The Beginning of the Problem

It is common that financial problems arise in companies as the result of financial mismanagement, operational decisions, sectoral threats, or changes in economic cycles. These problems can lead companies to default on their payment obligations.

This situation of widespread failure is what is known as “insolvency,” and its treatment should be extraordinary because it is a situation that is also extraordinary and because it refers to the entire universe of legal situations of a company in this situation. Laws that deal with insolvency are called insolvency laws, bankruptcy laws, or similar titles. In the case of Mexico, the law is called the Ley de Concursos Mercantiles (Bankruptcy Act).

The increase in nonperforming loans—which often lead to bankruptcy—affects the development of the economy as a whole—from production processes to distribution and consumption—because it alters the flow of funding and, ultimately, causes a decrease in social welfare. The increase in overdue loans produces two other negative effects: the increase in the cost of financing for borrowers who bear the risk of those not meeting their obligations, and an astringency in the flow of credit because financial lenders have less incentive to provide resources and therefore increase the requirements for loans.

Relevance of a Global and Orderly Strategy

Debt restructuring is a financial mechanism through which the terms of financial commitments (acquired by granting credit or by suppliers of goods and services and others) are modified. Such modifications usually comprise the term and interest rate, increased guarantees, and access to other sources of liquidity, among others, as financial engineering can provide many tools.

Restructurings can be achieved through bank financing, financing through bonds or debt instrument, business combinations and joint ventures, and through a process of restructuring of the accounting assets. Any of these restructurings may occur within a bankruptcy proceeding or outside it. As a preventive measure, restructuring is an important mechanism within the economy that allows agents to have a better management of their strategies and resources to avoid insolvency. The bankruptcy procedure is designed to ensure that the reorganization is an essential part of the same. The use of bankruptcy proceedings is not, however, the only measure that companies can use; informal groups can be assembled, direct negotiations with creditors, use of financial advisors, and use of professional mediators are among the other possible tools. In some jurisdictions such tools have received formalized legal treatment.

The first step in determining whether a restructuring is possible is to detect whether the company is viable; if a company’s liquidation value is greater than its value as a going concern, it is considered nonviable. In that case, the best solution may be to close that business and do it as quickly as possible because the value of assets tends to decrease rapidly as time passes.

In the case of a company that reaches insolvency, this is a decision that must be taken during the first stage of the procedure: the conciliation. This is the point where the conciliator, together with the merchant debtor and creditors, must arrive at a business plan that will allow the continuity of the company. If the conclusion is that the company is not viable, it will have to pass to the stage of bankruptcy, where the assets of the company will be liquidated to make the best-possible payments to the creditors. In fact, this analysis should be done prior to the commencement of insolvency proceedings to allow either preparation of a prepackaged agreement or definition of the lines on which the conciliation shall elapse; otherwise, it will be necessary to go directly to the stage of bankruptcy and liquidation.

Normally, restructuring includes a requirement that all creditors, including commercial banks, waive their right to demand forced recovery of defaulted payments. This would be in exchange for the debtor (or creditor) agreeing that the debts in question will be repaid according to a new agreed-upon program (Stein and Luis 2011).

As a rule, it is much easier for both parties, in the process of debt restructuring, to follow the legal proceedings. The procedures seem to be easier and more controllable by the debtor. If creditors were obliged to always go to judicial authorities to obtain payment of their claims, without being able to opt for another choice but to classify the loan as uncollectible, the financial institutions’ operating costs would rise extremely, thus producing a shortage of credit, which will be costly, in the end, to those debtors that pay their loans.

When companies become insolvent, creditors have three possible ways forward: the use of ordinary judicial mechanisms for forced payment, invoking the insolvency law, or using extraordinary mechanisms implemented by the government to help to resolve a crisis. A thorough examination of those three possibilities show:

• Ordinary mechanisms are insufficient.

• The state design and implementing mechanisms and special programs designed to address a crisis situation should be the last resort to use.¹

• The solution should be a system of legal treatment of insolvency to allow the restructuring of liabilities of enterprises, reintegration of their assets in the economy, and the maintenance of the jobs and the gross domestic product. This can be accomplished either through the use of judicial or administrative means.

A global strategy, if we are not talking about a systemic crisis, should include a system providing the following:

• If companies are not viable, there is an ability to sell them very quickly in order to preserve assets before they lose more value.

• If companies are viable, there is an ability to restructure them expeditiously, if necessary, by facilitating the post-bankruptcy financing of the enterprises that remain in operation (known as debtor in possession [DIP] financing).

Another measure in the strategy includes the enforcement of the liability of the company’s directors. The aim is to create awareness of the measures to be taken when approaching insolvency.

In the Event of a Systemic Crisis

When a bad financial situation is not adequately addressed—that is, when financial institutions have accumulated unsustainable levels of debt and have waited too long to address them—the solvency of these institutions will be harmed. This also can produce a systemic effect by producing a contagion to other companies in the same industry, or in the geographical area where the troubled company operates, and in the overall economy, thus compromising the welfare of the people, the country, and, in some cases, the international community.

A systemic crisis needs to be addressed with the participation of the corporate, financial, and government sectors. Proper analysis of corporate debt issues is essential and includes asset quality tests and reviews of the legal and institutional insolvency, the debt-enforcement framework, and aspects of regulation and supervision. A systemic crisis requires strong government involvement (because it is beyond the scope of the corporate sector and even the banks themselves) and consideration of standardized solutions for debt restructuring.

It is difficult to design an effective scheme beforehand to deal with systemic crises, because each crisis is unique. Even so, the lessons learned from the last crisis must be taken into account when designing insolvency regimes or bank funding schemes.

The first essential element in a comprehensive strategy to tackle the loans in an overdue portfolio deal is, above all, to prevent them in the first place. Therefore, the correct sequence in the adoption of measures to restructure companies with overdue portfolios should begin with the precautionary and prophylactic measures, that is, how not to get to the situation of an overdue portfolio. The regulatory framework for banks should be strict enough to prevent the origination of loans that borrowers do not intend to, or cannot, repay, while being, at the same time, a tool to promote bank lending. Too much rigidity or too many requirements may discourage the practice of granting credit.

Then will come the design of efficient systems for ordinary recovery, insolvency law, and regulations and supervision of credit institutions. Finally, it seems necessary that the judicial and prosecutorial system will also be reviewed in order to facilitate all recoveries.

Coordination between the actors and the creation of a forum where players can interact seems to be important. The business sector must assume its responsibility in the crisis and not play by the perverse incentive of the concept “too-big-to-fail,” under which entrepreneurs of certain companies or sectors expect the government to come to their aid with fiscal resources and therefore fail to avoid the crisis or work for a solution after a crisis has occurred.²

In short, when there is a crisis, the problem arises from the corporate and financial sectors. Therefore, the interest groups are the companies (perhaps chambers of commerce and the like), bankers, and regulators. Coordination among key stakeholders is essential to implement any strategy to deal with the crisis. The more serious the problem of nonperforming loans, the greater must be the support of the government, the central bank, and the banking supervisor to deal with overdue loans.

Informal or Out-of-Court Restructurings

One of the main reasons companies avoid using insolvency regimes is having to be involved in a complicated legal process that normally delays the arrival of solutions and thereby further deteriorates the value of assets. An ideal seems to be a system that allows the reorganization of companies without having to go to court.

However, the participation of a court of law usually is necessary because, at least according to Mexican law constitutional principles, a creditor may not be forced to accept a restructuring plan simply because other creditors have done so.

It therefore is necessary that due process allows creditors the opportunity to participate and be heard. Thus, the approval by the court of a reorganization plan is mandatory. The only way to avoid this is to obtain the agreement of 100 percent of creditors, which can be difficult.

The establishment of a hybrid system could be a solution: let creditors and the debtor reach a fundamental agreement that may be imposed on creditors who have not participated, and then take the agreement to court for approval. This gives the judge an important role, although often with only a limited amount of time in which to make a decision.

Key Features of a Robust Insolvency Regime

To begin with, it is necessary to think that the legal system provides sufficient tools to creditors to achieve effective recovery of funds. A legal regime, whatever its style or location in the physical or ideological map, cannot afford to allow that obligations are not met (pacta sunt servanda) or tolerate the negligence of obligations. To do so destroys the rule of law and leaves the fate of all to the law of the strongest.

The document prepared by the World Bank in consultation with experts from around the world, the “World Bank Revised Principles for Effective Creditor Rights and Insolvency Regimes,” begins with the following statement: “Effective insolvency and creditor rights systems are an important element of financial system stability” (World Bank 2015).

These systems help to ensure effective access to credit and the allocation of resources, improving productivity and growth. They also allow market players to better manage financial risk and other difficulties in the business sectors in a timely manner in order to minimize systemic risk, particularly in the banking system.

The aim is to assure a creditor with the possibility of making use of the assets of the debtor in a fast and effective manner. Whether or not the credits are backed with a real guarantee, gaining access to the firm’s assets would be more effective than the threat of resorting to an insolvency proceeding.

However, it is necessary to understand that when the negligence of a debtor is generalized, there can be no question that the ordinary means of recovery of the debts are efficient. In addition, this assumption is no longer just about the interests of a creditor with its debtor: it is an economic problem that affects the life of a community. This is where the insolvency regime must appear.

Developing and maintaining a strong insolvency regime is the fundamental basis under which companies suffering problems can get proper treatment. If the system has proved to be effective, all concerned stakeholders will have confidence in its future use when needed. The crisis in Mexico in the 1990s, for example, would have been very different if the country had an insolvency regime similar to that in place today.

Key features of a robust insolvency regime include the following:

• The first is the creation of a new paradigm in insolvency law. This will maximize the value of companies, either in achieving a reorganization or efficient liquidation, and will stop the deterioration of a company and avoid the systemic effect of its failure on the economy of a country. The overall goals are replacing the assets of troubled firms in the bloodstream of the economy, keeping jobs, and generating GDP.

• The second element is that the insolvency regimes should be transparent, with reduced costs and accessible to both large and small companies.

• A third element is the impact of the priority of claims. Whereas par condicio creditoris is a universal principle of insolvency law, providing that creditors should be given similar treatment, in reality credits are not similar and priorities must be set. The most common priorities are usually given to workers’ credits, credits that have a security, and tax credits. Also, the credits placed at the end of the list usually are those of related parties and credits held by shareholders or owners of the company. This priority system plays a key role in the debt restructuring with creditors because it determines who should be prioritized for the negotiation. For example, the super-priority of wage claims by Mexican legislation deters employers from using the insolvency system to solve their labor problems. Secured loans should have the priority usually given to them because giving them another degree would discourage the extension of credit. Leaving related credits at the end makes sense in terms of good governance for the company. With regard to the tax credits, the question is whether they should be given a specific priority or should be considered among the common creditors or even subordinated to them. The state must understand that tax collection should not be driven by short-term greed, because in the long term it is better for the state if taxpayers remain in operation.

• Another key element in the design of an insolvency regime is its brevity and speed. The saying “time is money” is never truer than when it comes to achieving the financial restructuring of a debtor. The passage of time deteriorates the value of assets inexorably, especially if the company has ceased to operate.

Design of Mechanisms for Debt Restructuring

Any restructuring should be made following a business plan. In a systemic situation it is necessary, furthermore, to take into account the global economic processes.

Usually there are three general ways to orient restructurings: the direct participation of the state, via the market, or a hybrid method that combines elements of the previous two. The implementation of each method depends on the circumstances and gravity of the situation.

The intertwining of the corporate and financial sectors that defines a systemic crisis is unique and requires that the restructuring will be addressed by both sectors regardless of the actions of the debtor and its creditors. For a debt restructuring mechanism to have the desired economic results, it is necessary to create an appropriate and well-specified legal framework, in which there are no gaps that would enable any party to either take advantage or deviate from the desired result.

There is also a need for incentives created by the authorities through the appropriate economic policies in a country, starting with the question of who takes the initiative. Companies in trouble need a push in the right direction, but it is difficult for a credit institution to be the one forcing that push. Part of the regulatory approach of the state authorities that dictate the economic policies should take this into account.

Consequences of Not Restructuring

The failure to restructure a failing financial situation leads to deterioration and the need for liquidation of a company. But the risk is not limited to that company because its insolvency can produce a contagion effect on other companies that interact with it.³ Contagion may even lead to a systemic effect throughout an industry or even in an entire national economy.

From the standpoint of the financial system, not to achieve an orderly and predictable restructuring of unsustainable debt owed by one company would result in financial institutions also accumulating unsustainable levels of debt because they waited too long before coping with the problem. This situation adversely affects not only the solvency of those financial institutions, but also can compromise the welfare of the people, the country, and, in some cases, the international community. The financial crisis of 2008 occurred because financial institutions had no way of reacting to nonperforming loans in the underlying securities, which then collapsed the entire building erected above them.⁴

Legal Framework

Although insolvency regimes were built for a long time on the basis of supporting creditors, sometimes and in some regimes the regulations seem to be tilted toward the side of those who do not pay, thus creating incentives for nonpayment. Neither of these exclusive approaches is appropriate; without neglecting the rights of participants in an insolvency problem, the legal framework should seek broader goals than serving the mere interests of those involved in the problem.

The legal framework and financial policy should aim to limit the impacts of a crisis on the credit markets to the least extent possible and avoid the slowing down of development resulting from the lack of lending. The legal framework and regulatory approach must be constructed and specified in a complementary manner to achieve an efficient and effective financial system so the benefits are realized correctly.

As stated by Mexican authorities, “A regulatory approach’s overall mission is to propose, direct and control the economic policy of the government in financial matters, taxes, spending, income and public debt, in order to consolidate a country with quality economic growth, equitable, inclusive and sustained, to strengthen the welfare of Mexicans.”⁵

The purpose of debt restructuring mechanisms is to ensure a reasonable return of credit. Those mechanisms will make sure that credit is available and rates (the cost of credit) are maintained at an affordable level for potential borrowers.

Miscellaneous Incentives

To these mechanisms should be added various incentives that encourage the financial system to keep credit offered and at a reasonable cost. These incentives may come from a state policy, regulatory aspects, or the contractual agreements themselves.

A good incentive, for example, would be to treat the tax credits without any specific priority, but as a common credit. Another incentive may come when the regulatory bodies of the financial system lift some barriers and requirements. When there are too many requirements and too much bureaucracy, actors tend to avoid formal means, which leads to out-of-control solutions. Another incentive is to include in the restructuring plans a clause prohibiting the advance payment of the restructured debt; doing this can avoid the perverse incentive to prepay on terms more favorable than those for debt that not been restructured.

The Role of the State

A question arises: Does the state have a role to play in the restructuring of debts of companies? The answer is yes, and it should be analyzed through the different roles that the state assumes according to its operation.

The more serious the debt problem is, the more active the state must be in becoming the solution to the problem—or at least an important part of the solution. The state (such as tax authorities) should play an active role in resolving the debt by participating in the debt restructuring with the aim of maximizing tax revenue. Officials involved in the debt restructuring should be protected from liability when they act in good faith.

As a Supervisor and Regulator of the Financial System

The state should set out all the regulations to ensure that banks and other credit providers carry out their activities within a framework of precautionary measures in order to achieve the lowest percentage of delinquency possible. The state should carry out the necessary supervision of financial institutions to ensure that the rules are complied with in practice and to avoid a collapse of the “bubbles” created by bad loans. The state must also allow and encourage financial institutions to create and develop new loan products to promote economic activity.

Although these principles might appear to be contradictory, the state should maintain a balance between its powers of regulation and supervision and its role as a promoter of economic activity.

As a Creditor

The role the state plays in a crisis must maintain a position beyond its particular interests as a creditor and allow it to concentrate on the overall situation and the future.

In Mexico, for example, we have some state-owned banks, the so-called development banks, whose purpose is to promote credit in those areas that, according to economic policies, should be promoted: for example, exporting small and medium-sized enterprises, large public projects, popular savings, and others. This role of acting from a “second tier” has proved a success.

As an Entrepreneur

State-owned enterprises have not always proven to be efficient. When such firms fall into serious trouble, it is necessary for the state to rescue them using, of course, taxpayers’ money, which is neither popular nor economically convenient.

It is necessary for the state to determine which of these troubled companies should remain under public ownership and which should go into private hands. Sovereign insolvencies have proven a useful means in getting rid of state-owned enterprises because of their need to obtain the necessary liquidity to meet their debt obligations.

As a Debtor

If we consider the state itself as debtor, then we are in another field: the sovereign insolvency. As illustrated by recent debt crises in Europe, this is a concern that has not yet found an entirely satisfactory solution.

The Responsibility of Public Officials

Generally, the legal system provides that officials, when acting within their public roles, must not be held responsible unless they have acted in bad faith. Otherwise, they might feel that failure to act is more secure for them personally than taking actions, even responsible ones, that might later come into question.

International Contributions

Ever since the Asian financial crisis in the 1990s and right up to recent cases of corporate insolvencies, international organizations have been working on a review of best practices and standards to achieve robust insolvency regimes that can provide an essential basis for the treatment of the problems of corporate debt. The greatest contributions have come from the United Nations Commission on International Trade Law (UNCITRAL) and the World Bank, without belittling the efforts that other governmental and nongovernmental organizations have been making, including the regional banks, the Organisation for Economic Co-operation and Development, the European Union, [MENA], the Organization for the Harmonization of Business Law in Africa, and many others.

The World Bank in 2001 developed the “Principles and Guidelines for Effective Insolvency and Creditor Rights Systems.” These principles, which bring together the best practices in the field, have set the standard for the conduct throughout the world of various review and valuation exercises called Reports on the Observance of Standards and Codes, which have provided countries with suggestions and practical tools for improving their legal systems.

In the case of UNCITRAL the first important step was the “Model Law on Cross-Border Insolvency” that has been adopted by more than 30 countries. It provides a basis of equality of treatment to insolvency problems that involve multiple jurisdictions.⁶ This document has been added with another that provides the vision of judges who have been in charge of the implementation of the Model Law, as has been adopted and adapted in their countries.

UNCITRAL took a second step in 2005 with the creation of the “Legislative Guide on Insolvency Law.”⁷ The purpose of this guide is to contribute to the creation of an efficient and effective legal framework to regulate the situation of debtors that have financial difficulties. The guide has been designed as an instrument of reference for national authorities and legislative bodies when preparing new laws and regulations or when considering a revision of existing ones.

Part three of the legislative guide focuses on the treatment of enterprise groups in insolvency. It states that “where an approach different to that taken in part two [of the guide] might be required with respect to a particular issue as it affects an enterprise group or where the treatment of enterprise groups in insolvency raises issues additional to those discussed in part two, they are addressed in this part. Where the treatment of an issue in the context of an enterprise group is the same as discussed above, it is not repeated in this part. The substance of part two is therefore applicable to enterprise groups unless indicated otherwise in this part.”

The fourth part of the legislative guide focuses on “the obligations that might be imposed upon those responsible for making decisions with respect to the management of an enterprise when that enterprise faces imminent insolvency or insolvency becomes unavoidable. The aim of imposing such obligations, which are enforceable once insolvency proceedings commence, is to protect the legitimate interests of creditors and other stakeholders and to provide incentives for timely action to minimize the effects of financial distress experienced by the enterprise.”

This is a document close to another one created by the International Association of Restructuring Insolvency & Bankruptcy Professionals “Directors in the Twilight Zone.”

Currently UNCITRAL’s Working Group V is working to complete some ideas related to the previous documents about the issues that arise in the context of groups of enterprises operating in different jurisdictions. The group is also working on the preparation of a Model Law on cross-border recognition and enforcement of judgments relating to insolvency. In addition, there is currently a project within the working group of UNCITRAL V to develop the basis for a treaty covering all issues arising from insolvency.

All these international efforts aim to offer everyone the best criteria to understand the problem of insolvency.

The Mexican Experience

The debt restructuring experience in Mexico generally has been good. Admittedly, very few cases have appeared under the law. The official figure for November 2015 was 636. For a country with around 1 million businesses, the figure of bankruptcy issues seems very low.

Why so few? The main reasons for this drought are as follows:

• Costs;

• Ignorance; and, above all,

• Reluctance to participate in a court of law, where lawyers and legal procedures, which are tedious and bureaucratic, are involved.

If Mexico could foster a system in which the involvement of the courts is significantly reduced, the number of firms in difficulty using the law of insolvency as a means to achieve restructuring, would increase.

Examples worthy of attention include planning legislation in Italy that facilitates the process of recovering credit and could reduce the required time to seven or eight months. As explained previously, there are pure systems that allow restructurings totally outside of the courts and mixed systems that involve the courts on a reduced basis. In Mexico a hybrid system was created in 2007 called insolvency with pre-agreed agreement (also known as “pre-packaged”). New provisions were enacted in 2014.

A new bankruptcy law (Ley de Concursos Mercantiles) was enacted in Mexico in 2000. This law welcomes all the new principles of insolvency that were being established in the world at that time, especially as a result of the crisis in Asia. Mexico took into account the studies and ideas that at that time were being collected by the World Bank, the IMF, and the United Nations. Subsequently, two amendments to the law were taken from the experience and the pace of progress both nationally and internationally. Famous cases as Satmex, Mexicana, and Vitro were a valuable input in these reforms.

It is expected that these rules will significantly increase the efficiency and reliability of the restructuring tools to allow debtors and creditors to achieve settlement agreements. So far, the system has proven to be effective. The main idea of this hybrid regime is that a debtor, along with creditors representing at least 50 percent of total liabilities, can design a reorganization plan and start the insolvency process by filing the proposed plan. The court then continues the insolvency process by calling in all creditors to apprise them of the plan. This is called a prepackaged agreement. Creditors who do not participate in the formation of the prepackaged agreement may voluntarily join it afterwards, and if the plan meets the requirements of law, especially that of the votes that approve the agreement, the court will approve the plan, making it mandatory for all (cram down). Therefore, the conclusion of the insolvency proceedings may come faster than under normal conditions.

Major cases in Mexico have been resolved through this procedure. In total, since the beginning of the new bankruptcy law, 35 percent of insolvency cases (223 of 636) have been concluded through an agreement between the parties involved.⁸

Companies and Credit

In Mexico, every year about 200,000 companies are created, of which 50 percent disappear in the first year and 30 percent in the second.⁹ One of the main reasons for this high rate of failure is the lack of access to finance that might have allowed companies to grow or to overcome the difficulties of repaying their debts. Poorly functioning credit markets represent one of the most important economic brakes on growth. Indeed, only 43 percent of companies in Mexico are reported to have used credit from financial intermediaries.

This factor is worrying, even when comparing the situation of Mexico with the rest of Latin America, as only 29 percent of formal companies with 100 or fewer employees have some bank financing, whereas the average in Latin America is 45 percent. A similar lag is present for companies with more than 100 employees (table 8.1).

^{Table 8.1.}

Formal Companies Using Banking Credit

Sources: Enterprise Survey IFC; and World Bank. Note: Figures are through 2010 for all countries, except Brazil, which is through 2009.

^{Table 8.1.}

Formal Companies Using Banking Credit

Country	Up to 100 Employees (%)	More than 100 Employees (%)
Chile	78	81.7
Peru	63	92.7
Colombia	53.1	92.2
Brazil	57	89.6
Uruguay	46.5	75.2
Argentina	46.5	75.3
Bolivia	44.9	78.6
Average	45.4	67.5
Venezuela	29.5	85.4
Honduras	30.3	31.7
Mexico	29.5	54
Panama	21	10.1

Sources: Enterprise Survey IFC; and World Bank. Note: Figures are through 2010 for all countries, except Brazil, which is through 2009.

View Table

^{Table 8.1.}

Formal Companies Using Banking Credit

Country	Up to 100 Employees (%)	More than 100 Employees (%)
Chile	78	81.7
Peru	63	92.7
Colombia	53.1	92.2
Brazil	57	89.6
Uruguay	46.5	75.2
Argentina	46.5	75.3
Bolivia	44.9	78.6
Average	45.4	67.5
Venezuela	29.5	85.4
Honduras	30.3	31.7
Mexico	29.5	54
Panama	21	10.1

Sources: Enterprise Survey IFC; and World Bank. Note: Figures are through 2010 for all countries, except Brazil, which is through 2009.

A problem lies in one of the financial policies followed by many of the financial intermediaries: grant credit only to companies with at least two years in business. The mistrust in the credit capacity of small and medium-sized enterprises limits their access to finance. An economy that is based largely on fragile companies is constantly confronted with bankruptcies, and this directly affects the employment of people, undermining the economic situation of families and thus affecting the entire society. The problem illustrates the economic and social importance of mechanisms of debt restructuring.

Certainly it is necessary to admit that there is a rise in schemes and strategies of financial support for micro and small businesses to encourage entrepreneur-ship. These efforts should be observed carefully to determine the rate of nonperforming loans, although world experience has shown that financing of micro entrepreneurs is usually successful.

Using Post-Commencement Financing

An example of how the legal or regulatory framework helps in the treatment of restructurings is the experience in Mexico regarding the financing of companies that are already in a bankruptcy proceeding and require financial assistance. This type of credit is known internationally as post commencement financing (or DIP).

This source of financing is an increasingly important development, although one that is still in its infancy in many jurisdictions. Examples in Latin America include the following: in Brazil for the first time a DIP financing agreement was prenegotiated with creditors as part of the reorganization plan rather than being sought by lenders after the plan was approved by the court. A Canadian/ Colombian oil company, Exploración del Pacífico, is currently in the process of restructuring its debt in the United States with the use of DIP funds from a Canadian investment group.

Alejandro Sainz, a Mexican lawyer, has stated: “The name of the game in insolvency is to get access to finance. The faster and cheaper is available, the better for investors.”¹⁰

Funding for companies that are in insolvency proceedings is logically a high-risk operation for the lender. However, it can provide a strong assist for the attainment of a restructuring, even if it is not the only way to achieve it. For this, the Mexican Insolvency Law has established provisions that facilitate such funding. In the latest reform, changes were introduced for that purpose to Articles 37, 43, 75, 224 of the act (see extracted material below). These reforms expressly authorized contracting loans, even after the filing of bankruptcy, which are essential to maintaining the regular operation of the company and the necessary liquidity at any time during the bankruptcy procedure. These credits may have guarantees. The merchant debtor must file a request for authorization to the bankruptcy judge, who must take into account the view of the insolvency representative (visitor or conciliator, depending on the stage of the procedure). Repayments of loans are not included in the automatic stay. They are credits against the estate and will be paid in the order given and before any of the others (except wage claims).

Article 37

Since the application for insolvency, or once admitted, Merchant may ask the judge for permission to immediate recruitment of credits essential to maintain the regular operation of the company and the necessary liquidity during the pendency of the bankruptcy. For the processing of the aforementioned loans, the judge may authorize the creation of security that may result from, if so requested by, the Merchant.

Filed the request of the Merchant and given the urgency and necessity of financing, the judge, after hearing the opinion of the inspector, will decide on the approval of the financing with the objective mentioned before, proceeding to issue the guidelines on which will be authorized the respective credit and its repayment during the bankruptcy, taking into consideration their preferred priority in terms of Article 224 of the Act.

Article 43. The business reorganization judgment will include: VIII. (REFORM 10 / I / 14)

VIII. The order to the Merchant to stop the payment of any debts assumed prior to the effective date of the business reorganization judgment, other than those that may be essential for the enterprise’s regular business, including any necessary credit to maintain the regular operation of the company and the liquidity required during the pendency of the bankruptcy, for which it must inform the judge within seventy-two hours following the date on which he makes the payments;

Article 75. If the Merchant keeps on managing his enterprise,

In the case of hiring necessary credits to maintain ordinary operation of the company and the necessary liquidity during the pendency of the bankruptcy proceedings, which have been authorized in terms of this article, the conciliator will define the guidelines for which will be authorized by the respective credit, taking into consideration their preferred priority in terms of Article 224 of the Act, including the provision of guarantees that may result from, if so requested by Merchant.

Article 224. The following are credits against the Estate and shall be paid in the indicated order and before any of the credits to which Article 217 of this Act refers:

II. Those assumed by the Merchant to manage the Estate, with the conciliator’s or receiver’s authorization or, where appropriate, the necessary credits to maintain the regular operation of the company and the necessary liquidity during the pendency of the bankruptcy. In the latter case,

All privileges and preference in payment will be lost in case of granting such loans in violation of the decision by the court or authorized by the conciliator or when it is resolved by a judgment that the loans were contracted in fraud to the detriment of creditors and the estate;

III. Those assumed to attend to the regular expenses for the protection of the properties of the Estate, their repair, preservation and management, and …

In reinforcing these reforms, the regulatory authorities of the financial system established accounting standards that give proper treatment to loans granted to companies facing insolvency. Previously, all credits granted to a company in insolvency were considered as part of the overdue portfolio, which forced banks to require very high reserves, thus serving as an incentive to deny the granting of credit. The rules issued by the banking authorities provide that credit institutions must qualify, form, and register in their accounts preventive reserves corresponding to each of the loans in its portfolio.¹¹ To accomplish this, banks must develop a complex calculation including indexes of “Probability of Default,” “Loss Severity,” and “Exposure to Breach.” Such terms are defined and provided with the necessary formulas for their calculation.

The indexes listed here have a special treatment for loans to companies in insolvency, during the life of the procedure, to maintain the regular operations of the company and the necessary liquidity, and to meet the normal costs for the safety of the goods of the estate, its renovation, conservation, and management.

The factor “Probability of Default” is fixed at its highest level, but in calculating the factor “Severity of Loss” in cases of prepackaged insolvency proceedings, favorable variants have been introduced. If additional guarantees have been granted for such loans, the calculation is even more beneficial.¹²

With this we can conclude that in Mexico, loans to DIP during insolvency proceedings are possible and provide a valuable tool for achieving financial restructuring.