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07 July 2000
Law 550, dated December 30 1999, introduced a new pro-debtor insolvency regime in Colombia. It aims to promote agreements to restructure companies that are insolvent or at risk of becoming insolvent. Additional regulation has been enacted amending existing provisions on bad debt reserves of financial entities, in order to make them compatible with the new restructuring law.
Restructuring agreements are approved by the majority of votes cast by internal and external creditors. Internal creditors are partners, shareholders or other parties that have contributed equity to a company. External creditors are all other creditors (including tax authorities and workers).
As a general rule, internal creditors are entitled to the number of votes equal to their participation in the equity of the company, and external creditors are entitled to the number of votes equal to the amount of the principal of their respective credit. For the purposes of determining the votes of due capital, they are adjusted for inflation. Tax credits include default interest and sanctions.
If approved by majority, the agreement is binding on absent and dissident creditors. There is a risk that, depending on the debt structure of the company, internal creditors may impose an unfavorable agreement on creditors by majority vote.
Securities created before December 30 1999
The creditor may initiate enforcement actions, obtain seizure and attachment of collateral, but will only be paid (by the sale of the collateral) if a restructuring agreement is not approved within an eight-month period. The creditor must also become a party to the restructuring negotiations. If an agreement is approved, the creditor will be bound by the terms of the agreement and will not be able to seek payment from the third party guarantor, unless expressly authorized under the agreement.
Securities created after December 30 1999
The creditor must choose between seeking payment from the company under restructuring or from the third party securing the credit. If the first option is chosen, all enforcement actions are suspended and the creditor must become a party to the negotiations. If there is no agreement within the specified term, the creditor will be able to enforce the third party security. However, if he or she chooses to enforce only the third party security, the creditor will forfeit the right to obtain payment from the debtor under restructuring.
In the agreement, parties may alter the legal priorities (except for the preference of tax and labor credits), provided the affirmative vote of external and internal creditors represents at least 60% of the admissible votes. In practice, this means that unsecured creditors, in conjunction with tax creditors and workers, may approve an agreement in which they receive payment before secured creditors.
External Circular Letters 026 and 030 (dated April 2000) set out new bad debt provision requirements for financial institutions that are creditors of companies subject to Law 550 restructuring negotiations.
Under existing regulations, provisions have to be made based on the credit rating attached biannually by the bank to each credit. Three factors are considered:
Credits may be assigned ratings from 'A' to 'E'. A normal credit (ie, an appropriately structured credit with adequate service by a debtor with sufficient payment ability) is given an A rating. Unrecoverable credits are rated as E.
Banks and financial institutions must have general reserves equal to 1% of their gross credit portfolio, regardless of the rating of their credits. They must make individual reserves for each credit rated in categories B through E, as follows:
|Rating||Amount in Reserve|
|Category B (acceptable)||1% of credit value, including capital, interest, monetary correction and other monetary accruals.|
|Category C (deficient)||20% including items described above.|
|Category D (difficult recovery)||50% of capital plus items described for B credits.|
|Category E (unrecoverable)||100% of capital plus items described for B credits.|
Moreover, when a credit is graded C or lower, for accounting purposes, the bank must stop accruing interest, monetary correction and exchange rate adjustments.
Before this new regulation, restructured credits would generally be given a lower credit rate, depending on the increased risk and financial conditions of the debtor. They could only be given the same, or an improved, rate if:
Under the new regulation, financial institutions must stop accruing interest and other accessories from the date of initiation of restructuring negotiations, but they can maintain the same credit rating. If negotiations fail, the credit will be assigned an E rating. All credits granted after the negotiation of the agreement will be given an A rating (to provide an incentive for the provision of fresh resources for restructured companies).
If the restructuring agreement calls for fresh equity contributions or capitalization of debt not less than 15% of the total debt of the restructured company with financial institutions, these institutions may accrue interest and reverse provisions if:
If the restructuring agreement envisages the capitalization of debt or its conversion into risk bonds of not less than 20% of the total debt of the restructured company with financial institutions, these institutions may accrue interest if the conditions described above are met. They may also reverse their reserves whenever the restructured company has paid at least 15% of the outstanding capital and is up-to-date on the payment of interest.
If creditors grant loan term extensions, grace periods, or write-offs, which improve payment capacity of the debtor, provided that the conditions described above are met and that the agreement is being complied with, financial entities are permitted to use cash-only basis accounting. Therefore, interest will only affect the profit and loss statement if it is effectively collected by the financial institution.
In all other cases, interest may only be accrued and provisions reversed when a minimum of 50% of the restructured credit is paid.
For further information on this topic please contact Daniel Posse at Posse, Herrera & Ruiz Abogados by telephone (+57 1 312 3157) or by fax (+57 1 313 0259) or by e-mail (email@example.com).
The materials contained on this web site are for general information purposes only and are subject to the disclaimer.
The materials contained on this website are for general information purposes only and are subject to the disclaimer.
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