Implementing Extrajudicial Reorganization Agreements in Ecuador: A Response to the COVID-19 Pandemic
By Paúl Noboa Velasco (Superintendencia de Compañías, Valores y Seguros)
Introduction
Due to the international spread of COVID-19, an increasing number of businesses are in the vicinity of insolvency. Others, because of this pandemic, have already gone insolvent. Unfortunately, the formal insolvency proceedings in Ecuador, due to their inefficiencies and complexity, will not contribute towards ensuring the survival of economically viable companies which are dealing with financial difficulties as a result of this crisis.
Traditionally, formal insolvency proceedings have been the only alternative recognized by the Ecuadorian insolvency framework. According to Aurelio Gurrea-Martínez, these legal proceedings, in emerging markets, are usually value-destroying for both debtors and creditors. For instance, the Ecuadorian formal insolvency regulation, which is costly and burdensome, imposes a qualified majority for the installation of the meeting of creditors (75% of all the admitted creditors). Besides, Ecuador requires the same high percentage for the approval of a restructuring agreement (called concordato, according to the Ecuadorian Insolvency Act). Among other aspects, these requirements may explain why the Ecuadorian Superintendence of Companies has only admitted 27 insolvency proceedings since 1997, most of them without the approval of the proposed arrangement.
Out-of-court reorganization agreements (also known as workouts) could be an efficient alternative to the formal insolvency proceedings. As the World Bank Group has argued, informal reorganization agreements, in times of COVID-19, will contribute towards rescuing viable companies as a going concern in a less time-consuming way, due to their flexibility and ease of negotiation. These extrajudicial mechanisms, considered as one of the four pillars of insolvency law, will allow debtors and creditors to restructure the original conditions of their contractual relationships more rapidly, without the complexity of the traditional insolvency proceedings. Extrajudicial arrangements are beneficial because they will facilitate a rapid restructuring of the debtor’s contractual obligations, without a formal and complicated insolvency procedure.
The Humanitarian Act: The role of mediators
As a response to the current economic crisis, Ecuador enacted the ‘Humanitarian Act’. The objective of the Humanitarian Act is to mitigate the adverse economic effects of the pandemic. Among its provisions, S. 27 of the Humanitarian Act allows debtors to negotiate exceptional out-of-court agreements with their creditors, to restructure the conditions of any due credit. Besides, S. 27 requires a mediator to conduct the negotiations. According to Álvaro Pereira, mediators do not have prior experience in insolvency law. Therefore, some could argue that it is unclear how mediators are going to supervise these restructuring negotiations adequately.
Under the Ecuadorian Arbitration and Mediation Act, a mediator should only be expected to facilitate negotiations among the debtor and its creditors. Based on this facilitation, the parties may reach an amicable agreement among them. This possibility could be advantageous, primarily due to the absence of a judicial process which is usually cumbersome and costly in terms of time. Besides, out-of-court reorganization agreements have a contractual nature. Hence, a mediator, while bringing the parties together, should only help them to find common grounds before consenting to a renegotiation of their previous contractual relationships. In the opinion of Francisco Reyes Villamizar, the role of mediators will reduce the procedural burdens which, without their participation, would have been imposed over debtors.
As a negative aspect concerning the role of mediators, the Humanitarian Act has not introduced a legal provision to recognize a moratorium regime, once the negotiation begins. Therefore, an Ecuadorian mediator, who does not have jurisdictional powers, could not order a moratorium to prevent creditors from filing a claim while they negotiate an out-of-court restructuring agreement. According to Adolfo Rouillón, some legal disadvantages may hinder the economic efficiency of workouts. Among those disadvantages, Rouillón highlights the inexistence of a moratorium while the parties negotiate the agreement. For this reason, the regulation of out-of-court restructuring agreements could be reinforced, under Rouillón’s view, through the recognition of a time-limited moratorium. For that purpose, Ecuador could follow the example set by the Singaporean Insolvency, Restructuring and Dissolution Act 2018. In Singapore, companies can enjoy the protection of a moratorium and other restructuring tools without having to initiate a traditional insolvency proceeding. Instead, these tools are available for companies conducting a scheme of arrangement. Therefore, as it was mentioned by Aurelio Gurrea-Martinez, the new insolvency and restructuring framework implemented in Singapore allows debtors to enjoy the advantages associated with both the traditional scheme of arrangement (e.g., flexibility, debtor-in-possession, lower costs and stigma) and a modern reorganization procedure (e.g., moratorium, rescue financing provisions, cramdown).
As it happens in most civil law countries, Ecuador does not have a scheme of arrangement. Still, the restructuring tools adopted in the Singapore scheme of arrangement, or at least the moratorium, could be adopted in the new extrajudicial agreement to be adopted by Ecuador. In fact, something similar has been temporarily implemented in Colombia as a response to the COVID-19 pandemic, and a similar framework exists in Spain. These restructuring tools were also approved by the European Union and the United Kingdom. Therefore, as some authors have mentioned, the adoption of restructuring tools outside of formal insolvency proceedings is a trend currently observed internationally.
In my view, the Humanitarian Act would have achieved its objectives more adequately if it had recognized a moratorium. As an alternative, creditors and debtor could sign a standstill agreement. According to a standstill agreement, creditors could either agree not to bring a claim against the debtor's assets or not to file for the debtor's bankruptcy, until the negotiation finalizes. Nonetheless, a standstill agreement, as a contract, will only bind those parties who signed it. For this reason, the scope of its protection is limited.
Contractual nature of the extrajudicial reorganization agreements
As previously mentioned, the general principles of contracts govern out-of-court reorganization agreements. Section 27 of the Humanitarian Act states that these contracts are ruled by the same laws applicable over the transaction arrangements. Hence, these extrajudicial agreements should be valid among the parties involved, and would only bind those who signed them. Therefore, these contracts could not be enforced against third parties who did not consent to their provisions.
Section 27 indirectly determines that a workout will only bind its contracting parties. Nonetheless, section 28 inconveniently dismisses the relative effects of these agreements. Section 28 clearly states that an out-of-court reorganization agreement, once signed by the debtor and the majority of its creditors, will bind dissenting and absentee creditors, even if the contract is not court-sanctioned. It appears that the Humanitarian Act mistakes a non-sanctioned voluntary restructuring agreement with the reorganization plans (either sanctioned by a public authority or approved as a result of a formal insolvency proceeding). Even though dissenting and absentee creditors are entitled to appeal the extrajudicial contract signed by the debtor and the majority of its creditors, providing an erga omnes effect to a workout without a previous validation process validated by a public authority is not adequate. First, this possibility infringes the principle of contractual relativity of out-of-court restructuring agreements. Second, it modifies the pre-existing relations of dissenting and absentee creditors without their express consent. In conclusion, S. 28 might undermine legal and contractual certainty which prejudices the interest of dissenting and absentee creditors.
The Ecuadorian out-of-court reorganization arrangements should only be valid and enforceable among the parties who signed them. For that purpose, Ecuador could follow Argentina’s and Colombia’s example, whose legislation recognize the contractual nature of these extrajudicial agreements. Based on the court-sanctioned scheme of arrangement (regulated, among other jurisdictions, by Singapore and the United Kingdom), the extrajudicial agreements should only bind dissenting and absentee creditors if, and only if, a public authority has sanctioned it. This suggestion would prevent abuse over a dissenting and absentee minority of creditors, who did not expressly consent to be bound by the arrangement approved by the majority.
Conclusion
The legal recognition of the extrajudicial restructuring agreements is undoubtedly positive, mainly because Ecuador has not regulated these contracts in the past. Nonetheless, the Humanitarian Act has a provision which could generate some inconvenience in the future. According to the Humanitarian Act, an out-of-court restructuring agreement will bind dissenting and absentee creditors even if the agreement has not been sanctioned by a public authority. This provision dismisses the contractual nature of these extrajudicial agreements and infringes the doctrine of privity of contracts. For these reasons, an amendment of this provision could be appropriate. Instead of its current regulation, the Humanitarian Act should determine that an extrajudicial reorganization agreement will be enforceable against a dissenting or absentee minority only when a public authority has sanctioned it. This court-sanctioned procedure will certainly prevent abuse and other inadequate practices against those creditors who did not approve the agreement. Additionally, it would be desirable to implement a moratorium for debtors seeking to reach these types of extrajudicial agreements.