“The Concurso Mercantil Law is not effective”

Insolvency in Mexico has been seen like a maze, the seven-heads demon or the evil. Insolvency is an effect of financial distress situations, which, in turn, are the effect of economic mistakes or diseases, abuse or greed, whether from the government or private sector or both. At the end, insolvency, most of the time, is a result of human action, rather than an act of God.

Under financial distress situations, it is of essence to be equipped with a modern, orderly, predictable, accountable, efficient and effective legal insolvency system to protect debtors' and creditors' rights, to optimise assets and as long as possible preserve jobs and businesses. Mexico through its history has lacked such a system. The current insolvency systems – concurso mercantil for merchants, enacted in 2000, and concurso civil for consumers, enacted in 1932 – have without a doubt failed.

In the systemic financial distress situations of the 20th and 21st centuries, Mexico has been forced to overcome distressed economies through vehicles outside insolvency proceedings. It was the case of the FICORCA in the mid 1980s, and the UCABE, the FOBAPROA and the IPAB in the high 1990s which were, in fact, official rescue programmes, wherein the government assumed the risks. Risks which, in the end, are paid by federal treasury with taxpayer funds. Most individuals, consumers, holding high debts, banking debts, mortgages, credit card debts, and other debts were forced to participate in ruinous restructuring programmes, recognising and acknowledging the full debt, principal plus interest, payable in a longer period. In other instances, financial systemic crises have been faced with the support of the international finance institutions, foreign indebtedness and other countries' financial support.

21st century upgrade
In the insolvency context, financial distress entrepreneurs and consumers look for reorganisation rather than liquidation or at least a fresh start. Debtors seek bankruptcy protection when available, whether in reorganisation, liquidation or out of court settlement. Insolvency systems should provide for predictable, timely, orderly, efficient and effective bankruptcy protection. Bankruptcy protection benefits the economy and trading chain, even with a fresh start. Major bankruptcy systems in the UK, US, Canada and Japan regulate and provide bankruptcy protection to prevent insolvency not only while under actual economical crisis.

Mexico's insolvency system lacks effective bankruptcy protection. Mexico has a double insolvency system. Firstly, it is for merchants, namely concurso mercantil, and secondly it is for non-merchants, concurso civil – consumers (both for individuals and legal entities). Concurso mercantil is governed by a federal law, Ley de Concursos Mercantiles (LCM), enacted in May 2000. Concurso civil is an estate regulation, governed by each estate's civil code, modelled on the Civil Code for the Federal District, enacted 1932. Insolvency petition is not mandatory. In case there is no plan of reorganisation, estate assets shall be liquidated. No concurso mercantil or concurso civil provide for discharge, except with the creditors' approval. Neither of them provide for dischargeable debts. Under concurso mercantil and concurso civil, the debtor remains liable after liquidation of any deficiency owed to creditors after liquidation and/or distribution. Thus, any creditor may enforce and execute thereafter its rights in the case of a debtor gathering new assets, inheritance or lottery. There is no discharge.

Notice that, surprisingly, there is no record of concurso civil filings in history. There are no official statistics whatsoever of concurso civil. Regarding concurso mercantil, the situation is similar. From 2000 to May 2010, there have been only 444 proceedings in concurso mercantil in total, involuntary and voluntary. Of these 208 (46 percent) have been terminated by settlement, of which only very few were terminated by the plan of reorganisation. This data shows that only a few cases arrive at such a status. These statistics show that debtors and merchants, under financial distress and within an economic crisis like the current one, do not file for concurso mercantil.

Bankruptcy protection as well as time and cost are important for both debtors and creditors. There is an immediate need for an insolvency culture and system in Mexico to eradicate the evident phobia surrounding insolvency.

For the time being, debtors are seeking out-of court reorganisations and settlements. As the financial situation becomes worse and with rescue programmes being insufficient, in 2011 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 close their and runaway by fact (factual liquidation). It is also expected creditor's foreclosures and judicial executions since concurso mercantil (insolvency) is not mandatory.

In Mexico we have already seen that the concurso mercantil law is not effective. Ley de Concursos Mercantiles strongly needs to be amended. Its structure was modelled in the old Spanish bankruptcy laws of the 18th century.

There is an urgent need for an insolvency system that will effectively provide for the 21st century legal regime and that will help debtors and creditors overcome the financial stress situation, including labour, tax, suppliers of goods, services and finance, merchants and non-merchants, whether large, medium or small. For instance in Mexico, small business (PYMES) and non-merchant (consumer) insolvencies lack all bankruptcy protection.

Another feature of the Mexican insolvency system is that labour creditors and tax creditors (federal, state and municipal) are super priority creditors. Labour and tax creditors do not enter into insolvency. They are enforced, recognised and paid in their special courts, outside of insolvency. When it happens, generally, there is nothing left for other creditors.

Likewise, only post-petition actions, including arbitration, enter insolvency proceedings under the concurso mercantil. Thus, pre-petition action and arbitration do not join the concurso mercantil.

On the other perspective, Sistema de Administracion Tributaria (SAT) data shows that Mexican IRS records 26.3 million active taxpayers – 16.3 million employed, nine million individuals and 831,000 legal entities. Informal sector – not under IMSS (Social Welfare) government control and non-taxpayers – 12,612,617 in April 2009 accounting for 28.3 percent of total employed people.

New approach
21st century insolvency systems encompassing and protecting all debtors and creditors, whether merchants or consumers as well as all creditors, including labour and tax, may help importantly to overcome and reduce significantly the informal sector and non tax payers, based upon the fact that all of them would prefer the insolvency benefits (such as the automatic stay, discharge and tax benefits) under the formal insolvency proceedings.

The new insolvency system shall, inter alia, provide for reorganisation and liquidation in bankruptcy in separate independent proceedings upon petition of creditors or debtor. It should incentivise discharge for a fresh start, when viable. Otherwise it should provide for timely, orderly, efficient and effective liquidation.

Oscos Abogados is drafting a new bill featuring issues for a 21st century insolvency system.

For more information tel +52 (55) 12 53 01 00; email: doscos@oscosabogados.com.mx; www.oscosabogados.com.mx

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