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Insolvency and restructuring in Mexico

In Mexico, commercial insolvency is regulated by a Federal Act applicable nationwide: Ley de Concursos Mercantiles (Insolvency Proceedings Act) (hereinafter, referred to as “LCM”). Such regulation was published in the Diario Oficial de la Federación (Official Journal of the Federation) on May 12, 2000, coming into force the day following its publication.1 Insolvency proceedings are therefore known as Concursos Mercantiles.

The LCM is the only legislation effectively addressing the insolvency phenomenon in Mexico, given that our Federal Civil Code regulates “Concurso Civil”,2 which is obsolete and as it is no longer applied for it does not contain effective tools to solve the issue regarding non-trading individuals. The main spirit of the law is that the company should continue to encourage restructuring over bankruptcy, but must consider the legitimate rights of the creditors. Hence, in this paper we will briefly expose the essential content of the LCM for any attorney to understand how insolvency is regulated in Mexico. We shall also reflect upon some modifications that, in my opinion, need to be implemented to improve the regulation on this matter in Mexico.

 

Basic terms of LCM

Merchant

According to the LCM, in order to be legally declared in bankruptcy you need to be a merchant.3 Therefore, this is one of the first limitations in our country: a non-trading individual cannot file for legal and effective insolvency proceedings. In addition to the traditional definition of a merchant, the LCM indicates that the following may also be subjects entitled to be declared bankrupt:

  1. Estate contributed to a trust with business activity purposes.
  2. Companies who are part of a business group, even though each process is carried out separately without asset mix-up.

Competence. Forum Shopping

The process is carried out before the Federal Judge of the actual domicile of the merchant, where its principal place of business is located; therefore, if the company is based in Cancún, Quintana Roo, and it has its assets and its principal place of business in that city, even if it has a branch in Mexico City, it cannot file for insolvency proceedings in Mexico City in the first instance.

Even if the merchant is incorporated in Mexico City, but its operations are carried out in another jurisdiction, at first, the Mexico City Judge is not competent. The foregoing implies that Forum Shopping is not possible in Mexico. The exception to the above comes in bankruptcy filings by a business group, where the competence is set by the first company of the group to become insolvent.

 

Legitimation to begin the process

Bankruptcy proceedings may be started voluntarily by the merchant through a request presented to the Judge,4 but the petition is not automatic given that certain requirements are demanded (sometimes too strict for small and medium-sized enterprises), which is one of the practical problems to quickly access the proceeding. It is worth noting that, unlike other legislation, in Mexico there is no minimum period to force the merchant to file for bankruptcy from the moment it falls into insolvency, and there is no sanction for not doing so. It may also be started involuntarily by any creditor of the merchant or by prosecution authorities through a lawsuit.5 Finally, it may be started as previously agreed between the merchant and the creditors representing a simple majority of its debt (pre pack).6

 

Insolvency events

According to the Ley de Quiebras y de Suspensión de Pagos (Bankruptcy and Suspension of Payments Act), in order to declare a merchant insolvent, generalised default on obligations was required. This ambiguous concept had many different interpretations and, therefore, there was no legal certainty in such regard. Because of this, the LCM does not leave it to the free interpretation of the Judges when the merchant falls in generalised default on obligations before two or more creditors. The LCM defined the situation precisely in two scenarios:7

  1. That more than 35% of the total obligations of the merchant are already due when the trial begins; and
  2. Not having 80% of liquid assets to cover already due obligations when the process begins. When this lawsuit is filed by a creditor or the prosecution authorities, both premises must be confirmed.

In case of a voluntary request by the merchant, at least one of the two premises must be confirmed, and it is also possible to file the request if it is imminent that they will occur within 90 days from the request.8

 

Stages of the insolvency process

In Mexico, the insolvency process is made up of three stages: verification, reorganisation and liquidation. Verification. It is the first stage of the insolvency process, except in the insolvency request with a prior restructuring plan.9 In this state, before passing the sentence, the Judge orders an inspection by an Insolvency Practitioner (IP) called Visitador (Visitor), who determines if the merchant falls into insolvency circumstances. Reorganisation. If the previous cases are confirmed, the Judge moves on to passing the Insolvency Sentence (concurso mercantil sentence), which shall always begin in the reorganisation stage. The purpose of the reorganisation stage is to reach a restructuring agreement between the merchant and its creditors. This stage can only be avoided if the merchant directly requests its bankruptcy declaration or if it is requested by a creditor and accepted by the merchant. It is important to point out that the merchant continues managing its company (Debtor in Possession), and that an IP called Conciliador (Conciliator) is appointed as supervisor and the person in charge of achieving a negotiation and reaching a restructuring agreement.

Contracting credits with preferential conditions to operate the company (Fresh Money) is allowed; however, strict banking regulation limits its execution. At first, a simple majority vote by the creditors is required for the execution of the agreement, and there are rules for subordinated creditors or related parties. The execution of the agreement only benefits the company declared in “concurso”, not its joint obligors or guarantors. This should not be a problem for large enterprises, but most of the companies in Mexico are small and medium- sized companies and their shareholders are also their joint obligors or guarantors; therefore, if there is not a process in which they are all being restructured at the same time, it will be useless because the creditors will execute personal actions disregarding the business. There are no limits on the amounts regarding releases or payment period. Liquidation. When the merchant and its creditors cannot reach an agreement, the Judge shall proceed to pass the Bankruptcy Sentence, in which an IP called Síndico (trustee) is appointed to take possession of the company and to liquidate the assets of the company to pay the creditors in terms of preference set by the LCM. The regular sale of the assets is carried out in this stage. The Síndico can sell the assets but it has limitations. It basically has three sales methods:

  1. Public auction that has to be authorised by the Judge;
  2. Out of public auction – this is when the Síndico believes it can obtain a better price for the sale of the assets, but it has to be previously authorised by the Judge; and
  3. Emergency sale – this is made directly by the Síndico, and then delivered by the Judge. In the above three stages, the IPs are named by the Instituto Federal de Especialistas en Concursos Mercantiles (IFECOM) (Federal Institute of Insolvency Practitioners), not the Judge.

Responsibilities

In Mexico, there is no civil or criminal responsibility for the merchant, its managers or directors for being declared in “concurso” per se, and it is not qualified as culpable or malicious.

There is a Title10 regarding responsibilities of the managers which in a casuistic manner specifies when there is a personal responsibility and how it should be demanded and charged. There is another Title11 regarding criminal aspects of insolvency, which classifies certain insolvency crimes; however, in the 19 years in which the Act has been in force, it has not been applied efficiently.

 

Special bankruptcy

The LCM, whose main purpose is regulating the insolvency of a merchant, and whose legally protected right is the preservation of the company, also regulates the insolvency of financial institutions and credit organisations in a few articles, whose legally protected right must be the investors, bank savings by the public, not the banking company. While it is true it refers to the applicable financial legislation, it is also true that it provides merchant insolvency structure to the insolvency of banking institutions and credit organisations, and this is not ideal. It does not matter that, regarding credit institutions, the process always starts in liquidation; the regulation is not as agile and efficient as it should be in a type of insolvency which is as specialised as banking insolvency.

 

Cross-border insolvency

Mexico was one of the first countries to adopt the UNCITRAL Model Law regarding Cross- Border Insolvency. Therefore, if there is an insolvency process filed abroad, the foreign court or IP may request commencement of an insolvency process in Mexico in two possible scenarios:

  1. if the insolvent person has an establishment in Mexico; and
  2. if the insolvent person has assets only in Mexico.

In the first scenario, an insolvency process must start from the beginning of the process and go through all stages, including verification, even if the foreign proceedings are reorganisation or liquidation because the LCM protects local creditors. The competent Judge is that of the domicile of its principal place of business.

In the latter scenario, where there are only assets, the foreign Judge or IP requests the acknowledgement of foreign proceedings in Mexico, as an auxiliary process for the Mexican Judge to help them take control of the assets and liquidate them. The Mexican Judge can even appoint the foreign IP as Síndico.

 

Concluding thoughts

As briefly described, the foregoing points comprise the backbone of our insolvency system in Mexico. As a result, the following conclusions arise: (a) In Mexico it is necessary and urgent to efficiently regulate insolvency of non-trading debtors, of the individual, of the consumer. (b) In Mexico it is necessary to regulate the insolvency of credit institutions and credit organisations with one specific act. It cannot be included in a law that protects the company, given that the investors (the bank savings) are those which must be protected in this kind of insolvency. (c) In Mexico it is necessary to make the LCM more flexible in favour of MSMEs (Micro, Small and Medium Enterprises). There are many requirements to access the insolvency process, including the verification, for example, documents, events, and when they finally access it may be too late. Also, the insolvency process of the company must be allowed along with the insolvency process of its joint obligors or guarantors even when they are not merchants, given that they are normally 100% committed in the whole business. Since 2002 there has been a law12 in Mexico which defines whether an enterprise is considered to be micro, small or medium. Art. 3 of the above Mexican law uses the number of employees criterion method for distinguishing MSMEs from large enterprises.13 But this concept is not included in the insolvency law. The main problems for the MSMEs for filing include: i. If you are filling as a debtor you need to verification substantial information that most MSMEs will not have readily available.14 ii. In most cases15 the judge will order the verification (Visita) where a professional audits the company to analyse if it qualifies for the procedure. This Visita comes at a cost for the debtor, and a lot of MSMEs cannot afford it.16 This is also a long process before entering the restructuring process.

  1. When you are in the restructuring process, an insolvency profesional17 is appointed and the debtor has to pay for those fees, which once again are expensive.
  2. We do not have special courts functioning, so if the debtor does not have legal advice it will be complicated to follow the process.

I think that it would be very complex to have a new legislation specifically designed for MSMEs. However, if we modified the existing legislation to apply to MSMEs it could work:

  1. Automatic stay when filing and no need for the Visita.
  2. Reduce at minimum the documents that you need to present.
  3. Reduce the cost of the insolvency professional.
  4. Reduce court participation.
  5. Eliminate the restrictions for the banks to lend to companies in formal restructuring.
  6. We already have the implementation of special courts, but they have not been implemented yet.
  7. If the debtor requires, natural persons that are collaterals should be allowed to join the process as in a group of companies even if they are not merchants.
  8. Allow a discharge for the natural person and a fresh start.
  9. Give options to the debtor facing tax problems and labour problems.
  10. In liquidation, let the trustee sell with minimum formalities. (d) In Mexico there is no sovereign insolvency process, neither for municipalities nor state agencies, so the law does not state a way in which they must be treated when they are declared bankrupt. And even though it seems a little-used tool, the situation must be addressed.

Notes:

1 This act replaced the Ley de Quiebras y de Suspensión de Pagos (Bankruptcy and Suspension of Payments Act), which was valid in Mexico for almost 60 years, since 1943.

2 Third Part, First Title.
3 In Mexico, we find the definition of merchant in the Code of Commerce, article three:
Article 3.– The following persons are considered merchants:
I.– Individuals with legal capacity to trade and who make out of commerce their ordinary occupation;
II.– Companies incorporated in accordance with commercial law;
III.– Foreign companies and its branches, that perform commercial acts within national territory.
4 Article 20 LCM.
5 Article 21 LCM.
6 Article 339 LCM.
7 Article 10 LCM.
8 Article 20 Bis LCM.
9 Article 341 LCM.
10 Title Ten Bis.
11 Title Eleven.
12 Ley para el Desarrollo de la Competitividad de la Micro, Pequeña y Mediana Empresa.
13 Micro 0-10. Small 11-50 in Industry and Services and 11-30 in Commerce. Medium 51-250 in Industry, 31-100 in Commerce and 51-100 in Services.
14 Art. 20 LCM.
15 Except if you file a prepack.
16 Around US$6,000. 17 Conciliador.
 

 

Author: Luis Palomino, Partner Peña Briseño, Peña Barba Palomino Abogados

Florencia 14 Colonia Juárez, Zona Reforma

Ciudad de México. C.P. 06600 Mexico

Tel: +52 55 5426 0909

Email: palomino@penabriseno.com Website: www.penabriseno.com



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