Weathering a Financial Crisis in Brazil

In recent years, at least two major events have contributed to an increase in debt restructuring in Brazil: the severe economic recession, and corruption probes such as Lava Jato that have hit a number of the country’s major enterprises and smaller companies that depended on them, leading to a reduced capacity of many Brazilian companies to serve their debt.

From a political perspective, President Bolsonaro’s administration is, to some extent, focused on promoting legislative reforms aimed at improving the business environment in Brazil. Amendments to the Brazilian Bankruptcy Law would play a particularly important role. In that context, a bill to amend the Brazilian Bankruptcy Law was put before Congress by the Executive in 2018. Although this bill may be altered as it makes its way through Congress, it may demonstrate the government’s concern regarding business recovery.

Brazilian companies’ exposure to international credit markets

In most Latin American countries, companies will raise funds in the international financial and capital markets at some point of their corporate lifespan. That is the case of many Brazilian companies, especially exporters.

Many factors may lead Brazilian companies to raise capital in the form of debt in the international markets. In certain stages of credit cycles, it makes sense to benefit from lower interest rates and either run the risk of exchange rates or hedge it against income from exports. Liquidity is another factor. Usually, there is more cash available for high-yield investments in the global markets than locally. Also, international exposure may be beneficial for companies planning to establish a long-term relationship with the international investment community and benefit from this relationship in future attempts to raise capital, either through new debt issuances or equity offerings. Frequent issuers tend to find a friendlier environment, which may translate into better terms for the transaction.

Another aspect of accessing international markets concerns local regulations. For instance, lenders that provide credit to be used by Brazilian exporters in their production activities will benefit from zero income tax over the interest charged in the transaction. International lenders who invest in certain infrastructure projects will also benefit from zero income tax, in accordance with Federal Law 12.431/2011. This tends to decrease the cost of capital in terms of lower interest rates and the gross-up effect.

On the other hand, having international creditors exposes Brazilian debtors to more complex dynamics if and when they have to restructure their debt in a distressed scenario. Creditors, in turn, will have to navigate the Brazilian legal system, courts and culture.

Financial distress and creditors’ base

Different events and circumstances may trigger financial crises for businesses. Whether the crisis is a consequence of market conditions or idiosyncratic events, when it happens, most business managers will find themselves facing demands from lenders and holders of debt securities, alongside demands coming from other stakeholders; in a distressed scenario, these tend to occur simultaneously.

The chance of a distressed debtor having better results in managing the relationship with financial creditors certainly increases if the debtor is well informed about the profile of its creditors. Although all creditors share the same basic interest in recovering the highest possible value for their respective credits, specific interests and tactics may differ greatly from one type of financial creditor to the other. Differences in approach are perceptible among different groups – for example, bank lenders (including relationship banks) and holders of debt securities, par investors and distressed investors. There are also differences among individuals within one same group – for example, hedge funds with a more constructive approach and hedge funds with more litigious strategies.

As debt instruments are likely to change hands during the various stages of a business’s financial crisis, it is paramount that the debtor constantly studies the base of creditors holding claims against it to learn as much as it can about them. This includes researching the historical behaviour of relevant creditors, who their advisers are (which may help debtors anticipate the approach these creditors will take) and when they acquired their positions (and, from there, derive the approximate price they paid for their claims). Another exercise recommended for debtors in these circumstances is to review on an ongoing basis the extent to which holders of all the different existing financial instruments can extract value from the enterprise in a potential liquidation relative to a restructuring (rate of recovery), taking into consideration where they rank in the debtor’s capital structure, either based on the statutory ‘waterfall’ (i.e., the statutory hierarchy of funds distributions following liquidation) or as provided for in the relevant debt instruments. That value is commonly a measure of quality or ranking of the instruments they hold and the net asset value of the free assets of the debtor.

In the early stages of financial distress, if an issuer of bonds intends to restructure its outstanding debt through liability management exercises, such as debt exchange offers, it will probably find par investors on the other side of the negotiations table. In that environment, negotiations tend to be sparse, disorganised and, often, the terms of the new securities being offered in the exchange are based on input from the issuer’s advisers and their perception of what would be acceptable for the existing investors’ base. Par investors, like mutual funds, have virtually no incentives and probably no authority to engage in structural negotiations or accept to affect the terms of the securities they hold more severely than just an extended maturity. They may also require a cash incentive for accepting to exchange.

In the advanced stages of financial distress, upon default or communication of an imminent default – when bonds are rated as in default or severely downgraded – par investors will likely find themselves forced to sell-off their positions, as they would probably not be allowed under the terms of their investment mandates to hold distressed debt securities in their portfolios. On the buy side of that sell-off, there will be investment firms with more appetite for risk, possibly with knowledge of the local market, its political and regulatory environment, and flexible mandates to hold distressed debt for a long time, until either the debt is restructured or the issuer recovers, causing bond prices to rebound. Private credit (i.e., bank loans) may also be for sale at some point and some distressed investors will find this a good opportunity in light of the reduced competition to consolidate their positions in those credits too, increasing their stake on the indebtedness, subject to a potential restructuring, which could score them more advantageous conditions as compared to those offered to creditors with smaller or less strategic positions. In this scenario, the negotiation dynamics will be significantly different from those of the early stages mentioned above. Likely, a lower number of creditors – mainly hedge funds – will concentrate larger positions and seek engagement with the issuer on an organised manner. An ad hoc committee is likely to engage experienced legal and financial advisers, and lead discussions with the issuer.

It is the advanced stages of financial distress and the above-mentioned latter category of creditors that provide a backdrop to this chapter, where we take the perspective of a Brazilian debtor and international creditors in the context of debt restructuring in Brazil.

Managing creditors’ interests

It is not easy for a debtor to assess what the first reaction of creditors will be upon a default or the threat of default, and whether it will be feasible to manage creditors’ expectations and interests during the process of restructuring. Commonly, debtors will have some time to elaborate a restructuring proposal and take the opportunity to try a negotiated out-of-court restructuring. This is mainly because it takes a while before creditors fully understand the debtor’s real situation and, more often than not, creditors have nothing to lose in listening to what the company has to offer. Also, in many cases, the debtors’ net asset value in liquidation will not be enough to even start paying financial claims, so, given that the legal consequence of a failed judicial reorganisation can be bankruptcy or liquidation, creditors may lose leverage taking restructuring to court, and are usually aware of this. Moreover, sometimes an agreed workout may be a more convenient or appealing option to creditors, given that an out-of-court solution is likely to be less disruptive for creditors and the market as a whole when compared to court-supervised restructuring and liquidation, which usually have a more negative impact on the asset value.

If creditors do not enforce their claims immediately and there is a prolonged truce – which may either be formalised in a standstill or other form of forbearance agreement, or only existing de facto – debtors may have a chance to reach an agreement to restructure through a less painful method, namely out of court. In this case, restructuring is implemented by amending the existing debt instruments to reflect terms that are more comfortable and suitable to the financial situation of the debtor, or exchanging the outstanding debt instruments with new ones that reflect the negotiated terms.

However, the success of a negotiated workout depends on several factors, including having an organised group of creditors, an alignment of interests among different classes of creditors, the concrete possibility of business turnaround – including the perception that post-restructuring cash flows will create more value than liquidating the business and selling its assets (which, in Brazil, tends to take several years and minimises relevant value for both creditors and shareholders), and time limits creditors may be subject to, among others. What is key is that, at the end of the day, the combination of all factors leads to a high level of support. For instance, a debt exchange offer, to be considered successful, may require the support of more than 80 per cent of the debt holders, depending on the terms of the respective bonds indenture and the intended changes.

In Brazil, the Bankruptcy Law provides for the extrajudicial reorganisation, a restructuring proceeding somewhere between an out-of-court workout and a judicial reorganisation. While the Brazilian judicial reorganisation is commonly compared to a Chapter 11 proceeding, the extrajudicial reorganisation is generally referred to as the Brazilian version of the well-settled practice of pre-package restructurings carried out under Chapter 11. Under the extrajudicial reorganisation, a restructuring plan can be filed with the bankruptcy court provided it has been previously negotiated and can count on the approval and support of holders of at least 60 per cent of the claims modified by the plan. Further, upon the court’s acceptance and confirmation, this restructuring plan will bind 100 per cent of the claims subject to the proceeding.

The extrajudicial reorganisation can be a useful tool, allowing for a faster and less troublesome process compared with a judicial reorganisation. Nevertheless, practice has shown that when the terms of an extrajudicial reorganisation proposal require a significant commitment from creditors, including, for example, material implicit or explicit haircuts, combined with absence of collateral, long grace periods, among others, the chances that the debtor obtains the necessary support are low.

Although forbearance agreements and good-faith negotiations may hold creditors back for some time, almost no truce lasts forever. On the verge of a failed deal with the debtor, creditors may pursue enforcement of their claims. Bearing that in mind, a common dilemma for debtors in situations like this is whether to anticipate any aggression from creditors and move forward proactively with the filing for court protection by means of a judicial reorganisation, or to wait until it is hit by enforcement and file for judicial reorganisation as a defence.

Interestingly, the specific interests and tactics of some creditors may lead them to maintaining a friendly attitude towards the debtor, including refraining from enforcing their claims following an unsuccessful out-of-court restructuring negotiation. Their incentives may include not wanting to cause bond prices to plunge, as they may mark their assets to market. They could, therefore, find it in their best interests not to force the debtor to file for a judicial reorganisation – which would certainly negatively affect the price of the bonds – but wait until they have more clarity about the debtor’s prospects or the terms of a possible court-supervised deal.

In any case, most creditors will share a certain level of anxiety about the prospects for their credit recovery, and question how they can influence the terms of a restructuring plan.

Although the Brazilian Bankruptcy Law seeks to provide all creditors with an opportunity to participate and influence the discussions concerning a debt restructuring plan, as well as to vote on the debtor’s restructuring proposal, there are hurdles international creditors face in practice when dealing with debt restructuring in Brazil. Uncertainties about the process and how to effectively influence its outcome increase anxiety in, and suspicion from, international creditors, which may translate into additional difficulties for the debtor to manage the restructuring process and close a deal in reasonable terms.

The following topics are aimed at reviewing aspects of participation in a judicial reorganisation in Brazil – which debtors may manage, to a certain extent – and how debtors can be aware of some aspects of international creditors’ participation in the proceeding.

International creditors’ participation in a formal judicial reorganisation

The ability to file motions

In principle, in a judicial reorganisation (which is commonly referred to as the Brazilian version of the Chapter 11 proceeding under the US Bankruptcy Code), all creditors that have been recognised as such in a judicial reorganisation will be entitled to file motions with the Brazilian restructuring court.

Any creditors not included in the creditors’ list initially submitted by the debtor, or that disagree with the amount or the classification ascribed to their claims in that list, may file their respective proof of claim before the court-appointed trustee (judicial administrator) at the first stage of the proceeding or with the Brazilian court at a later stage in the proceeding, and this proof of claim must contain, inter alia, the creditor’s name and address; the amount of the claim and its origin and classification; a brief description of the security granted, as the case may be; and be accompanied by documents evidencing the claim and its features.

The procedure set forth in the Brazilian Bankruptcy Law with regard to verification and proof of claims has proved itself to be burdensome, to a certain extent, for international creditors in general, and particularly to bondholders.

The mechanism for bondholders to disenfranchise their individual claims from the global amount held before the court under the indenture trustee’s name is not provided for by the Brazilian Bankruptcy Law, so practitioners and courts have developed a mechanism, in practice, aimed at closing that legislative gap. Bondholders interested in disenfranchising their individual claims – which would allow them to act directly within the judicial reorganisation (and no longer through the indenture trustee) – must provide the court and the court-appointed trustee with further evidence of their capacity as the actual beneficial owner of the relevant claim, including a statement from the custodian of the relevant bonds. This is known as the ‘individualisation of claims’ procedure, which is often applied in judicial reorganisations that involve the restructuring of debt represented by bonds.

The main consequence borne by bondholders that opt not to follow the individualisation of claims procedure is that they will remain represented within the judicial reorganisation by the relevant indenture trustee and may only act through that trustee, in accordance with the indenture terms. Therefore, they will not be able to file motions with the court, attend creditors’ meetings or vote on the restructuring plan directly and on their own behalf. In other words, the indenture trustee would remain the one entitled to carry out those actions, as the trustee would keep representing all bondholders that do not individualise their claims.

Typically, bondholders that individualise claims are experienced investors, mainly hedge funds, that have purchased claims in the secondary market at a discount; are accustomed to restructuring proceedings throughout different jurisdictions; are assisted and represented by leading international and local law firms; and are familiar with holding out tactics and employing them to extract a greater recovery value from their claims. Naturally, those creditors’ interests are not necessarily aligned with the interests of the debtor or other creditors, including of the bondholders that did not individualise their claims and remained represented by the indenture trustee.

Bondholders who typically individualise their claims represent the minority of outstanding debt. The vast majority of bondholders do not usually go through the individualisation of claims procedure, either because they are unfamiliar with the local requirements for this procedure or because they do not want to incur additional expenses inherent to it.

On the other hand, indenture trustees – which, in practice, remain representing the majority of bondholders’ claims – historically tend to refrain from adopting a more proactive approach to debt restructuring, including judicial reorganisations. In a great number of cases, indenture trustees have abstained on voting for the restructuring plan. As a result, other creditors, and particularly bondholders that have individualised their claims, will naturally take the lead and play a significant role to determine the outcome of the judicial reorganisation.

Although the experience and proactivity of hedge funds that usually participate directly in restructuring processes may help towards closing a deal, a frequent question among Brazilian practitioners is whether the terms of that deal could have been different if a broader group of bondholders participated in the process.

Required attendance of the creditors’ meeting and vote on the restructuring plan

A restructuring proposal submitted by the debtor in its judicial reorganisational in Brazil must be voted by creditors at a general meeting whenever any creditor objected to its terms. Under the Brazilian Bankruptcy Law, only creditors included in the latest list of creditors made available in the dockets, and those whose claims have been proved by the date on which the meeting is held or whose claims have been admitted or modified by judicial decision, will be admitted to attend the meeting and vote on the restructuring plan.

Therefore, in addition to actions to be taken by creditors in connection with the proof of claims, creditors interested in participating and voting on the restructuring plan will need to attend the relevant creditors’ meeting in person or through duly appointed representatives.

Regardless of any discussions that may be held in parallel (and outside the court’s close and immediate oversight) among debtor and creditors on potential amendments to the restructuring plan initially filed by the debtor with the court, any changes to the original plan will need to be decided by creditors at the general meeting.

In practice, there have been cases in which amendments to the restructuring plan were proposed during the course of the creditors’ meeting (i.e., not in advance by means of the filing by the debtor of a revised or updated plan). In these cases, unless the meeting is adjourned to a later date, creditors attending the meeting will be required to review and decide on the amendment proposed at the very same meeting. It makes the lives of international creditors more difficult, because their representatives present at the meeting usually do not have instructions to vote on a variation of the restructuring plan previously assessed by them or the ability or time to receive instructions from their respective constituents.

To attempt to reduce the constraints for bondholders to vote and foster a broader participation in the restructuring process, we have been introducing, in the context of restructuring cases, the concept of a new alternative voting mechanism that would potentially allow international creditors to cast their vote remotely more easily. Although not yet tested before Brazilian courts, we have discussed this new mechanism among local and international legal advisers engaged in complex restructuring cases, as well as with information agents, the relevant clearing houses, indenture trustees and court-appointed trustees. With the support of debtors and key stakeholders, bondholders may benefit from a more levelled voting mechanism and distressed issuers may potentially benefit from support from (so far) silent groups of bondholders. This alternative voting mechanism (which is a work in progress) will aim also at facilitating the vote on potential amendments to the restructuring plan that might be proposed in the course of a creditors’ meeting.

Another point of concern is the form and content of the restructured debt instruments. Usually, international creditors hold notes or credit instruments that are governed by the laws of well-established jurisdictions, such as New York and the United Kingdom, and contain market-standard provisions. Therefore, they are usually concerned about the terms and conditions of the new instruments to be issued in the restructuring process, in exchange for the original claims. Points of concern go beyond the face value and payment conditions of the new debt instruments, as we will discuss in the next topic.

Issues related to the restructured debt instruments

Each restructuring plan will present implementation challenges, some of which will be discussed as conditions to closing the deal. Other issues potentially causing concerns may not be anticipated until the last minute. Plans that include the exchange of debt for equity, and plans that offer an exchange of the original debt for new debt facilities and securities, share some issues and present specific concerns related to the nature of the instruments involved.

International creditors are not only concerned about the payment conditions of new debt instruments. They are also typically concerned about the legal instruments through which the restructuring plan will be implemented – whether the debtor intends to deliver private credit facilities or marketable securities, in the local markets or internationally.

From the perspective of a Brazilian debtor, it may be tempting to offer creditors local debt in the form of debentures, for example. Debentures are easily issued, costs are lower than those to be incurred in issuing global debt securities, and the issuer will not have to endure foreign regulations, disclosure requirements and so on. However, from the perspective of international creditors, they may stand to lose a lot if they accept or are forced into receiving locally issued debentures. At the very least, in such circumstances, creditors would lose liquidity. The secondary market for debt, in Brazil, is much less liquid than international markets and platforms for negotiation of debt provided by clearing houses (e.g., DTC, Clearstream, Euroclear).

As liquidity plays a material part in pricing securities, and creditors will resist being subject to the limited liquidity of the Brazilian debt markets if and when they decide to sell their restructured securities, it may be hard for creditors to accept a debtor’s proposal to exchange international debt with debt instruments issued locally.

Many creditors may not even have the authority to hold Brazilian securities in their books, or the disposition to go through the bureaucratic process for complying with the Brazilian Central Bank’s requirements to invest in Brazil (e.g., having a representative in Brazil, enrolling with CVM, the Brazilian Securities and Exchange Commission or hiring a local custodian).

It is also often the case that, alongside a reduction of the principal outstanding amount (i.e., haircut), restructured debt imposes extended maturity, long grace periods or interest payments in kind. Creditors may not want to hold such debt to maturity and, therefore, may demand to be given the option of selling it at some point. For that reason, in addition to having the new debt issued in liquid markets, creditors usually require marketable conditions to the restructured debt securities.

There are issues that specifically concern restructuring plans involving the exchange of debt for equity. Issuing equity in the international markets is not as simple as issuing debt. International regulations usually require that equity is issued under more restrict structures, such as American depositary receipt or global depositary receipt programmes. For those reasons, it would be fair not to deliver shares to creditors abroad. If the debtor offers to deliver equity locally, creditors would have to endure the bureaucratic processes mentioned above (and others if the issuer is a private company) to receive the debtor’s shares in Brazil, in exchange for their original claims.

On the other hand, the local equity market in Brazil is much more liquid than the debt markets; global investors are more familiar with it and they represent a large portion of daily trades. Therefore, a relevant issue in exchanges of debt for equity is whether the debtor is a publicly traded company, with access to the stock exchange, or a private company, whose shares would bring to the creditor potential liquidity problems.

Regarding debt-for-equity exchanges, it is also worth mentioning that cultural issues in Brazil make this type of transaction less common than it could be. Many businesses in Brazil are still owned, controlled or managed by families. Usually, members of founder families are emotionally attached to their businesses and are reluctant to accept a dilution of control or handing the wheel over to creditors in a restructuring scenario.

Tax implications

Below are the possible tax implications of debt restructuring, which depend largely on the characteristics of the restructuring plan. There are two recurring points of discussion for Brazilian companies to consider: the tax treatment of nominal haircuts and the possible implications of restructuring pre-payment export transactions.

Taxation on haircut amounts[2]

When restructuring includes a nominal haircut (i.e., a reduction of the principal value of outstanding debt), the amounts equivalent to the haircut would be treated as forgiveness of debt. In other words, these amounts would be included in the debtor’s taxable basis, which would subject the amounts to corporate income tax and social contribution on net profits (CSLL) at the rate of 34 per cent. The effects therefrom may be significant. Applying this tax burden to companies that are undergoing a judicial reorganisation is contrary to the very concept of restructuring and reducing debt through haircuts, but, unfortunately, current legislation does not allow for excluding these amounts from the taxable basis.

In this context, it would be intuitive that the debtor be entitled to offset carried-forward losses from its taxable basis and, by doing so, neutralise the negative effect of taxation over haircut. This is especially the case considering it is not uncommon that companies in financial distress accumulate tax losses over the years preceding debt restructuring. However, legislation limits the set-off to a maximum of 30 per cent of the debtor’s taxable profits, which means that, even if the company has accumulated carried-forward losses to offset the entire amount, it will inevitably have to pay income tax and CSLL of over 70 per cent of its taxable profits. This issue has been the focus of recent discussions about changes in legislation applicable to debt restructuring.

In addition, tax authorities have the view that, over the haircut amounts, social contribution on gross revenues (i.e., PIS and COFINS) should also be levied at the combined rate of 4.65 per cent, which is debatable.

Restructuring EPP facilities

It is common that Brazilian exporters finance their production with credit from pre-payment export (EPP) facilities. To benefit from the zero income tax rate on the interests applicable to the facility, the debtor is required to export products in amounts at least equal to the facility’s principal amount.

Usually, companies in financial distress face credit constraints and may not be able to finance their operations as before. This can cause a reduction or even cessation of output, and failure to fulfil the export requirement mentioned above may, by itself, be considered by tax authorities as grounds to lose the EPP facility tax benefit.

Regardless of how a company chooses to restructure, the terms of its EPP facilities will most likely be modified. Legally, the facility may be amended, and it should continue to benefit from the beneficial tax treatment on its amended terms, to the extent the debtor fulfils the export requirement over the term of the facility (especially if the amendments are made before a default).

DIP and exit financing

Debtor-in-possession (DIP) financing is an important tool for debtors to keep their business and affairs up and running, and to remain as a going concern during the restructuring process. Brazilian law provides for a kind of DIP financing, which aims at providing certain safeguards in terms of priority for such new money. However, whether coming from third parties or shareholders, there are reservations about DIP financing in Brazil.

As a general rule, unless the bankruptcy court is otherwise satisfied, management will be kept ahead of the debtor’s business and affairs during the judicial reorganisation. In this capacity, management would be entitled to procure and obtain post-petition financing. If such financing is not backed by any non-current assets of the debtor, entering into an agreement with a third party interested in providing such new money would not require, by the terms of the law, prior approval from the bankruptcy court or the creditors. Where the provision of new money is to be secured by non-current assets of the debtor, approval from the bankruptcy court or the creditors, as the case may be, will be required under the Brazilian bankruptcy law. The reason behind such requirement is that a debtor under judicial reorganisation cannot encumber its non-current assets, except when the encumbrance (1) has been authorised by the court or (2) is provided for under the judicial restructuring plan approved by the creditors. Notwithstanding, some scholars in Brazil advocate that any post-petition financing should always be previously approved by the bankruptcy court or the creditors, even where such financing is not secured by any of debtor’s assets, given that the provision of the new financing would impact the debtor’s financial conditions.

Generally, pursuant to the Brazilian Bankruptcy Law, any financing provided to a debtor during its judicial reorganisation will be deemed to be excluded claims (i.e., not subject to the judicial reorganisation) and, in a liquidation scenario, will have priority over most pre-petition claims. It is important to emphasise that the priority of new money provided to the debtor under such circumstances will only apply if the debtor ends up being declared bankrupt following an attempt to restructure its indebtedness in a judicial restructuring proceeding. During the judicial reorganisation, DIPs will be paid as they become due under their own terms. As the experience has shown so far, the current statute in that regard does not provide interested third parties with the comfort and certainty that they would typically require for providing new funding to a debtor in judicial reorganisation. Consequently, the provision of new money to a debtor in judicial reorganisation in Brazil is still not as customary as we believe it could be, as a potential means for the debtor’s restructuring.

Although the Brazilian Bankruptcy Law does not set out a priority for new money over pre-petition claims in the context of a judicial reorganisation, there are cases where debtors managed to obtain funding from creditors in the course of the judicial reorganisation. One of the contributing factors to making the provision of new money attractive to creditors in those cases was that the relevant restructuring plans provided for the concession of more advantageous terms to the pre-petition claims held by creditors that provided new money during the judicial reorganisation compared with the treatment conferred to pre-petition claims held by other creditors. Even though this practice has been developing in Brazil, the inexistence of statutory rules and parameters as to the concession of a more advantageous treatment to claims held by creditors that accept to provide new money remains an obstacle to restructurings carried out through judicial reorganisation in Brazil.

Furthermore, if the new funding is to be provided by shareholders of a debtor in a judicial reorganisation, another concern typically raised is whether the claim will enjoy the priority set forth in the law if the debtor goes bankrupt or the claim arising from such new funding is subordinated to other claims. The reason behind this concern is that, under the Brazilian Bankruptcy Law, claims held by shareholders of a bankrupt entity are subordinated to other claims, while the law does not clearly specify the nature of the shareholders’ claims it intends to subordinate – whether claims deriving from equity participation, credit instruments, either pre- or post-petition. Court decisions and literature are also unclear in that regard. This topic has been constantly debated among practitioners and authorities, including in the context of legislative reforms.

Although there is a reasonable argument to be made that the post-petition funding provided by shareholders should be deemed to be an excluded claim, and therefore benefit from priority over pre-petition claims, the risk that Brazilian courts will classify those claims as subordinated claims (i.e., junior to all secured and unsecured and unsubordinated claims) in the liquidation bankruptcy cannot be ruled out.

Selling assets in a judicial reorganisation

Among the alternatives available for debtors under a judicial reorganisation in Brazil to reach liquidity and restructure is the sale of assets, either individually, in groups or even organised under the form of an isolated productive unit (UPI).

After commencing a judicial reorganisation in Brazil, the debtor will not be able to dispose of non-current assets, unless the obvious purpose of doing so has been recognised by the court or the sale of these assets has been indicated in the restructuring plan approved by the creditors. Non-current assets is an accounting expression that refers to long-term assets, such as property, plant and equipment, which are not available to be disposed of by the debtor in its day-to-day operations and not expected to be consumed or converted into cash in the short term.

Therefore, pursuant to the Brazilian Bankruptcy Law, for any sale of non-current assets in a judicial reorganisation, the debtor must obtain prior authorisation from court or the sale must be provided for under the restructuring plan approved by the creditors. In the case of a judicial authorisation, the debtor will have to demonstrate to the court that the sale of the relevant assets is both useful and viable within the context of the debtor’s restructuring. When the transaction is provided for in the restructuring plan as the sale of a UPI, the relevant assets are hived off from other activities of the debtors and sold to a third party under the scrutiny and supervision of the court.

The main advantage of carrying out a sale of assets through a UPI compared with the sale of assets individually (or in groups that do not characterise a UPI) is that, insofar as certain legal requirements are met, the sale of the UPI will be concluded without the succession of purchaser in any liabilities of the debtor. The exclusion of succession fosters competition among parties interested in purchasing such assets, potentially pushing the value of competing bids up and thus contributing to maximise the proceeds that could be raised by the debtor through the transaction.

Experience has shown that taking precautions when planning and performing an asset sale in a judicial reorganisation may minimise the risk of disputes regarding the validity of the transaction and secure the exclusion of liability. This includes the provision for the creation of the UPI in the restructuring plan; the existence, after the sale of the UPI, of assets with the debtor that suffice for it to continue running its business, albeit on a reduced scale; and compliance with the procedures set out in the Brazilian Bankruptcy Law, including that the sale be carried out by means of a competitive process through public auction.

However, the debtor’s related parties, including direct and indirect shareholders (although indirect shareholders are not clearly stated in the law) will not benefit from the statutory succession exclusion.

Although some of the precautions mentioned above might be taken in the context of the sale of individual assets as an attempt to reduce potential risks for the purchaser, especially in connection with a potential succession of the purchaser in liabilities of the debtor, the fact remains that a protection similar to the one conferred to the sale of UPI is not provided for by the Brazilian Bankruptcy Law, which leaves a degree of uncertainty.

Finally, there have been cases in Brazil where subsidiaries of the debtor were deemed to be UPI for the purposes of selling assets within the relevant judicial reorganisation proceeding. In those cases, shares in such subsidiaries were then sold to third parties interested in acquiring the underlying assets in each subsidiary.

Cross-border legal implications

A debtor undergoing a judicial reorganisation in Brazil may need to seek recognition by foreign courts of decisions rendered by the Brazilian bankruptcy court to bind creditors located abroad and, thus, to protect its interests, rights or assets in those jurisdictions.

Some jurisdictions provide for a legal framework for the recognition of decisions handed down by foreign courts, as a result of having incorporated into their respective legal systems the Model Law on Cross-Border Insolvency, which was first enacted by the United Nations Commission on International Trade Law in 1997 as a global initiative to establish a framework for harmonising the development of international cooperation between courts in insolvency cases, and has been the subject of debates on potential improvements from time to time.

It has become customary that debtors in judicial reorganisations in Brazil that hold interests, rights or assets in the United States seek recognition by the relevant American bankruptcy courts of decisions rendered by the Brazilian bankruptcy court, and they do so by applying for the appropriate and applicable relief under the rules set forth in Chapter 15 of the US Bankruptcy Code, through which the general guidelines set out by the UNCITRAL Model Law have been adopted in the American legal system. Usually, these requests are accepted by American bankruptcy courts when the requirements under Chapter 15 are met.

On the other hand, it is important to point out that the Brazilian Bankruptcy Law does not provide for cross-border insolvency procedures. Therefore, a separate proceeding must be initiated in Brazilian courts for the enforcement of decisions rendered by foreign courts in restructuring proceedings commenced and administered in other jurisdictions, should these decisions be intended to have effect in Brazil. This would be the case of a restructuring proceeding concerning members of an economic group that is administered by a foreign court, but aimed at being binding and having effect in Brazil.

To enforce a foreign judgment in Brazil, the interested party will be required to file a recognition claim before the Superior Court of Justice (STJ). Once the foreign decision has been recognised by the STJ, the interested party will need to commence enforcement proceedings before the lower federal court with jurisdiction over the debtor located in Brazil or its assets. To be recognised by the STJ, the foreign ruling must meet, among other things, the following requirements:

  • the decision must be res judicata;
  • the decision must have been issued by a court that is empowered and competent to deal with the matter;
  • the parties must have been served with the process in the country of origin (or in the case of judgment by default, the default must have been duly verified under the laws of the country);
  • the decision must not offend Brazilian sovereignty, Brazilian law or public policy;
  • the decision must not relate to matters that fall within the exclusive jurisdiction of Brazil’s courts; and
  • the decision must be authenticated by the consular authority and translated into Portuguese by a certified translator.

Foreign decisions declaring the bankruptcy of Brazilian companies would probably not be recognised and enforced in Brazil on the grounds that Brazilian’s courts should have exclusive jurisdiction for the matters related to the debtor’s insolvency, given that the debtor would have its main place of business in Brazil. Furthermore, there is a chance that foreign decisions declaring the bankruptcy of the controlling shareholders of a Brazilian debtor in judicial reorganisation would not be recognised and enforced in Brazil on the grounds that the recognition of such a foreign judgment would offend Brazilian sovereignty by frustrating the judicial restructuring proceeding; and breaching the rule that gives to the courts of the venue where the debtor has its main business establishment the exclusive jurisdiction for relevant insolvency proceedings.

There are no specific regulations in Brazil concerning cooperation during concurrent insolvency proceedings (i.e., in the case of restructuring proceedings underway simultaneously in different jurisdictions that to some extent have connection with a debtor located in Brazil). Although in some cases there was cooperation, to a certain degree, with foreign courts, court cooperation is generally conducted case by case.


[1] Camila Goldberg is a partner, and Conrado C Stievani and Igor Silva de Lima are senior associates at BMA – Barbosa Müssnich Aragão.

[2] Faloppa, José Otávio and Costa, Luis Henrique, Valor Economico, 3 September 2019.

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