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.