An extract from The Restructuring Review, 13th Edition
Overview of restructuring and insolvency activity
In general, restructuring practice in Mexico continues to focus on out-of-court settlements, with a remarkably high rate of success. That cannot be said with regard to formal insolvency proceedings, concurso mercantil, which, with few exceptions, has failed to become a reliable tool to implement solutions to preserve companies as ongoing concerns or an efficient instrument to cause orderly, supervised liquidations that may preserve value.
Undoubtedly, the few cases filed in the 12 month period prior to the covid-19 emergency continued to reflect the many continuing deficiencies in restructuring cases governed by the Law of Commercial Insolvency of 2000 (as amended, the Concurso Law). In recent years, relevant cases (those involving claims in excess of US$100 million) have stalled amid daunting formalities and creative delaying tactics, and a litigious environment fuelled by challenges to the growing practice related to the request and granting of wide-ranging 'precautionary measures', in addition to ever-expanding interpretations of 'due process' and 'human rights', which cause continual delays and a lack of rule of law. The mandatory time frame established in the Concurso Law is widely ignored, resulting in the destruction of value. Only those exceptional filings that have been made under a pre-packaged plan, pursuant to which the company and a majority of its creditors jointly agree to seek a court-protected reorganisation through concurso, have been resolved and successful restructurings achieved within a period of less than a year.
At the time of writing, the drastic impact of an unprecedented pandemic on the world economy, and on Mexico, coupled with a weakening currency, a deteriorating health system, poorly improvised responses to the emergency and the presentation of deceitful statistics, as well as the continuing, calculated attacks by the current administration on free enterprise, the prior energy reform and private investment, in the context of a startling neglect of the rule of law and an insistence on redirecting public spending to unproductive and highly questionable and environmentally unsustainable large-scale projects, is beginning to have dire effects on the Mexican economy and investor confidence. There is no doubt that the unforeseen pandemic, when added to irresponsible populist policies, will cause an unparalleled recession, unemployment and, ultimately, poverty. Today, supply chains have been severely affected in many sectors, and businesses of all sizes will have to deal with falling revenues and profits , and an economic downturn of gargantuan proportions. Entire sectors of the economy (such as businesses relying on discretionary consumption, hospitality, real estate development, construction, tourism, entertainment, aerospace and airlines) and individual companies will surely come under financial stress due to the lack of economic growth and a precipitous decrease in demand and supply, especially if the administration fails to provide much-needed fiscal support and responsible policies to encourage confidence and investment.
At present, forecasting and budgeting are objectively impossible. Debtors and creditors (led by a solid, well-capitalised banking system – at least in the immediate foreseeable future) have responsibly turned to constant risk analysis exercises and interim mitigating initiatives, through actions such as the extension of immediate maturities and interest payment relief, in respect of consumer and commercial credits alike. The financial authorities and the Central Bank have supported these efforts through provisional regulatory relief (by granting cautious flexibility on non-performing loan status and preventive reserves), as well as measures to provide liquidity and federal fund rate reductions. Nevertheless, the administration is yet to react to the continuing appeals of the productive sector of Mexico for fiscal backing and credit support to companies of all sizes. Not only have petitions been largely ignored, but the President has vowed not to bail out any private company, no matter the size or importance, while at the same time pouring billions of dollars into the dark well that is Pemex, the government's oil monopoly, in the midst of a major oil oversupply, including the construction of an additional refinery, among other dubious projects.
As to insolvency practice, in the past two decades, the Supreme Court of Justice, as head of the Federal Judiciary, which has exclusive jurisdiction on insolvency matters, has shown only sporadic interest in attending to the evident regression in concurso mercantil proceedings. In addition, with honourable exceptions, federal judges continue with their preference for avoiding bankruptcy cases, largely ignoring them or turning them down based purely on formalities. It is essential that the Federal Judiciary react to the unmistakable drawbacks encountered continually in bankruptcy practice. There is no doubt that companies of all sizes and sectors of the economy, and creditors and stakeholders, will be forced to turn to concurso as a last resort to salvage their business continuity as a result of the economic crisis looming in the immediate future and the prevailing volatility.
Recent legal developments
Material amendments to the Concurso Law were enacted by Congress in 2014. The principal objectives of the reform focused on the goals of a more expedient and efficient procedure, greater transparency and a reasoned intent to formally introduce DIP financing.
The most relevant provisions introduced by Congress were:
- prohibiting the judge from extending the periods set forth in the Concurso Law;
- the procedural consolidation of concurso mercantil proceedings of companies that are part of the same corporate group, the concept of which now includes companies that have the capability to make decisions with respect to another company, regardless of the actual shareholdings (it is noted that substantive consolidation is not aloud);
- the ability of a debtor to request the concurso mercantil status prior to being generally in default with respect to its payment obligations, when such situation is expected to occur inevitably within the following 90 days;
- the possibility of requesting a concurso mercantil directly in the stage of bankruptcy (liquidation);
- permitting common representatives to file credit recognition claims on behalf of a group of creditors and the addition of certain rules for the subscription of the debt restructuring agreement in the case of collective credits through their individualisation;
- allowing for the use of standardised forms to voluntary request or involuntary demand concurso mercantil;
- the prospect of filing petitions and other communications electronically;
- an emphasis on transparency;
- provisions permitting debtors to obtain DIP financing as necessary to maintain the ongoing business of the company and the essential liquidity during the concurso, the financing of which will be considered privileged in ranking (with a preference over all secured creditors) for purposes of the preference of the payment thereof in the event of a liquidation;
- the recognition of subordinated creditors, including inter-company creditors in accordance with certain rules, which, among others, establish that such inter-company creditors will not be allowed to vote for the approval of the debt restructuring agreement when such inter-company creditors represent 25 per cent or more of the total amount of recognised credits, unless such creditors consent to the agreement adopted by the rest of the recognised creditors of the same class; and
- the broadening of the retroactivity period applicable for the review of fraudulent conveyances with respect to transactions entered into with inter-company or related creditors (to twice the statutory periods).
To avoid abuses in respect of an insolvent debtor, the amendments to the Concurso Law also included a set of provisions that refer to the potential liability of the debtor's management and relevant employees for damage caused to the debtor company if:
- acting with a conflict of interest;
- favouring one or more shareholders and causing damage to other shareholders;
- obtaining economic benefits for themselves or for others;
- knowingly making, providing, disseminating, publishing or ordering false information;
- ordering or causing the accounting registries, related documentation or conditions in a contract to be altered, modified or destroyed;
- failing to register transactions or causing false information to be registered, or causing non-existent transactions or expenses to be registered, or real transactions or expenses to be exaggerated, or otherwise carrying out any act or transaction that is illegal or prohibited by law, causing damage to the bankrupt debtor and obtaining an economic benefit, directly or indirectly; and
- in general carrying out any wilful or illegal act or acting with bad faith pursuant to the Concurso Law or other laws.
Although the Concurso Law adopted the business judgment rule contained in the Securities Law applicable to the members of the board of publicly traded companies and allows such directors and relevant employees to obtain insurance, guaranty or bonds to cover the amount of the indemnification for losses and damages caused, except for wilful misconduct, acts of bad faith, the Concurso Law expressly prohibits any agreement, or provisions in the by-laws with respect to any type of consideration, benefit or exemption that may limit, release, substitute or redeem the liabilities of such members of the board and relevant employees of a bankrupt debtor in the event of wilful misconduct or bad faith.
Finally, as part of the 2014 amendments, a bank resolution regime was created and regulated in the Law of Credit Institutions. Such regime is characterised by its celerity, pre-intervention corrective measures by the Institute for Banking Savings Protection and its effectiveness in reaching an orderly liquidation if required, among other relevant features.
In August 2019 amendments were passed to clarify that corporations owned by the Mexican Government may be eligible to file under the Concurso Law. In this respect, it is emphasised, however, that neither Pemex nor the Federal Electricity Commission (CFE) are corporations. They are productive state-owned enterprises, governed by their own comprehensive legal regimes, and they carry out specific constitutional mandates relating to oil and gas and electricity for the Mexican State. As a matter of Mexican Law, either may be declared bankrupt or insolvent or be subject to a concurso. Specific legislation enacted by the Mexican Congress would be required to judicially restructure or liquidate Pemex or CFE.
Significant transactions, key developments and most active industries
Recent cases have continued to underline material limitations with regard to concurso proceedings. The impact of the pandemic emergency remains to be seen, although there seems to be little hope for improvement in insolvency matters in the near future.
Although the Law allows creditors and debtor companies in a pre-pack concurso to appoint a conciliator who is not a member of IFECOM, understandably IFECOM has been a zealous protector of its oversight responsibility, placing stringent scrutiny on any such conciliator – and perhaps, acts of harassment – especially with respect to formalities that seem to go well beyond the Law. There continues to be a marked emphasis on the use of cumbersome IFECOM formats and computer software, which are not designed for large corporations, causing many delays at all stages of the procedure. The procedure and requirements that have been imposed by IFECOM with regard to the recognition of creditors stress the physical delivery of original documents, which in practice has meant that the conciliator may not rely on the audited financial statements of the company but on empirical evidence of debt, which may lead to months of otherwise inexplicable interruption, notwithstanding that the Law provides otherwise. With the recent appointment of a new director general of IFECOM, practitioners remain hopeful that IFECOM may again become a positive factor to oversee that procedures are fair, transparent and consistent with the concurso law.
In other matters, transparency and efficiency are far from being acceptable. The Federal Judiciary has failed to implement electronic filings of any sort, which leads to a considerable administrative burden on the courts themselves, not to mention a colossal waste of paper and natural resources. As a consequence, reviewing all the documents actually filed in any major process is a difficult task, which of course affects the timing of the concurso – the 'strict' time periods in the Law have been extended more often than not – and moreover, create a perfect setting for many appalling delaying tactics, which do not merit serious comment, although their existence is undeniable.
Mexican companies have not been aided by DIP financing from Mexican banks or institutional sources, and foreign entities have failed to be persuaded to fund any such facilities until recently, given continuing procedural uncertainties resulting in questions as to preference.
As to the ranking of claims, only registered mortgages and pledges have been given statutory preference on a clearly reliable basis, given a literal reading of the Concurso Law. Creditors holding security rights under trusts or escrows have been recognised in most cases as common creditors only, although they are given the 'privilege' of separating assets in trust from those of the company in question, a concept that makes little sense in view of the stated objective of the Law: to keep the corporation as an ongoing concern during the workout or conciliatory stage of the concurso. Breaking up operating assets is inconsistent with this objective. A better view is that such creditors should be recognised as creditors with a stated contractual privilege to specific assets or flow of funds, irrespective of any procedure of separation – a view that is supported by a correct reading of the Law and by the author. While still common and generally recognised, in recent years guarantee trusts involving future contractual flows assigned to creditors have come under attack, but yet have been defended by rulings of the Eighth Circuit Collegiate Court.
Formal cases have brought about a debate both at IFECOM and among a number of judges as to which concepts will actually be recognised as reimbursable expenses in a concurso proceeding. Professional fees, legal fees and those of financial advisers have often been considered as substantially onerous and have thus been reduced significantly. In the extreme, the professional fees of a conciliator were turned down by a judge as unnecessary.
Among the more alarming points of view generally shared by the litigation bar, is that, to the extent that a capitalisation of debt becomes part of an exit plan, even if voted upon and approved by overwhelming majorities of every class of creditor, shareholders do in fact have a veto power over a plan if they disagree. The author, even though his view is by no means widely accepted, does not share this perspective as it is contrary to the notion of absolute priority, and because the Concurso Law empowers the judge to impose the capitalisation, although most judges are reluctant to do so.