All companies, including those in bankruptcy, need access to cash to continue operating. Companies are usually driven into bankruptcy due to a shortage of cash. Therefore, ensuring the availability of cash may be the most important aspect of a reorganization proceeding. Without adequate cash flow, the debtor will be unable to reorganize its business and financial affairs to successfully emerge from bankruptcy. Therefore, the ability to obtain financing may determine the success or failure of a business.
Therefore, debtor-in-possession financing (DIP Financing) is necessary in order to: (i) maintain liquidity to finance the debtor’s operations during the reorganization process (for example, payment of wages, suppliers, payment of rents, hiring and payment of professionals, and production of merchandise, among others), and (ii) allow the debtor to focus on reorganizing its affairs, operating its business, and negotiating a reorganization plan with its main creditors.
With this in mind, and taking into account that lenders will assume high potential risks in order to extend credit to financially troubled companies, the trend is for domestic legislations to provide benefits, special advantages and full protection to these lenders, including such benefits as ranking seniority as creditor over all other previous creditors.
Commercial Insolvency Law (CIL) and DIP Financing in Mexico.
In Mexico, the Commercial Insolvency Law (Ley de Concursos Mercantiles) is the primary legislation governing insolvency and restructuring proceedings. The CIL was enacted in 2000 following the UNCITRAL Model Law, and it was recently amended in January 2014.
In this recent amendment, the CIL incorporated 2 paragraphs to article 37 providing the possibility to debtors to obtain DIP financing during the insolvency or bankruptcy proceeding:
Article 37.- (….)
At the time of the delivery of the insolvency petition, or once it has been submitted to be processed, the Merchant may request the judge’s authorization for the immediate request of credits that are essential to maintain the ordinary operation of the company and the necessary liquidity during the commercial insolvency proceeding. For the processing of those credits, the judge may authorize the establishment of guarantees as is appropriate, if so requested by the Company.
Once the Company has filed its request, and demonstrated the urgency and necessity of the financing, the judge, once he/she has heard the opinion of the visitor, will resolve the authorization of the financing with the objectives previously mentioned, dictating the guidelines in which the respective credit will be authorized and paid, taking into consideration its preferred priority in terms of article 224 of the Law.
Pursuant to article 37 of the CIL, lenders who provide this kind of financing are given priming liens on property subject to existing liens. In point of fact, DIP lenders will get a first-priority lien on the debtor’s inventory, receivables, and cash (whether or not they are subject to an existing lien), as well as a second lien on any other encumbered property and a first-priority lien on all unencumbered property.
However, even when the CIL allows debtors to use DIP Financing, unfortunately the banking legislation in Mexico discourages and actually forbids this kind of financing.
Banking Regulation and DIP Financing in Mexico.
All lenders which provide DIP financing fall into two categories:
- The debtor’s existing secured lenders. These DIP financings are known as “defensive DIP’s” because existing lenders typically are motivated to defend, or protect, their existing loans. Oftentimes these are the only lenders which are willing to provide financing, especially in today’s market.
- New lenders. These DIP financings are known as “new money DIPs” or “offensive DIPs” because new lenders are often interested in becoming a creditor in order to take control of or own the company. New lenders may include banks, venture capitalists, or other institutional investors. In today’s market it has been harder to find new lenders, due to a dearth of unencumbered assets to serve as collateral for the DIP loan as well as expected challenges from existing lenders to the priming of their liens.
Pursuant to article 65 of the Credit Institution Law (Ley de Instituciones de Crédito), before granting any credit, all credit institutions must estimate the viability of payment by creditors or counterparties byusing an analysis based on quantitative and qualitative information that can establish the economic solvency and the ability of the debtor to pay the credit under specific terms. The foregoing shall be observed without prejudice to any considerations of the monetary value of the guarantees that have been offered.
Likewise, any amendment to the credit or loan agreements must be necessarily based on an analysis of feasibility of payment, based on quantitative and qualitative information.
Banking regulations in Mexico establish that when adverse financial circumstances or those different from that considered at the time of the original analysis (which prevent the borrower from meeting his acquired commitments in a timely manner), or when the viability of the recovery is improved, credit should be based on quantitative and qualitative analyses that reflect an improvement of the possibilities for credit recovery, in order to sustain the viability of the agreed-upon restructuring.
In such cases, credit institutions must take all necessary steps to obtain partial payments or additional guarantees to those originally contracted. If the reorganization, in addition to the modification of the original conditions, requires additional resources, there should be a study that supports the feasibility of payment of the new debt under these new conditions.
Beyond that, article 112 of the Credit Institution Law states that directors, officers and/or employees of a credit institution or those who intervene directly in the authorization or conduct of these operations, knowing that these interventions will result in loss or damage to the assets of the institution, will be sanctioned with imprisonment of 3 months to 2 years and a fine of 30 to 2,000 days of salary when the amount of the operation, breach or property damage, as appropriate, does not exceed the equivalent of 2,000 days of salary.
Additionally subject to the same sanctions are, directors, officers and/or employees involved in the granting of credits to one or more individuals or companies in a state of insolvency, or to persons whose insolvency status is known, or to persons whose lack of financial capacity to pay is foreseeable at the time of the transaction and may result in loss or damage to the credit institution.
- DIP Financing is a necessary toolkit to any type of company, including those with economic and financial hardship.
- The CIL in Mexico allows DIP financing of companies going under an insolvency or bankruptcy proceeding, with the Court’s prior authorization.
- However, Banking Regulations in Mexico discourages and actually sanctions all directors, officers and/or employees of credit institutions who grant credit to a company in a state of insolvency.
- A legal initiative to reform the Banking Regulation is necessary to make it compatible with the Commercial Insolvency Law, supporting the reorganization of Mexican companies with economic problems whileboosting foreign investments in our national market.