MEXICO: An Introduction to Bankruptcy/Restructuring
Alejandro Sainz, Founding Partner and Chairman of the Insolvency and Restructurings Practice Group at Sainz Abogados S.C.
Throughout 2020 and 2021, Mexico, like many other countries, has faced consequences related to health and the economic impact and slowdown derived from the global COVID-19 pandemic.
This pandemic exacerbated an already weak economic situation in Mexico, causing a significant economic contraction. Going into 2020, Mexico was already in a recession, due in part to falling investments resulting from political uncertainty and fiscal tightening.
Even as economies reopen – regardless of their size, and whether in the formal or informal sector – most businesses’ and industries recovery remains uncertain as many continue to be cautious about returning to a physical environment.
Mexico’s vulnerability to the pandemic was largely due to its weak healthcare system and its high dependence on the services sector.
The government announced extended nationwide lockdowns and restrictions on non-essential economic activities. Businesses, among many other issues, faced a decrease in income and, in many cases, the need to continue incurring fixed costs made them struggle financially and default their credit payments and commercial obligations.
Our courts were closed for almost three months and currently the operation of federal courts, regarding insolvency proceedings, still suffers many deficiencies due to the pandemic restrictions.
Unlike many countries, which quickly responded by enacting emergency legislation and implementing measures concerning restructurings, rights of creditors and insolvency proceedings, Mexico did not implement or modify its insolvency laws during these unforeseen times.
On top of this, while many economies relied on government support which provided significant relief to businesses (loan guarantees and wage subsidies for workers, tax stimulus and moratoria) this was not the case in Mexico. There has been very limited government support for the private sector. It is reported that Mexico has only spent around 0.7% of GDP on tackling this crisis, mainly providing loans to low income households, compared to, for example, 8% of GDP in Brazil and an average of 4% in emerging markets.
Evidently the willingness from the banking sector to restructure financial terms was not enough and the effects of this weak economic scenario will continue for an extended period of months, forcing businesses in various sectors and industries to evaluate their financial liquidity and define restructuring plans or opt for insolvency and bankruptcy.
In the face of continued uncertainty, we consider that the real effects of the serious collapse worldwide, and particularly in our jurisdiction, are still yet to be fully seen and evaluated.
Companies will need to identify inefficiencies, suspend non-essential operations, optimize activities, and negotiate amendments to their business plans and contractual terms to take into account the current scenario.
Businesses can no longer rely on suspension of debt obligations or any reliefs granted by government subsidies. Neither can they afford to wait for an eventual recovery to take place with the continuing uncertainty of the extent and duration of the economic situation.
At the beginning of the health emergency, the initial consensus predicted an unquestionable increase in the number of insolvencies and bankruptcies due to the negative economic impact of the pandemic.
However, evidence has shown that insolvency and bankruptcy cases have not necessarily increased and in many countries business insolvency cases have even dropped since last year.
This has been partly due to the governmental and private sector support programs which kept insolvency and bankruptcy rates down during the critical initial period of the crisis, mitigating the pressure to restructure.
Additionally, new insolvency legislation in many countries and the barriers to initiate insolvency filings (whether caused by the financial impossibility of businesses to afford the cost of initiating judicial proceedings or the judicial suspensions and operational hurdles ordered by the government) played a role. Insolvency and bankruptcy play very different roles for large and sophisticated corporations compared to small businesses. Large players may be able to turn to bankruptcy for protection, while small ones often only see this as a last resort.
Surprisingly, some businesses may withstand the storm and some lessons will be learned from this situation.
For instance, the e-commerce sector in Mexico, which already had an upward trend before the crisis, registering as one of the highest e-commerce growth rates in the world, benefited from the pandemic as consumers became more informed and opted for online shopping for practicality reasons.
However, although the expected increase in insolvency and bankruptcy rates has not yet occurred, we are certain that the restructuring activity will pick up in the mid and long term as government and bank support is lifted. Insolvency will move back onto the agenda particularly for those that operate in heavily affected countries and/or industries. Lower sales, lack of supplies, higher unemployment, accounting vulnerabilities, and liquidity challenges will continue to hit their finances.
Debt defaults will eventually build up and banks will strengthen their provisions for bad debt and increase restrictions on new credits.
We strongly believe that more than ever the Mexican government must assist by strengthening the insolvency regime, developing expedited mechanisms and an efficient judicial process, to mitigate some of the pandemic’s worst economic effects and provide businesses with an opportunity for survival.
In Mexico, the latest inquiry prepared in 2021 by the National Institute of Statistics and Geography (Instituto Nacional de Estadística y Geografía – INEGI) regarding the impact caused by the COVID-19 pandemic reported that 56 out of 100 businesses considered they will be in risk of insolvency/bankruptcy within the next year if they continue operating under the current economic circumstances. Only 3.8 per cent of businesses reported having received any economic support.