Despite the economic gains made by the world’s 11th-largest economy – the World Bank predicted Mexico to expand four percent in 2011 – its insolvency culture remains worryingly fragile and ineffective.

The issue is pressing because the US and Mexico are commercial partners under the North America Free Trade Agreement (NAFTA), worth as much as $400bn a year to both sides. But despite gains in corporate law that have strengthened the hand of some investors, and attempts to deal with bankruptcy law through the late 1990s, legislation remains mired in ideological, political and economic differences – differences that go back many, many decades.

Historical distress
More than a decade ago, the law governing the Mexican insolvency regime – the Ley de Concursos Mercantiles – arrived. Although an upgrade on its predecessor (the Bankruptcy and Suspension of Payments Law 1943), the new 2000 legislation did not, says Darío Oscós, supply the protection many still need.

“This law provides for a monolithic proceeding made up of two major stages,” says Oscós. “One, conciliation for the plan of reorganisation, and second, liquidation in bankruptcy. If no plan is reached within 185 calendar days with two possible extensions of 90 calendar days each, subject to creditors approval of 66.6 percent for the first, 90 percent for the second extension, the proceeding turns liquidation into bankruptcy.”

But in 11 years, says Oscós, there have been just 440 insolvency filings: fewer than 40 filings a year, on average. One cause is that under the former law, the debts of banking and the financial sector did not lead to insolvency proceedings. “Another cause might be that Mexican insolvency statutes remain riven, still, with the old Spanish laws of another century. That is why it is of essence to have in Mexico a new 21st century insolvency law.”

Oscós feels his law firm has set a milestone, by “successfully adjudicating the first and second case ever in the world that recognised and fully enforced another country’s insolvency proceedings under the UNCITRAL [UN Commission on International Trade Law] model law on Cross-Border Insolvency,” he says. This move has also been adopted, inter alia, by the US, UK, Canada and Japan.

Milestone
But protection is still needed, especially when trouble blows up. Following the credit seizure of 2008, many large Mexican corporations quickly ran into debt-servicing difficulties, which severely tested the strengths and weaknesses of the current regime. The law was found, in many cases, severely wanting.

Look no further than Mexican glassmaker Vitro SAB (see below). It makes everything from perfume containers for luxury fragrance and cosmetics brands, to beer bottles; and has defaulted on $1.5bn of debt. Not surprisingly, lawmakers are unhappy about Vitro’s use of up to $1.9bn (estimated figures) of debt to control bankruptcy proceedings in Mexico.

However, Oscós Abogados is now playing a major role in the insolvency proceedings of this case, following previous wins, helped by close, clever argument.

The issue has even roused three US Republican Representatives, who are lobbying Secretary of State Hillary Clinton about the issue: warning of the dangers of Vitro being permitted to move forward with a restructuring plan despite the objections of major US bondholders. The Dow Jones Daily Bankruptcy Review reported recently: “If allowed to stand, Vitro’s manoeuvres will have a chilling effect on US investment abroad, particularly in Mexico, and will set a dangerous precedent for companies seeking to mitigate equity loss when faced with bankruptcy.”

And the accompanying costs could be dramatic, with additional risk premiums being charged or attached. Mexican companies, be in no doubt, will pay the price; international investors may also fight shy of putting their money into Mexican companies that are not listed on the NYSE, LSE or other exchanges.

Double trouble
But in order to understand the need for change, some understanding of the past is needed. What went wrong with the 2000 legislation, the Ley de Concursos Mercantiles? Was it that bad? “It was guided with the help of the World Bank and the International Monetary Fund comprising the newest regulations at the time. However, the statute failed to incorporate all of them,” says Oscós.

Disappointingly, this 2000 Ley de Concursos Mercantiles was intended to be the model for other transformative business legislation, he says. So the impact has been considerable – not all for positive reasons – in other areas.

In fact, Mexico has a double insolvency system. The first, concurso mercantile, is for commerce; the second, concurso civil, is aimed at non-commerce or consumers, both individuals and legal entities. “Concurso mercantil is governed by a federal law, Ley de Concursos Mercantiles, enacted in May 2000,” explains Oscós. “Concurso civil is an estate regulation, governed by each estate’s civil code, patterned in the Civil Code for the Federal District, enacted 1932. Insolvency petitions are not mandatory. In case there is no plan of reorganisation, estate assets can be liquidated.”

Mind the gap
But there are no provisions in either concurso mercantil or concurso civil for discharge, except with creditors’ approval. Nor does either system provide for dischargeable debts. Under both concurso mercantil and concurso civil, the debtor remains liable after liquidation for any deficiency owed to creditors after liquidation and/or distribution: there is no fresh start, Oscós warns.

As mentioned at an earlier stage, between 2000 and July 2011, there were just 440 applications filed for concurso mercantil, involuntary and voluntary. “From these 440 applications only 267 were adjudicated in concurso mercantile,” clarifies Oscós. “Of which 245 have been terminated for different causes, and of which only very few were terminated by the plan of reorganisation – less than four percent. In this mater, less than one percent of the plan of reorganisation cases have been successful.”

Furthermore, in a closer analysis, in the first half of 2011 there were 39 petitions for concurso mercantil filed, of which 79.9 percent were involuntary.

Stay or run?
For the time-being, debtors are seeking out-of-court reorganisations and settlements, says Oscós. “As the financial situation becomes worse, and with rescue programmes being insufficient, it is expected that there will be an increase in insolvencies and eventual liquidations. In some cases there may be a plan of reorganisation settled by debtors and creditors to overcome a financial distress situation as a transitory vehicle.”

On the other hand, distressed financial entities may just shutter their business and attempt to run. Oscós Abogados also anticipates that more creditor foreclosures will occur, since concurso mercantil (insolvency) is not mandatory, he warns.

The future
A new insolvency system, Oscós says, should ensure bankruptcy protection, even before a company gets even close to becoming insolvent, eliminating the current insolvency standard. “There should be voluntary or involuntary reorganisation and liquidation in bankruptcy in separate independent proceedings upon petition of debtor or creditors, and it should incentivise legal discharge for a fresh start, when viable, whether in reorganisation or liquidation, providing for timely, orderly, efficient and effective liquidation.”

There should also be room for post-insolvency financing, effective enforcement of voidance actions of fraudulent preferences, transfers and conveyances – plus a regime for groups of companies and consolidation, as well as joint administration of insolvency proceedings, provisions on intercompany debt and adequate provisions to privilege a reorganisation plan in any reorganisation or liquidation. Quite a list, all in all.

“In essence,” says Oscós, “There is an urgent need for an insolvency regime that timely and efficiently prevents, when possible, insolvency; as well as a regime that timely and efficiently protects from insolvency; comprising in the respective regime, if not all, then at least most agents of the economy, whether consumers or legal entities in general.”