Restructuring in Mexico

Introduction

Mexico encountered a precipitous decrease in its economic activity in the past four quarters. As a major exporting oriented economy, the global downturn in demand and supply of goods and services at the height of the covid-19 pandemic caused a sharp downturn in its gross domestic product (GDP) (minus 8.2 per cent for 2020), not seen since the 1930s. Inconsistent policies of the Lopez Obrador administration currently in power as regards untimely responses in public health initiatives, a sluggish vaccination process, attacks on the private sector, reversals on clean energy and a disregard towards investment in several sectors, coupled with a lack of fiscal initiatives to support the private sector at all levels, contributed to a significant downturn in manufacturing and exporting output.

The many restrictions imposed globally and locally on travel suffocated the thriving tourism and hospitality industry. Commerce, real estate investment, retail sales, entertainment, the movie industry, airlines, trucking and packaging were among those sectors suffering substantial liquidity issues. Nevertheless, given the unprecedented fiscal incentives and infrastructure projects introduced in the United States and the notable comeback and expectations of growth of the US economy – Mexico is the principal trading partner of the United States, ahead of Canada, China and other countries – the Mexican economy has shown remarkable resilience and is certainly on the path to recovery. Nevertheless, many companies continue to face critical situations.

The Central Bank introduced modest programmes allowing the financial sector to provide temporary relief to debtors generally, while a clearer picture of realistic expectations and a basis for projections begin to surface for purposes of longer-term restructuring relief.^[2]

In general, for the many reasons referred to throughout this chapter, restructuring practice regarding corporations of a certain size, whether measured in assets, earnings, liabilities or a combination thereof, has and continues to be focused on consensual out-of-court restructurings, with one of, if not the highest rates of success in Latin America. Although this is true, given the training and sophistication of restructuring professionals in finance and law, one major factor for this preference has been that formal insolvency proceedings (concurso mercantil), with few exceptions, have basically failed as a reliable tool to implement successful solutions to either contribute to the preservation of companies or to support orderly, supervised liquidations that may preserve value for all stakeholders.

Cases have stalled amid daunting formalities, creative delaying tactics and a growing litigious environment fuelled by challenges to the growing practice relating to the request for and granting of wide-ranging pre-petition precautionary measures. Pitfalls arising from expanding interpretations of due process and human rights are not uncommon. Other than in the few cases of filings under a pre-packaged plan (plan de resstructura previo) implemented through a concurso, the otherwise ‘mandatory’ time frames established in the Insolvency Law^[3] have been largely ignored. In addition, the independence of the judiciary has often been questioned.

Developments arising from the covid-19 pandemic

The temporary closure for several months of government offices and, principally, the federal judiciary, which has jurisdiction over insolvency proceedings^[4] further to the express provisions of the Insolvency Law, did not have a major effect in respect of insolvency practice.

Since Mexican corporations generally view concurso as a very last resort, the closures occasioned by the pandemic had little effect on corporate insolvency practice for any large company. The federal judiciary implemented a modest electronic filing system, which has remained largely untested for concurso but has become much more relevant in constitutional practice, through the protective filing offered against violations of the Constitution by public entities, known as the amparo.

The only covid-19-related legal initiative worth mentioning was a proposed amendment, allegedly supported by the principal Mexican Bar Association, to alleviate the tardiness of the concurso proceeding in extraordinary circumstances, such as a pandemic.

In April 2020, an opposition party submitted a bill intended to create an ‘emergency insolvency regime’ within the Insolvency Law concerning any filing made after a declaration of a present or future health emergency owing to force majeure, such as that generated by the covid-19 pandemic (the Initiative).

The intention of the Initiative was to accelerate insolvency proceedings given the extraordinary emergency affecting the commercial, business and jurisdictional environments. With good reason, the Initiative recognised that there are industries and sectors of the economy that practically came to a halt, resulting in significant financial damages.

Concurso has had as its main objective, and as a matter of public interest, to preserve the ongoing concern of companies, and to prevent the possibility that a general breach regarding payment obligations may jeopardise the continuity of businesses and of other companies with which they maintain a business relationship.

The aim of the Initiative was to offer any company, irrespective of its size, to file for an insolvency proceeding on a fast-track basis, as a tool to keep it in operation through an expedited procedure that could significantly limit the time and formalities of the process.

The emergency insolvency regime, according to the Initiative, would apply to the extent that ‘unforeseen material adverse effects or a force majeure event, or a declaration of emergency, sanitary contingency, or natural disaster, at a regional or national level, aggravates the economic situation of the country or a region, affecting individuals or legal entities’.

The application of the emergency insolvency regime presented by the Initiative was intended to be available for as long as any such emergency subsists, and for up to six months thereafter.

The main features proposed in the Initiative were as follows:

• A voluntary request by a company, in a format to be designed by the IFECOM (an agency of the federal judiciary entrusted with the guidance and development of insolvency practice) based solely on a declaration under penalty of perjury, disclosing that it finds itself in a generalised non-compliance situation with its payment obligations, would be sufficient to allow the formal initiation of the insolvency process, without the need for further evidence.
• The insolvency procedure may be carried out electronically in its entirety, without the requirement of physical submission.
• Under the emergency insolvency regime, it would not be necessary to verify general insolvency through an examination (visita) of the IFECOM.
• The judge would automatically accept the filing and, without the need of summons, will issue a judgment declaring insolvency within three days.
• In the declaration of insolvency under the emergency insolvency regime, which would not admit any appeal, the relevant judgment would contain:
  • the prohibition of the company to carry out any sale or encumbrances of its main assets;
  • the prohibition to make payments of obligations that became due prior to the date of issuance of the judgment, as well as the stay on creditors, which could not proceed against guarantors or joint obligors (or both);
  • the lifting of all asset attachments that may have been carried out in regard to the company’s bank accounts; and
  • the prohibition to modify or revoke administrative concessions and construction agreements that the company considers essential for its business (the Initiative does not distinguish whether it refers to public or private contracts).
• Tax claims would be given the treatment of common unsecured credits, and the resulting insolvency plan would be mandatory to the tax revenue service (SAT).

Notwithstanding the simplicity it seeks, the Initiative is inconsistent with the rule of law, given its failure to include basic legal definitions, leaving debtors and creditors with little assurance of legal protection and prohibiting appeals. The Initiative as currently drafted leaves open many questions regarding the emergency proceeding and its consistency with traditional notions of procedural due process embedded in Mexican law and jurisprudence. Furthermore, the attempted removal of several principles set forth in the Federal Tax Code would seem to materially affect the statutory preferences and the collection efforts of the federal tax authorities.

Congress has failed up to now to act on or even discuss the Initiative. It is probable that it may never be brought to the floor.

Finally, it is relevant to point out that the Initiative establishes that the Federal Judiciary Council will designate the district courts ‘with experience in insolvency proceedings’ in order for them to be designated as those specialised in proceedings under the emergency insolvency regime. However, very few district judges have the experience and the interest in handling insolvency matters. Notwithstanding the above comments, to the extent that the Initiative would be ever discussed in Congress – which, as mentioned, is uncertain – it could eventually lead to a potentially meaningful discussion of the many pitfalls existing in Mexican insolvency practice, and which must and should be addressed.

Given the sporadic interest in attending to the evident regression in concurso mercantil proceedings by the Supreme Court, as head of the federal judiciary, and the IFECOM, the prevailing use of delaying tactics, the lack of specialised insolvency courts and the uncertainty arising from several precedents as to the outcome for creditors and debtors in concurso mercantil, large Mexican corporates facing issues of illiquidity have turned during the covid-19 pandemic to an alternative for in-court restructurings: Chapter 11 in the United States.^[5]

It is noted in this respect that, as a matter of Mexican law, a business enterprise that is found to be generally in default with respect to its payment obligations will be declared commercially insolvent. The debtor, any creditor or, exceptionally, the Office of the Attorney General or the tax authorities may file for insolvency, to the extent that the formal notion of ‘being generally in default’ can be established (and only then).

The Insolvency Law establishes precise rules that determine when a debtor is ‘generally in default’. The principal indications or presumptions are the failure by a debtor to comply with its payment obligations in respect of two or more creditors, and the existence of the following two conditions: 35 per cent or more of its liabilities outstanding are 30 days past due; and the debtor fails to have liquid assets and receivables, which are specifically defined, to support at least 80 per cent of its obligations, which are due and payable.

Specific instances, such as insufficiency of assets available for attachment or a payment default with respect to two or more creditors, are considered by the Insolvency Law to be facts that by themselves will result in a presumption of insolvency.

In theory, the 2014 amendments allow the debtor to file for concurso if it can be anticipated that it will generally be in default with respect to its payment obligations or falling within either of the conditions leading to a presumption of insolvency, as mentioned above, within 90 days of the petition filing. On the other hand, involuntary filings have been largely unsuccessful because of the many formalities that must be met.

It is true that several sectors of the economy, and in particular the global aviation industry, have suffered severely from the impact of the pandemic. As of March 2020, several airlines from many countries were forced to restructure or cease operations, turning to Chapter 11 protection (17 in total). Aeromexico, the flagship airline of Mexico, was no exception in being harshly affected by the pandemic.

An initial issue was that, while experiencing a substantial cash burn because of a dramatic reduction in total passengers serviced domestically and internationally, at the time it considered filing for protection, it was nowhere near the parameters of formal insolvency established in the Insolvency Law as mentioned above, and indeed held a seemingly strong cash position. However, it was evident that insolvency was looming in the absence of a meaningful restructuring.

Aeromexico and its principal subsidiaries filed for Chapter 11 protection at the end of June 2020. Several factors had to be dealt with to successfully attempt and administer a Chapter 11 proceeding, among them (1) being current in its tax and labour obligations and (2) having the support of its unions.

Strategically, and considering that never in the history of bankruptcy filings in Mexico has any Mexican airline survived a concurso mercantil,^[6] Aeromexico filed for Chapter 11 protection. The case is ongoing but the features of an automatic global stay of creditor claims, the availability and obtention of debtor-in-possession (DIP) and exit financing,^[7] the ability afforded to pay critical suppliers and foreign vendors of pre-petition amounts and to continue business post-filing and the transparency and discipline process, have led to more predictable outcomes in the reorganisation efforts of Aeromexico – so far, a success.

It is noted, nevertheless, that Chapter 11 is generally substantially higher in costs, it leads to significant reporting and disclosure obligations, and it opens a US forum for claimants. One additional obstacle is that recognition of foreign proceedings in Mexico is not available, given the numerous flaws existing in the Mexican version of the UNCITRAL Model Law (i.e., Chapter 15).

Chapter 11 was also used as a meaningful restructuring tool in cases involving cinemas and, to a lesser extent, a large retailer.

In any event, while an avenue to be considered by large corporations, the use of Chapter 11 for Mexican companies remains, and will remain, an exceptional alternative for consideration in very specific and extraordinary instances.

In other developments meriting comment, as a corollary to covid-19, the pandemic has created dynamic opportunities for investment in distressed securities, in equities and, predominantly, in bonds. A key element is the fact that investors in Mexican securities that are in default or below investment grade, must consider specific knowledge as to the issuer and its principals, their reputation and their prior track records under economic stress. Sectors vary. Although potentially lucrative, deliberate investment in distressed bonds carries a significant level of risk as to recoveries, especially considering the weaknesses of judicial practice.

The liquidity in the financial markets, the effects of historically low rates of interest, coupled with the monetary policies of the central banks of the major economies, and the savviness of large institutional investors, such as hedge funds, private equity firms, investment banks and specialist firms, has led to a very active secondary market in distressed bond investment, and opportunities in Mexico. As an example, distressed assets are becoming the fixer-uppers of the commercial real estate sector. Investment in distressed real estate opportunities may climb to the top of the risks-rewards structure.

In general, it is anticipated that many opportunities in distressed assets will continue to emerge in the medium term, with a potential for significant returns, especially if the debtor is kept out of the tentacles of concurso mecantil, unless a pre-packaged option can be arranged.

Restructuring outcomes in Mexico

In recent years, with very few exceptions, concurso mercantil has failed as a reliable, predictable tool to implement successful solutions to preserve significantly sized corporations as going concerns, or as an efficient instrument to cause orderly and supervised liquidations that may preserve value for stakeholders.

The hundreds of successful major restructurings that have taken place outside concurso were predicated on establishing sound and informed relationships between borrowers and lenders, the formation of creditors’ committees in constant discussion of companies’ short-term and long-term expectations, and the importance of minimising costs, at a time when a company’s cash resources were in short supply.

It is noted that, in several successful restructurings, the principles of restructuring practices developed in the London corporate banking market with the support of the Bank of England (the London Approach) have served as informal guidelines to establish the basis for complex negotiations. Creditors and debtors have realised that it is in the interest of all stakeholders that businesses that offer a reasonable prospect of viability survive and that only those that by general consent are deemed hopeless cases, must be either sold or put into an orderly liquidation.

In the context of more recent out-of-court restructurings (OCWs), and while guidelines set forth in instruments such as the Insolvency and Creditor Rights Standard of the Financial Stability Board constitute a useful tool in addressing efforts to improve insolvency and restructuring practice, they have remained somewhat unattended. Restructuring practice has focused on OCWs, leaving on hold further advancement in legal structural reform.

As mentioned, in recent years, revising what many believe is an inadequate legal framework in the Insolvency Law, or efforts attending to a more robust functioning of commercial courts, on the one hand, or developing formal guidelines for OCW practices and procedures, has not been a priority for any of the branches of government. Specialist practitioners in the legal and financial markets have mainly taken a pragmatic approach, including in cross-border restructurings and insolvency matters, on a case-by-case basis.

In recent months, there has been a concerted effort led by the Mexican Bankers Association in developing consensual guidelines to promote orderly OCWs, establishing suggested practices such as the formation of creditors’ committees, recognising the respect of absolute priority among secured and unsecured creditors, creating a workable basis for standstills, setting forth the role of a lead bank and addressing other procedures to deal with cases of corporate financial difficulties.

On the other hand, as mentioned, while underlying the fact that a US bankruptcy proceeding is not generally available as a recommended alternative, the Chapter 11 filing of Aeromexico is heading towards a successful reorganisation. In any event, as a starting point, the airline has continued to operate with a positive prospective outlook for its continuing survival and growth. A principal reason for the positive outlook is that Aeromexico was able to arrange a US$1 billion DIP financing, in market terms and conditions (including a capitalisation option for the DIP lenders) for a debtor in a Chapter 11. DIP financing has been rarely available in Mexico. In addition, despite covid-19 conditions, no support of any kind has been, or is expected to be, provided by the current government to the private sector. On the other hand, the depth of the financial market in the United States regarding DIP financing is second to none, with many seasoned institutional participants. It is expected that a second exit financing will be negotiated in the coming months, contributing to the continuing success of the airline upon its reorganisation.

Sovereign restructuring

With an estimated growth in Mexico’s GDP for 2021^[8] of 5.2 per cent, in exports of 10.7 per cent, in private consumption of 8.3 per cent and a projected annual inflation of 5.5 per cent, and considering a manageable public deficit of 2.9 per cent and an average rate of exchange of 20.20 pesos (to the dollar), reflecting a commitment to fiscal discipline, albeit with little support to the private sector during the covid-19 pandemic, the three rating agencies – Fitch Ratings, S&P Global and Moody’s – have confirmed an investment-grade rating for all external debt of the United Mexican States. Despite the authoritarian populist policies of the current administration and its controversial investment in non-productive assets, such as refineries, a train project through what is left of a tropical forest and an ill-fated modest airport project, the relative stability of the Mexican economy and its resilience is expected to continue to sustain investment-grade rating for Mexico’s external foreign debt at least until 2022.

For close to 30 years, Mexico has steered away from any public sector restructuring. The dark cloud on the horizon is the continuing deterioration of Petróleos Mexicanos (Pemex), a productive state enterprise, entrusted constitutionally to guide the exploration, extraction, refinement and distribution of Mexico’s oil, gasolines and by-products, amid modest competition from the private sector. Because of the unconditional economic support given to Pemex by the government, any restructuring of a financial nature is not expected during the current administration, which ends its term in 2024.

A fundamental strategic economic area as defined in the Mexican Constitution is the exploration and exploitation of oil and other hydrocarbons. Specifically, the Constitution establishes that with respect to petroleum and solid, liquid or gaseous hydrocarbons found beneath the surface, the ownership and domain by the nation shall be absolute and, in consequence, statutes of limitations will not apply, and domain may not be waived in any manner.

To substantially contribute to the long-term development of the nation, the state is constitutionally instructed to explore and exploit oil and other hydro­carbons through field assignments made to productive state enterprises, or through contracts to be executed with such entities and private parties, in accordance with the applicable regulatory law.

Pemex is a productive state enterprise carrying out a precise mandate further to specific constitutional provisions. As such, Pemex, as a productive state enterprise (empresa productiva del estado) has its own detailed framework establishing the rules concerning its administration, organisation, functioning, corporate governance and economic regime.^[9] The Pemex Law (Ley de Petróleos Mexicanos) was enacted in 2014 by Congress because of the constitutional energy reform, and establishes the regime applicable to Pemex according to its legal status as a productive state enterprise. Pemex is not a corporation (not even a state-owned corporation) and its Law is a specific law regulating a constitutionally protected mandate established in the Constitution.^[10]

To summarise, Pemex is a productive state enterprise organised under the Mexican Constitution. It is governed by its own comprehensive legal regime (i.e., the Pemex Law), which applies to the business, operations and management of Pemex, and may not be placed voluntarily or involuntarily in a concurso mercantil.

Although a general restructuring is not anticipated any time soon, it should be expected that any material restructuring of Pemex bonds would involve the Pemex parties, the Ministry of Finance and Public Credit and the bondholder constituency (represented by one or more ad hoc committees), and, indirectly or directly, multilateral official creditors such as the International Monetary Fund or the Interamerican Development Bank, and other financial creditors (i.e., an ad hoc group of financial institutions that are creditors of the Pemex parties). Indicative restructuring scenarios would be presented and analysed, in a hypothetical situation, with the objective of pursuing perhaps not the ‘best’ restructuring but rather a restructuring that may be possible. Maturity extensions, coupon adjustments, potential guarantees by the government, debt relief, enhancements, use of US government-issued zero coupon bonds as principal collateral, contractual protections, financial covenants and events of default may be expected to come into play, should a restructuring effort arise. However, for now, these are only speculations.

Industry case studies for Mexico

The effects of the covid-19 pandemic are unfortunately enduring. There are several ongoing restructuring cases involving substantial amounts, which originated well before the pandemic and are currently either in unending litigation or in extended concurso proceedings with no end in sight, among them Oro Negro, Senda, Interjet and Oceanografía. None merits any special mention, other than the constant frustration by all stakeholders.

Perhaps by year, Aeromexico may become a valuable case study, hopefully completing a complex restructuring and survival as a going concern, through a Chapter 11 proceeding in the Southern District of New York.

Ongoing restructuring cases (mostly out-of-court) in the financial non-banking sector, entertainment, tourism and hospitality, telecommunications, retail commerce, the energy sector and broadcasting should come to an end in the next 18 months. Recovery is expected, to a great extent, to be driven by renewed demand (if government policies will allow). It is certain that valuable experience will be gained on conclusion of these cases.

What is expected, however, is that reorganisations undertaken in voluntary or involuntary concurso mercantil, unless a pre-pack option is included at the time of filing, will continue to pose challenges of gargantuan proportions to restructuring professionals, whether representing debtors, creditors or the board of directors.

Consensual restructurings will continue to be favoured over other alternatives. Mexican companies entered 2021 with tighter levels of liquidity. Undoubtedly, balance sheets will need to be right-sized to match more realistic business plans and cash flow projections. Yet from a different perspective, the current landscape will present many opportunities in the Mexican market to well-positioned corporations. Not only will financial restructurings bring about long-term support for business, but in many cases, positive operational turnarounds and improvements, which will result in greater efficiency and resilience.

Notes