Mexico, a Historical Challenge

In summary

Mexico faces unprecedented times and historical challenges. The covid-19 pandemic exacerbated already deteriorating economic conditions that coexist with policies undertaken under a left-leaning agenda. The concurso remains useful to overcome struggling and extraordinary conditions, although socialisation and promotion of a much wider use is well deserved, which may be achieved by bolstering simplicity, celerity and specialisation in the process. New rules alone will not make the difference for a renewed practice. A less belligerent environment is deserved, one that favours a business and financial approach to the big picture.

Discussion points

• We live in unprecedented times; in Mexico, it is a perfect storm
• What can companies do? Are there mitigating tools out there? How and when to use them?
• The concurso, a useful tested tool, yet scarcely used after 20 years
• Concurso proceedings
• Challenges ahead
• Changing the paradigm

Referenced in this article

• Covid-19
• The AMLO presidency
• Aeroméxico
• Grupo Famsa
• Commercial Insolvency Law
• US Bankruptcy Code
• Federal Institute of Commercial Insolvency Proceedings Specialists

We live in unprecedented times; in Mexico, it is a perfect storm

The economic downturn brought on by the covid-19 pandemic has throttled emerging markets, particularly so in the larger nations in Latin America. During the summer and fall of 2020, we saw the rate of deaths per million in Brazil, Peru, Chile and Mexico soar as high or higher than in the advanced economies where the pandemic surged in the spring of 2020, such as Belgium, Italy, Spain and the United Kingdom, nations with far greater resources with which to cushion the blow.

In Mexico, the withering headwinds came in after several years of disappointing economic growth and amid the most turbulent political transformation conceivably in a century. It has been a perfect storm.

How long can we expect the dark clouds of economic uncertainty to hang over Latin America? Will we ever see demand for export goods reach pre-pandemic levels? How long will it take for the tourism industry to fully recover? Given high unemployment and default rates, when can the governments of Latin America begin again to count on levels of tax revenue sufficient for them to carry out the kinds of development projects that could right the economy?

The covid-19 pandemic exacerbated an already deteriorating economic outlook. Even before the pandemic, the Mexican economy had been showing poor growth figures. The fall in oil prices had its impact, but for the period beginning in 2018, experts trace the downward momentum to policies that current President Andrés Manuel López Obrador (AMLO) has undertaken in order to transform the country according to his left-leaning political agenda.

Medium and long-term effects of the current crisis will likely exceed the 1982 debt crisis, the 1994 peso crisis and the 2007–2008 global financial crisis in breadth, duration and severity.^[1]

According to a recent report of the World Bank^[2] on Mexico:

• output contracted by 18.6 per cent year-over-year in the second quarter of 2020;
• there is a sharp increase in risk aversion that has triggered capital outflows from Mexico;
• the fiscal policy response has been very limited and targeted to transfers and loans to micro, small and medium-sized enterprises and workers;
• the economy is projected to contract by 10 per cent in 2020, with a gradual recovery in 2021 and 2022;
• it may take more than three years to attain pre-pandemic levels of gross domestic product (GDP);
• foreign direct investment (FDI) will slow significantly, although ratification of the United States–Mexico–Canada Agreement (USMCA) should ease some of the uncertainties that limited FDI;
• the expected gradual recovery may be slowed if policy uncertainty with respect to private investment, including in the energy sector, is not lifted;
• the state’s need of greater tax receipts will likely stimulate tax reform; and
• the financial situation of Petróleos Mexicanos (Pemex) may require further relief from its tax and transfer obligations to the federal budget.

An October 2020 International Monetary Fund (IMF) working paper concludes that the Mexican government’s fiscal response to the pandemic has been modest compared to its peers, reflecting the authorities’ desire to not issue new debt for spending. This approach risks a more severe recession and a weaker economic recovery and, thereby, long-term stress across the board.^[3]

What can companies do? Are there mitigating tools out there? How and when to use them?

Whether a debtor or a creditor, a customer or a supplier, almost anyone doing business or with assets located in Mexico these days is experiencing symptoms of distress – economic distress, if not physical and emotional distress. Corporate balance sheets reflect this. The effects are felt throughout the country and across all sectors of the Mexican economy. So companies, many for the first time, are taking stock of what protections Mexican insolvency law offers them.

The pandemic has disrupted the automotive and construction sectors of the Mexican economy, as well as wholesale and retail trade, and most service industries, including tourism, entertainment, food service, transport and communications.

In Mexico, as elsewhere, the decrease in air travel has significantly affected airlines. Unlike in many other countries, the federal government in Mexico has not extended the kind of short-term assistance that would help keep airlines afloat. This austere approach puts Mexican airlines at par with some African airlines. Despite the International Air Transport Association (IATA) calling for government–industry dialogue in Mexico to aid airlines, the government has not offered any assistance.^[4]

This has led Mexican carriers to adopt extraordinary measures. As early as July 2020, Mexico’s legacy flag carrier, Aeroméxico, filed for voluntary restructuring under Chapter 11 of the US Bankruptcy Code, and has, more recently, returned a significant number of aircraft to financiers, suspended a major number of routes and reported substantial accumulated losses in past months. Another critical player in the market, Interjet, a Mexican low-cost carrier, has also returned a significant number of aircraft after a major drop in passengers transported during past months.^[5]

The banking sector is not indifferent to the situation. Even though well-capitalised and in line with Basel III requirements and safeguards, the soundness on assets on the balance sheets is to be tested in the coming months. On June 2020, the National Banking and Securities Commission (CNBV) revoked the banking authorisation of Banco Ahorro Famsa following its failure to meet the minimum capitalisation index and amid the filing under Chapter 11 of the US Bankruptcy Code by its holding company Grupo Famsa.

The renewables market is also on the spotlight beyond a lack of support for new developments, as AMLO’s government is pushing to take away the path travelled by the sector under the previous administration, often with measures of dubious legality. With a view to bringing the country’s energy companies to their former glory, policies have not only turned away renewable investment and prompted internal legal struggle, but seriously endangered existing projects. In all likelihood, the renewables market will not turn around until sometime after AMLO’s term ends in 2024.

The review of the balance sheet and cash flow projections of a company are an essential first step, along with the anticipation of potential disruptions in contractual obligations and the preparation of a business plan tailored to recognise a new business reality. Where feasible, the assistance of external financial and legal advice is of great help. Whether or not insolvency proceedings are to be faced, the more conscious the company is about its reality and the challenges ahead, the greater its chances to achieve a better outcome.

Insolvency proceedings are also an alternative to be carefully analysed in light of the actual conditions of a company and the particular needs to preserve its value.

Insolvency proceedings in Mexico

The concurso, a useful tested tool, yet scarcely used after 20 years

Historically, bankruptcy proceedings were rare in Mexico. Many attributed this to both cultural resistance and legal impediments to voluntary declarations under former law.^[6]

The Commercial Insolvency Law, in effect since May of 2000 and amended in 2007 and 2014,^[7] changed the way businesses and legal practitioners see insolvencies involving persons or property in Mexico. Enacted to help keep struggling businesses^[8] in operation and to reactivate credit transactions in Mexico, the Commercial Insolvency Law aimed to minimise the negative effects of non-payment of debts on defaulting businesses, creditors and the Mexican economy as a whole.

By providing for a single insolvency proceeding (concurso mercantil) separated into two not necessarily successive stages, conciliation (reorganisation) and bankruptcy (liquidation), the law aims to protect both debtors’ and creditors’ rights. A debtor and its creditors are initially compelled to try to reach a settlement agreement on mutually acceptable payment and restructuring terms during the conciliation stage, before a defaulting business and its assets may be sold off to pay its debts during the bankruptcy stage.

While a number of features of the proceeding remain controversial among practitioners, the concurso proceeding remains a useful tool to overcome struggling and extraordinary financial conditions in a relatively efficient manner following modern legal and financial trends in the international practice.

The World Bank has recognised this by assessing the following key indicators^[9] on insolvency proceedings in Mexico and affording a score and ranking on Mexico’s legal regime for resolving insolvency higher than that of comparable economies in the Latin American region.^[10]

However, insolvency proceedings remain far less common in Mexico than in other jurisdictions. Almost a million bankruptcy cases have been filed in the United States in 2020.^[11] Only 801 concurso filings have been made under the Commercial Insolvency Law since it was enacted in May of 2000.^[12] Concurso has clearly been underused by debtors in Mexico, some of which have even elected to initiate proceedings elsewhere (mainly before US courts following proceedings under the Bankruptcy Code).

As noted above, recent cases of Mexican companies filing for protection under Chapter 11 in the United States include Aeroméxico and Grupo Famsa. The reasons behind electing to have a US court as the main insolvency forum may vary, but may essentially have to do with the type of debt held, as well as other factors such as the availability and efficient recognition of debtor-in-possession (DIP) financing, a generalised stay of obligations and well-tested simpler and expediter proceedings in charge of specialised courts.

The concurso proceeding

The Commercial Insolvency Law applies to insolvencies of individuals or entities that fall under the definition of a debtor merchant. This definition includes the debtor’s assets held in trust when business activities are affected and entities holding more than 50 per cent of another company’s shares that give the holder voting rights. The definition also includes the branches of foreign companies although only regarding the assets located in Mexico.

Insolvency declaration

Only a debtor, one of its creditors or a federal public prosecutor may file a petition for an insolvency declaration judgment. To obtain the insolvency declaration, one must show that a debtor is in general default of payment of debts, which occurs when the debtor has debts to two or more different creditors and the debts are 30 calendar days or more overdue and represent 35 per cent or more of all the debtor’s debts, or the debtor does not have sufficient assets to pay at least 80 per cent of its outstanding debts.

A federal district court sitting in the debtor’s domicile has exclusive jurisdiction to declare a debtor insolvent and conduct the commercial insolvency proceeding. After admitting a petition to declare insolvency, the court asks the Federal Institute of Commercial Insolvency Proceedings Specialists (IFECOM) (a judicial agency) to appoint an examiner to inspect the debtor’s financial records for a period of 15 days, which can be extended for 15 additional days. If, after conducting the inspection, the examiner reports to the court that the debtor is in general default of payment of debts, the court evaluates the reports and the other evidence that appear in the file in order to declare the debtor insolvent by rendering an insolvency declaration judgment and, thereby, initiating the insolvency proceeding.

The debtor and the creditors representing more than 50 per cent of all debts of the debtor can agree on a pre-filing (or prepackaged) settlement agreement. Once presented to the court, if the court finds that the settlement agreement satisfies the foregoing and all other legal requirements, the court will render an insolvency declaration judgment, initiating the insolvency proceeding directly within the reorganisation stage, thus avoiding the appointment of an examiner and the inspection of the debtor’s financial records. The proceeding will run its course and the settlement agreement will have to be finally and definitely approved by the court.

Reorganisation

After the court declares a debtor insolvent, the debtor and creditors must submit to reorganisation. This first stage is held under the supervision of a conciliator appointed by the IFECOM and its purpose is to preserve the debtor’s business through a settlement agreement between the debtor and the recognised creditors. This stage lasts for a period of 185 calendar days beginning on the date the insolvency declaration judgment is published, unless the court grants an extension.

If, during the reorganisation stage, the conciliator and more than half of the recognised creditors believe a settlement is about to be reached, they may ask the court to extend the reorganisation term for up to 90 calendar days. If the debtor and at least 75 per cent of the recognised creditors request it, the court may grant an additional extension for up to 90 calendar days. In no event may the reorganisation period extend beyond the 365 days following the publication date. If an agreement is not reached within the original or extended term, the court will declare the debtor bankrupt.

During reorganisation, no one may attach or sell a debtor’s assets, even if judicially ordered. An exception is allowed for the attachment or sale of assets to pay labour-related debts

Conciliator

For reorganisation purposes, the IFECOM appoints a conciliator upon the court’s request, who supervises the debtor’s business management, reviews financial records and receives creditors’ claims. The debtor, however, continues to manage and operate his business during reorganisation as DIP. A conciliator also decides whether to terminate agreements that are pending execution or performance and whether to take out new loans (DIP financing). New loans authorised by the conciliator to fund the debtor’s ordinary operation as the proceeding runs its course hold a super-priority claim against the debtor’s estate.

Debt recognition and management

Creditors may file to have their debts recognised during any of the periods the law allows. Even if some creditors do not file to have their debts recognised, the conciliator must request recognition of all debts, provided they have sufficient information for this purpose based on the merchant’s accounting.

To determine the amount of the debtor’s debts, all pending debts are considered due and, to the extent that the debtor’s debts are not secured, they no longer accrue interest. Any outstanding principal and interest in Mexican pesos are converted into inflation-linked units of account (UDIs). Regardless of the agreed place of payment, any principal and interest in foreign currency are converted first into Mexican pesos and then into UDIs. A secured debt secured is maintained in the original currency agreed upon and only accrues regular interest up to the value of the property that secures it.

Settlement

Settlement agreements are only effective if the debtor and the recognised creditors representing more than 50 per cent of the total recognised common (unsecured) and secured or special privileged creditors sign it.

Once signed, a settlement agreement is presented to the court. If the court finds that the settlement agreement satisfies all legal requirements and is not contrary to public policy, and if the creditors do not file objections or veto the agreement, the court will render judgment approving the settlement. This judgment ends the insolvency proceedings and the approved agreement binds the debtor, all recognised common (unsecured) creditors and all recognised secured or special privileged creditors that either signed the agreement or whose debts are covered under the agreement.

Bankruptcy and liquidation

While the reorganisation stage aims to preserve the debtor’s business by achieving a settlement agreement among the recognised creditors, the purpose of the bankruptcy stage is to sell off the debtor’s assets in order to repay the recognised creditors.

The court may order an insolvent debtor bankrupt if:

• the debtor files a request;
• the reorganisation stage expires and a settlement agreement has not been filed for court approval; or
• the conciliator files a request, citing a lack of cooperation between the debtor and creditors to reach a settlement.

Receiver

After it renders a bankruptcy judgment, the court orders the IFECOM to appoint a receiver for the debtor’s assets.

The debtor must turn over to the receiver possession and management of all the assets and rights of the estate in liquidation. Receivers owe a fiduciary duty to the debtor’s estate and must inventory and sell the assets that integrate the debtor’s estate.

Effect of bankruptcy declaration

Generally, the judgment declaring the debtor bankrupt implies removing the debtor from the management of his business. The receiver must file reports with the court after it takes possession of the estate.

Debtor’s duties

Among the debtor’s principal duties is that of accompanying the receiver, either personally or through a legal representative, on matters related to the bankruptcy and refraining from undertaking certain acts without the receiver’s general or specific written authorisation.

Selling off estate assets

The receiver is entitled to begin selling the debtor’s assets and the rights that make up the estate. If selling the business as a productive unit may yield the highest sales proceeds, the receiver must consider the option of keeping the business as a going concern.

Order of preference and payment

For the purposes of payment of debts as agreed upon in the settlement agreement or liquidation during the bankruptcy stage, a debtor’s debts are paid based on the nature of the credit and in accordance with the following specified order of preference:

• labour debts related to employee wages and severance for the two years preceding the insolvency declaration and certain super-priority debts (including, among others, those assumed to manage the business by the debtor with the conciliator’s authorisation (DIP financing) and those related to the examiner’s, conciliator’s and receiver’s fees);
• singularly privileged credits (applicable only if the debtor is an individual);
• secured credits;
• labour-related debts (other than those identified above) and unsecured tax debts;
• debts to creditors with a special privilege (pursuant to business statutes or by right of retention);
• debts to common (unsecured) creditors; and
• subordinated credits (including inter-company credits).

Conclusion of the proceedings

The court may conclude insolvency proceedings on its own motion or upon a valid request:

• when a settlement agreement is reached;
• when all recognised creditors are paid in full;
• when recognised creditors are paid in accordance with insolvency proceeding quotas and there are no more assets to sell;
• when the estate assets are insufficient to pay the necessary expenses in connection with labour obligations and insolvency proceedings; or
• at any time the recognised creditors and the debtor file a request.

Special proceedings and cross border insolvency

Special rules apply for insolvency proceedings involving a debtor that is a public service provider under government concession, a bank or an auxiliary credit institution.

The Commercial Insolvency Law also contemplates cross-border insolvency for handling cases (domestic and foreign) in which the debtor has assets in more than one county. Following the UNCITRAL’s Model Law on Cross-Border Insolvency, Mexican law on international cooperation allows access to Mexican courts to a person administering a foreign insolvency proceeding. It contemplates coordination in concurrent insolvency proceedings, allows Mexican courts to declare a foreign debtor’s business in Mexico insolvent and the debtor’s creditors to obtain interim orders to protect their rights against a foreign debtor.

Challenges ahead

There are many factors that could explain the scarce number of proceedings initiated after 20 years of the Commercial Insolvency Law. It is clear that areas of opportunity include the need to socialise and promote a much wider use of concurso proceedings.

The need to preserve value is at the heart of insolvency situations. Prompt, if not immediate, and effective actions are often required and simpler and expediter proceedings in the hand of specialised courts would definitely detonate a wider and wholesome use of the concurso. District courts in Mexico, entrusted to resolve concurso proceedings, are not insolvency-­specialised and are mostly overloaded with other cases (mainly civil and commercial trials and first-instance constitutional proceedings), which discourage them from the very acceptance of cases, depriving the concurso an efficient resolution environment.

Only in April 2020 was an initiative to amend the Commercial Insolvency Law was published in the Mexican Senate Gazette,^[13] aimed to incorporate the concept of an emergency regime allowing for digital access to a concurso. Although a step forward, a more comprehensive review of the law is very well deserved.

Changing the paradigm

New and enhanced rules are definitely needed for our concurso. But new rules alone will not make the difference to achieve a renewed insolvency practice. As Stephen Covey once said ‘if you want small changes in your life, work on your attitude, but if you want big and primary changes, work on your paradigm.’

A less belligerent environment is probably needed. A practice that takes care of the procedural side of the equation, but favours a business and financial approach to the big picture.

Notes