A to-do list upon liquidity constraints or the imminence of restructuring
Introduction
Companies globally are facing enormous challenges and complications as a consequence of a harshly decelerating economy with recession looming courtesy of Covid-19. In the case of Mexico, where a sharp decline in economic activity has intensified, a substantial number of companies of all sizes, private and public, are experiencing acute liquidity tests and, in some cases, the clear and present prospect of insolvency.
The following is intended to be a firstinstance list of issues and hopefully useful recommendations which could be helpful in the handling of a potential crisis when considering the path of restructuring or contemplating insolvency remedies before courts in our country.
a) What to watch for in the legal side?
Prompt and sharp assembly of contracts containing affirmative and negative financial obligations and covenants, principal and interest payments and default triggers and consequences. Primary focus to information delivery, default notice, dividend distribution, absence of changes and other associated covenants, representations, events of default, how and when should payment of principal and interest is required to be made and default interest and the calculation of other derived penalties. Legal counsel to work collectively with the internal accounting and financial department and other advisors is key to identifying potential systemic failure. Close scrutiny of financial statements, matching legal and financial obligations under credit facilities and other debtgenerating documents is equally of priority, with particular emphasis on marginal notes. This allows for the proper assessment of materiality, disclosure and crossed action of a company’s current and contingent obligations. It is also key towards identifying personal guaranties or other collateral provided by shareholders, board members and officers, whether directly or by operation of law. Many times, banks require companies’ shareholders to sign documents in their personal capacity, potentially in the form of avales, obligaciones solidarias – joint obligations, or fiadores or as depositaries of merchandise pledged or otherwise subject to alternative forms of security. Identifying any of these personal obligations is important in managing exposure and allowing for the construction of negotiation priorities and strategies in liquidity distress scenarios.
Review terms of, and structures for, decision-making within companies, whether through board action, by the shareholders, majority and supermajority special provisions – negative control and determine the status and profile of investors, groups of shareholders, controlling groups and other influential constituencies is also a relevant factor in shielding from undue exposure. Reviewing shareholders’ agreements, company’s bylaws and other legal documents allows for proper decision-making and a common-terms approach of the company for strategic communications and engagement without adversely affecting negotiation leverage or procedural defenses.
Review terms of, and structures for, decision-making within companies, whether through board action, by the shareholders, majority and supermajority special provisions – negative control and determine the status and profile of investors, groups of shareholders, controlling groups and other influential constituencies is also a relevant factor in shielding from undue exposure. Reviewing shareholders’ agreements, company’s bylaws and other legal documents allows for proper decision-making and a common-terms approach of the company for strategic communications and engagement without adversely affecting negotiation leverage or procedural defenses.
b) What to do with financial documents?
As mentioned above, review of the company’s financial statements to properly calculate outstanding amounts whether current, due or overdue and establish the rankings and priorities each has becomes essential for creating a proper strategy, with liquidity-constraint action plans to be devised and installed. Tax and labor creditors have priority under Mexican law. Typically, secured creditors are preferential to unsecured – subordinated obligations, but there are some non-sensical exceptions. Seniority of creditors in this context should also be identified and determined. In this same context, upon identifying dates of payment of principal, interest, default interest, penalties, commissions and other amounts due, confirm the legal effects that failure to comply would have, including from a disclosure standpoint, cross-default and regulatory reporting.
It is advised to analyze credit agreements, indentures and other associated security documents to:
(i) Determine default triggers, review cross-defaults and cure-periods.
(ii) Identify secured and senior debt and analyze it together with labor obligations and obligations before tax authorities and strategic suppliers.
(iii) Analyze supra-subordination structures in place (whether by contract or by operation of law) and enforceability potential of security packages and the consequent foreclosure analysis.
In addition to a legal-specific analysis, a 360° de facto assessment of the context of the company is also advisable to detect opportunities not otherwise available strictly from a legal perspective.
Analysis on potential civil and criminal liability of board members and management is always a priority, identifying obligations and exposure pursuant to duties and special provisions, especially those applicable to publicly listed companies. It is advisable to verify a review protocol of how decisions were adopted and supported, especially in monetary borrowings and how to prioritize payments within a liquidity constraint situation vis a vis a business plan, fairness – business judgement rules. The law provides for duties of board members, members of committees and officers. Obligations under securities law are more restrictive to board and committee members and are oftentimes correlated to damages and indemnity consequences, including for officers and management generally.
Agreements or negotiations with creditors and the status of those negotiations, considering their stakes and position under insolvency and work-out scenarios must be closely monitored. Conversations with creditors, groups of creditors, investors or their representatives and the existence of any exchange of written communications – term sheets, mandates or letters of intent and any binding documents, are frequently ignored by companies. In the absence of these protocols, it is advisable to craft a plan on the strategy and timing of communications and negotiations before the execution of definitive arrangements with creditors or investors.
It is advisable to carefully identify existing obligations in the form of puts, calls, special provisions on conflict resolutions, forced sales or purchases of shares, preferential rights and steps required to exercise rights. Discuss potential terms of participation of new investors in the form of a merger or an acquisition. New investors are oftentimes relevant in contributing liquidity to companies. Also advisable is the review of convertible debt and terms of conversion and identify whether conversion into equity can be triggered or accelerated. The assessment of other prioritized claims such as labor and tax is also the centerpiece of a successful negotiation.
González Calvillo is a solution centered law firm with a broad commercial practice which includes finance, M&A and litigation, with relevant experience in work-outs, local and crossborder restructurings and concursos mercantiles.
