António Aires and Alberto Scher of Demarest Advogados assess corporate restructuring and insolvency in Brazil
In Brazil, any company, be it a sole proprietorship or a business corporation, facing liquidity or financial problems, may seek recovery in a judicial reorganization procedure, restructuring itself under the protection of the Brazilian Bankruptcy and Reorganization Law (Law 11,101/2005) ("BBRL") or, if the recovery is unfeasible, file for voluntary bankruptcy (self bankruptcy - liquidation) or defend itself in an involuntary bankruptcy-liquidation case under the same law.
We will list now 10 important things to know about the reorganization and bankruptcy process in Brazil, the focus being their practical relevance to investors and going beyond the basic concepts of the law.
1. Multijurisdictional insolvency
Brazilian law uses the concept of main business place in Brazil, in order to establish jurisdiction of the insolvency court. Such concept determines both internal and international jurisdictions.
In other words, the insolvency of a Brazilian branch of a foreign company must be held according to Brazilian bankruptcy procedure, governed and applied by the jurisdiction of Brazil. Additionally, real estate owned by a foreign bankrupt debtor shall be so governed and judged.
2. Judicial reorganization plan. The last word is the debtor's
Under the BBBRL, the debtor has full control of the Judicial Reorganization Plan (“JRP”). This means that the debtor submits the JRP itself and may also unilaterally reject any proposed amendment. Due to this negotiation leverage, multiple fragmented negotiations are held individually with the relevant creditors. This makes risk assessment and credit recovery perspective quite hard to achieve.
In addition high yield investors lose their attraction/interest in companies under court-supervised reorganization, creating a difficult environment for the concession of DIP (Debtor In Possession) Financing.
Also, potential investors (could be current creditors or new investors) with interest in equity participation or acquisition of assets are less likely to approach, lend to, or take an equity position in, the debtor.
3. Debtor manoeuvre
There are some actions that may be carried out, more likely in less serious privately and family owned middle market debtor companies, trying to obstruct the enforcement of security liens on debtor's assets granted to investors. For instance: (i) replacement of credit-card terminals to evade credit card collateralization; (ii) sale of pledged assets; (iii) transfer of business to straw men; (iv) asset stripping to companies owned by off-shore (tax-heaven) controlling company/foundation; (v) registration of "family asset", which is protected by law. This is why it is important to register liens in the appropriate public registries and monitor the collateral.
4. Debtor in possession (DIP) financing
During the court-supervised reorganization new loans or any other credits granted to the debtor, which is still running the business (debtor in possession), have absolute priority of payment in case of a subsequent liquidation (Chapter 7). However, that there are pre-petition credits that are also exempt from the normal order of payment of the credits. This often results in a disincentive for the DIP lender. Examples are the pre-petition credits secured by fiduciary ownership (chattel mortgage), ownership retention, financial leases and advances under foreign exchange agreements (agreements whereby a Brazilian exporter gets an advance from a local bank on the hard currency it should receive from the payment of its exports under a certain period of time).
5. Asset sale without succession
An important feature that may attract investors to the scene of a company in court-supervised reorganization is the sale of independent productive units (a factory, a line of business or a store, for example), without succession in debtor responsibilities, including labor and tax liabilities. In order to obtain the best offer for this production unit (known as "UPI"), and hence ensure non-succession, a tender/auction or similar procedure must be performed.
According to the courts, overdue debts existing before the reorganization request may be offset with existing and matured credits at that time. However, in case of debts, which become overdue after the filing, there is a risk that the offset may be challenged. Nevertheless, such offset may be provided in the reorganization plan, and, in this case, the challenge risk is eliminated.
In case of liquidation, which mandatorily accelerates the liquidated entity's debts, the offset is still possible, even if the creditor's debt towards the liquidated debtor is not matured, in which case it may be accelerated at the decision of the creditor, so that the offset is possible.
7. Management removal
The replacement of the management pending a judicial reorganization procedure may be decided by the insolvency court, based on evidence of criminal actions, intentional acts against creditors. Mere request by creditors must be accepted by the debtor company. After removal, the creditor’s meeting must approve a judicial manager.
8. Capital market protection mechanisms
The BBRL has introduced several capital market protection mechanisms. One of them is its article 136, paragraph 1, which establishes that the assignment of credits between the originator, which went liquidated, and the securitizer, will be held valid and cannot be rendered non-effective or void. In other words, should an investor participate in a securitization transaction in the capital markets, the assignment of the credits backing the securities acquired will always be upheld, regardless of the situation of the company facing difficulties and of the creditor´s estate.
9. Suspect (hardening) period
The hardening period retroacts for up to 90 days from the request for liquidation or court-supervised reorganization or from the first protest by lack of payment.
In order to avoid the annulment of deals made during the suspect period, it is recommended they are duly provided for and performed as set forth in the JRP.
10. Reorganization of utilities companies, such as eletric power companies
Lien on essential assets ("affected assets") owned by regulated entities — such as utility companies—, or by companies operating under the concession, permission or authorization of the Government, may depend on the approval or communication to the competent Governmental Agency.
In the energy sector, Brazilian Government went beyond such type of protection and enacted Law n. 12,767/2012, preventing electric power concessionaires from using the benefits of the court-supervised reorganization set forth in BRRL. The reorganization of these entities is carried out under the supervision of the National Electric Energy Agency.
The content of this article is intended to provide a general guide to the subject matters. Specialist advice should be sought about your specific circumstances.