the 2015 Civil Code, Decree No. 21/2021/ND-CP, and relevant sectoral regulations will enable banks to attain the maximum level of safety when accepting future-formed property as collateral.

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Khuong Ngoc Lan