Credito Real Body-Checks Mexican and US Insolvency Laws – Will the US Court Fight Back? – Insolvency/Bankruptcy
“Credito Real is trying to circumvent Mexican and U.S. insolvency laws and roll out a corporate liquidation statute with almost no protection for creditors. The success of Credito Real’s strategy is about to be tested by a U.S. bankruptcy court.”
Facing financial difficulties stemming from allegations of financial reporting deficiencies and deteriorating market conditions, and following crumbling discussions with its group of creditors, Credito Real circumvented a court-supervised restructuring under U.S. or Mexican law, choosing instead to pursue a business liquidation process under Mexican law.
Credito Real’s suspension of restructuring discussions with its creditors had led some unsecured creditors to file for involuntary bankruptcy against Credito Real under Chapter 11 of the United States Bankruptcy Code. Credito Real responded to this request by initiating the process of liquidating the company under Mexican law, for which it requested recognition under Chapter 15 of the United States Bankruptcy Code.
Credito Real filed a petition under Chapter 15 of the Bankruptcy Code of Delaware (the state in which its US subsidiary was organized) to establish the primacy of the Mexican business liquidation process. In addition, Credito Real argued that the involuntary Chapter 11 case against it pending before Judge David S. Jones in the United States Bankruptcy Court for the Southern District of New York should be dismissed for lack of jurisdiction and because a court-supervised liquidation process was already underway. underway in Mexico (where the majority of Credito Real’s assets are located). While the involuntary Chapter 11 case has been transferred to Delaware bankruptcy court, the hearing to dismiss the involuntary petition is still ongoing.
From the point of view of some creditors, the opening of the liquidation process by Credito Real seems to be a fraudulent strategy to avoid the imminence of criminal proceedings against its main shareholders and directors, as well as an inappropriate tactic to avoid paying its creditors. unsecured (mainly bondholders). From the perspective of minority shareholders, it is a perverse ploy deployed by controlling shareholders to distribute assets without considering the views or interests of minority shareholders at a shareholder meeting. For this reason, the latter group filed an appeal in August against the liquidation of the company before the 52nd Civil Court of the State of Mexico, requesting the suspension of the liquidation process. The local court granted the request, which the Third Chamber of Appeals of the Supreme Court of Justice in Mexico City recently upheld.
The problem with the liquidation process
Unlike liquidation under Mexican insolvency law (Ley de Concursos Mercantiles), the business liquidation process initiated by Credito Real under the General Law of Commercial Companies (Ley General de Sociedades Mercantiles, “Mexican corporate law”) does not conform to the basic tenets of most modern insolvency laws. Therefore, it could produce an outcome contrary to US public policy. In addition, the corporate liquidation process regulated by Mexican corporate law lacks the necessary judicial oversight to ensure fair treatment of creditors, including allowing preferential payment to local unsecured creditors. It also restricts the flow of information to creditors and their participation in the process, setting the stage for flagrant violations of the absolute priority and equal treatment rule that governs most insolvency proceedings.
What the Delaware Bankruptcy Court Ruling Could Mean
At present, the question to be decided is whether the Delaware bankruptcy court should grant recognition under Chapter 15 of the corporate liquidation process initiated by Credito Real under Mexican corporate law or instead dismiss this application for recognition and issue a creditors’ relief order. involuntary Chapter 11 petition. To do so, the Delaware bankruptcy court must determine whether it believes that the interests of all parties are better served in a Chapter 11 proceeding than in a Mexican business liquidation process. This resolution may well have significant implications for cross-border investment in the Mexican market.
If the Delaware bankruptcy court decides to recognize the corporate liquidation process under Chapter 15, not only does the involuntary Chapter 11 petition filed by the ad hoc group be dismissed, but this group of unsecured creditors will be left in a disadvantaged procedural position vis à vis local creditors. For example, without a court order prohibiting it, Credito Real can expect to continue to pay its local creditors in the amounts and order of priority of its choice according to the conditions that the liquidator agrees with each of these creditors. Moreover, the liquidator can be expected to continue to act on the instructions of the majority shareholder without regard to good business practices and customs to maximize the proceeds from the sale of the company’s assets. Moreover, the company’s liquidation process does not provide for a retrospection period allowing certain transfers made before the declaration of bankruptcy to be contested as fraudulent transfers; there is no process to check whether the transactions that Credito Real has already implemented have been to the detriment of unsecured creditors.
Even if the Delaware bankruptcy court denies recognition of the company’s Chapter 15 liquidation process and places Credito Real in Chapter 11 proceedings, the chances of unsecured creditors recovering their debts and recovering a portion of their money are almost non-existent. It should be noted that Credito Real’s lawyers have implemented a complex but effective strategy to settle several of the company’s debts with its secured creditors. For example, Credito Real paid off its debt with Banorte by transferring part of its loan portfolio to the bank, which Banorte then sold to Crédito Maestro (a subsidiary of Credito Real). The problem is that by the time the Delaware bankruptcy court rules, it may already be too late to recover the assets sold by Credito Real. It is true that under Chapter 11, unsecured creditors or their representatives may be able to bring actual or constructive fraudulent conveyance actions against some of Credito Real’s assignees to bring the transferred property back into the estate. However, some of the transactions likely to be subject to such measures were executed by Credito Real in Mexico and with Mexican counterparties (some of which are not present in the United States). This situation could prevent unsecured creditors or a trustee in bankruptcy from reversing these transactions and bringing the transferred assets back into the bankruptcy estate for distribution to all creditors under the priority regime of the Bankruptcy Code. .
Takeaways for non-bank lenders in Latin America
Depending on the result of Credito Real, investors could rethink their debt strategy in Mexico and perhaps elsewhere in Latin America, in particular their appetite for unsecured debt. Although the Credito Real strategy can be deployed by a company in any sector, since Credito Real is a non-bank lender, like Alpha Credit and UNIFIN, this sector may be subject to greater risk aversion. Additionally, investors considering taking a minority stake in a Mexican company may wish to try to protect themselves against controlling shareholders who pursue a course of action similar to that of Credito Real. To adapt, non-bank lenders need to strengthen their accounting practices and corporate governance; only then can they take advantage of the new opportunities that will undoubtedly open up to lenders who learn to navigate this stormy new climate of investor suspicion and financial uncertainty.
The Credito Real case underscores the scope and implications of cross-border insolvency proceedings in Latin America, highlighting the lingering unresolved Chapter 15 issues related to the narrow construction of public policy exemptions to recognition of foreign proceedings. Highly controversial, Credito Real’s strategy created a crisis similar to that resulting from the Vitro case, where intercompany debt was misused to crush the group of third-party creditors.
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This article by Mayer Brown provides information and commentary on interesting legal issues and developments. The foregoing is not a complete treatment of the subject matter covered and is not intended to provide legal advice. Readers should seek specific legal advice before taking any action regarding the matters discussed here.