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The Analysis for Mexico includes articles on Revenue Based Finance – Debt, and Revenue Based Finance – Equity
Investment in Preferred Shares
Investment Structure Summary
Under Mexican Law it is possible for companies to issue preferred and common shares. The rules for preferred shares may be set by the General Shareholders’ Meeting authorizing their issuance.
Upon the liquidation of the company, preferred shares will be paid in first place prior to the payment of the common shares. Preferred shares may also have special distributions or dividends and may have special economic rights or preferred dividends based on revenues. These preferred shares may have a preferred right to receive a dividend in an amount equal to a percentage of the revenues prior to any distribution to common shares.
Category
Equity
Category for tax purposes
Preferred Shares and the payment of dividends will be subject to the payment of taxes and the corresponding withholding.
Governance Rights
Yes, preferred shares may grant to their holders corporate rights over the management of the company that may be determined by the General Shareholders’ Meeting authorizing their issuance.
Moreover, it can be structured to issue specific series of preferred shares with special economic rights based on revenues; having preferred dividends over revenues. In which case, such preferred shares may have a preferred right to receive a dividend in an amount equal to a percentage of the revenues prior to any distribution to common shares.
Investor Qualification Requirements
As long the shares are issued in a private offering to less than 100 offerees, there are no qualification requirements. If the preferred shares are offered to more 99 offerees, the investors may need to be institutional or qualified investors to avoid triggering a public offering.
In limited industries there may be foreign-investment and foreign-ownership restrictions.
Currency Considerations
Shares need to be registered in Mexican Pesos although they could have special coupons or payments denominated in foreign currency. However, as a general rule, under Mexican law, payment obligations denominated in foreign currencies and payable in Mexican territory may be discharged by paying the amount equivalent in Mexican Pesos pursuant to the exchange rate set forth by the Mexican Central Bank (Banco de México) one day before the applicable payment date
Collateral
Preferred shares, as they are equity, cannot be secured or guaranteed by any type liens or collateral.
Priority Payment Rights
Payment of preferred shares will be made after all employees and creditors are paid but before common shares.
Distribution and Redemption Limitations
As a general rule, all companies shall hold an annual shareholders’ meeting approving their annual financial statements reflecting the net losses or profits of the corresponding year. Dividends cannot be distributed before annual financial statements reflecting net profits are approved.
Moreover, companies are required to severe 5% of the net profits to form a “statutory reserve” until this reserve amount to the 20% of the capital stock of the company.
No distribution of dividends is allowed if there are no net profits or if 5% of the net income has not been separated for forming the statutory reserve.
In this sense, for purposes of clarity, while distributions need to be approved by the General Shareholders’ Meeting, the shareholders may undertake to make such distributions. As such, dividends may only be distributed only after the corresponding financial statements have been approved reflecting the existence of net profits; regardless if the amount of the distribution is based on revenue, net profits need to exist to make such distribution. Further, distributions cannot exceed the net profit or retained earnings shown in the financial statements approved by the General Shareholders’ Meeting and a statutory reserve of 5% of the net profits needs to be created each profitable year until the reserve equals 20% of the paid-in capital.
There are no restrictions to redemption if the redemption is approved by the General Shareholders’ Meeting. Note that companies are forbidden to buy back their shares but they can redeem them subject to approval of the General Shareholders’ Meeting. According to the law, redeemed shares should be determined randomly but shareholders can waive this requirement
Legal limitations to pricing or total return
No limitations to pricing or to the total return of the investment in preferred shares except that no share (preferred or common) may be issued for less than par value
Status in Insolvency Proceedings
In case of bankruptcy, holders of preferred shares are paid after all employees and creditors and only prior to common shares.
Limitation of Liability
As a general rule, investors’ liability towards the Company its limited to the payment of their shares.
However, there are certain exceptions derived from tax, antitrust and criminal law. There are also some recent precedents of plaintiffs being able to pierce the corporate veil.
Transfer Restrictions
As a general rule, by law, there is no mandatory restriction for the transfer of preferred shares. However, the shareholders may include transfer restrictions in the bylaws or in shareholders’ agreements.
Also note that public offerings may be subject to registration and authorization by the securities regulator (Comisión Nacional Bancaria y de Valores) and in limited industries there may be foreign-investment and foreign-ownership restrictions.
Critical Tax Considerations
Any payments made to the investors would be subject to the corresponding withholding and payment of applicable income taxes at the corporate level.
Withholding rate varies depending on the tax residence of the investor and its beneficial owners and available tax treaties
Investment in Debt with Interest over Gross Revenues
Investment Structure Summary
Under Mexican Law it is possible for companies to issue debt, linking both principal and interest payments to gross revenues. If principal repayment is based on revenues and the amount payable is higher than the originally disbursed amount, then the excess will be deemed interest. If the amount payable is lower than the originally disbursed amount, then a write off / haircut on principal shall be deemed to have occurred.
In this case the amount owed by the company will be treated as a liability.
Category
Debt
Category for tax purposes
Interest and fees payable to investors will be deemed as income sourced in Mexico (if the issuer is a Mexican entity) and subject to withholding taxes. The rate varies depending on the tax residence of the investor and its beneficial owners and availability of tax treaties
Governance Rights
No, debt instruments do not grant to their holders any type of corporate or voting rights over the company or its management. However, control over management may be achieved through affirmative and negative covenants. Breach of affirmative and negative covenants may only trigger debt acceleration and payment obligations and it will not be possible for investors to enjoin any action taken by the company in breach of those covenants.
Investor Qualification Requirements
No, there is no need investors need to comply with any particular qualification or requirement.
Currency Considerations
Debt may be denominated in foreign currency.
However, as a general rule, under Mexican law, payment obligations denominated in foreign currencies and payable in Mexican territory may be discharged by paying the amount equivalent in Mexican Pesos pursuant to the exchange rate set forth by the Mexican Central Bank (Banco de México) one day before the applicable payment date.
Collateral
Debt instruments, can be secured or guaranteed by any type liens or collateral, or third-party guarantees.
Priority Payment Rights
Ranking will depend on whether the debt is secured or unsecured. Unsecured debt is generally paid after all employees, secured creditors and other creditors with special preferences are paid. See Status in Insolvency Proceedings below for further detail.
Distribution and Redemption Limitations
For the payment of debt instruments there is no limitation or restriction. Investors or holders are considered creditors and are to be paid and liquidated at the maturity of the instrument.
Legal limitations to pricing or total return
In all instances usury laws shall be honored. Usury laws generally provide that interest shall not be that disproportionate or excessive preventing the investor from gaining an excess profit.
Pursuant to Mexican law, there is no statutory definition of usury, however it is sanctioned by both civil and criminal laws.
Article 2395 of the Federal Civil Code caps ordinary interest rates by providing that when such an interest rate is so disproportionate that it creates the appearance of abuse by the creditor due to the debtor’s ignorance or inexperience, a debtor may request the judge to equitably reduce it to the legal interest rate. Likewise, under civil law, the legal annual ordinary interest rate is 9%, unless otherwise agreed by the parties.
On the other hand, under Article 387 subsection VIII of the Federal Criminal Code, usury is a felony, sanctioning usury advantages by means of contracts or agreements providing for higher yields or profits than those usual in the market.
In commercial law, according to several precedents issued by the Mexican Supreme Court of Justice, usurious interest rates are prohibited by law. In this sense it has ruled that upon judges’ knowledge of an interest rate that may be considered usurious in a commercial proceeding, they are obliged to analyze it ex officio and reduce it to market standards.1
Additionally, below please several court precedents regarding usury and the parameters to be observed for its determination:
Under court precedent 1a./J. 46/2014 (10a.)2 issued by the First Chamber of the Mexican Supreme Court of Justice, the Supreme Court resolved that usurious interest rates contravene the provisions of Article 21 paragraph 3 of the American Convention on Human Rights (the “Convention”), which provides that all forms of exploitation of man by man, including usury, must be prohibited by law. In this sense, if a judge notices an excessive or usurious interest rate, it must disregard the agreed interest rate and impose a cautious interest rate in a reasoned and motivated manner according to the particular circumstances of the case at hand. Interest accrued at the usurious interest rate cannot be collected by the lender.
Under court precedent 1a./J. 47/2014 (10a.)3, the First Chamber of the Mexican Supreme Court of Justice ruled that judges must reduce excessive interest rates to avoid usury. To determine whether an interest rate is usurious, judges have to take into consideration the following parameters:
The nature of the relationship between the parties;
The nature of the parties involved in the credit and whether the creditor’s activity is regulated;
The credit purpose;
The credit amount;
The use of the proceeds;
The tenor of the credit;
The existence of collateral or guarantees;
The interest rates of the banking institutions for similar operations to those under analysis (this element only constitutes a reference);
The variation of the national inflationary index during the actual life of the loan;
Market conditions; and,
Other matters that generate conviction in the judge.
On top of the foregoing, judges must evaluate whether there are circumstances that reflect any kind of disadvantage of the debtor in the credit relationship with the lender.
In conclusion, there is no objective standard or percentage of what is considered usury being subject to court interpretation considering the court precedents previously mentioned.
In this sense, it is not that this limitation would prohibit revenue based financing, as long as the interest is proportionate to gross revenues, irrespective of the fact that there could be periods with high payments. What must be observed is the principle of no excessiveness and usury, taking into account the parameters and considerations mentioned above.
Status in Insolvency Proceedings
Below is the waterfall of payments in an insolvency proceeding:
- Employee-creditors (wages, salary and other employment benefits accrued during the last year);
- Credits regarding essential expenses for the operation of the debtor’s business, or credits regarding expenses for the conservation, protection and administration of the insolvency estate, approved by the estate’s representative;
- Singularly privileged creditors (burial and illness expenses);
- Secured creditors;
- Tax creditors and other employee and labor creditors;
- Special privileged creditors;
- Unsecured (common) creditors; and
- Subordinated creditors.
As of the day of company’s declaration of insolvency:
- Unsecured capital and ancillary obligations of credits arranged in Mexican currency will stop accruing interest and will be converted into UDIs (a Mexican-inflation pegged index);
- Unsecured capital and ancillary obligations of credits arranged in foreign currency will stop accruing interest and will be converted into Mexican currency and into UDIs;
- Secured credits will be maintained in the agreed currency or unit and will only accrue interest up to the collateral value
Limitation of Liability
Lenders’ liability is limited to disbursing committed funds in agreed terms. They are not liable vis-à-vis third parties for actions or omissions of the company.
Transfer Restrictions
No statutory restriction except that public offerings may be subject to registration and authorization by the securities regulator (Comisión Nacional Bancaria y de Valores)
Critical Tax Considerations
Interest and fees payable to investors will be deemed as income sourced in Mexico (if the issuer is a Mexican entity) and subject to withholding taxes. The rate varies depending on the tax residence of the investor and its beneficial owners and availability of tax treaties
- Court precedent VI.2o.C. J/32 (10a.) Digital Registry: 2019367, issued by the First Chamber of the Supreme Court of Justice of Mexico, published in the Weekly Judicial Journal of the Federation, Book 14, February 2019, Volume II, page 2395 entitled “USURIOUS INTEREST IN CIVIL MATTERS. THE SAME RULES THAT APPLY IN COMMERCIAL MATTERS MUST BE APPLIED.” ↩︎
- Court precedent 1a./J. 46/2014 (10a.) Digital Registry: 2006794, issued by the First Chamber of the Supreme Court of Justice of Mexico, published in the Weekly Judicial Journal of the Federation, Book 7, June 2014, Volume I, page 400 entitled “PROMISSORY NOTE. ARTICLE 174, SECOND PARAGRAPH, OF THE NEGOTIABLE INSTRUMENTS AND CREDIT TRANSACTIONS LAW, ALLOWS THE PARTIES TO FREELY AGREE ON INTEREST AS LONG AS SUCH INTERESTS ARE NOT USURIOUS. INTERPRETATION IN ACCORDANCE WITH THE CONSTITUTION [ABANDONMENT OF COURT PRECEDENT 1a./J. 132/2012 (10a.) AND OF ISOLATED THESIS 1a. CCLXIV/2012 (10a.)].
↩︎ - Court precedent 1a./J. 47/2014 (10a.) Digital Registry: 2006795, issued by the First Chamber of the Supreme Court of Justice of Mexico, published in the Weekly Judicial Journal of the Federation, Book 7, June 2014, Volume I, page 402 entitled “PROMISSORY NOTE. IF THE JUDGE NOTICES THAT THE INTEREST RATE AGREED UPON BASED ON ARTICLE 174, SECOND PARAGRAPH, OF THE NEGOTIABLE INSTRUMENTS AND CREDIT TRANSACTIONS LAW IS NOTORIOUSLY USURIOUS, HE MAY, EX OFFICIO, REDUCE IT PRUDENTIALLY”. ↩︎