Trends in Distressed Investing in Latin America

In this chapter we discuss certain trends in distressed investing in Latin America. We begin with an overview of the general historical trends in Latin America restructurings, then provide an analysis of the effectiveness of local law insolvency laws and survey recent corporate bond default and restructuring activity in Latin America. After these general topics, we briefly touch on several other issues of interest, including a focus on Argentina’s sovereign, provincial and cross-border corporate bond markets, increasing inter-creditor conflict and the recent use of Chapter 11 proceedings in Latin American cross-border insolvency. We conclude with a brief comment on the outlook for distressed investing in Latin America in the next couple of years.

General historical trends in Latin America restructurings

Following the ‘lost decade’ of the 1980s, the normalisation resulting from the introduction of the Brady Plans^[2] across Latin America allowed first sovereign and then corporate borrowers to begin to raise funding through the international bond markets. As always, with new lending comes debtors’ difficulties in meeting contractual payment terms leading to defaults and, by the mid-1990s, there had been several defaults on Mexican corporate bonds around the peso crisis of 1994, including Aeroméxico in 1994, Synkro in 1995 and the Grupo Sidek complex in 1996.^[3] In 1997, Grupo Mexicano de Desarrollo defaulted on its bonds, a case that eventually made its way to the US Supreme Court.^[4] The creditor responses to these defaults varied as the bondholders were unsure how to respond, and legal and financial advisory specialists in bankruptcy proceedings in the US and UK were not aware or equipped to provide the support needed by either debtors or creditors. Further, local jurisprudence regarding dealing with defaulted debt was at best outdated and at worst unworkable, with virtually no provision for a going concern resolution, and local practitioners and courts had no relevant experience in grappling with cross-border issues.

During the nearly 35 years since the first Brady Plans, there has been a significant institutionalisation of the reorganisation process for large, cross-border restructurings in the major countries in Latin America and indeed in many of the emerging markets. In terms of judicial processes, more modern restructuring regimes have been introduced, with Mexico’s Insolvency Law^[5] introduced in May 2000, Argentina’s amendments to the 1995 Insolvency and Bankruptcy Law^[6] and the introduction of the extrajudicial preventive agreement under Law No. 25,589 in May 2002, Brazil’s New Bankruptcy and Business Recovery Law^[7] in February 2005, Colombia’s Law 1,116 in June 2007 and Chile’s Law No. 20,720 on the Reorganisation and Liquidation of Companies and Individuals in October 2014. There were substantial revisions to the regime in Mexico in 2007 and 2014 and in Brazil in late 2020, with Mexico closing the intercompany payable loophole, Brazil permitting creditor plans to be submitted and strengthening asset sales mechanisms, and both introducing a form of debtor-in-possession (DIP) financing. It is not the objective of this short chapter to provide a summary of the major Latin American insolvency rules and procedures, as there are a number of articles and presentations that do that. For example, INSOL International put out a summary of various regimes in 2015.^[8] Many law firms have published their own version of the same over the years.

Also important to note is the introduction of Chapter 15 as an addition to the US Bankruptcy Code by the Bankruptcy Abuse Prevention and Consumer Protection Act of 2005. This was the United States’ adoption of the Model Law on Cross-Border Insolvency promulgated by the United Nations Commission on International Trade Law (UNCITRAL) in 1997, and it has become an integral tool in the reorganisation of large cross-border obligations involving international bondholders in Latin American corporations.

In addition to the changes in the laws governing insolvency resolution across many countries in the region, the procedures and infrastructure for responding to large corporate defaults have also become more established and refined. Creditors have become used to forming ad hoc groups comprising the larger stakeholders with an understanding of the need for collective action. Most debtors have recognised the benefit of having an organised creditor group with which to negotiate a resolution, and thus are prepared to support the process by funding the expenses for legal and financial advisers for both themselves and their creditors. Virtually all the global financial advisory and legal firms with a restructuring practice have dedicated practitioners focused on the region, several with local offices, and there are a number of international boutique firms with specialist expertise.

Analysis of effectiveness of local insolvency laws

All these legal updates and qualitative improvements have undoubtedly improved the prospects for creditor recoveries and the preservation of value of the estates of companies involved in large cross-border insolvencies. There have been at least a couple of attempts to quantify the effectiveness of the new restructuring regimes during the past few years.

The first example is the ‘Resolving Insolvency’ section of the World Bank’s Doing Business Survey. By documenting changes in regulation in 12 areas of business activity (including resolving insolvency) in 190 economies, Doing Business analysed regulation that encourages efficiency and supports freedom to do business. Only two African economies rank in the top 50 on the ease of doing business; no Latin American countries rank in this group.

Doing Business studied the time, cost and outcome of insolvency proceedings involving domestic legal entities. These variables were used to calculate the recovery rate, which was recorded as cents on the dollar recovered by secured creditors through reorganisation, liquidation or debt enforcement (foreclosure or receivership) proceedings. To determine the present value of the amount recovered by creditors, Doing Business used the lending rates from the International Monetary Fund, supplemented with data from central banks and the Economist Intelligence Unit. Summary results on the measures involved with Resolving Insolvency for the major Latin American countries are provided in Table 1, below.

Colombia and Mexico score reasonably high on the Resolving Insolvency score, ranking at 32 and 33 out of 190 countries (23 of which have no restructuring laws), with around the same score as Cyprus, New Zealand and Indonesia. Brazil (ranked at 77) has a similar score to those for Belarus, Afghanistan and Zambia, while Argentina (ranked at 111) is scored below Bolivia, Paraguay and Nicaragua.

Another relative analysis of the effectiveness of the local restructuring frameworks in connection with cross-border insolvency was published by Cleary Gottlieb in February 2020.^[10] The presentation reviewed Argentina, Brazil, Chile, Colombia, Mexico and Peru and provided an overview of the laws, key features, creditor issues and risks, key indicators, precedents and sources, a summary of the World Bank Doing Business data points and a Cleary ‘rating’. Colombia and Mexico were rated B; Argentina, Brazil and Peru were rated B-; and Chile was rated C.

Notwithstanding the improvements in the legal framework in several Latin American countries, the local judicial process is typically merely an implementation mechanism (often with a Chapter 15 filing) for a large cross-border restructuring. Getting to a successful reorganisation still usually requires an out-of-court negotiation between creditors, controlling shareholders and the debtor. Although defaulting debtors are increasingly comfortable using the protective aspects of concurso mercantil in Mexico or recuperação judicial in Brazil, the laws themselves do not provide a mechanism for establishing a resolution as there is no ‘absolute priority’ rule (as there is in the United States under Chapter 11) that establishes capital structure prioritisation, except in Colombia. A purely litigation approach in the courts is impracticable as the laws throughout Latin America do not typically provide rules to resolve the inevitable conflicts of interests of creditors as compared with shareholders, except in a liquidation. Specifically, a reorganisation plan in Brazil and Mexico cannot be agreed without shareholder approval, although the recent law changes in Brazil suggest that such approval will not be needed if a creditor plan is filed and receives the requisite creditor approvals. Accordingly, the informal mechanism of having an ad hoc creditors group negotiating with the company and its shareholders to find a solution that can get the requisite majority approvals remains the standard operating procedure.

Recent corporate bond default and restructuring activity

With the exception of 2020, the past five years have been relatively quiet for Latin American corporate bond defaults. Although 2021 and the first seven months of 2022 have been very active in global emerging markets, Latin America has not seen a similar level of new defaults. This activity level is summarised in Table 2, below. The emerging markets (EM) corporate distressed market was very quiet in 2018 and 2019, with only about US$11 billion in corporate bond defaults or distressed exchanges each year owing to the loose monetary policies and strong growth being enjoyed across the globe. However, with the onset of the covid-19 pandemic, defaults jumped to US$27 billion and 50 issuers in 2020; Latin America represented about 35 per cent of the total in number and amount. The number of EM corporate bonds defaulting doubled in 2021. These were centred in Asia, as the Chinese property market came under severe stress. This idiosyncratic manifestation has continued in the first third of 2022, with further Chinese property company bond defaults and an increasing number of Russian corporate bond defaults owing to the payment system sanctions being imposed as a reaction to the military conflict in Ukraine.

According to data compiled by JPMorgan, the 2021 corporate bond defaults in Latin America represented 2.5 per cent of the total stock of high-yield debt as of the prior year’s close, compared with 4.4 per cent in 2020. During the past 15 years, that default rate has been below 4 per cent each year except for 2008 (4.3 per cent), 2009 (5.7 per cent), 2013 (10.6 per cent), 2014 (6.5 per cent), 2015 (5.7 per cent) and 2016 (9.2 per cent). The global EM corporate high-yield default rate was at 7.1 per cent in 2001 (13.2 per cent in Asia), with other peaks of 10.5 per cent in 2009 (16.4 per cent in EM Europe) and 5.1 per cent in 2016 (9.2 per cent in Latin America).

There has been more than US$25 billion in corporate bond defaults in Latin America since 2018, with cases spread across industries in Argentina, Brazil and Mexico, and a smattering in Chile, Colombia, Ecuador and Jamaica. A few themes emerge. In Argentina, there was significant pressure on the private sector because of the sovereign default, power sector politics and the currency devaluation. We discuss some additional issues below. In Brazil, there were continuing issues in the construction and sugar industries. In Mexico, there have been problems in the non-bank financial institutions sector, in oil services and with some legacy defaulters.

Argentina: the gift (to legal and financial advisers) that keeps giving

During the past 50 years, the Latin American and Caribbean regions have experienced at least 50 sovereign debt crises and sovereign debt restructurings across 20 countries.^[13] In 2020, owing to the economic and fiscal pressures resulting from the covid-19 pandemic, five EM countries defaulted on their debt: Argentina, Ecuador, Lebanon, Suriname and Zambia.^[14]

Since independence from Spain in 1816, Argentina has defaulted on its sovereign debt nine times, and it stands out among global serial defaulters. Its most recent default was on 22 May 2020 when the country missed a payment to its bondholders in the midst of inflation at more than 50 per cent and dwindling reserves. By September 2020, Argentina reached an agreement to restructure around US$65 billion in foreign bonds and more than US$40 billion in foreign currency debt issued under local law, with international bondholders, led by Black Rock, agreeing to an exchange at 55 per cent of par. In January 2022, Argentina agreed to a deal with the International Monetary Fund to restructure US$44.5 billion of debt that had resulted from the US$57 billion that Argentina had borrowed in 2018 under a previous government. As part of the agreement, Argentina agreed to reduce its primary fiscal deficit gradually from 2.5 per cent of gross domestic product (GDP) to 0.9 per cent in 2024. Central bank money printing to finance the deficit would slow to 1 per cent of GDP in 2022 (down from 3.7 per cent in 2021) and then ‘close to zero’ in 2024.

In addition to the sovereign debt restructurings, 11 Argentine provinces restructured approximately US$12.6 billion in cross-border bonds in 2020 and 2021. The restructuring transactions provided significant liquidity relief to the provinces amid the pandemic and the recession across the country. No haircuts were either imposed or negotiated but liquidity relief was provided through the reduction in coupons and extension of the maturity profiles. A total of 24 separate bonds were restructured; all but two of the bonds (consisting of US$166 million in principal issued by the province of Buenos Aires) were restructured under collective action clauses, eliminating holdouts.

The cross-border corporate bond sector has also been affected by local financial problems and government responses to preserve reserves and mitigate pressure on the currency. Pursuant to Communication A 7106 dated 15 September 2020, the Argentine Central Bank tightened currency controls. According to the new regulation, private sector companies and financial institutions were required to reprofile at least 60 per cent of any payment of principal scheduled between 15 October 2020 and 31 March 2021 on any external financial debt (other than intercompany debt) and dollar-denominated local securities offerings, a requirement that has been extended several times. A somewhat similar debt repayment moratorium had been imposed by the government in the aftermath of the currency peg termination and the government debt default in 2001, although the restriction prohibited all repayments owing to the depth of the crisis. As generally occurred in the early 2000s, the large corporate sector is now restructuring its obligations at non-hostile terms but within the limitations imposed. Companies such as Genneia, Edenor, Cresud, GEMSA, IRSA, YPF, CGC, Mastellone, YPF Luz, Telecom, Aeropuertos 2000, CLISA, MSU Energy and others have refinanced their maturities in line with Communication A 7106, with an estimated US$5.3 billion transferred abroad to repay debt.^[16]

Increasing intercreditor conflicts

Traditionally, out-of-court debt restructurings in the United States have been mostly consensual and collaborative. During the past five to six years, however, there have been a number of hostile, aggressive, non-consensual restructuring transactions that have been to the benefit of the company and only a subset of active creditors to the detriment of the broader non-participating creditor group. The techniques vary but rely on hyper-technical interpretations of the debt agreements. One increasingly popular hostile restructuring method involves issuing new debt that enjoys higher priority than the existing debt (uptiering), while another involves transferring valuable collateral away from existing lenders to secure new borrowing (drop-down). In both cases, active creditors participate by acquiring advantaged security for cash or their existing holdings (or both). Unlike a normal out-of-court restructuring, which may use legal mechanisms to coerce minority holdouts to participate and receive equal treatment, the transactions are designed to prime the otherwise pro rata interests of the members of the lender group that are not allowed to participate in the new debt.^[17]

These kinds of actions, referred to as ‘creditor-on-creditor violence’ by data provider Covenant Review,^[18] have arisen largely because of the lax protections in ‘covenant-lite’ debt documentation that has proliferated in the past decade in the time of loose monetary policy. An article published on the Institutional Investor website referenced TriMark, Serta and Boardriders, all of which completed similar uptier exchanges in 2020, under which a majority of first lien lenders consented to amendments providing them with super-priority debt capacity. Those consenting lenders exchanged their first lien term loans through prearranged ‘open market’ purchases for that new super-priority debt, although the last two of these transactions remain in litigation. In each case, the trans­actions subordinated minority first lien lenders who were not offered the chance to participate in the exchange. Drop-down (also known as ‘trap-door’) cases include the unrestricted subsidiary intellectual property transfers championed by J.Crew in late 2016 and copied by PetSmart in 2018 and Travelport in 2020, effectively moving a significant amount of valuable collateral to support new lenders.

During the past 25 years or so of EM restructurings, with restructuring terms negotiated out of court, ad hoc creditors’ committees generally have been seen to act on a consensual and collaborative basis. The outcome has been such that pari passu creditors would be treated pro rata without discrimination to the detriment of debt providers in a similar situation. With most EM bonds structured as unsecured debt, the focus of the international creditors’ committees would typically be to act in concert to increase their negotiating leverage with the debtor. For corporate bonds, with so many EM companies being family-controlled, this would involve negotiation of the value allocation between creditors and the shareholders (who, traditionally, were rarely impaired despite the fact that, on both a nominal and a net present value basis, creditors were typically providing considerable concessions so as to permit an enterprise to be viable and thus successfully restructured). In the sovereign context, negotiations were often triangular, with creditors on the one hand, government officials (with a political agenda) on a second, and multilateral and bilateral agencies (often unwilling to accept haircuts) in the third corner. In both corporate and sovereign situations, for the most part, the creditors’ focus was on negotiating for as much of the relative value to accrue to the benefit of the creditors instead of to the shareholders or the government and multi­laterals; to use a metaphor, they were focused on increasing the size of the pie for all creditors, not fighting over how the pie should be sliced to get a bigger piece among the creditors.

Similar to the situation in the United States, a few instances of a more hostile restructuring approach have been evident in the past couple of years, perhaps as more of the traditional US distressed funds have begun to get involved or even dominate the creditor constituencies in Latin American bond defaults. This is not the old-fashioned holdout problem, such as Elliott’s 15-year saga with Argentina (which was finally resolved in 2016). Rather, a prime example of a ‘hostile restructuring’ involved Digicel, a Jamaica-based telecommunications company, which announced it was restructuring out of court its nearly US$3 billion of bonds on the Friday evening of the US Labor Day weekend in 2018. Although the company had a complex multi-tiered debt stack, there were two bonds at the holding company level that were pari passu but with different maturities: US$2 billion 8.25 per cent notes due in 2020 and US$1 billion 7.125 per cent notes due in 2022. Although a single bondholder group was formed, it became apparent as the good faith internal discussions progressed that a subset of the group led by Davidson Kempner (DK) (which was primarily invested in the ’20s) was negotiating behind the scenes with the company for preferential treatment to the detriment of the ’22s, which were mainly held by traditional EM bond investors, including Amundi, Argentem Creek, Doubleline and Gramercy. Instead of pushing for more concessions from the shareholder, the DK group arranged that the ’20s would exchange half of their exposure for a new US$1 billion note issued by DGL1 (an intercompany holdco supported by the company’s valuable operations in Papua New Guinea), priming the ’22s. The balance of the ’20s and all of the ’22s would be exchanged for the new note at DGL2, structurally subordinated to DGL1, provide a payment-in-kind option and extend their maturities respectively by two years each. DK was able to convince the single largest bondholder, Ashmore, with very significant exposure across the entire capital structure, including both ’20s and ’22s, to support the transaction, and the ’22s were unable to block the transaction unless they were willing to jeopardise the entire enterprise by doing an involuntary bankruptcy filing. The transaction was completed in January 2019, although there have been multiple subsequent restructurings. There have also been ramifications for the company and its shareholders as, in late 2021, ‘Fitch warned that Digicel’s “aggressive corporate governance” in pursuing debt restructuring deals in the past two years “remains a constraint” on the upside for the ratings’^[19] and thus its ability to refinance debt.

Another example is the situation with Brazilian telecommunications company Oi SA (Oi) and certain of its subsidiaries involving nearly US$15 billion in financial debt, including approximately US$10 billion in New York and English law-governed bond debt. With its recuperação judicial filed in June 2016, it was the largest corporate restructuring in the history of Latin America and the first truly public Brazilian company to go through judicial restructuring since Brazil reformed its insolvency laws in 2005. Certain intercompany claims by Dutch finance vehicles used to issue certain of the Oi bonds became the focus of a group of bondholders known as the International Bondholder Committee (IBC), who sought to use the existence of these intercompany loans to improve the recoveries of creditors of the specific finance entities and, thus, their bonds. The strategy manifested itself in litigation in the Netherlands, Brazil and the United States, whereby they sought to have the Chapter 15 court recognise the Dutch proceeding as the centre of main interests (COMI) and give the Dutch judicial administrator the power to block the Chapter 15 court from enforcing a reorganisation plan confirmed in Brazil. Oi, supported by the steering committee of an ad hoc group of bondholders (the AHG steering committee), opposed the request. The bankruptcy court for the Southern District of New York issued an opinion in December 2017 against the COMI shift. Ultimately, the IBC and the AHG steering committee agreed that their respective claims would receive pari passu treatment, which helped to cement a coalition of creditors to negotiate a consensual restructuring with Oi. Also in late 2017, and immediately following some particularly egregious actions by the minority controlling shareholders and their board representatives, the AHG steering committee and the IBC were successful in their motion seeking to remove the voting rights of two minority, but effectively controlling, shareholders and their board members in response to their abusive actions, and the plan was confirmed by the Brazilian restructuring court in January 2018.^[20]

There have been a variety of other types of inter-creditor conflicts, in part because the issuance market has created levels of complexity that certain investors have found ways to exploit. Latam Airlines’ restructuring featured conflicts between international and domestic creditors. Another area has been DIP arrangements, whereby certain creditors have excluded others in providing financing at very favourable terms, a situation seen in the case of Mexican non-bank financial company Alpha Credit with its Colombian assets. Furthermore, in the case of Puerto Rico, there was not only the intercreditor conflict between the treatment of general obligation (GO) and tax-receipt (COFINA) bonds, but also litigation regarding the validity of certain of the GOs on the grounds that their issuance exceeded a territorial constitutional debt limit. We should expect to see more and more of this type of creditor partisanship as global distressed investors gain more experience in EMs and become more comfortable with employing the same strategies across borders.

Recent use of Chapter 11 in Latin American cross-border insolvency

An interesting phenomenon has been the recent use of Chapter 11 procedures to resolve Latin American cross-border insolvency. Chapter 11 as a restructuring option is covered in far greater detail in Chapter 4 of this Guide and the challenge of getting DIP financing is addressed more completely in Chapter 13, but the topic bears comment in this brief survey.

Until recently, Chapter 11 has been shunned by Latin American corporate bond issuers either in or about to default, in large part because so many remain family-controlled companies. Given the absolute priority rule, their shareholders have been loath to risk putting their patrimony in jeopardy by going through the US courts. However, during the past couple of years, there have been a number of high-profile restructurings through Chapter 11, including Aeroméxico, Alpha Credit, Maxcom and Posadas from Mexico; Latam Airlines and Alto Maipa from Chile; Avianca from Colombia; and Stoneway from Argentina. Without going into great detail, there are at least three main reasons for this.

• Certainty of outcome: Based on common law and with numerous precedents in handling a wide range of complications, Chapter 11 offers a dependable outcome with little chance of surprises, unlike local law proceedings. The sophistication of the judges in these specialist courts adds to the certainty. A pre-packaged reorganisation plan with sufficient votes can be concluded in 30 to 60 days. Furthermore, for example, the resolution of an insolvency under concurso mercantil in Mexico is still subject to constitutional challenges (amparos) as was seen with cases such as GEO, Urbi and ICA.
• DIP financing: Although both Mexico and Brazil have introduced DIP financing in their insolvency regimes, they are untested and still effectively require the ability to isolate specific unencumbered assets of sufficient value to support the new money. DIP lenders under Chapter 11 enjoy a first-priority lien on substantially all the assets of the estate and the highest priority claim against the estate.
• Rejection of uneconomic contracts and leases: Chapter 11 permits a debtor to reject any contract or unexpired lease if the company determines it is non-economic or non-essential under its business plan going forward.

The certainty of outcome by going through Chapter 11 was an essential element for all the above-mentioned restructuring cases. The access to DIP financing was crucial in the restructuring of the aforementioned airlines and for Alpha Credit. The airlines also needed to be able to right-size their operating overheads to adjust to the effects of the pandemic by reducing labour and fleet costs. The flexibility of a Chapter 11 pre-pack, for example, being a fall-back implementation mechanism to bind creditors to a plan if a voluntary exchange gets more than 67 per cent consent but not the 95 per cent or more approvals usually sought, is attractive, and was used by CLISA in its extrajudicial preventive agreement.

Outlook for distressed investing in Latin America

As at the end of 2021, according to JPMorgan, US$356 billion of non-investment grade bonds issued by Latin American corporates were outstanding, with US$50.5 billion of high-yield corporate bonds newly issued in 2021 alone. This compares with US$1.049 billion of non-investment grade bonds outstanding for high-yield corporates across all EMs, with US$196 billion of high-yield corporate bonds issued in 2021. Stifel estimates that, as at the beginning of 2022, there were corporate bond maturities for non-investment grade Latin American issuers of US$38.5 billion in 2022, US$29.1 billion in 2023, US$26.8 billion in 2024, US$30.4 billion in 2025 and US$37.3 billion in 2026. These US$152 billion of high-yield corporate bonds will need to be refinanced during the next five years in the context of markedly higher interest rates than have prevailed during the past decade and in an economic environment that is likely to be under strain from supply chain disruptions, significant inflation and high energy prices, as well as political volatility. There is a good prospect for these pressures to lead to significant financial disruption in the region, resulting in distressed investing opportunities and the need for creative restructuring solutions for several years to come.

Notes