Reform in Mexico Five Years Later

Reform in Mexico Five Years Later

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Five years ago this month, in May 2000, Mexico reformed its bankruptcy code. The new law, known as Ley de Concursos Mercantiles (Concursos for short), significantly enhanced creditor protections and established a system to help ensure that professional standards are maintained throughout the bankruptcy process. While the process continues to build credibility and gain acceptance, opinions remain divided over whether the new law represents lasting change.

Out with the Old

Vicente Fox's victory in the Mexican presidential election in 2000 was widely hailed as an historic moment for Mexico; for the first time in 70 years, an opposition party won the presidency. The long-dominant Partido Revolucionario Institucional (PRI) had been steadily losing power in gubernatorial, mayoral and legislative elections around the country. But the political system in Mexico always had a strong executive, and the Fox victory was a watershed event.

Also in 2000, but much less noticed, Mexico completely reformed its bankruptcy laws, which had been in place since the 1930s. Under the old system, known as Suspensiòn de Pagos, or Suspension of Payments, debtors could simply stop servicing debts. In the rare event lenders took a debtor to court, procedures could last decades.

There had been talk of revising the bankruptcy laws since at least 1963. It took a major economic crisis for bankruptcy reform to take hold. In late 1994, as a result of a liquidity crisis brought on by sudden capital flight, the peso was devalued against the U.S. dollar by close to 40 percent between December 1994 and February 1995. By the end of 1995, the prime lending rate was 58 percent. A record number of businesses defaulted on their debts, banks were unable to force performance under Suspensiòn de Pagos, and the banking system came close to collapse.

The Mexican government intervened to save the banking system, acquiring bad loan portfolios from banks and attempting to lead the collection process, with limited success. The total cost of the rescue is estimated to have been about US$100 billion, or 19 percent of Mexico's GDP. The U.S. government contributed US$50 billion to keep its neighbor afloat. Following the bailout, most Mexican banks—now with healthy balance sheets—were acquired by foreign banks. Today, as a legacy of that time, foreign-owned banks hold more than 80 percent of the assets of the Mexican banking system.

In with the New

The severity of the 1994 crisis and the weakening of the PRI created a climate for change, and bankruptcy reform was enacted in May 2000 with the Concursos. Creditors now have a clearly defined process for enforcing performance on loans. In addition, a federal bankruptcy administrator, the Instituto Federal de Especialistas de Concursos Mercantiles (IFECOM), has been created to maintain the professionalism of the judges, lawyers and specialists involved in bankruptcy cases.

A company can enter Concursos by filing, or two of its creditors can sue to initiate the process. The court sends an auditor to verify the company is insolvent. If so, the court appoints a mediator (conciliador) to negotiate a reorganization settlement between the company, creditors and stakeholders. Once the mediator is appointed, interest stops accruing on debt, and foreign currency debts are converted to peso-denominated debt. In most cases, the debtor continues managing the business, but there are mechanisms for removal. Theoretically, the time from filing to reorganization is limited to one year, though there are many creative strategies available to those who wish to prolong the process.

Finally, if reorganization is not possible, the court appoints a receiver (sìndico), who assumes the administration of the business in order to oversee its liquidation.

Need for More Professionalism

The Concursos legislation established a federal bankruptcy administrator, IFECOM, in an effort to increase the transparency and predictability of the bankruptcy process. IFECOM's responsibilities include training federal judges in insolvency matters and creating and supporting a roster of specialists, the auditors, mediators and receivers on whom the courts rely for financial, economic and management expertise. IFECOM sets qualifications for the specialist positions, ensuring that auditors have solid accounting, auditing and cost-analysis skills, that mediators have experience in turnarounds and restructurings, and that receivers know how to conduct the liquidation or sale of a business.

Specialists are appointed to cases by a random process overseen by IFECOM. IFECOM then supervises their performance, imposes penalties when required, provides continuing education and regulates specialists' fees. Finally, IFECOM is responsible for publishing statistics, research and analysis related to insolvency.

In Practice, Issues Remain

Concursos, at least on paper, represents an enormous improvement over the former bankruptcy law, Suspensiòn de Pagos. In practice, however, its benefits are less clear. The process rarely proceeds as rapidly as the law intended, so in-court restructurings drag on for two years or more. For example, it has taken 96 days on average from filing for a case to reach the mediation phase. The absence of debtor-in-possession (DIP) financing within Concursos limits companies' restructuring options. There have been cases in which creditors resisted the conversion of their foreign currency debt to peso-denominated debt. Some believe the structure of specialists' fees creates an incentive to keep the process going as long as possible. Another issue involves the games played with inter-company debt, which can proliferate due to the number of entities often held by Mexican companies for tax purposes. On the other hand, Concursos may motivate companies and creditors to negotiate a restructuring out of court, a process that can often be completed in a matter of months.

The judiciary is slowly developing its independence, but corruption and cronyism reportedly persist. Some creditors continue to express frustration that they have little leverage to collect, since a company under pressure may use its contacts to arrive at an outcome favorable to the company. Suits are pending to challenge the constitutionality of Concursos, and some of the provisions of the law are still being worked out by the courts.

Since Concursos was passed, the percentage of delinquent loans has fallen from 38 to 15 percent...

Other indicators point to a positive impact from the reform. Since Concursos was passed, the percentage of delinquent loans has fallen from 38 to 15 percent, although, of course, a number of other factors influence that statistic. Financings and investments have increased. The World Bank's 2004 World Development Report recognized that Mexico's business environment had improved and acknowledged that the improvement was due in part to the new bankruptcy process.

As of November 2004, 166 cases had been filed involving 196 businesses, more than 50,000 creditors and about US$20 billion in debt. About half of the companies were forced into Concursos by their creditors; the other half filed for protection.

Of the 166 cases, 43 have completed a restructuring, 32 are in the process of liquidation and the rest are in audit or mediation. The number of cases has been growing steadily, less a reflection on Mexico's economy than the result of companies' and creditors' gaining a better understanding of the process and becoming more comfortable with the possible outcomes.

Five years down the road, the outcome of Mexico's bankruptcy reform is unclear. The new law represents a big step in the right direction, but implementation remains challenging.

Journal Date: 
Sunday, May 1, 2005