This article analyzes the complex and emerging Mexican regulation governing the acquisition of distressed businesses. In some sections, it engages in a comparative analysis with Spanish bankruptcy law for purposes of analyzing the challenges that the acquirer would face, before or during the different stages of the bankruptcy process under Mexican law.
Article One of the Mexican Bankruptcy Law (Ley de Concursos Mercantiles, "Bankruptcy Law") cites the tension between the public interest in preserving bankrupt companies and the public interest in protecting the creditors of companies in general default of their payment obligations. Given the significant social and economic burdens associated with these conflicting interests, distressed mergers and acquisitions ("M&A") transactions may offer creative solutions that traditional debt restructuring is unable to deliver. Specifically, distressed M&A transactions may present an efficient solution that is attractive to both the company and its creditors because it preserves the business and saves jobs while also seeking to maximize creditor recovery. Despite the merits of a distressed M&A strategy, the Bankruptcy Law offers no clear rules concerning the different methods and mechanisms for disposing of assets of a company that is undergoing a bankruptcy process aside from the overriding principles of the preservation of a going concern (in the reorganization stage) and value maximization (in the liquidation stage).
This article seeks to analyze the complex and emerging Mexican regulation governing the acquisition of distressed businesses. In some sections, the article discusses the problems that the acquirer would face under Mexican law, before or during the different stages of the bankruptcy process, through a comparative analysis with Spanish bankruptcy law. Countries such as the United States (with the sales procedure provided in Section 363 of the U.S. Bankruptcy Code) and the United Kingdom (and its pre-pack administration rules) provide guidance to establish clear rules regarding the sale of business assets to maximize creditor realization in a bankruptcy scenario. However, as Spain and Mexico are both civil law jurisdictions, Spanish law better navigates the interplay between the bankruptcy regime and other complementary civil law regulations.
While in Mexico a business is generally acquired through either the purchase of the shares of the company that owns such business or the purchase of the assets that make up the business, a share purchase is rarely a viable alternative for a distressed company because the buyer would directly acquire all of the assets and liabilities of the company in question (whether known or unknown) and not only those that are of its interest.
Additionally, the sale of the shares of the bankrupt company is not an alternative that offers solutions in an insolvency situation since the shareholder and not the company would receive the proceeds of the sale. Therefore, it is unlikely that a sale of the bankrupt company's shares would help to meet the goal of rescuing the bankrupt company. Accordingly, this article only analyzes the second of these alternatives: namely, the sale of assets.
The sale of assets of a company going through financial hardship can take place in four different time frames:
- In the vicinity of insolvency;
- During the reorganization stage;
- During the execution of the reorganization plan; and
- During the liquidation stage.
This article analyzes each of these stages and explain both the advantages and disadvantages of disposing of the bankrupt company's assets under the Mexican legal framework.
DISPOSING OF ASSETS IN THE VICINITY OF INSOLVENCY
Avoidance Powers Rules
There is no de facto prohibition on the sale of distressed assets owned by a business close to insolvency under the Bankruptcy Law. However, the main risk that any acquirer of such assets would face is the related asset purchase agreement being considered a fraudulent transaction and, therefore, being set aside (i.e., ineffective vis-à-vis the bankruptcy estate). Bankruptcy Law on fraudulent conveyance is focused on overturning past transactions to which the insolvent debtor was a party or which involved the debtor's assets whose consummation is found to be prejudicial to the debtor (i.e., a reduction to the net value of its property).
The retroactive period is the period that begins 270 days prior to the bankruptcy declaration. Such a period may be extended to an earlier date by the judge, at the request of the conciliator (conciliador), the receiver (síndico), the conservators (interventores) or any creditor, provided that:
- The facts invoked by the abovementioned persons fall within any of the circumstances set forth in Articles 114 to 117 of the Bankruptcy Law (providing the relevant documentation);
- The requested extension date does not exceed three years prior to the bankruptcy declaration; and
- The request is filed before the issuance of the debt recognition, priority, and ranking ruling.1
Some types of transactions carried out prior to the bankruptcy declaration can be set aside. The transactions subject to avoidance can be grouped in four categories:
- Per se fraudulent transactions;
- Cases of constructive fraud;
- Objective preferences; and
- Subjective preferences.2
Per se fraudulent transactions are those that a company carries out before the bankruptcy declaration, intentionally defrauding creditors if the third party that participated in the transaction had prior knowledge of such fraud. Pursuant to Article 113 of the Bankruptcy Law, all per se fraudulent transactions are avoidable, regardless of the time when they were carried out. On the other hand, the other types of transactions subject to avoidance (cases of constructive fraud, objective preferences, and subjective preferences) are avoidable only if they are carried out within the retroactive period.
The Bankruptcy Law sets forth a series of iuris et de iure and iuris tantum presumptions regarding which types of transactions are carried out as creditor fraud if they were carried out following the retroactivity date. Pursuant to Article 114 of the Bankruptcy Law, the following are conclusively presumed to be fraudulent (without admitting evidence to the contrary):
- Gratuitous transactions;
- Transactions under which the debtor pays consideration of a substantially higher value, or receives consideration of a substantially lower value than that of its counterparty;
- Transactions in which conditions or terms significantly differ from then-prevailing market conditions or trade usage or practices;
- Any debt remission made by the debtor;
- Any payment of un-matured obligations; and
- The discount of debtor's payables by the same debtor.
These circumstances of presumptively fraudulent transactions, where no evidence to the contrary is admitted, constitute a limited list of transactions subject to being voided since the article in question does not provide a section that causes us to assume the existence of other acts that are analogous to those mentioned above.
Furthermore, Article 115 of the Bankruptcy Law sets forth certain iuris tantum presumptions with respect to fraudulent transactions carried out following the retroactive date, which are based on granting objective preferences to certain creditors with respect to others. Thus, under the article in question, the following are presumptively fraudulent transactions: (i) granting of collateral or additional collateral if not initially contemplated in the transaction documents, and (ii) payments-in-kind if such method of payment was not originally agreed to in the transaction documents. Likewise, Articles 116 and 117 of the Bankruptcy Law set forth other iuris tantum presumptions concerning fraudulent transactions, which, unlike Article 115, are based on granting subjective preferences to related parties of the debtor. Article 116 lists the presumptive fraudulent acts if the bankrupt company is an individual debtor, while Article 117 lists the fraudulent acts concerning an entity debtor.3
The three aforementioned articles set forth presumptions that admit evidence to the contrary, therefore, it will correspond to (i) the bankruptcy specialists or of any interested party, to provide evidence regarding the facts related to the circumstances in question, and (ii) the third party with which the bankrupt company entered into an agreement during the retroactivity period, to prove its good faith, to be able to disprove the iuris tantum presumption of creditor fraud.
In addition to the authority granted to Mexican bankruptcy judges to set aside fraudulent transactions under the Bankruptcy Law, civil judges have an authority to set aside transactions based upon a definition of civil law insolvency focused on a debtor's balance sheet (i.e., the sum of the debtors' property and collection rights, estimated at their fair value, are less than the sum of its debts).
In the law, insolvency is understood as the status of assets vis-à-vis liabilities, when the former is insufficient to pay the latter . . . ceasing payments does not always entail insolvency, since it may occur without the latter occurring . . . a company may cease its payments not because its assets are insufficient to pay its liabilities, but rather because, due to certain circumstances, which are quite frequent nowadays, it lacks the cash to do so. Lacking cash is not the same as being insolvent.4
Accordingly, as the civil standard differs, a debtor may be insolvent under civil law, regardless of whether it may also be declared in bankruptcy under the Bankruptcy Law.
Civil law courts have authority to nullify transactions carried out by the debtor to the detriment of its creditors under the following claims:
- Creditor fraud claim (actio pauliana);
- Nullity claim due to simulation (acción de nulidad por simulación); and
- Subrogation claim (acción oblicua).
Of these three types of claims, only the first one is relevant for the case of disposing of assets of a distressed company. According to the provisions of Article 2163 of the Mexican Federal Civil Code, for a transaction to be deemed to detriment the creditor and rendered unenforceable, it must render the debtor insolvent. Therefore, not all acts that are detrimental to creditors will be deemed to give rise to creditor fraud for purposes of the actio pauliana, but rather only those that produce (or increase)5 the insolvency of the debtor.
Additionally, unlike the Bankruptcy Law, for the actio pauliana to be admissible, the following conditions must be met:
- The debtor must have entered into or performed an actual (not simulated) transaction;
- Such voidable transaction shall cause or increase the debtor's insolvency;
- The rights on which the plaintiff 's claim is based must precede in time the voidable transaction; and
- Both the debtor and its counterparty acted in bad faith.6
Furthermore, pursuant to Article 2175 of the Federal Civil Code (Código Civil Federal), the transaction would only be void vis-à-vis the creditor plaintiff for an amount up to the amount of its credit.
Regime Applicable to Executory Agreements
Mexican legislators consulted the United Nations Commission on International Trade Law's ("UNCITRAL") legislative guide on insolvency law in determining the treatment to be given to agreements entered into by a bankrupt company prior to the declaration of bankruptcy, both in light of the special law that governs each of the specific agreements, and the different factors that may justify interrupting their enforcement. The UNCITRAL legislative guide specifically provides that, to achieve the objectives of maximizing the value of the estate and reducing liabilities, it is fundamental that the bankrupt company be able to (i) preserve all agreements that are beneficial to it, and (ii) set aside all agreements that are burdensome to it (i.e., those where the ongoing cost of performance exceeds the benefit to be derived from the agreement).
According to the Bankruptcy Law, as a general principle, the declaration of bankruptcy does not affect the enforceability of an executory agreement, unless the conciliator sets it aside on the grounds that it is in the best interest of the estate.7 Any party to an executory agreement with the debtor shall be entitled to request that the conciliator determine whether he will allow or set aside the agreement. If the conciliator allows the agreement to continue, the debtor must perform or guarantee performance thereunder. If the conciliator sets aside the agreement or does not provide an answer within 20 business days, the debtor's counterparty may thereafter, declare the early termination of the agreement by giving notice thereof to the conciliator.8 The 20-day term balances, on the one hand, the conciliator's need to complete a thorough analysis of any agreements pending enforcement with the need for the debtor's counterparties to receive a definitive response from the conciliator.
The authors consider that the 20-day silent accession rule must provide an exception in cases where there is an ongoing distressed M&A strategy and there are bidders subject to a process to acquire the assets of the business as a going concern. If the 20-day term proves too short to allow the conciliator to objectively evaluate his decision with respect to a particular contract and there is an ongoing distressed M&A effort, the debtor counterparty should not be permitted to terminate it and potentially render the business less attractive to potential bidders because it is left without an agreement that may potentially be critical to operating as a going concern.
Additionally, the Bankruptcy Law denies the effectiveness of the so-called ipso facto or automatic termination clauses as a result of the filing of a petition or demand for, or the declaration of bankruptcy, making them inapplicable to the bankrupt company if it were determined that its application would worsen the financial condition of the debtor.9 While disallowing ipso facto or automatic termination clauses goes against the general principles of Mexican contract law and may increase transaction costs due to the negotiation of alternative contractual protections, it is undoubtedly crucial to a successful bankruptcy proceeding. The Bankruptcy Law does not recognize claims by creditors adversely affected by the ineffectiveness of their contractual ipso facto protections for demonstrated damages or losses resulting from the continued contractual performance after a bankruptcy declaration.
1. See precedent VI.1o.C.133 C, which is published in the Federal Weekly Judicial Gazette, Ninth Period, Volume XXX, October 2009, page 1507, titled: "BANKRUPTCY. REQUIREMENTS TO DECLARE THE INCIDENTAL PROCEEDING OF AMENDMENT TO THE RETROACTION DATE ADMISSIBLE."
2. Sepulveda, Eugenio, et. al. Mexican Legal Framework of Business Insolvency. White & Case, 2011, p. 43.
3. Pursuant to Article 116 of the Bankruptcy Law, related parties of an individual debtor include (i) his or her spouse, concubine, blood relatives up to the fourth degree, in-law relatives up to the second degree, and adopted relatives, and (ii) legal entities in which the debtor or any of the persons mentioned in (i) is the manager or director, or directly or indirectly, together or alone, hold rights that enable them to exercise the vote with respect to more than 50 percent of the capital stock, or have decision-making powers at the shareholders' meetings, are entitled to appoint a majority of the directors or are otherwise entitled to make fundamental decisions for such entities. Additionally, pursuant to Article 117 of the Bankruptcy Law, related parties of an entity debtor include (i) the manager, directors or relevant employees of the debtor or of its related parties; (ii) the spouse, concubine, blood relatives up to the fourth degree, in-law relatives up to the second degree, and adopted relatives of a manager or director; (iii) individuals who directly or indirectly, together or alone, hold rights that enable them to exercise the vote with respect to more than 50 percent of the capital stock of the bankrupt company or of its related parties or that have decision-making powers at its shareholders' meetings, are entitled to appoint a majority of its directors or are otherwise entitled to make fundamental decisions for such entity; (iv) entities sharing managers, directors or principal officers; and (v) entities that control, are controlled by or are under common control of the debtor.
4. PALLARES, Eduardo, Tratado de las Quiebras, Editorial Porrúa, México, 1937, pp. 58 and 59.
5.See precedent I.9o.C.58, which is published in the Federal Official Weekly Gazette. Ninth Period, Volume IX, May 1999, page 985, titled: "CREDITOR FRAUD ACTION. NOT ONLY INSOLVENCY MAKES IT ADMISSIBLE, BUT ALSO THE AGGRAVATION OF THE ALREADY EXISTING INSOLVENCY."
6. Bad faith consists of the knowledge of insolvency.
7. Arts. 86, 92 of the Bankruptcy Law.
8. Art. 92 of the Bankruptcy Law.
9. Art. 87 of the Bankruptcy Law.
Originally published by Practical Journal Bankruptcy Law.
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