Jorge  Valdés  King  Harvard  Law  School                                                                                                                                                                                                                                                                          LL.M.  Program                                                                                                                                                                                                                                                                      Supervisor:  Prof.  Martin  Bienenstock                                                                                                                                                                                              Corporate  Reorganization  

May,  2012  

 

Chapter  11  and  Ley  de  Concursos  Mercantiles:  which  is  better  at  fostering  the  rehabilitation  of  a  company?  

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Chapter 11 and Ley de Concursos Mercantiles: which is better at fostering the

rehabilitation of a company?

Jorge Valdés King

Introduction

This paper is based on a comparative study of the reorganization provisions of Title

11 of the United States Code (“Chapter 11”)1 with the reorganization provisions of

Mexico’s Ley de Concursos Mercantiles (“LCM”)2. Although based on a comparative

study, this work does not intend to be a complete description of the analyzed statutes.

Chapter 11 and LCM vary in a wide number of aspects, being the reason of such

differences not only the divergent legal traditions but also the structure of the

judiciary and the size of each country’s economy. Where relevant, references are

made to such differences.

The purpose of this work is to determine which statute is better at fostering the

rehabilitation of a company and how each statute can or cannot save the lifelines

necessary to maintain the company as a going concern. This paper highlights the

advantages and disadvantages of each approach and provides conclusions in which

preferences are expressed. In addition, this paper intends to identify what public

policies each statute serves and how well do they serve them.

                                                                                                               1 Title 11 of the United States Code (2006) [hereinafter U.S.C.] is the primary source of bankruptcy law in the U.S.C. It is 2 Ley de Concursos Mercantiles (Bankruptcy Law), as amended, Diario Oficial de la Federación, 12 de Mayo de 2000 [hereinafter LCM]. LCM provides for one sole bankruptcy proceeding (concurso mercantil), encompassing three successive stages: (i) verification (verificación), (ii) reorganization (conciliación), and (iii) liquidation (quiebra). This paper is mainly focused on the reorganization stage, but some references are made to the verification and liquidation stages. Under certain circumstances, if voluntarily requested by a debtor, the verification stage might be followed by the liquidation stage. In some other cases, known as prepackaged reorganizations (concurso mercantil con plan de reestructura previo), the bankruptcy proceeding might be initiated in the reorganization stage.

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The discussion will address the applicable reorganization provisions to companies

rather than to individuals, and it is focused in large companies instead of in small

ones.3

The purpose of a reorganization proceeding is allowing a company to be rehabilitated

as a going concern. But to determine whether Chapter 11 and LCM save or do note

save the needed lifelines to achieve that goal, it is necessary to understand the

functioning and procedural structure of each reorganization system. In the following

pages, while analyzing whether each statute saves or not the needed lifelines to

rehabilitate a company, I try to explain the basic functioning and procedural structure

of each system.

An important caveat: “[A]nytime you compare the bankruptcy systems of the United

States and Mexico, you are comparing apples to oranges because the two economies

are so very different. There is such an incredible amount of debt in the United States'

                                                                                                               3 In the United States (“US”), the 1938 Chandler Act created two separate business reorganization chapters in the Bankruptcy Code. Chapter X for publicly traded companies and Chapter XI for small business, but the Bankruptcy Reform Act of 1978 changed the structure of business reorganization. Under this new code, the formal distinction between small businesses and big companies was largely abolished. However, in 2005, the US Congress passed a large package of amendments that, among other things, reintroduced the small-case/big-case distinction that had been eliminated in 1978. The 2005 amendments added a new small business case definition for businesses with debts less than $2 million at the time of filing (for cases filed on or after April 1, 2010, the amount should be no more than $2,343,300). See Elizabeth Warren, Chapter 11: Reorganizing American Businesses, 6-8 (2008). The Mexican statute also distinguishes between small and big debtors. LCM applies to any physical person or legal entity that is considered a merchant or commercial agent (comerciante) under the Mexican Commercial Code. See LCM, arts. 3-4. According to the Mexican Commercial Code, individuals who engage in commercial activities as their day-to-day occupation, all Mexican private corporations and the Mexican branches and agencies of non-Mexican corporations are deemed to be merchants or commercial agents. See Código de Comercio (Commercial Code), as amended, arts. 3, 14 and 15, Diario Oficial de la Federación, 7 al 13 de Octubre de 1889. Notwithstanding, LCM only applies to small commercial agents to the extent that they expressly submit to it. See LCM, art. 5. This means that small commercial agents cannot be involuntary subjected to the bankruptcy proceeding established on LCM. Indeed, it is unclear which bankruptcy proceeding applies to small commercial agents that do not voluntarily submit themselves to LCM. I think they are subjected to Ley de Quiebras y Suspensión de Pagos (Bankruptcy and Suspension of Payments Law), as amended, Diario Oficial de la Federación, 20 de abril de 1943. See infra note 10. LCM defines “small commercial agents” as those whose debts are less than 400,000 UDIS (inflation-linked units) at the time of filing. See LCM, art. 5. Considering the current UDIS value and the peso-dollar exchange rate, such amount is approximately $145,000. The cap for small cases under Chapter 11 is approximately 13 times bigger than the cap for small cases under LCM. Such a gap reflects the difference in size of the economies of these countries.

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system, and comparatively little debt in Mexico.”4

Commencing reorganization proceedings

Both in Mexico and in the US, a reorganization proceeding could be initiated

voluntary or involuntary. In the first scenario it is the debtor directly who files the

motion, and in the second one are generally the creditors of the debtor who do it.5

Besides creditors, in the US fewer than all of the general partners of a partnership,6 or

a foreign representative of the debtor’s estate, if such estate is in a foreign

proceeding,7 may file an involuntary motion; while in Mexico, the Attorney General

(Ministerio Público) is also authorized to file an involuntary petition.8

Although Chapter 11 allows creditors to initiate a reorganization proceeding,

“involuntary bankruptcy petitions [filed by the creditors] are so rare that the

Administrative Office of the United States Courts quit publishing the data on the

number of involuntary cases nearly twenty years ago”.9 The opposite happens in

Mexico. Up to November 2010, ten years and a half after LCM’s enactment,10

creditors had filed 36.36% of the insolvency petitions.11

                                                                                                               4 Nathalie Martin, Que es la Diferencia?: A Comparison of the First Days of a Business Reorganization Case in Mexico and the United States, 10 U.S.-Mex. L.J., 73 (2002). 5 In Mexico, tax authorities have standing as creditors to file an involuntary petition. See LCM, art. 21. 6 11 U.S.C. § 303(b)3. 7 11 U.S.C. § 303(b)4. 8 LCM, art. 21. 9 Warren, supra note 3, at 23. 10 LCM is relatively new; it was enacted on May 12, 2000. It substituted Ley de Quiebras y Suspensión de Pagos (Bankruptcy and Suspension of Payments Law) of 1943. The old law remains in force and effect to any bankruptcy proceeding filed prior to May 13, 2000, and arguably (see supra note 8), it remains in force and effect for small commercial agents that do not voluntarily submit themselves to the bankruptcy proceeding foreseen on LCM. The old law had many deficiencies that lead to constant abuses. Its loopholes allowed debtors to stay in endless suspension of payments. 11 Instituto Federal de Espcialistas de Concursos Mercantiles [IFECOM] (Federal Institute of Bankruptcy Specialists), Informe correspondiente al Semestre del 1º de junio de 2010 al 15 de noviembre de 2010 (Semestral Report June 2010 – November 2010), 6 (2010). Available at http://www.ifecom.cjf.gob.mx/PDF/informes/21.pdf (last visited May 3, 2012).

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More interesting than statistics is determining why US companies are more willing to

voluntarily file than Mexican companies. As explained in more detail below, a reason

could be that debtors do not have an incentive to voluntary file in Mexico because

their motion will not produce an automatic relief,12 and the statute provides the

mandatory appointment of an expert (conciliador) that, during the reorganization

proceeding, intervenes in the management of the company in a greater or lesser extent

and may displace current managers.

Addressing the same question from the opposite perspective, we should ask why US

creditors are less willing to initiate bankruptcy proceedings than the Mexican

creditors. One answer could be that in the US, involuntary petitions by creditors must

be filed by three or more entities, each of which is either a holder of a claim or an

indenture trustee representing such a holder.13 In Mexico, a single creditor may file an

involuntary petition.14

Another reason could be that, in the US, if petitioning creditors file an involuntary

case that is later dismissed because the debtor is generally paying its debts as they

come due, such creditors shall pay costs, attorneys fees, actual damages and in some

cases punitive damages.15 In Mexico, a petitioning creditor does not face the risk of

                                                                                                               12 According to LCM provisions, between the filing of an insolvency petition and the issuance of an order for relief, there might be up to 83 business days. 13 11 U.S.C. § 303(b)1. If a debtor has fewer than 12 creditors, a single creditor holding a claim of at least $10,000 may file an involuntary petition. See 11 U.S.C. § 303(b)2. 14 LCM, art 24. Notwithstanding that LCM, art. 11 establishes a rebuttable presumption for considering a company under the insolvency situation that the law describes, when an entity does not pay debts to two or more creditors, a single creditor may file an involuntary petition. See CONCURSO MERCANTIL. SU DECLARACIÓN PUEDE SER SOLICITADA POR UN SOLO ACREEDOR DE CONFORMIDAD CON LOS ARTÍCULOS 9o. FRACCIÓN II Y 21, PRIMER PÁRRAFO, DE LA LEY DE LA MATERIA, Tribunales Colegiados de Circuito [T.C.C.] (Collegiate Circuit Courts), Semanario Judicial de la Federación y su Gaceta [S.J.F y su Gaceta], Novena Época, Tomo XXVI, Julio de 2007, Tesis VI.1o.C.104 C, Página 2475. 15 11 U.S.C. § 303(i)(1)-(2).

  5

paying punitive damages in case of dismissal,16 but only the payment of costs and

visitor fees.17

Moreover, the US standard for determining whether a debtor is not generally paying

its debts as they come due is higher than the Mexican one, since a disputed debt is not

enough to achieve it. “[T]he court believes that where a debtor fails to pay a debt

which is subject to a bona fide dispute that debt should not be considered a debt

which has not been paid as it became due. There is no apparent reason why a debtor

should have to pay disputed debts to avoid the entry of an order for relief.”18

Order for relief

An order for relief might be defined as the event that marks the beginning of a

reorganization proceeding. This date is important because it affects other matters,

such as the beginning of the stay.

In the US, filing a voluntary petition constitutes an order for relief.19 When an

involuntary petition is filed, the debtor may contest whether an order for relief should

be entered. If the petition is contested, a hearing is held. The court will enter the order

for relief if it finds either that a custodian for the debtor has been appointed or that the

debtor is generally not paying its debts as they become due.20

                                                                                                               16 For US cases awarding punitive damages for involuntary petition dismissals see: Sjostedt v. Salmon (In re Salmon), 128 B.R. 313, 318-19 (Bankr. M.D. Fla. 1991) (awarding $250,000 in punitive damages under § 303(i)(2)); In re Fox Island Square Partner- ship, 106 B.R. 962, 969 (Bankr. N.D. Ill. 1989) (finding the involuntary petition was filed in bad faith and awarding $500 in punitive damagcs); Jaffe v. Wavelength, Inc. (In re Wavelength, Inc.), 61 B.R. 614, 620-21 (B.A.P 9th Cir. 1986) (awarding $10,000 in punitive damages against two individuals who filed an involuntary petition in bad faith). 17 LCM, art. 48. Although LCM does not authorize a court to award actual damages in case of dismissal of an involuntary petition, there is no provision that prevents a debtor to file an independent claim for such damages. 18 In re All Media Properties, Inc., 5 Bankr. 126, 144 (Bankr. S.D. Tex. 1980). 19 11 U.S.C. § 301. 20 11 U.S.C. § 303(h). See In re All Media, supra note 18 at 142-44 in connection with the treatment of "disputed" debts for determining whether a debtor is generally not paying its debts as they become due.

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Chapter 11 does not foresee a financial standard that must be satisfied before filing a

bankruptcy petition. Not even balance sheet insolvency is required. “Disputes over

insolvency and litigation over eligibility to file for bankruptcy are largely absent from

the U.S. system. That is a deliberate policy choice, made on the assumption that very

few businesses would choose to file bankruptcy unless they needed it. Wasting time

and resources to litigate eligibility for bankruptcy is likely to doom the last fragile

hope for reorganization”.21

Notwithstanding, US courts have created a good faith test to ensure that the system is

not abused. For instance, the Second Circuit’s standard includes a dual test: “a

bankruptcy petition will be dismissed if both the objective futility of the

reorganization process and the subjective bad faith filing the petition are found.”22

Things are different in Mexico. When a debtor files an insolvency petition and the

judge considers that such petition fulfills certain formal requirements,23 the court

formally declares the beginning of the insolvency proceeding in the verification

stage,24 but such pronouncement does not constitute an order for relief. After issuing

the beginning declaration, the court orders IFECOM 25 to appoint a visitor

(visitador).26

                                                                                                               21 Warren, supra note 3, at 24. 22 In re Kingston Square Assocs, 214 B.R. 713, 725 (Bankr. S.D.N.Y. 1997). 23 According to a non-binding precedent, presumptive evidence that debtor is under the insolvency situation that the law describes is enough to declare the beginning of the verification stage. See CONCURSO MERCANTIL, SOLICITUD DE. BASTA DEMOSTRAR EN FORMA PRESUNTIVA LOS EXTREMOS DEL ARTÍCULO 10 DE LA LEY DE CONCURSOS MERCANTILES PARA QUE SEA ADMITIDA A TRÁMITE, T.C.C., S.J.F. y su Gaceta, Novena Época, Tomo XVIII, Diciembre de 2003, Tesis I.7o.C.42 C, Página 1362. 24 See supra note 2. 25 IFECOM stands for Instituto Federal de Especialistas de Concursos Mercantiles (Federal Institute of Bankruptcy Specialists). 26 LCM, arts. 24 and 29.

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The visitor is a specialized auxiliary whose functions are analyzing and reporting to

the court whether the company “has breached the performance of its financial

obligations in a general manner” and, if necessary, suggesting the adoption of interim

reliefs to protect the estate.27 The auxiliary is named visitor because she actually visits

the debtor’s office to gather the needed information.28

After the visit, the court analyzes both, the documentary evidence that the debtor

submitted with its petition29 and the visitor’s report. Then the court enters an order for

relief if the debtor “has breached the performance of its financial obligations in a

general manner”.30

Something similar happens with involuntary petitions. When a creditor files, the court

declares the beginning of the insolvency proceedings and orders the appointment of a

visitor. The debtor is given the opportunity to contest. If the petition is contested a

hearing is held and after analyzing the visitor’s report and the evidence that the parties

submitted,31 the court enters an order for relief if the debtor “has breached the

performance of its financial obligations in a general manner”. There is a rebuttable

presumption in case the debtor does not contend the creditor’s petition.32

A commercial entity shall be declared insolvent and subject to a proceeding under

LCM (declarada en concurso mercantil) to the extent it has breached the performance

                                                                                                               27 LCM, arts. 30, 36 and 40. 28 LCM, art. 32. 29 A debtor must attach to its voluntary petition, among other documents, the balance sheets of the last 3 years. See LCM, art. 20. 30 LCM, art. 42. 31 LCM does not expressly establish that the parties may file evidence for challenging the visitor’s report but such right has been recognized in a non-binding precedent. See CONCURSOS MERCANTILES. LAS PARTES PUEDEN OFRECER PRUEBAS PARA DESVIRTUAR EL DICTAMEN DEL VISITADOR AL MOMENTO DE DESAHOGAR LA VISTA QUE ORDENA EL ARTÍCULO 41 DE LA LEY RELATIVA, Primera Sala de la Suprema Corte de Justicia de la Nación [1a. Sala SCJN] (Supreme Court - 1st Chamber), S.J.F. y su Gaceta, Novena Época, Tomo XX, Julio de 2004, Tesis 1a. XCIV/2004, Página 191. 32 LCM, art. 26.

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of its financial obligations in a general manner.33 It is deemed that a commercial

entity has breached the performance of its financial obligations in a general manner

when:

(i) it has failed to pay matured debt obligations owed to two or more

creditors;

(ii) among such outstanding debts, there are some that have been unpaid for at

least 30 days from their maturity date and represent 35% or more of the

total outstanding liability of the entity at the filing date; and

(iii) the commercial entity does not have assets to pay at least 80% of its total

matured debts at the filing date.34

For the purpose of (iii) above, only the following assets are considered: cash; term

deposits, investments and account receivables, with a maturity date no later than 90

days after the filing date; and securities whose value is known and could be sold in 30

business-days after the filing date.35

A voluntary petition would be admitted if the debtor satisfies condition (i) and either

(ii) or (iii). An involuntary petition would be admitted only if the three conditions are

met. From an economical perspective, “insolvency” situation that LCM requires to

carry out a reorganization proceeding is similar to illiquidity since fixed assets are not

considered for any purpose.

                                                                                                               33 LCM, art. 9. 34 LCM, art. 10, fracc. I-II. 35 LCM, art. 10, pfos. (a)-(d).

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In addition, LCM establishes a rebuttable presumption for considering that a company

has “breached the performance of its financial obligations in a general manner”, when

no assets are found to perform a judicial order of attachment or foreclose a judgment

lien, when the entity does not pay debts to two or more creditors, when the

management of the company is not found or the offices have been closed, when the

commercial entity engages in fraudulent activities to avoid payment of its obligations

or when breaches the pecuniary obligations established on a previous reorganization

plan.36

It is clear that Chapter 11 and LCM have different criterions to initiate reorganization

proceedings. In the US, “[i]f you are a potential Chapter 11 debtor, the reason for

your decision to file a Chapter 11 case is irrelevant, and totally up to you. You can do

it for strategic reasons; you can do it to increase your market share; you can do it

because you are Macy’s Department Store and you feel like having a big sale.

Insolvency is not required. A person or company can file at any time. In Mexico,

without insolvency in the ‘not-paying-debts-as-they-come-due-sense’, you cannot

maintain a case under Ley de Concursos Mercantiles.”37

Chances of a successful rehabilitation are bigger when a debtor addresses its financial

distress at an early stage. In line with the odds, the international trend is not to delay

voluntary filing until a debtor is illiquid. Some countries allow the debtor to file

whenever it wishes (e.g. the US), while others allow the debtor to file when it foresees

                                                                                                               36 LCM art. 11. It has been recognized in a non-binding precedent that an insolvency judgment might be based on legal presumptions. See CONCURSO MERCANTIL, DECLARACIÓN DE. PROCEDE CON BASE EN PRESUNCIONES LEGALES, T.C.C., S.J.F. y su Gaceta, Novena Época, Tomo XVII, Marzo de 2003, Tesis I.8o.C.239 C, Página 1703. 37 Martin, supra note 4, at 78.

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that will no be able to fulfill its commitments when they come due. Involuntary

petitions still subjected to a general cessation of payments.38

LCM does not completely follow the international trend on voluntary petitions.

Neither allows debtor to file whenever it wishes, nor when it envisages a future

illiquid scenario. Therefore, the fixed, numerical and actual illiquid criterion

established on the Mexican statute as a requirement to voluntary file, puts at stake the

reorganization’s success.39

Regarding voluntary petitions, I consider that the US approach is better at fostering

the rehabilitation of a going concern, since it allows debtors to address their financial

difficulties at an early stage. In contrast, regarding involuntary petitions, the Mexican

system is better than the American since the latter provides punitive consequences in

case of dismissal, which discourages creditors from filing.

Stay

In the US, when an insolvency petition (voluntary or involuntary) is filed, an

automatic stay is imposed on all litigation against the debtor and its property. The

filing automatically operates as a stay and no specific facts must be pleaded or proven

to cause it to become effective. The stay is self-executing, even without specific

notice.40 While the automatic stay is in place, no action can be taken against the

                                                                                                               38 International Monetary Fund, Legal Department, Orderly & Effective Insolvency Procedures: key issues, 1-2 (1999). 39 After reviewing the statement of motives included in the bill to enact LCM and the diary of the discussions among the congressmen in connection with such statute, I have the impression that the policy choice behind establishing a rigid numerical concept of insolvency as a requisite for initiating bankruptcy proceedings was to prevent debtors from filing with fraudulent purposes, but at the same time, to avoid that debtors were submitted to bankruptcy proceedings by their creditors without having a real financial distress. 40 11 U.S.C. § 362.

  11

debtor without obtaining prior court approval, or relief from the automatic stay. The

court shall grant relief from the stay if an interest in property is not adequate

protected, if the debtor does not have equity in the property and if the property is not

necessary to an effective reorganization.41

There are some statutory exceptions to the automatic stay. For instance, the automatic

stay does not apply to regulatory actions by governmental units,42 neither to any act

by a lessor to a debtor to obtain possession of nonresidential real property under a

lease agreement that has terminated by the expiration of the stated term of the lease

before the commencement of or during a reorganization proceeding.43 The policy

choice behind this provision is protecting landlords’ interests.

The analysis of each exception to the stay is beyond the scope of this paper but the

possibility that a landlord may remove a bankrupt tenant if the real estate lease

terminated before or during reorganization does not foster the rehabilitation of a

company. One of the most important things a company should have for continuing its

operations is an adequate place to do that.

An eviction does not diminish the assets of a company; therefore, allowing a landlord

to remove a tenant when the lease has terminated does not directly constitute

depletion of debtor’s assets. Notwithstanding, forcing a debtor to move when facing

an insolvency situation might be the death of a company, not only because it should

carry out and pay a move, but because the business could be non-rentable in a

different location.

                                                                                                               41 11 U.S.C. § 362(d). 42 11 U.S.C. § 362(b)(4). 43 11 U.S.C. § 362(b)(10).

  12

In Mexico, when the court issues the judgment declaring a debtor under the

“insolvency” situation that the law describes (sentencia de concurso mercantil), any

judicial order of attachment, execution or foreclosure against the debtor or its

properties should be stopped.44 The stay is self-executing even without specific

notice. Unlike in the US, pecuniary actions or lawsuits begun by or against the debtor

that are pending at the time of issuing the insolvency judgment shall not be stayed.45

Another difference is that LCM does not provide relief from the stay.

There are two statutory exceptions to the stay. The stay does not have effect over a

judicial order of attachment, execution or foreclosure against the debtor or its

properties, if such order derives from a labor judicial proceeding or trial in which

workers are seeking to collect due wages of the last two years before the filing.46

Likewise, the stay does not have effect over an order of attachment to secure tax

duties.47

The abovementioned exceptions, particularly the one that allows foreclosing debtor’s

assets for paying due wages, do not foster the rehabilitation of a company. When

facing financial distress, a business needs to save money and preserve assets;

therefore, allowing workers to deplete company’s active does not benefit the

reorganization purpose.

                                                                                                               44 LCM, art. 65. 45 LCM, art. 84. 46 LCM, art. 65. 47 LCM, art. 69.

  13

A going concern needs employees and they do not work for free. Thus, it is

reasonable for a statute to provide that debtors should pay their employees while

being reorganized, but allowing foreclosure on company’s assets to pay past due

wages can cause the doom of a company.

This provision reflects that the Mexican Congress chose protecting certain labor rights

even over the rehabilitation of a company. Indeed, this provision derives from the

Mexican Constitution,48 which recognizes the payment priority of past due wages of a

year before filing, even over secured claims.49

According to Robert Rauch, “[o]ld-style Latin American procedures historically

tended to give massive protections to labor claims and to the fiscal claims of the

government. This precluded effective reorganizations (and often had the perverse

impact of ensuring these claimants never saw much of a recovery) as such claims

typically overwhelmed the financial capacity of the corporation. Management and

shareholders would often continue to run their business as usual, to their own benefit,

with little effort to resolve their financial situation. Private creditors could expect little

recovery.”50 It seems that the Mexican reorganization system, although recent, still

have some of the historical vices of the “old-style” Latin American procedures.

                                                                                                               48 See Constitución Política de los Estados Unidos Mexicanos (Political Constitution of the United Mexican States), as amended, art. 123, pfo. A, frac. XXIII, Diario Oficial de la Federación, 5 de Febrero de 1917. 49 The Mexican Congress extended the constitutional payment priority of past due wages from one year before filing to two years before filing. See LCM arts. 224-225. However, in a not binding precedent, such an extension has been declared unconstitutional for violating the right to equality. See CONCURSOS MERCANTILES. LOS ARTÍCULOS 224, FRACCIÓN I Y 225, FRACCIÓN I, DE LA LEY RELATIVA, AL ESTABLECER LA PRELACIÓN DE CRÉDITOS A FAVOR DE LOS TRABAJADORES POR EL TÉRMINO DE DOS AÑOS, VIOLAN LA GARANTÍA DE IGUALDAD ANTE LA LEY, 1a. Sala SCJN, S.J.F. y su Gaceta, Décima Época, Libro VI, tomo 1, Marzo de 2012, Tesis 1a. VIII/2012 (9a.), Página 271. Hence, since the exception to the stay foreseen on Art 65 LCM derives from the constitutional payment priority of past due wages, it can be argued that such exception to the stay is unconstitutional when applied to attachments, executions or foreclosures to collect past wages due prior a year before filing reorganization. 50 Robert L. Rauch, Mexico’s Concurso Mercantil from an International Bondholder’s Perspective, 4 (2011). Available at http://gramercy.com/Portals/0/PDFs/2011%20December%20-%20Concurso%20Mercantil%20from%20an%20International%20Investors%20Perspective.pdf (last visited May 3, 2012).

  14

The scope of the stay foreseen on the US statute is more convenient for a debtor than

the established on the Mexican law. By stopping any litigation and collection effort

against the debtor, the US stay allows a debtor not to be distracted by defending itself

at different courts and be focus in its rehabilitation proceeding.

In contrast, the scope of the stay foreseen on the Mexican law, at first glance, seems

to be more convenient for creditors because they can continue litigating their claims

against the debtor. This creditors’ “advantage” under the LCM provisions, however,

might be immaterial because at some point both systems allow creditors to litigate

their pecuniary claims against the debtor within the reorganization proceeding and the

stay prevents foreclosure on estate’s assets.

Chapter 11 allows to relief the stay under certain circumstances, while LCM does not

provide a relief. This is an important difference because the mere possibility of lifting

the stay gives creditors bargaining leverage to get a prepetition settlement.

Managing the company

In both countries, during a reorganization proceeding, the company does not need to

be shut down at any moment. This is a deliberate public policy to preserve the going

concern value by avoiding damages and losing revenue.

In the US, upon the commencement of a reorganization proceeding, the debtor

becomes a “debtor in possession” by virtue of law. During the pendency of the case,

the debtor remains in possession of all its assets and is authorized to continue

  15

operating the business through its current management, unless the court orders the

appointment of a trustee.51

In Mexico, the debtor remains in possession of the assets that it legally owns,52 and

continues operating the business.53 However, the statute provides for the mandatory

appointment of a conciliator (conciliador).54

In the US, before confirming a reorganization plan, a trustee might replace a debtor in

possession from running the business, for fraud, dishonesty, incompetence, or gross

mismanagement of debtor’s affairs by current management, either before or after the

commencement of the case; or simply if appointing a trustee is in the interest of

creditors, security holders or the estate.55

“[T]he courts have appointed trustees based on adequate showing of: irreconcilable

conflict of interest; commingling of assets; inadequate accounting records or controls;

failure to pay taxes; especially employee withholding taxes; dishonesty; and fraud.

The courts have also ordered the appointment of a trustee where the debtor in

possession has consistently violated the applicable local rules, and where the debtor in

possession has either failed to make payments to a secured party or has made

unauthorized payments including, for example, payments on account of prepetition

indebtedness.”56

                                                                                                               51 11 U.S.C. § 1101(1), 1104(a)(1) and 1108. 52 LCM, art. 70. Interested parties might request to repossess those assets whose property has not been transmitted to the debtor. 53 LCM, arts. 74-75. 54 LCM. art. 43, frac. IV. The court, within the insolvency declaration (sentencia de concurso mercantil), shall order IFECOM to appoint a conciliator. 55 11 U.S.C. § 1104(a)(1)-(2). 56 Robert J. Berdan and Arnold G. Bruce, Displacing the Debtor in Possession: The Requisites for and Advantages of the Appointment of a Trustee in Chapter 11 Proceedings, 67 Marq. L. Rev., 478-81 (1983-1984).

  16

The courts have also appointed a trustee “in those instances in which the debtor in

possession lacked credibility or failed to instill confidence, or where, by analogy, the

debtor in possession displayed an inability to effectuate a plan of reorganization.”57

Despite of the above, the appointment of an outsider trustee should be the exception

rather than the rule.58 As a matter of fact, “the courts have declined to appoint a

trustee where current management has a need expertise in a complex industry, or

where it was unclear whether a trustee was any more likely to successfully rehabilitate

the debtor than the debtor in possession.”59 If the court is reluctant to appoint a

trustee, it may appoint an examiner to investigate debtor’s conduct and business

affairs.60

Under Chapter 11, the debtor in possession or appointed trustee has, among others,

the following duties:

• Taking care of the estate’s property.61

• Examining and, if necessary, opposing to the claims that creditors submit.62

• Providing information about the operation of the estate to all parties in

interest.63

• Filing tax reports in case the business continues operating.64

• Making a final accounting of the estate.65

                                                                                                               57 Id. at 481 58 According to Gerard McCormack, this was stressed on In Re Marvel Entertainment Group (1998) 140 F 3d 463 at 471. See Gerard McCormack, Corporate Rescue Law – An Anglo American Perspective, 81 (2008). 59 Berdan and Bruce, supra note 56, at 484. 60 11 U.S.C. § 1104(c). 61 11 U.S.C. § 1106(a)(1) and 704(a)(2). 62 11 U.S.C. § 1106(a)(1) and 704(a)(5). 63 11 U.S.C. § 1106(a)(1) and 704(a)(7). 64 11 U.S.C. § 1106(a)(1) and 704(a)(8). 65 11 U.S.C. § 1106(a)(1) and 704(a)(9).

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In Mexico, some of the responsibilities that in the US correspond to the trustee or

debtor in possession are commended to the conciliator. Pursuant to LCM provisions,

the conciliator has, among others, the following duties:

• Examining and suggesting to the court which creditors’ claims shall be

allowed.66

• Monitoring debtor’s business operations.67

• Deciding on the termination of executory contracts, approval of post-filing

financing, substitution of liens or establishment of new ones over debtor’s

property, and sales of assets outside ordinary business operations.68

• Analyzing the desirability of the continuance of the business and, if necessary,

requesting the court to shut down the business.69

• Requesting the court to remove the debtor in possession70 and, if removed,

assuming the administration of the company.71

• Trying that the debtor and creditors negotiate a reorganization plan.72

• Requesting the extension of the reorganization stage73 or the beginning of the

liquidation stage.74

It is clear that both statutes foresee the appointment of an outsider that, in a greater or

lesser extent, intervenes the management of the company. In the US, the appointment

                                                                                                               66 LCM, arts. 121, 123, 128 and 130. 67 LCM, art. 75. 68 LCM, art. 75. 69 LCM, art. 79. 70 LCM, art. 81. 71 LCM, art. 82. 72 LCM, art. 148. 73 LCM, art. 145. 74 LCM, art. 150.

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of a trustee is exceptional, while in Mexico the appointment of a conciliator is

mandatory.

In the US, before the Bankruptcy Reform Act of 1978, the Chandler Act of 1938 had

created two separate business reorganization chapters, Chapter X for publicly traded

companies and Chapter XI for small business. For protecting the interests of public

investors, Chapter X required the appointment of a trustee in most cases. In contrast,

since Chapter XI addressed situations with less complicated corporate structures,

where public investors were not likely to be affected, the appointment of a trustee was

unavailable and the debtor generally remained in possession, managing the business

and pursuing the reorganization effort.75

“Under the mandatory trustee provision, the trustee became the key figure in the

reorganization process. The trustee was generally authorized to operate the debtor’s

business, to investigate the debtor’s affairs, to pursue causes of action on behalf of the

estate and to provide information to creditors and stockholders. The trustee was also

responsible for developing, in consultation with creditors and stockholders, a

reorganization plan. In this respect, the trustee provided structure to the case by

serving as the focal point about which formulation of the plan revolved.”76

Although Chapter X authorized to retain debtor’s management even after the

appointment of a trustee, in most cases the trustee displaced the management. This

induced debtors to attempt to reorganize under Chapter XI, where they could remain

in possession and control of the business. This practice supported the view that

                                                                                                               75 Barry L. Zaretsky, Trustees and Examiners in Chapter 11, SCL Rev., 917-20 (1992). 76 Id at 917-19.

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mandatory appointment of a trustee deters debtors from filing reorganization at an

early stage. Hence, the mandatory trustee provision was considered one of the most

problematic aspects of the former reorganization system.77

At the time of discussing the Bankruptcy Reform Act of 1978, the mechanisms of

debtor in possession and mandatory trustee were both considered. At the end, as

explained above, the US Congress opted for the debtor in possession as default rule,

with the possibility of replacing it with a trustee under certain circumstances.

In contrast, while enacting LCM at the beginning of this century, the Mexican

Congress opted for the mandatory appointment of a conciliator, whose role is quite

similar to the one that trustees used to have under Chapter X.

Unfortunately, there is not a clear response to the question of which method is better.

“To leave the old management in control as DIP –debtor in possession- is to run a

number of risks. Old management, after all, often comprises the same folks who

brought the business to the brink of collapse, which may not be a strong endorsement

for their management skills and business acumen. More important, old management

may have incentives that are at odds with those articulated in the bankruptcy

system.”78 For instance, old managers may prefer to continue running the business

although it is clear that the company is not going to be rehabilitated, rather than

liquidating it for the benefit of the creditors.

                                                                                                               77 Id at 919-21. 78 Warren, supra note 3, at 60.

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Notwithstanding, in some cases, even creditors will often prefer to deal with current

managers with whom they are familiar than to suffer the time and expense of

educating an outsider about the business and its problems. Replacing the old

management is not necessarily the best alternative, particularly when the company is

facing an insolvency situation and the business continues its operations. Key business

decisions should be done rapidly and outsiders might not be prepared to take them.

Knowledge of the business is an important asset when the company’s life is at stake.

Chapter 11 and LCM try to conciliate these contradictory positions. Both statutes

allow the old management to continue running the business but in a monitored and

controlled manner. The difference is in the mechanisms and extent of such control

and surveillance. The US system provides that a trustee might, exceptionally,

substitute the debtor in possession, as well as the appointment of examiners,79 and

creditors committees.80 In contrast, LCM provides the mandatory appointment of a

conciliator, who closely supervises debtor’s management and, to a certain extent,

controls its activities, as well as the appointment of examiners (interventores).81 The

Mexican statute does not provide the appointment of creditors committees.

The mandatory conciliator provision might have deterred Mexican debtors from

voluntary filing for reorganization since current managers does not want to be

supervised, controlled or supplanted by a conciliator. However, the number of

deterred debtors should be small because managers of Mexican companies, even in

big pocket businesses, are regularly the controlling shareholders themselves, and as it

                                                                                                               79 11 U.S.C. § 1104(c). 80 11 U.S.C. § 1102(a)(1). 81 LCM, arts. 62-64. The so-called “interventores” have similar functions to the ones examiners have under Chapter 11.

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is explained in more detail below, the reorganization proceeding is shareholder

friendly because LCM does not establish the absolute priority rule.

After analyzing both alternatives, I consider that the best mechanism is allowing the

debtor in possession’s current management to continue running the business under the

supervision of a mandatory outsider (trustee or conciliator) who, under certain

exceptional circumstances, prior court approval, might totally replace the current

management at request of any stakeholders or the outsider himself. This proposal

defers from the US system in the sense that the outsider appointment is mandatory,

and from the Mexican one, in the sense that any stakeholder might request the

managers’ removal and not only the conciliator.

Retaining key employees

Running a business during reorganization is not easy. It requires management skills

and technical knowledge that are difficult to find. Chapter 11 makes difficult to retain

key managers because it does not allow to transfer or pay any amount to an insider for

the purpose of inducing such person to remain with the debtor’s business,82 unless the

transfer is essential to retain such person because she has a similar job offer,83 or she

is essential to the survival of the business,84 and the transfer is not greater than 10

times the amount of a similar transfer given to non-management employees,85 or if no

similar transfers were made to non-management employees, not greater than 25

                                                                                                               82 11 U.S.C. § 503(c)(1). 83 11 U.S.C. § 503(c)(1)(A). 84 11 U.S.C. § 503(c)(1)(B). 85 11 U.S.C. § 503(c)(1)(C)(i).

  22

percent of the amount of any transfer made to such insider for any purpose during the

calendar year before.86

In a similar path, LCM establishes under a rebuttable presumption of fraud, among

others, any and all operations carried out against the estate (i.e. any transfer or

payment by the debtor) in benefit of any member of the board of directors, if done

within 270 days before the issuance of the insolvency judgment.87 Since any operation

made under a presumption of fraud is voidable, unless made in good faith, LCM also

makes complicated to retain management employees.

There is a difference between these approaches. In the US such payments are banned

unless made on necessity and within an established cap, while in Mexico are voidable

unless made in good faith. The Mexican system seems to be more effective for

retaining key employees because it does not cap the amount of the payment. Although

good faith is required under LCM provisions, such a burden is similar to the necessity

requirement established in Chapter 11.

In contrast, by capping the amount of the payments allowed for the benefit of

management employees, the US statute protects in a clearer manner the creditor’s

interest.

Both statutes reflect a similar policy choice, preventing managers to be benefited from

the insolvency of the company.

                                                                                                               86 11 U.S.C. § 503(c)(1)(C)(ii). 87 LCM, arts. 112 and 117.

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Operating the business

As mentioned above, both Chapter 11 and LCM provide that the debtor can continue

running the business. However, every aspect of a business requires the use, purchase,

sale or lease of property. For example, a retail debtor must use cash to buy inventory

and then sell that inventory to its costumers.

Thus, a statute that allows a debtor to pay its employees, purchase supplies, and

produce the services and goods that keep income coming in, is more efficient at

fostering the rehabilitation of a company than a statute that does not allow it.

Notwithstanding, since running a business implies risk, the interest of creditors needs

to be protected.

Chapter 11 authorizes the debtor in possession or trustee to enter into transactions

without the need to seek judicial approval, including the use, sale or lease of property

of the estate, provided that such transactions are within the ordinary course of

business.88 In a similar path, LCM authorizes the debtor in possession to carry out all

of its ordinary business operations under supervision of the conciliator.89

Hence, under both statutes, the debtor in possession has immediate access to cash

generated on the regular course of business, but such cash can only be used for

ordinary operations.

                                                                                                               88 11 U.S.C. § 363(c)(1). 89 LCM, art. 75.

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In addition to cash, cash-collateral might be important for continue operating the

company. Chapter 11 provides that the use, sell or lease of cash-collateral is not

allowed unless the entities having an interest in it give their consent,90 or under court

authorization after notice and a hearing.91 Authorization may be granted only if the

creditor remains adequately protected.92

LCM does not have an explicit provision regarding the use of cash-collateral.

However, it provides that the substitution of a guarantee outside of the debtor’s

ordinary course of business requires conciliator approval and the consent of the

interested creditor. 93 Hence, it might be argued that by authorizing collateral

substitution, LCM implicitly authorizes the use of cash-collateral because on secured

transactions the use of cash-collateral automatically implies the substitution of a

guarantee.94

Assuming arguendo that LCM allows the use of cash-collateral, there would be,

anyway, a difference on its treatment. In the US, the use of cash-collateral always

requires the consent of the interested creditor or approval of the court; while in

Mexico, it would require no approval if the cash-collateral is used within the ordinary

course of business, and would require the approval of the conciliator and consent of

the interested creditor when used outside the ordinary course of business.

                                                                                                               90 11 U.S.C. § 363(c)(2)(a). 91 11 U.S.C. § 363(c)(2)(b). 92 11 U.S.C. § 363. 93 LCM, art. 75. 94 For example, a working capital loan extended for the acquisition of raw materials is initially secured with the acquired supplies. When the raw materials are transformed, the loan is secured with the resulting inventory. Later on, the loan is secured with the account receivable derived from the inventory sales. Once the receivable is collected, the cash itself becomes collateral, but if the borrower uses the cash again, the loan is now secured with whatever has been acquired.

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Under the assumed construction of LCM provisions, the Mexican statute would be

more convenient than the US from a debtor’s perspective, but much more less

protective from the point of view of the creditors with an interest in cash-collateral.

Chapter 11 provides that a debtor in possession may use, sell or lease property of the

estate outside of the ordinary course of business, after notice and a hearing.95 In

contrast, LCM establishes that the sale of estate’s assets outside the ordinary course of

business requires the approval of the conciliator, who has to consider the non-binding

opinion of appointed examiners.96 If the subject of the sale is a perishable asset or an

asset whose conservancy cost is higher than its expected recovery value, the

conciliator might not request the examiners’ opinion.97

The Mexican approach (conciliator approval) seems to be more efficient than the US

one (court authorization, after notice and hearing) regarding the sale of estate’s

property outside the ordinary course of business. However, since the conciliator may

have to consider the opinion of the appointed examiners, the advantage of efficiency

could be insignificant.

Another thing to consider is the right to sell property free and clear of liens and other

interests. Such a right is important because the estate could be able to obtain superior

recoveries from assets that might otherwise be worth considerably less if foreclosure

is carried out.

                                                                                                               95 11 U.S.C. § 363(b)(1). 96 LCM, art. 75. 97 LCM, art. 77.

  26

Chapter 11 establishes that debtor in possession may sell property of the estate free

and clear of any interest in such property provided the satisfaction of one the

following conditions: (i) non-bankruptcy law permits the sale; (ii) the entity having an

interest in the property consents to the sale; (iii) the interest in the property is a lien

and the price exceeds the value of all liens on the property; (iv) the interest in the

property is in bona fide dispute; or (v) the entity could be compelled, in a legal or

equitable proceeding, to accept a money satisfaction of its interest.98

LCM does not explicitly address the sale of estate’s assets free and clear of any secure

interest during the reorganization proceeding. However, besides authorizing the sale

of estate’s assets and collateral substitution, LCM provides that alienation of assets, at

least within the liquidation stage, should be done in a manner that maximizes

recovery.99 Thus, I consider, and this is just a personal assumption, that a sale of

estate’s assets free and clear of any secure interest would be allowed within a

reorganization proceeding under LCM provisions, as long as the sale maximizes the

recovery.

Still under the previous assumption, if such a sale were not among the debtor’s

regular operations, approval of the conciliator and consent of the creditors having an

interest in the property would be required. If such a sale were within the ordinary

course of business, the debtor would not need any authorization to do it. However, in

order to respect the priority rule, it is my impression that in any case, creditors having

an interest in the property should remain adequately protected.

                                                                                                               98 11 U.S.C. § 363(f). 99 LCM, art. 197. This provision corresponds to the liquidation stage. See supra note 2.

  27

As stated above, Chapter 11 provides the requirements for using cash-collateral and

selling estate’s assets free and clear of any interest and liens, while LCM does not

explicitly do that.100 Based on the principle of legal certainty, I personally consider

that the US statute has an advantage over the Mexican with regard to those issues.

Financing

Every business needs financing to fund its operations. However, a company that is

facing insolvency is regularly under credit and loan default. Such a bad reputation

makes difficult for a debtor to obtain post-petition financing and, therefore, a statute

that somehow facilitates a debtor to obtain financing while under reorganization

contributes to save the lifelines of a going concern.

Chapter 11 allows a debtor in possession to obtain three different kinds of post-

petition financing:

(i) A debtor in possession may obtain unsecured credit in the ordinary course

of business. Such credit does not require court approval and is granted

administrative expense status.101 It must be paid in full if a reorganization

plan is confirmed and has priority over all other types of prepetition debts

in case of conversion to Chapter 7 liquidation.

                                                                                                               100 Under certain construction of LCM provisions, it could be argued that the statute implicitly authorizes the use of cash collateral and the sale of encumbered estate’s property; such a construction, however, has not been addressed on judicial precedents. Thus, it cannot be assured that the use of cash collateral and the sale of encumbered estate’s property would be permitted on every reorganization case. 101 11 U.S.C. § 364(a).

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(ii) After notice and a hearing, the court may authorize a debtor in possession

to obtain unsecured credit outside the ordinary course of business as an

administrative expense.102

(iii) If the debtor in possession cannot obtain unsecured credit, the court may

authorize post-petition credit (a) with priority over all other administrative

expenses, (b) secured by unencumbered property, or (c) secured by a

junior lien.103

(iv) If credit is not otherwise available and the existing lenders are adequately

protected, the court may authorize a debtor in possession to obtain credit

secured by a senior or equal lien.104

Under LCM provisions, post-petition financing always requires conciliator’s

approval. The conciliator, considering the opinion of the examiners, may authorize a

debtor in possession to obtain secured or unsecured credit, in or outside the ordinary

course of business.105 Post-petition unsecured credit is granted administrative expense

status.106 LCM does not allow granting a primary lien; therefore, a post-petition credit

may only be secured by unencumbered property or by a junior lien.

As mentioned before, for a company subjected to reorganization, obtaining financing

is not easy because lenders are afraid of not being able to recover their money. Such

fear diminishes when lenders became secured creditors and even more when they get

a primary lien. A statute that allows a debtor in possession to obtain financing secured

by a primary lien saves an important lifeline of a going concern. Hence, regarding

                                                                                                               102 11 U.S.C. § 364(b). 103 11 U.S.C. § 364(c). 104 11 U.S.C. § 364(d). 105 LCM, art. 75. 106 LCM, art. 224.

  29

post-petition financing, Chapter 11 is better than LCM at fostering the rehabilitation

of a company.

Reorganization plan

The purpose of a reorganization proceeding is to maintain the debtor’s business alive

as a feasible and profitable company. Since the economic value of an insolvent

debtor’s assets is regularly not enough to fulfill all its prepetition commitments, a

reorganization plan seeks to fairly redistribute such value among the interested parties

(creditors, shareholders, etc.).

Filing a plan

In the US, during the first 120 days after the issuance of the order for relief, only the

debtor may file a plan.107 If the debtor files a plan within that period, such plan has to

be accepted within the first 180 days after the order for relief.108 Both periods may be

extended or shortened.109

If a debtor does not file a plan within the 120-days period, or if filed does not gain

acceptance within the 180-days period, other parties may file a plan. A debtor may

lose its exclusive right if a party in interest has obtained an order decreasing or

terminating the exclusivity period;110 or a trustee has been appointed.111

                                                                                                               107 11 U.S.C. § 1121(b). 108 11 U.S.C. § 1121(c)(3). 109 11 U.S.C. § 1121(d). The 120-days period within which only the debtor may file a plan may not be extended beyond 18 months after the order for relief, while the 180-days period within which to gain acceptance of the plan may not be extended beyond 20 months after the order for relief. 110 The exclusivity period can be reduced “for cause”. See 11 U.S.C. § 1121(d). 111 11 U.S.C. § 1121(c)(1).

  30

Once the debtor’s exclusivity period ends, “[a]ny party in interest, including the

debtor, the trustee, a creditor’s committee, an equity security holder’s committee, a

creditor, an equity security holder, or any indenture trustee, may file a plan.”112

The Mexican statute has a complete different approach. LCM does not provide an

exclusivity period in which only the debtor may file a plan. Indeed, any party in

interest may propose a plan at any time during the reorganization stage. Actually, the

plan is negotiated outside the court, regularly at conciliator’s initiative.113

Once the conciliator considers that the debtor and the creditors required to accept a

plan have a favorable opinion about a proposed plan, he files into the court a proposal

of the plan to be considered by all the parties in interest. After all the parties had been

given the chance to review the proposal, the conciliator may file the reorganization

plan that the debtor and the required creditors have signed.114 Later on, each creditor

has the opportunity to reject the plan, and the court will determine if the plan

complies with the legal requirements.115

A reorganization plan must be filed within 185 days as of the day in which the

insolvency judgment was published in the Federal Official Gazette (Diario Oficial de

                                                                                                               112 11 U.S.C. § 1121(c). 113 One of the responsibilities of the conciliator is trying that the debtor and the creditors negotiate a reorganization plan. See LCM, art. 148. An important amount of the conciliator’s fees depend on the confirmation of a plan. See Reglas de Carácter General de la Ley de Concursos Mercantiles (General Rules of the Bankruptcy Law), Regla 36, Diario Oficial de la Federación, 18 de Diciembre de 2009. 114 LCM, art. 161. 115 LCM, arts. 163-164.

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la Federación);116 otherwise, the debtor would be declared in liquidation (quiebra)

and the court would start the liquidation stage.117

The 185-days period may be extended for 90 days more, at request of the conciliator

or of the creditors that hold at least two-thirds in amount of the total allowed claims.

A second extension may be granted for an additional period of 90 days, at request of

the conciliator and the creditors that hold at least 90% in amount of the total allowed

claims. In any case, the period for filing a plan cannot exceed 365 days.118

As mentioned above, Chapter 11 provides for an exclusivity period in which only the

debtor may file a plan, while LCM does not foresee such exclusivity. In my opinion,

such difference is irrelevant because LCM does not respect the absolute priority rule

and provides that any reorganization plan requires debtor’s approval to be effective.119

In the US, the exclusivity period is important to keep control over the reorganization

procedure since a plan can be approved even without debtor or shareholders’

acceptance. Shareholders and managers might be deprived from their controlling

interest if a creditor’s plan is approved. Thus, in the US, the existence of an

exclusivity period for the debtor to propose a plan is a device that diminishes the

threat of losing control and promotes the use of reorganization proceedings.

Approving a plan

                                                                                                               116 LCM, art. 145. 117 LCM, art. 167. 118 LCM, art. 145. The 365-days maximum length of the reorganization stage has not been respected in several cases (e.g. Compañía Mexicana de Aviación, S.A. de C.V. and Grupo Fertinal, S.A. de C.V.). 119 These ideas are discussed in more detail below.

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In the US, voting on a plan is by class.120 Thus, any plan must classify similar claims

together and treat claims within a class similarly.121 Claims, not creditors, must be

classified. It is important to determine whether a class of claims or interests is

impaired or not because unimpaired classes cannot vote on a plan, since they are

presumed to have accepted it.122

Pursuant to Chapter 11 provisions, a plan might be consensual or nonconsensual. A

plan is consensual if all impaired classes vote to accept it. A particular class accepts a

plan if creditors that hold at least two-thirds in amount and more than one-half of the

allowed claims of such class vote to accept the plan.123 For a class of interests to

accept a plan, at least two-thirds in amount of the allowed interests who voted must

have voted to accept the plan.124

If a plan is not accepted by each class, it may be confirmed if at least one class of

impaired creditors accepts the plan;125 the plan does not discriminate unfairly, and is

fair and equitable as to the dissenting classes. 126 The capacity to confirm a

nonconsensual plan is known as “cramdown”.

In any case, unless a class unanimously accepts the plan, members of a class must

receive under the plan at least as much as they would get in a Chapter 7 liquidation.

                                                                                                               120 11 U.S.C. § 1126. 121 11 U.S.C. § 1123(a)(4). 122 11 U.S.C. § 1126(f). 123 11 U.S.C. § 1126(c). 124 11 U.S.C. § 1126(d). 125 11 U.S.C. § 1129(a)(10). 126 11 U.S.C. § 1129(b)(1).

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In Mexico, for a plan to be approved, it requires the acceptance of the debtor and the

creditors holding a specific amount of debt. Regarding the debtor’s acceptance, an

important question is who has the legal authority to accept a plan on behalf of the

debtor when the conciliator has completely replaced the debtor’s managers. In my

opinion, LCM does not provide a clear answer to this question, and there is no public

precedent that addresses this issue. There are three possible answers: (i) the

conciliator, who has the duty of administering the debtor’s business; (ii) the replaced

managers, who had the legal authority to act on behalf of the debtor; or (iii) any

representative appointed by the old managers or the shareholders meeting.

On the other hand, a plan requires the acceptance of creditors holding a specific

amount of debt. The specific amount of debt should be bigger than the sum of 50% of

the total allowed unsecured claims plus 50% of the allowed claims of the secured

creditors that accept the plan, if any.127 Under this logic, if none secured creditor

accepts the plan, the plan needs the acceptance of the creditors that hold a simple

majority of the total allowed unsecured debt, but if any secured creditor accepts the

plan, the simple majority of the allowed unsecured debt is not anymore enough for

accepting the plan. In this sense, as long as a secured creditor accepts the plan, the

destiny of the unsecured creditors is not anymore in the hands of the creditors that

hold a simple majority of the allowed unsecured debt.

Notwithstanding the above, an accepted plan cannot be confirmed if a simple majority

of unsecured creditors, or any number of creditors holding 50% in amount of the total

allowed unsecured claims, expressly rejects the plan.128

                                                                                                               127 LCM, art. 157. 128 LCM, art. 163.

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It is considered that all unsecured creditors have accepted a plan, when such a plan

provides the payment of the entire amount of their claims.129

For a plan to be confirmed, it cannot provide for the creditors that did not accept it, a

discount or forgiveness of principal and interest, a maturity extension, or a

combination of both, bigger than the granted by the creditors that accepted the plan

and hold at least 30% in amount of the total allowed unsecured claims.130

A creditor that holds a secured claim and did not accept the plan may foreclose on the

corresponding collateral, unless the plan provides for the payment of the claim or the

payment of the collateral value. If the collateral value is lesser than the amount of the

claim, the deficiency is treated as an unsecured claim.131 Notwithstanding, any

secured claim whose payment is provided for in the plan is still secured by the

collateral with the corresponding lien priority.132 In this sense, a secured creditor can

still foreclose on the corresponding collateral if the claim provided for in the plan is

not paid.

Unlike in the US, where claims are sophisticatedly classified and two-thirds in

amount and a majority in number of each class is required to vote in favor of a plan

(unless confirmation is sought by cramdown), the Mexican statute only distinguishes

between secured and unsecured claims, and the consent of creditors holding a specific

amount of debt is enough to confirm a plan. Moreover, under LCM provisions, claims

                                                                                                               129 LCM, art. 158. 130 LCM, art. 159. 131 LCM, art. 160. 132 LCM. art. 165.

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held by debtor affiliates and insiders are also counted for purposes of calculating the

required amount of debt to approve a plan, while such claims are not considered for

voting purposes under Chapter 11.

The Mexican approach has advantages and disadvantages for the debtor. A debtor

may only need to negotiate with a group of creditors who hold the specific amount of

debt needed to approve a plan, even though such creditors do not hold a majority of

the claims or represent a majority of the creditors in number. Moreover, the debtor

can consider the claims of its affiliates and insiders to achieve the required amount of

debt.133

On the other hand, a debtor cannot benefit from the flexibility that Chapter 11

provides. Claims classification, particularly of unsecured claims, facilitates the

approval of a plan, since the necessities of each class of creditors might be different.

In addition, pursuant LCM provisions, secured creditors cannot be crammed down

since a plan shall provide for the payment of their claim, or the payment of the

collateral value. This circumstance is relevant in those cases where secured creditors

hold the majority of the allowed claims.

As mentioned above, LCM does not respect the absolute priority rule, which

essentially provides that creditors or holders of equity interests may not receive any

recovery of their claims or interests unless the creditors with a higher priority have

received full payment of their claims. As a matter of fact, pursuant LCM provisions,

as long as holders of the specific amount of debt accept the plan, shareholders of a

                                                                                                               133 Examples of the use of affiliated debt for obtaining the required amount of debt to approve a plan are seen in the reorganization proceedings of Corporación Durango, S.A. de C.V., (although in this case such strategy was not used at the end), Vitro, S.A.B. de C.V., and Fertilizantes Nitro, S.A. de C.V.

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debtor company could retain their equity interests even though the company’s

unsecured creditors are not receiving full payment.134 This circumstance supports

shareholders’ reluctance to offer creditors equity during the negotiation of a

reorganization plan.

“As with so many revolutionary regulatory changes, the [LCM’s enactment] process

was highly political as the various interest groups lobbied for advantage. The final

procedures, effective in May 2000, reflect the politics. In the context of understanding

the bias of the procedures, they would be characterized as ‘controlling shareholder

friendly,’ with the exception that the local banks were able to lobby for absolute

protections for secured creditors by incorporating no provision for cram down.”135

Although Chapter 11 has important devices to achieve the confirmation of a

reorganization plan, such as the cramdown provision and the sophisticated

classification of claims, it is my impression, and this is just a personal assumption,

that the mechanisms of specific amount of debt and inclusion of debtor’s affiliated

and insiders debt for purposes of calculating the amount of debt required to approve a

plan under LCM provisions, could be more effective at getting the approval of a

reorganization plan.

From an unsecured creditor perspective, the US system is fairer than the Mexican one.

Under Chapter 11, a plan requires the acceptance of each class of unsecured creditors,

unless confirmation is sought by cramdown, in which case fairness and equity is

needed anyway. In contrast, under LCM, a plan does not require the approval of the

                                                                                                               134 This circumstance can be understood within the Mexican economic situation, where a few prominent people control many of the largest companies and expect to retain their controlling interests at the end of a reorganization proceeding. 135 Rauch, supra note 50, at 5.

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unsecured creditors as a class, but of the holders of certain amount of debt, in which

debtor’s affiliated debt and secured debt could be considered. Unlike in the US, it

might be the case that unsecured creditors receive less under a LCM reorganization

plan, than what they would get in case of liquidation.

Effects of confirming a plan

In the US, upon confirmation of a plan, prepetition and post-petition debts are

discharged and treated as set forth in it. A confirmed plan binds the debtor and all

creditors and equity security holders, regardless whether they voted to accept the plan,

or whether the plan impairs a claim or interest.136

Unless otherwise provided in the plan, confirmation vests all of the property of the

estate in the debtor.137 Except as otherwise provided in the plan, the property dealt

with by the plan is free and clear of all claims and interests of creditors and owners.138

Preexisting secured claims, if any, are eliminated and replaced by any secured claims

provided for in the plan.

In a similar path, LCM provides that a confirmed plan binds the debtor, all the

unsecured creditors, the secured creditors that accepted the plan, and the secured

creditors for which the plan provides a complete payment. Creditors holding secured

claims do not waive their collateral or their lien priority by subscribing the plan;

                                                                                                               136 11 U.S.C. § 1141. 137 11 U.S.C. § 1141(b). 138 11 U.S.C. § 1141(c).

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therefore, any claim provided for in the plan is still secured by the collateral with the

corresponding lien priority.139

Public policies

Public policy is an equivocal concept. Thomas R. Dye defines public policy as

“Whatever governments choose to do or not to do.”140 Curiously, the author argues

that searching for a definition of public policy may degenerate in a word game that, at

the end, adds little more understanding.

Thomas A. Birkland defines policy as “a statement by government – at whatever

level- of what it intends to do about a public problem.”141 However, based on Dye’s

definition, Birkland also sustains that “the lack of a definitive statement of policy may

be an implicit policy.”142

In my opinion, both statutes correctly serve the following public policies:

(i) Preserve the financial distressed companies, as well as the companies that

have dealings with them (suppliers and costumers).

(ii) Preserve the going concern value for allowing rehabilitation or

maximizing stakeholder’s recovery in case of liquidation.

(iii) Reduce the cost of credit.

(iv) Preserve employments.

                                                                                                               139 LCM, art. 165. 140 Thomas R. Dye, Understanding Public Policy, 18 (1972). 141 Thomas A. Birkland, An Introduction to the Policy Process: Theories, Concepts, and Models of Public Policy Making, 9 (2011). 142 Id at 9.

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(v) Maintain the number of taxpayers.

(vi) Establish and orderly mechanism for distributing costs and proceeds.

(vii) Deter individual collection and piecemeal depletion of debtor’s assets.

In addition, Chapter 11 serves the policy of protecting the reputation of solvent

businesses, by providing that the court may award punitive damages in case of

dismissal of an involuntary petition. The Mexican statute does not serve this policy.

Likewise, Chapter 11 intends to serve the public policy of encouraging out of court

restructuring and settlement, by providing the possibility of granting relief from the

automatic stay.143 The Mexican statute does not serve this policy.

Conclusions

Effective bankruptcy proceedings induce debtors to be careful in the incurrence of

liabilities and provide greater confidence in creditors when extending credit or

rescheduling their claims. Although insolvency procedures are implemented through

the judiciary, an effective and organized insolvency system establishes incentives for

debtors and their creditors to negotiate out-of-court-agreements. They promote

growth and competitiveness and may also assist in the prevention and resolution of

financial crises.144

The social, political and economical background of each country determines the

manner in which they have decided to regulate reorganization proceedings.

                                                                                                               143 For cases recognizing the enforceability of prepetition waivers of the automatic stay as a matter of public policy see: In re Club Tower L.P., 138 B.R. 307 (Bankr. N.D. Ga. 1991), In re Cheeks, 167 B.R. 817 (Bankr. D.S.C. 1994), In re Shady Groove Tech Center Associates Ltd. Partnership, 227 B.R. 422 (Bankr. D. Md. 1998). In re Excelsior Henderson Motorcycle Mfg Co. 273 B.R. 920 (Bankr. S.D. Fla. 2002). 144 International Monetary Fund, Legal Department, Orderly & Effective Insolvency Procedures: key issues, 1-2 (1999).

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The US commencement criterion (whenever the debtor wishes) for entering a

reorganization proceeding is better than the Mexican one (fixed and numerical

insolvency) at fostering the rehabilitation of a company because it allows addressing

financial distress at an early stage and reduces disputes about insolvency

requirements, which saves time and resources.

It might be argued that if Mexico adopts the US approach, that would conceivably

cause more abuses in Mexico than the ones seen in the US, because a possible perjury

prosecution for having filed in bad-faith has less intimidating impact in a country

whose criminal system has proved inefficiency. Although such reasoning is arguably

true, I think that changing the commencement criterion would produce more benefits

than damages, besides that there are many ways to ensure the reimbursement of a

damage so caused.

LCM provides the mandatory intervention of specialized auxiliaries (visitor and

conciliator), who necessarily charge the estate with their fees. The intervention of

auxiliaries is not mandatory under Chapter 11, so the estate is not necessarily charged

with their fees. Hence, the US reorganization proceeding is arguably less costly than

the Mexican one.

Despite of the above, I consider that Mexico should not eliminate the auxiliaries’

mandatory intervention because, unlike the US, Mexico does not have specialized

bankruptcy courts and without such intervention the system would be inefficient.

Having specialized bankruptcy courts in Mexico would be great but the size of the

economy and the number of filings is not yet that big to urge an immediate change.

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An efficient reorganization system provides the debtor with a breathing period. The

sooner it is provided, the better. In this sense, the timing of the automatic stay

foreseen in Chapter 11 is better at fostering the rehabilitation of a company than the

timing of the stay provided in LCM. Even though granting a stay before confirming

the necessity of it might cause abuses, I consider that the benefits of an automatic stay

are bigger than the possible damages, besides that there are many ways to ensure the

reimbursement of a damage so caused.

The scope of the stay foreseen in Chapter 11 serves better the rehabilitation purpose

than the stay provided in LCM. In the US, all litigation against the debtor is stopped,

while in Mexico the debtor should continue defending itself in different courts.

Likewise, Chapter 11 encourages out-of-court negotiation by providing instances to

lift the stay. In turn, LCM does not serve that policy.

Regarding the exceptions to the stay, I consider that LCM, by allowing the attachment

and foreclosure on debtor’s properties to satisfy labor claims, diminishes the chances

to rehabilitate the company. The exceptions to the stay foreseen on Chapter 11 seem

to be less prejudicial towards the rehabilitation of the company, excluding the one that

allows a landlord to remove the debtor from a real estate property once the lease is

terminated.

Both statutes allow the managers at the time of filing to continue running the

company, but also provide that managers can be removed. There is no a clear

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advantage for any country on this department, except that LCM makes easier to retain

key employees.

Provisions about the operation of the business during reorganization are better on

Chapter 11 than on LCM. In both countries the debtor has access to cash and is

allowed to continue the business and sell estate’s assets, but Chapter 11 is much more

clear than LCM on the use of cash-collateral and the sale of encumbered property free

of liens.

Regarding post-petition financing, Chapter 11 has a clear advantage over LCM in the

race of achieving the rehabilitation of a company, because unlike the Mexican statute,

it allows the debtor to obtain a credit secured by a primary lien.

The process and requirements for completing a reorganization plan are substantially

different in each country. Chapter 11 has interesting devices to achieve that goal, such

as the exclusivity period in which only the debtor can file a plan, the sophisticated

classification of claims and the cramdown procedure. LCM does not have such

devices. A plan requires the acceptance of the holders of a specific amount of debt,

and debtor’s affiliated and insider debt can be considered for that purpose. This

mechanism could be particularly prejudicial for unsecured creditors.

In a general assessment of the provisions of both statutes, I conclude that Chapter 11

is better than LCM at fostering the rehabilitation of a company as a going concern.