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necessary to assure validity, would not necessarily cause that state to be a party to the transaction or to assume any burdens of the debt. At the present day, lending banks may fairly demand that external colonial loans be irrevocably and permanently impressed upon the particular colony concerned, regardless of future changes of sovereignty. This can best (and doubtless in some instances only) be accomplished by making the colonial government the obligor, by confining expenditure of the proceeds to the territory of the colony, and by imposing no burden of service under any contingency upon any political entity outside of it.13

It is not suggested that the lender can always fully protect itself. Its very demands for safeguards may encourage or involve abuses of power on the part of the borrower and jeopardize the validity or success of the transaction. On the other hand, it ought to be clear that, if a change of sovereignty of territory of the borrower, and especially of parts thereof furnishing assets relied upon as security, is fairly to be anticipated, the lender is put on its guard. It must, at the present day, anticipate dangers in imposing upon communities having no voice in negotiation fiscal burdens lacking local approval, unless the benefits of the loan through the expenditure of the proceeds are confined to the territory burdened with service. The lender must take note also of the relative instability, in case of a change of sovereignty, of bare pledges of uncollected revenues, as compared with mortgages placing beyond the control of the borrower and within that of the lender or of an agency acting for it tangible assets of value. It must perceive the inherent danger of transactions subversive of the principles of international law as they are interpreted and applied by the United States. Conversely, there is distinct advantage for lender and borrower alike in arrangements which while respecting those principles, at the same time safeguard the equities of both parties as against contingencies which may otherwise work injury to each.

SECURITY

Oftentimes distinct from the problem of validity is that which concerns security. The importance of the matter in a particular case varies with the character and vigor of the borrower. The known strength and scrupulousness of some borrowers render negligible any question of security. This circumstance offers no criterion, however, of the importance of that question when numerous other states become applicants for loans abroad.

Whenever the matter of security is vital, one general and underlying consideration demands attention: the normal impotence of the lender to control the conduct of the borrower, if a sovereign state, when it commits any act jeopardizing the payment of principal or interest. Not only is the borrower immune, as is well known from suit by the lender (unless the

13 An interesting instance of an arrangement substantially on such lines is seen in a certain colonial bond agreement of January, 1922.

borrower consents to subject itself to jurisdiction), but it is also free in fact to act at will with respect to any asset remaining within its control, howsoever designed to assure service. The legal restraint imposed by the contract upon the borrower is not to be underestimated; but the contractual restraint, except in so far as disrespect for it may be productive of diplomatic interposition, does not serve to remove from the borrower the possession and control of what may be used to induce credit. It is the actual condition confronting the lender to a foreign state, rather than the extent of its theoretical rights derived from the contract, which needs frankest recognition during the period of negotiation. Failure to perceive that condition or to deal with it on its merits, has even within the past decade resulted in substantial losses to lenders. It is believed, therefore, to be of first importance in the negotiation of any loan where the matter of security is deemed essential, to endeavor to save the lender from dangers peculiar to the nature of the borrower, and to safeguard it from the operation of the principle above noted. In such an endeavor the terms of some agreements of the past ten years offer guidance. In examining any proposal for application in a given case, the inquiry must be unceasingly pressed: Does the operation of the contract serve to remove from the borrower the power as well as right to control adversely the thing pledged? And again: Does the contract place within the reach of the lender or of any agency in its behalf an asset the retention of which will deter the borrower from conduct injurious to the security or jeopardizing service?

In every loan requiring and providing for security, a preliminary question confronts the lender, concerning the effect of the security upon the obligation of the borrower to pay principal and interest. To be specific, is that obligation a primary one, or is it one contingent upon the failure of income derivable from the thing pledged to maintain service? The design of the parties should be set forth in the agreement. At times this has been done, and in such a way as to manifest a direct liability of the obligor irrespective of any security pledged under the agreement.14

It may be doubted whether the borrower should be permitted to assume merely the responsibility of a guarantor, to be subjected to the burden of payment of interest or principal solely upon the insufficiency of income from pledged revenues or mortgaged assets. Although the borrower may contemplate the satisfaction of service from such sources, anticipating no fiscal obligation of its own until they become inadequate, the lender should, whenever possible, secure the right to rely upon the direct obligation of the borrower throughout the life of the loan.15 The external bond agreements of China during the past decade have lacked uniformity in this regard. In some instances the borrower appears to have assumed a direct obligation irrespective of the security; in others, there is less assurance of such a design. In numerous Chinese agreements the borrower has undertaken to procure requisite funds from other sources should the revenues from pledged assets prove insufficient as security. The wisdom of such provisions may be doubted. Service is better assured where, through the terms of the agreement, definite and ample security is obtained, and arrangement made for its complete protection and control by or in behalf of the lender throughout the life of the loan. Recourse to a procedure contemplating possible insufficiency in the security (possibly not taken wholly from the control of the borrower), and to be followed in such event by pledges of other property, is unfortunate in its effect upon the mind of the obligor. It is not conducive to precision or certainty or to the protection of the lender. It is believed to be a loose mode of propping up an asset of the insufficiency of which both parties to the arrangement confess doubt.

14 "The loan represented by the proposed bonds shall constitute and is hereby declared to be a direct liability and obligation of the Republic irrespective of any security provided hereunder.” (Section I (12) of a certain Bond Trust and Fiscal Agency Agreement of 1920.)

See also Article II of proposed loan agreement of 1911, between the Republic of Honduras and Guaranty Trust Company of New York as fiscal agent.

It must be obvious that the value of any security depends upon its freedom from prior encumbrance. A loan agreement may advert to the fact. It has happened, however, that even where the borrower has declared the security to be free, other foreign lenders have denied the fact and so impaired the value of the property pledged as a safeguard for the lender. Such an occurrence may be due to a variety of causes, and among them, in particular, to the failure of the borrower to adhere to a system insuring formality and notoriety in the negotiation of every external loan. Regardless of the difficulty involved, the lender must always be on its guard to ascertain whether in fact the security utilized to induce credit is subject to a prior lien.

Whenever a valid lien is sought to be impressed upon any asset of the borrower for the protection of the lender, the main question confronting the latter is two-fold: first, whether the valuable thing to be pledged will suffice to secure and maintain service; and secondly, whether, in case of default, it will enable the lender to protect itself from all loss. The solution of both questions really depends, in most cases, upon one conditionthe extent to which the borrower puts beyond its own possession and control the asset pledged as security, and so protects the lender against acts which the borrower as a sovereign state might commit, either in good or bad faith, adverse to the interests of the lender. The action to be demanded of the borrower, through the terms of the agreement, may depend in part upon the nature of the security. For that reason differences between the forms of assets oftentimes utilized therefor warrant scrutiny.

15 It may be, however, that the lender is willing to proceed on a different theory and content that service should be effected primarily out of income derivable from the security, and secondarily from the general revenues of the borrower.

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An asset frequently utilized by way of security is the future revenue from resources under the public control of the borrower. These vary greatly in kind. They may be those derivable from governmental monopolies in certain activities such as the production of tobacco, or wines or salt.16 The pledged revenues may, on the other hand, be prospective customs from specified ports or from all ports of the borrower, or on particular articles to be imported or exported. In either case they represent at best, a pledge of future revenues which, however valuable, normally require executory action on the part of the borrower as a means of rendering them beneficial to the lender.17 When the agreement merely adverts to the pledge of the obligor without more ado, the lender merely accepts or obtains the undertaking of the borrower to regard as hypothecated for the benefit of the former the particular asset involved. Such an arrangement is generally open to two objections: first, it leaves within the actual control of the borrower an asset which should be placed beyond its reach; and secondly, in case of default, it requires further action on the part of the borrower to utilize or render beneficial for the lender what was pledged for its benefit. Obviously these objections are applicable in any case where, regardless of the nature of the thing pledged, the borrower retains control of the security and must take some affirmative action upon default.

Some agreements have purported to place checks upon the freedom of the borrower, and others have provided that in case of default, the lender may exercise certain privileges resulting from the pledge. The various arrangements of this character are believed to be insufficient because while, on the one hand, they purport to exact a security, they commonly fail to safeguard the lender during the life of the loan, and especially when default occurs. The borrower remains free, except for its contractual undertaking, to control as a sovereign what should be removed as far as possible from its grasp. Upon default, there is no means whereby the lender or any agency in its behalf can acquire control of what has been pledged and of which the obligor may even then decline to relinquish possession. It thus becomes impossible for such an agency to possess itself in that event automatically of the asset needed to maintain service and protect the lender. Whenever security is needed as against the default of the borrower, the asset pledged should, by the terms of the agreement, be safeguarded and rendered capable of appropriate utilization. Arrangements which are lacking in this regard may prove dangerous for the lender. It should be observed, however, that the danger is likely to be due to the difficulty in making appropriate and necessary provision for the treatment of the particular type of asset pledged as security.

It is not to be implied that pledges of future revenues may not be rendered a practical means of safeguarding the lender. In several instances they have been so utilized to its advantage. This has been due to the care taken to remove from the borrower during the life of the loan the control of the collection and expenditure of such revenues. Arrangements with the Dominican Republic, with Nicaragua and Liberia, and under the governmental approval of the United States, are typical. Removal from the control of the borrower of the revenues pledged has been effected through the medium of a receiver or trustee authorized to fulfill the function of collecting and distributing for the service of the loan the funds designed to serve that purpose, and thus enabled to act without the special authorization of the borrower under various contingencies throughout the life of the loan. Such arrangements, it should be noted, have proved efficacious because the arrangements with the lenders have been conditioned upon or in pursuance of public conventions of the United States with the borrowers which, in consequence thereof, have accepted the protecting arm of the United States partly as a means of financial rehabilitation.

16 Such monopolies have been so utilized by both Japan and China.

17 See Memorandum of American Peace Commission, at Paris, November 21, 1898, Moore, International Law Digest, I, 381, 384.

In certain countries of other continents such as Serbia, there is seen an instance of the revenue-collecting function in the possession and control of the so-called Autonomous Administration of Monopolies at Belgrade, which is independent of the government, and maintains service on the external loans. Again, in Greece, the so-called International Financial Commission exercises a control over certain revenues assigned for the service of the external debt. In Egypt the so-called Commission and Caisse de la Dette have served a like purpose. Each of these entities or agencies has been brought into being, or established or upheld through the unified action of the countries whose nationals were interested in external loans. It may be doubted, however, whether they suggest modes of procedure likely to appeal to American lenders contemplating loans to prospective borrowers on the American continents. It will be recalled that, in 1911, both President Taft and Secretary Knox intimated that the activities and methods of European creditors to protect themselves as against Honduras were considerations enhancing the desirability of the United States-Honduran proposed loan convention of that year, and which contemplated a collector general of customs nominated by an American fiscal agent and approved by the President of the United States.18

Another aspect of the use of public revenues by way of security deserves attention. As has been observed, pledges thereof, and especially the transfer of the collecting function to foreign agencies, however valid, may give rise to practical difficulties in case the territory from which such revenues are specially derived undergoes a change of sovereignty. Even though sovereignty be retained by the borrower, local popular opinion may vigorously denounce the exercise of the revenue collecting function by a foreign fiscal agency, and that regardless of its efficacy in serving both borrower and lender. That opinion may challenge as an unlawful or unreasonable

18 See United States Foreign Relations, 1912, pp. 555, 556, 559, 591.

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