Pitfalls and promises of pre-pack restructuring

in Mexico, Brazil, UK and US

 Read our article in the Cayman Financial Review Magazine, eversion 

Pre-pack restructuring is gaining ground as a procedure of
choice for business reorganisation in Latin America. In December 2010, the
supermarket giant Controladora Comercial Mexicana became the first major
Mexican company to achieve a pre-pack arrangement, for $2 billion of debt,
under new pre-pack-friendly concurso provisions. In May 2011, Mexican
glassmaker Vitro won its appeal to salvage a pre-pack restructuring of debts
totalling almost $3.5 billion(1).

What is a pre-pack, and why might it be the latest procedure
of choice? A pre-packaged, or “pre-pack”, restructuring differs from an
ordinary reorganisation in one primary respect: the restructuring plan is
negotiated informally and accepted by the relevant decision maker before a
formal reorganisation proceeding is commenced. Subsequently, the agreed plan is
implemented under the auspices of a formal process very quickly and with
limited administrative expense. Usually, only those key creditors are involved
in the negotiation (especially secured claimants, like bank groups), whose
support is essential to the legal imposition of the plan on dissenting
creditors. On the positive side, then, pre-packs are quicker and less expensive
than full-blown reorganisation proceedings, they are private and can therefore
minimise negative publicity, and they allow negotiations to concentrate
productively on key creditors, avoiding distraction by out-of-the-money
claimants with no bargaining leverage.

On the not-so-positive side, the technique is often
challenged as improperly skewing benefits to certain creditors, including
insiders and inter-company claimants, as well as to former owners/managers of
“phoenix” companies that simply rise from the ashes after having been
essentially laundered through a truncated sale process. If a pre-pack
arrangement is presented to unsecured claimants as a fait accompli that
benefits only favoured claimants and perhaps bargain buyers, the process
engenders ill feelings and suspicion of underhanded dealing. This feeling is
exacerbated if the buyers of the “new” restructured company are the very same
pre-bankruptcy owners (or managers) who ostensibly bear some responsibility for
the company’s demise. The stark juxtaposition of controlling winners and
disenfranchised losers has given rise to brutal criticism of pre-packs,
especially in the UK press. The Times last year featured a column crowing that
Britain could become an “insolvency brothel” fostering “blatant and offensive abuse”
of the pre-pack procedure by “low-life businesses(2).”

These criticisms must be placed in context, however, as not
all pre-pack procedures are the same. The key question is whether the
pre-arranged workout deal is at least not vastly worse for unsecured creditors
than the likely result from more rigorously supervised in-court proceedings.
Each legal system tests the resulting pre-pack deal in a slightly different
way. A glance at the methods adopted in four prominent jurisdictions offers
some insights into the comparative strengths and weaknesses of the Latin
American approaches and the future promise of the pre-pack technique.

The uniquely lax oversight system in the UK explains the
criticisms levelled at the British pre-pack process. Critically, creditors are
not asked to vote on the proposed pre-pack plan, nor is prior court approval
required. Instead, a private administrator appointed by the company simply
decides whether, to take a common example, a sale of the entire business,
perhaps to its former owners, is “necessary or expedient”. If key secured
creditors approve the deal and its terms, the pre-arranged sale is implemented
immediately upon the filing of a formal administration case. Unsecured
creditors might challenge the administrator’s decision after the fact, but such
challenges are difficult to mount. One commentator sums it up nicely by
observing that the “English system invests its trust in the stewards of the
process3”. Given the dangers outlined above, one can understand unsecured creditors’
hesitance to “invest their trust” in a single private administrator appointed
and paid by the very business owners who seem to be sloughing off debts in
exchange for a non-market-tested bargain laundering of creditors’ claims.

The new Latin American procedures deal much more carefully
with the dangers of pre-packs. Brazil offers a fine example, where since 2005 a
new pre-pack process called recuperação extrajudicial at least subjects such
arrangements to a creditor vote. Creditors must accept the pre-pack plan by a
positive vote from 60 per cent of each category of claims. Indeed, some claims
are insulated from the operation of pre-pack restructuring altogether, such as
labour and tax claims4. The Brazilian approach may be too restrictive with
these exclusions and super-majority requirements, but these protections make
the pre-pack process far more palatable.

The Mexican pre-pack provisions, adopted in 2007 to enhance
the concurso procedure, take essentially the opposite approach of that in the
UK. Mexican pre-pack arrangements reflect little more than preliminary
expressions of creditor support, still subject to significant formal review. A
pre-pack restructuring can be presented to the court only if 40 per cent in
face value of affected claims has signed on to the proposed concurso plan.
Final implementation of the plan, however, requires review by an appointed
conciliador and the court, as well as ultimate approval by a majority of
creditors5. The out-of-court process in Mexico thus does not produce a “done
deal,” but simply sets the stage for a quicker and smoother in-court
restructuring process.

Some Latin American companies have taken advantage of the
more aggressive but still creditor-controlled approach in Chapter 11 of the US
Bankruptcy Code. Companies that have used the pre-pack provisions of US law
include the Chilean power company, Empresa Electrica del Norte Grande, in a
$340 million restructuring, and the Colombian power company, Chivor, in a $330
million restructuring6. Binding votes in favour of an eventual Chapter 11 plan
can be solicited informally from any type of creditor, and creditor-supported
pre-packs can be imposed on dissenters quite quickly in an abbreviated formal
proceeding without a re-vote. In the extraordinarily restructuring-friendly US
law, not only can a pre-pack plan be imposed on dissenters within each class,
with the positive vote of a majority of class members holding two-thirds of the
class claims, but entire classes can have a plan “crammed down” on them if even
one class approves the plan and a few other requirements are satisfied.   

Pre-pack procedures are the future of reorganisation
practice in Latin America and elsewhere. A proper evaluation of their promises
and dangers requires an understanding of the particulars of each very different
approach. The global marketplace of legal competition will likely continue to
exert pressure on Latin American countries to continue their pre-pack
bankruptcy reforms. They need not surrender all control and acquiesce to the
heavily criticised UK approach, but they might move further toward the US model
of super-charging minorities of creditors to achieve more global workouts with
limited time and expense. Some pre-packs are more equal than others.

 

EndNotes 

  1. See Elinor Comlay, “Mexico’s Vitro says prepackaged bankruptcy approved,” Reuters (Apr. 11, 2011); Emily Chasan & Cyntia Barrera Diaz, “Supermarket poised to test Mexico insolvency law,” Reuters (May 18, 2010).
  2. See Michael Herman, “Abuse of pre-pack deals ‘could turn Britain into an insolvency brothel,’” The Times (Jan. 18, 2010).
  3. Hugh Sims & Peter Cranston, Pre-packs: Recent law and practice” ¶ 81 (Apr. 2007).
  4. See Thomas Benes Felsberg & Andrea Acerbi, “Brazil overhauls restructuring regime,” Int’l Fin. L. Rev. (2006).
  5. See David D. Cleary et al., “Uncertainty For Prepackaged Bankruptcies in Mexico,” Law360 (Feb. 23, 2011).
  6. Id.

 

 

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Jason Kilborn

Professor Jason Kilborn teaches business and commercial law at John Marshall Law School in Chicago.  His primary focus is on the comparative analysis of insolvency systems for individuals, though his interest extends to international bankruptcy as well. He recently co-authored a book on international co-operation in cross-border insolvency cases, published by Oxford University Press.

Jason Kilborn
Professor of Law
John Marshall Law School, Chicago
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Chicago, IL 60604
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