Why the Peruvian Bankruptcy Law requires urgent reform amid anticipated legislative changes | Guillermo Puelles
Why the Peruvian Bankruptcy Law requires urgent reform amid anticipated legislative changes
Nuestro socio especialista en Reestructuración e Insolvencia, Guillermo Puelles, comparte su articulo titulado ¨Why the Peruvian Bankruptcy Law requires urgent reform amid anticipated legislative changes¨ para Latin Lawyer.
“The GBL is obsolete and insolvency proceedings are slow, inflexible and rather hostile to both creditors and debtors. From being a creditor-oriented law where creditors had the power to make the most important decisions without the authority intervening in the merits, the GBL became a tedious and ineffective way to deal with entrepreneurial crisis.”
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General overview
The current Peruvian General Bankruptcy Law (GBL) was enacted in 2002, with high expectations and hopes for both debtors and creditors in the market. The previous restructuring law had many gaps and grey zones and was amended on various occasions. The new GBL was supposed to not only give solutions to the previous law’s problems but also create a better environment for the widespread use of the insolvency legal framework by market agents. However, the new GBL ended up failing in its purpose and set the start of an era of declining public insolvency proceedings in Peru.
Now, more than 20 years after its enactment, the GBL is obsolete and insolvency proceedings are slow, inflexible and rather hostile to both creditors and debtors. From being a creditor-oriented law where creditors had the power to make the most important decisions without the authority intervening in the merits, the GBL became a tedious and ineffective way to deal with entrepreneurial crisis. There are many reasons and extensive analysis of the causes that led to this situation. We will not focus on them; instead, we will concentrate on the most urgent and needed reforms, which, in part, are under consideration by a GBL reform project that is currently under consideration in Congress. First, however, a brief overview of the Peruvian bankruptcy system is necessary, to subsequently understand the problems at stake and their potential solutions.
The Peruvian bankrupcty framework
In Peru, insolvency proceedings are administrative – that is, they are followed not before a judicial court but before the National Institute for the Defense of the Competition and Protection of Intellectual Property (INDECOPI) through its Insolvency Proceedings Commission (the Commission), which is the administrative authority in charge of handling insolvency proceedings and supervising the process.
The GBL provides for two different bankruptcy proceedings: (1) the ordinary proceeding and (2) the preventive proceeding. On the one hand, the ordinary proceeding allows creditors to restructure or liquidate the debtor, considering its patrimonial situation and the viability of its economic and financial restructuring. The debtor itself is entitled to voluntarily file for an ordinary proceeding if (1) it has incurred in losses in excess of one-third of its paid-in capital or (2) it has unpaid and past due obligations in excess of one-third of its total liabilities. On the other hand, creditors may also initiate an ordinary proceeding against a debtor if such debtor has an unpaid credit of 50 tax units (approximately US$65,000) past due for more than 30 days.[2]
In general terms, the ordinary proceeding vests upon the creditors (by means of the creditors’ meeting) the right to freely decide the best course of action with respect to the insolvent debtor. Therefore, the creditors are entitled to (1) decide whether to restructure or liquidate the insolvent debtor, (2) remove and appoint new management in a restructuring scenario or appoint the liquidator in a liquidation case, and (3) freely decide the terms and conditions of a restructuring plan with certain specific mandatory regulations but with ample freedom and flexibility so as to determine the economics, financing and rescheduling of maturity terms, etc., of a restructuring agreement with the debtor.
INDECOPI has only a supervising role in this proceeding; therefore, the authority will not evaluate, approve or confirm the content, economic reasonableness or merits of a restructuring plan or liquidation agreement. The authority role will be limited to having a supervising role with respect to the legality of the creditors’ meeting decisions – for example, in the correct regulation of approval requirements and majorities, mandatory legal provisions, compliance with general bankruptcy regulations and inexistence of abuse of rights, etc.
On the other hand, in a preventive proceeding, a distressed debtor facing temporary financial or economic distress may obtain an automatic stay and propose to its creditors moratorium terms, lower interest rates and a reschedule of debts, among other financial waivers or advantages. In this proceeding, creditors have fewer attributions and rights and liquidation is not an option. Moreover, the debtor retains control of management at all times during the proceeding. Notwithstanding, there is also a risk for the debtor: if the creditors’ meeting does not approve the refinancing agreement proposed by the debtor, then a vote of the majority of the acknowledged claims in the proceeding can immediately result in the commencement of an ordinary proceeding against such debtor. Thus, debtors must propose a sound refinancing agreement and be convincing to the creditors, or they may end up in an ordinary proceeding fully controlled by the creditors. This preventive proceeding, because of its nature, can be initiated only by the debtor and the filing will be accepted only if (1) the debtor’s losses are less than one-third of its paid-in capital and (2) the debtor’s unpaid and past due obligations do not exceed one-third of its total liabilities.
For the purposes of this chapter, we will refer mainly to the ordinary proceeding, as it is by far the most used in Peru.
The current problems and the need for legislative reform
Once the Commission declares the commencement of an insolvency proceeding and publishes such decision in INDECOPI’s Official Bulletin, an automatic stay of all the debtor’s obligations and a protection regime for the debtor’s estate immediately begin. This stay applies to all pre-petition debt incurred by the debtor up to the date of publication. Credits arising or generated after the publication (post-petition claims) are not subject to stay and may be collected regardless of the insolvency status of the debtor.
A first significant problem is that obtaining such automatic stay currently takes from four to six months from the date of the filing, either voluntary or involuntary. Worse, once the insolvency proceeding commences, it takes from 12 to 18 months until the first creditors’ meeting takes place. Effectively, once the proceeding is initiated, creditors have 30 business days to file for the allowance of their credits before the Commission. This allowance is extremely important because the only creditors that are entitled to participate in a creditors’ meeting are those that have been duly recognised by INDECOPI and, as we have mentioned, creditors are the ones that will adopt all the decisions concerning the debtor (i.e., whether restructuring its debts or liquidating the company). If a creditor fails to file for allowance of its credits in a timely manner, it will not have voting rights in the creditors’ meeting and will not be able to participate in the discussions and decisions held therein. This allowance of credits process, which in the past used to be fast and expeditious, currently takes from 12 to 18 months on average, and in large cases with a significant number of creditors it could take up to two years. Of course, the creditors’ meeting cannot be established until the allowance process is concluded.
This means that the time of response of the Peruvian insolvency system is, on average, 22 to 24 months before anything can be finally decided and executed with respect to the debtor. During this period, the debtor’s shareholders retain control and possession of the business, but management is restrained from taking any significant action because of the prohibitions and clawback provisions that are described below. Similarly, the board will maintain its attributions during this period; therefore, they can take all corporate decisions that are allowed by the debtor’s by-laws (other than any transfer, lien or any other act affecting the insolvency estate). However, in all these actions, the management and the board should act with due diligence and reference to the fiduciary duties owed to the creditors and therefore they should avoid any act outside the ordinary course of business. This, of course, is a killer feature for any restructuring effort if nothing impactful can be done for almost two years to rescue the company.
On the other hand, pursuant to the GBL, once the debtor files for insolvency or is served with an involuntary filing, all actions taken by management during the previous year and until the creditors reunite and decide to maintain or replace the debtor’s management may be challenged before the judicial commercial courts. Effectively, Article 19 of the GBL provides two types of insolvency actions that can be brought by creditors (and the debtor’s administrator or trustee) if the debtor is insolvent:
- the clawback action (also referred to as the look-back period action), which covers all actions or transactions taken by the management of the debtor, whether for consideration or not, during the period that is one year prior to the date when the debtor files for its insolvency or is given notice of a filing by a third party, and which meet the following two-prong test: (1) they have a negative or adverse effect on the net worth of the debtor’s estate and (2) they are not part of its ordinary course of business; and
- the avoidance action, which sets a list of acts or transactions by the debtor that can be judicially challenged and declared inefficacious if they are carried out from the date in which the debtor files or is served with the filing of an insolvency proceeding and until the first creditors’ meeting takes place.
These clawback and avoidance actions have not been largely used or proved effective in any significant way. This is another problem the system suffers from. If there are no incentives to properly control the debtor’s fraudulent conveyances or preferential payments and the debtor remains in full corporate and factual control of its company for 22 to 23 months, then this is a perfect formula for a disastrous and ineffective insolvency legal framework.
In addition, the GBL is certainly a hostile environment for debtor-in-possession (DIP) financing. As the clawback provisions basically restrict the ability of the debtor to enter into transactions out of the ordinary course of business, this limits any chance for a DIP financing during the whole initial stage of the proceeding. The regulations also restrict encumbering assets, transferring property or otherwise doing anything that could affect the debtor’s estate until the creditors reunite.
In the past, the insolvency process was much faster, and creditors reunited in less than three months from the publication and commencement of the case. There, creditors could approve post-petition DIP financing and rapidly address the debtor’s financial or economic crisis. If now it takes almost two years to get to the point where decisions can be made, obviously, the debtor may very well be ‘dead’ by that time.
Even worse, the GBL does not acknowledge any special right, privilege or appropriate treatment for post-petition financing, causing potential lenders to avoid any loans or credits to an insolvent debtor. And to create even more hostility, post-petition liens and encumbrances will not be acknowledged by INDECOPI and will not be effective if, subsequently, the debtor fails in its restructuring effort, goes into liquidation and does not repay the post-petition financing. This causes a great disincentive for any potential finance opportunity for the debtor. It is of no surprise that in Peru almost all insolvency proceedings are aimed only at liquidating companies and not restructuring them.
Finally, the lack of cross-border regulation in the GBL renders largely ineffective any chance to communicate and implement foreign jurisdiction insolvency proceedings in Peru. First, Peru-domiciled corporations are not able to submit to a foreign insolvency jurisdiction, such as a Chapter 11 in the United States. Effectively, according to Article 6.1 of the GBL, INDECOPI has jurisdiction to conduct all insolvency proceedings involving debtors domiciled in Peru.
On the other hand, a foreign insolvency proceeding of a multinational debtor that has assets located in Peru (e.g., a Chapter 11 filing made in the United States) does not have an immediate impact or legal effect in Peru, and such a foreign proceeding will have to be acknowledged by the Peruvian courts through an exequatur proceeding, giving place to a ‘local secondary proceeding’, which, for the worse, will privilege local creditors with respect to the Peru-located assets or estate of the debtor. This secondary insolvency proceeding, although restricted to the debtor’s assets located within Peruvian territory, will be regulated by the GBL and conducted by INDECOPI, leaving an obscure and rather undefined landscape as to how the Peruvian and foreign authorities will interact.
This means, for example, that the automatic stay triggered by the Chapter 11 case will not be immediately applicable in Peru, thus distorting the functionality of the foreign proceeding. In this light, also, the appointment of a trustee for the debtor within the Chapter 11 proceedings in the United States (which could eventually take corporate control over the Peruvian subsidiaries or assets) of other similar situations occurring abroad will not have an immediate recognition in Peru. Even worse, given the fact that Peruvian secondary proceedings will be regulated by the GBL, then the local creditors could decide on and appoint a different management or liquidator for the insolvent debtor, in contradiction with the mandate or decision taken by the court with a Chapter 11 case.
A much-needed reform
As can be seen, there are many major problems in the GBL that affect the very core of the insolvency system. The problems described above have resulted in an insolvency system that has been used less and less by market agents, and specifically the creditors, those who were at the centre of the legislators’ interest and focus. The main idea of the insolvency regime, which was to protect the ‘credit’ itself and, thus, create an environment with more access to credit facilities for companies of any size, has largely failed.
There are a vast number of other mistaken, unfortunate and inefficient regulations contained in the GBL, but we have depicted just those that seem more urgent to resolve if we want to maintain hope in a brighter future for the restructuring practice in Peru.
Many years ago, aware of these problems, INDECOPI led the discussion about and preparation of a general reform of the GBL that could address the serious concerns and dysfunctionalities created by the law itself, as well as the need for an enhanced, powerful Commission with the necessary resources and personnel to be efficient and fast in the handling of cases. More than four or five years have passed since the commencement of those debates, discussions and comments to drafts of new regulations, etc., but the project for legislative reform is still carefully secured in some legislator’s desk, and it is not clear when it will be put to final discussion and approval. The projected draft of a GBL reform is also subject to debate. There may be many new problems and grey zones, but at least it would be an important first step in the path of a truly modern and effective restructuring law.
In any case, a real and much-needed reform of the GBL requires, at least, the following changes:
- A faster proceeding, where the filing leads to an immediate automatic stay. Act fast, ask later – at least for the voluntary cases. Part of the problem today is the burdensome and bureaucratic load of requisites that the debtor must provide in order to submit to an ordinary proceeding. The same occurs with creditors, which are scrutinised as if they were all liars and criminals. The financial and economic crisis requires a swift response or everybody loses. Granting an automatic stay and focusing subsequently on reviewing and confirming adequacy with all the legal requirements is what should be done. Of course, maximum severity is assumed for cheaters, breachers and bad-faith companies, managers and creditors, but we must indeed establish an environment that is attractive to debtors in distress.
- A quick allowance of the credit process, based on a veracity presumption attitude with, post-commencement, a more in-depth review of the merits of each creditor. Consumer claims and labour petitions, etc., should be excluded from the case in exchange for a fast track for the payment of their claims.
- A truly functional regime for fraudulent conveyances and preferential payments, with rewards to those pursuing the recovery of assets in favour of the debtor’s estate and clearer rules for the application of the clawback and avoidance actions. Nowadays, the Peruvian commercial courts are confounded and do not have a clear idea of how these actions work. This is logical and understandable: those courts do not handle, regulate or participate in insolvency proceedings, as INDECOPI is the government authority in charge. We need to regulate appropriate interaction between INDECOPI and the judiciary and we also need more development in the applicable rules.
- An attractive system for DIP and other post-petition financing, which is a feature of enormous importance for a successful reorganisation. Such credits need to be obtained quickly, but they must be designed carefully. A fast insolvency proceeding will help, certainly, but we need to reinstate the privileges and rewards to those risking their resources to finance companies in distress.
- Finally, it is indispensable to have cross-border regulations that really allow for swift, efficient and fair interaction between foreign proceedings and local insolvency regulations. Cases such as LATAM Airlines, Avianca and others have demonstrated that Peru is well behind almost every other Latin American country in terms of insolvency laws and, worse, Peruvian laws have become adverse and pernicious to achieving effective outcomes in large transnational insolvency cases.
The very much anticipated legal reform addresses some of these matters, adequately in some cases and with doubts and concerns in other cases, but it is indispensable to movng forward because, otherwise, the landscape will remain the same: the insolvency realm as a supposedly promised land that results in a dangerous and poisonous territory and, just outside it, thousands of companies waiting to enter once the promised land becomes such.