TO BE PRINTED IN INTERNATIONAL LEGAL MATERIALS (ILM) BY THE AMERICAN SOCIETY OF INTERNATIONAL LAW

2007 Protocol on international rail equipment concluded at Luxembourg February 23, 2007.

By Harold S. Burman i

Overview

The “Luxembourg Protocol” on international finance of railroad equipment was concluded at a Diplomatic Conference in February 2007ii as the second Protocol to the 2001 Convention on mobile equipment financeiii. The Conference was organized by UNIDROIT, the Rome-based intergovernmental bodyiv which initiated the Cape Town treaty system for the new concept of “international interests” (contractually created liens or security interests) in high- value mobile equipment, and OTIF, the Intergovernmental Organization for International Carriage by Rail, based in Berne, Switzerlandv. By validating the new concept of international secured interests in railway rolling stock (mobile assets such as locomotives, freight cars, passenger cars and other equipment) and providing for the registration of such interests in a new global computer system, the Luxembourg Protocol can have a significant effect on lowering costs and increasing exports of rail equipment, prompting regional cross-border transportation, and modernizing commercial law in various parts of the world.

Background

The underlying treaty framework is the Cape Town Convention, which entered into force on April 1, 2004, and the Aircraft Protocol which entered into force March 1, 2006vi (the U.S. is a party to both the Convention and the Protocol). Until the mid-1990’s, it had been accepted wisdom that harmonization of secured finance laws was unachievable. By that time however globalization had set in motion several international projects aimed at modernizing commercial finance, including concurrent negotiations on draft conventions covering secured financing of equipment at UNIDROIT and assignments of receivables at UNCITRAL, both of which were concluded toward the end of 2001.vii Regionally, during the same period of time an OAS Model Law on Inter-American secured

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financeviii following the same basic approach as UNIDROIT and UNCITRAL was adopted in spring 2002, and the European Bank for Reconstruction and Development (EBRD) has moved along a somewhat similar path.ix

The Cape Town Convention sets up the world’s first international legal structure for security interests. It rests on the concepts of asset-based finance and non-possessory liens that were introduced into the Uniform Commercial Code in the 1960’s and seen by a number of countries until recently as a too radical departure form accepted constraints of traditional property and collateral law. Each category of equipment requires a separate negotiated protocol to the Convention, to reflect the financing practices and international dynamics particular to that sector.

Approximately 40 States participated in the Luxembourg conference, capping a three year process, representing all regions, plus the World Bank, the Hague Conference, the Southern African Development Community (SADAC), the European Investment Bank, the European Commission, and industry-based NGO’s including the UNIDROIT-sponsored Rail Working Group (RWG), the International Rail Transport Committee, the International Union of Railways, and the International Union of Combined Road- Rail Transport Companies (private commercial law negotiations differ from public international law in several respects, including the prominent role played by industry representatives, often through NGOs).

The U. S. signed the Final Act but has not yet signed the Protocol. While the Protocol provides that four ratifying states are needed to bring it into force, the Protocol defers entry into force until OTIF has also certified that the registry system is operational, which includes a determination that a sufficient volume of rail transactions would be represented by the ratifying states so as to make the registry system economical to operate (Articles XII(6) and XXIII(1)).

Principal objectives

The final text of the Protocol satisfies the principal USG objectives for the international railroad finance treaty system:

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(1) expansion of exports and imports of rail equipment and spin-off effects on track development and rail services, by increasing availability of rail finance and lowering cost through adoption of market-tested concepts already in US, Canadian, and a limited number of other countries’ commercial laws. This was accomplished by reaffirming the basic approach of the Cape Town Convention, including concepts of asset-based finance.

(2) promoting infrastructure of developing and emerging states through acquisition of modern rail equipment and, where possible by virtue of geographical and political factors, development of subregional rail systems which can be a focal point for future economic development.

(3) promoting capacity building in developing countries through law reform, since adoption of the Cape Town Convention and one or more of the Protocols would move legal and finance systems toward modern concepts of commercial law. These changes can mean economic progress for developing countries in advance of achieving general progress on upgrading of judicial systems, since capital markets can self-correct for failures to uphold rights under these Protocols.

(4) protection of the existing North American system for registering and recording interests in rail rolling stock, so that no changes to that system can result from future participation in the Protocol system without prior agreement of US railroads and other US rail interests.

Conference dynamics

The was an active participant in the Conference and its preparatory meetings and was represented on all key committees. US views were closely coordinated with and , since all three operate rail transportation under a largely integrated North American system.x

The dynamics surrounding agreement on the substantive finance law concepts, i.e., acceptance of UCC concepts of asset- based financing, were controversial and a major part of the negotiations resulting in the Cape Town Convention and Aircraft Protocol (2001). By the time of the Rail Protocol, however, acceptance of the concepts was much less of an issue, perhaps

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because since March 2006 already over half the world’s transactions on major commercial aircraft were subject to the Cape Town regime.

The dynamics of bringing the Rail Protocol into force also are likely to differ from those of the Aircraft Protocol. The economics of aircraft finance meant that without early US participation, the new aircraft registry system might not for some time have had sufficient volume to be viable, whereas in rail finance early participation by some EU states and/or large developing country markets can provide the needed volume. EU states have had a track record in post-WWII years of more significant public investment in rail infrastructure than has been the case in the US. With the growth of integrated markets under the EU system, EU states are seeking to further integrate EU rail systems and rail finance, an integration that has already been largely accomplished in North America. Also relevant was the fact that while rail equipment exporters, including US manufacturers, can benefit from the Protocol, rail operators, unlike companies, are often more territorially focused. This plus the fact that rail car equipment involves tens of thousands of pieces of equipment will pose challenges for a future interface between existing US and North American registry practices and those that may be required for a new international system. On the other hand, the Rail Protocol offers an opportunity for a number of regions to further integrate their rail services, which may become one of the significant results of the Protocol.

Establishing the treaty framework for implementation of the Aircraft Protocol drew substantially on the lead role of the International Organization (ICAO), established by the 1944 Chicago Convention and headquartered in Montreal, which operates as a specialized UN agency.xi No comparable intergovernmental rail body exists. Organizational rail interests at the Conference revolved around OTIF, which is largely European based (none of the NAFTA states are a party), with some member states coming from the Near East and North Africa,xii although membership might be expected to increase as a result of its role on the Luxembourg Protocol.

The Government of Luxembourg, host state of the Conference and an important financial center for rail finance, will be the host state of the new international finance registry for rail equipment.xiii, 4

Basic provisions

The Protocol must be read together with the underlying Cape Town Convention; the provisions of the Convention apply unless modified by a protocol.

“International interests”: The Convention (Article 2 et seq) establishes for the first time in multilateral treaty practice an “international interest” (i.e., a treaty-based security interest) in high value mobile equipment.

International registry: The Convention (Chapters IV-VIII) and Rail Protocol (Chapter III) provide for the establishment of a world- wide, electronically accessible, treaty-based, computer registry of international interests in rail equipment. A registered international interest will have priority over subsequently registered international interests and, with limited exceptions, over other rights that may exist under national laws of contracting States.

Oversight by States of the international registry: Assurance that States parties can assert their concerns as to the operation of the new international rail registry is provided through establishment of a Supervising Authority (Convention Articles 16-17) comprising representatives of States parties and, at the outset, to assure geographic representation as well as the presence of key rail service States, six additional States appointed by the two Intergovernmental bodies hosting the negotiation, UNIDROIT and OTIF Protocol Article XII).

Treaty declarations: The Convention (Articles 54-58) and Rail Protocol (Articles XXVII-XXXI) together permit ratifying states to adjust nearly twenty provisions by way of formal treaty declarations. Consistent with international commercial law (ICL) treaty practice, such declarations are not reservations as defined by the Vienna Convention on treaties, but modifications to specified provisions which affect transactions in the declaring state only.

Remedies: The Convention (generally Chapters III and VIII-X) and Rail Protocol (Articles VII and VIII) promote predictable and

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timely remedies in case of default, all of which can substantially lower transaction and country risk. The Rail Protocol in addition addresses the export and physical removal of rail equipment, a not uncommon problem confronting secured creditors enforcing claims against equipment considered part of transportation infrastructure.

In addition, options (Article XXV) were negotiated to permit States by prior declaration to constrain creditor’s rights to assume control of equipment, based on need for public services by the declaring State. Given the significant drop in credit value of the Protocol for States to the extent that they made such declarations, protections were built in, including obligations for compensation, which are effective without delay, and avoid the common treaty reference to “fair and equitable” compensation because of the widely differing application of those terms in international treaty practice.

Insolvency: The key provision as far as lowering credit costs for high-value assets that are also mobile: the Rail Protocol (Article IX) offers each contracting State four options: adopt one of three declarations or continue to apply its existing law. The first optional declaration is modeled after US Code Section 1168 which provides special priorities for rail interests, and is the option most likely to lower credit costs (a similar provision in the Aircraft Protocol follows US Bankruptcy Code Section 1110).xiv The second option, which also appears in the Aircraft Protocol at the request of EU states but which has not been adopted by any of the 16 States parties to that Protocol, essentially leaves enforcement to courts. It is the option least likely to lower costs. A new third option sought by European rail interests takes an intermediate position.

Limitations on Sovereign Immunity: Both the Rail (Article XVIII) and Aircraft Protocols provide for binding waivers of sovereign immunity when evidenced in writing, in matters before courts specified in Articles 42 and 43 of the Convention and such other courts as may have jurisdiction in enforcement proceedings under the Protocol.

Protection of the regional tri-NAFTA state rail system: The Rail Protocol assures that the existing North American system (or other regional systems, such as those in the Russian Federation, , and elsewhere) would not be required to 6

undertake any changes they did not expressly agree to. More specifically, the Protocol provides that any interface between those systems and the international registry is subject to agreement of the respective national or regional system identified by treaty declaration (Article XIV(2)); that any action by the Supervisory Authority that affects in particular any state party or group of states parties is subject to approval of those states (Article XII(10)); that a state may by declaration require any recording from that State in the international registry be through a designated entry point (Article XIII); and that rail equipment may be identified in a manner consistent with the above (Articles V and XIV).

Path forward

In order to fast-track implementation of the Rail Protocol, Luxembourg, selected by the Diplomatic Conference as the host state for the new international rail registry, together with OTIF and UNIDROIT in July 2007 convened in Berne, Switzerland the first meeting of the 20-state Preparatory Commission which will draw up draft regulations and technical parameters for a global computer registration system. The process can be relatively short (possibly one year), since it would draw on many solutions already developed for the international aircraft registry. Conclusion of that process and assessment of costs and options for implementation will allow consideration of possible ratification by the United States. U.S. ratification would affect costs of exporting or importing such equipment, but would not require participation of the North American rail registration system, absent its consent. Once the rail registry is operational, ratifications would be expected to increase. xv

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i Office of Legal Adviser, Department of State and co-head of US Delegation for the negotiation of the Luxembourg Protocol. Steven Harris, co-reporter for Uniform Commercial Code Article 9 Revised, and Professor of law, Chicago Kent-IIT Law School, was a member of the delegation and contributed to this introduction. Other contributors were co-head of delegation Peter Bloch, Department of Transportation Office of General Counsel, and Louis Emery, member of the delegation, US Export-Import Bank, Office of General Counsel. ii www..org/eng/adopted texts/conventions/Luxembourg Protocol. See Field Code Changed generally, Transnational Commercial Law, R. Goode, H. Kronke, E. McKendrick, J. Wool, Oxford Univ. Press 2004. iii The Cape Town Convention came into force April 1, 2004. www.unidroit.org/eng/conventions. The United States ratified the Convention Field Code Changed and the Aircraft Protocol in November 2004. See Senate Treaty Doc.108-10, 108th Congress, 1st Sess. Each category of equipment must have a separately negotiated treaty protocol in order for it to be subject to the terms of the Convention. The first Protocol to the Convention, covering aircraft finance, came into force March 1, 2006. iv Established 1926 as an auxiliary body of the League of Nations, formally the International Institute for the Unification of Private Law, later reconstituted as an independent multilateral body. The United States joined UNIDROIT in 1964. v Established May 1, 1985 by multilateral agreement. 42 member states (the United States is not a party). www.otif.org. Field Code Changed vi See the UNIDROIT Official Commentary on the Convention and Aircraft Protocol, R. Goode, authorized by Resolution 5 of the Diplomatic Conference. vii H. Burman, “The Commercial Challenge in Modernizing Secured Transactions Law”, UNIDROIT 75th anniversary Congress, 2003 Uniform Law Rev. 1-2 (Vol.VIII), pp.347 ff. See generally, B. Kozolchyk, Making Free Trade Work in the Americas, pp.5 ff “NAFTA’s Commercial Legal Highway”,Transnational Juris Pub., 1993. viii Organization of American States. www.oas.org/about the OAS/structure/dept Field Code Changed of intern legal affairs/off of intern law/private international law/CIDIP VI. ix See generally, special issue on international developments in secured finance, Uniform Law Rev. 2002-1. x The Association of American Railroads and related organizations in the United States, Canada and Mexico monitor the integrated North American system; www.aar.ogr. The US Department of Transportation Surface Transportation Field Code Changed Board (STB) oversees federal interests and industry matters, www.stb.dot.gov. Field Code Changed

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xi www.icao.org. ICAO joined the UNIDROIT-initiated process and hosted Field Code Changed multilateral meetings on the draft Convention and Aircraft Protocol. xii 42 states are currently members, primarily those of the European Union, including eastern European EU states but, with the exception of the not other prior states of the Soviet Union, and four Near-Eastern and three North African states. There are at present no broad multilateral bodies for rail transportation that include the NAFTA states or all principal geographic regions. xiii A factor that may facilitate approval by the European Council for EU member states to adopt the Protocol, subject to whatever conditions are laid down by the Council. xiv Credit enhancement will be furthered if ratifying states also adopt the 1997 UNCITRAL Model law on cross-border insolvency cases, recently enacted in the United States as the new Chapter 15 of the US Bankruptcy Code, 11 U.S.C. 1501 et seq. xv Having concluded the rail equipment Protocol, negotiation under UNIDROIT auspices will resume on a third protocol governing international interests in satellites and other space assets, a substantially different challenge since, unlike rail transportation which is grounded on a variety of national laws and some regional legal frameworks, commercial activity in outer space has a minimal legal structure and limited application of national law. www.unidroit.org/eng/work in Field Code Changed progress/intern interests in mobile equipment. A fourth protocol in the initial stage of consideration, supported by the United States, would cover agricultural, construction and mining equipment.

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