Implementing Extrajudicial Reorganization Agreements in Ecuador: A Response to the COVID-19 Pandemic

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 those economically viable companies dealing with financial difficulties resulting from 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 debtors and creditors. For instance, the Ecuadorian formal insolvency regulation, which is highly costly and burdensome, imposes a qualified majority to install 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 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 will allow debtors and creditors to restructure the original conditions of their contractual relationships more rapidly, without the complexity of the formal insolvency proceedings. Extrajudicial arrangements are beneficial because they facilitate a rapid restructuring of the debtor’s contractual obligations without a formal and complicated insolvency procedure.

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, section 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, section 27 requires a mediator to conduct the negotiations. According to Álvaro Pereira, mediators do not have prior experience in insolvency law. Therefore, it might be argued that it is unclear how mediators will 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, usually cumbersome and costly in terms of time. Besides, out-of-court reorganization agreements have a contractual nature. Hence, while bringing the parties together, a mediator should only help them find common ground so that consent to a renegotiation of contractual entitlements can emerge. 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.

More negatively, it is noteworthy that the Humanitarian Act does not impose a moratorium once the mediated 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. Adolfo Rouillón has previously highlighted how the inexistence of a moratorium can hinder these negotiations. For this reason, the regulation of out-of-court restructuring agreements could be reinforced, according to 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 initiating a formal insolvency proceeding. Instead, these tools are available for companies conducting a scheme of arrangement. Therefore, as it was mentioned in a recent post, the new insolvency and restructuring framework implemented in Singapore allows debtors to enjoy the advantages associated with both the traditional scheme of arrangement (eg, flexibility, debtor-in-possession, lower costs and stigma) and a modern reorganization procedure (eg, moratorium, rescue financing provisions, cramdown).

As 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. Something similar has been temporarily implemented in Colombia due 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.

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 would have achieved its objectives more adequately if it had recognized a moratorium for those agreements. That said, Ecuador is currently analyzing a new Corporate Restructuring Bill, intended to modernize its legal insolvency framework. Among other objectives, the mentioned bill seeks to improve the regulation of out-of-court reorganization agreements, according to the proposals analyzed in this post. Adequate regulation of these agreements, considered as the first pillar of a corporate insolvency framework in emerging markets (such as Ecuador), will promote the reorganization of valuable firms dealing with financial distress due to the adverse effects of the COVID-19 pandemic.

Paúl Noboa-Velasco is a lecturer in Corporate Law at San Francisco de Quito University and the academic coordinator of the Ibero-American Institute for Law and Finance.

A different version of this post was previously published on the Singapore Global Restructuring Initiative.