What Investors Need to Know About the New Brazilian Bankruptcy Law

By Allen D. Moreland and André F. R. Rocha

The amendments to the Brazilian Bankruptcy Law (Law nº 11.101/05) that became effective on January 23, 2021, through the passage of Law nº 14.112/20, aim to enhance judicial certainty and efficiency in Brazilian insolvency proceedings. They were intended, in part, to correct perceived shortcomings of the original 2005 version of law and, in part, to codify a series of judicial decisions that had interpreted it.  As before, the law governs both Chapter 11 type restructurings and Chapter 7 type liquidations.

There is much that investors in Brazilian distressed assets will find appealing about the new legislation, including (i) a limitation on the value of labor claims that are superior to secured creditors,  (ii) mandatory disclosure of all debtor liabilities (including the so-called extraconcursal obligations that are exempt from bankruptcy proceedings), (iii) wider discretion in selecting the group of assets that can make up an UPI (“isolated production unit”) that may be sold off without successor liability, (iv) greater flexibility in negotiating the amount and repayment terms of federal tax debt, (v) the promotion of pre-packaged, “extrajudicial” arrangements instead of judicial restructurings, (vi) the availability of DIP financing, (vii) the possibility that creditors may propose their own restructuring plan, and (viii) the adoption of the UNCITRAL Model Law on Transnational Insolvency.

Labor Claims

The new law makes headway in dealing with labor claims – which can be notoriously problematic in any Brazilian insolvency proceeding due to the byzantine nature of the country’s labor legislation and the fact that these claims are superior to the secured creditor class.  First, individual labor claims now only have priority over secured ones to the extent they do not exceed 150 times the Brazilian minimum wage (presently roughly US$ 204 per month). Previously, debtors were required to repay all labor claims within 12 months of the homologation of the restructuring plan – the new law permits the payment deadline to be extended out to two years, subject to the approval of labor creditors.  In addition to that, the debtor must provide security that guarantees the totality of the labor debt and is deemed to be sufficient by the presiding judge.  Furthermore, these claims, as noted below, may now be more expeditiously resolved in extrajudicial proceedings.

Disclosure of Exempt (Extraconcursal) Obligations

Certain intensely debated amendments did not make it into the final law. Obligations secured by a fiduciary lien (alienação fiduciária) (a type of security interest widely used in Brazilian financings), advances on foreign exchange agreements (a type of financing facility frequently used by exporters), financial and operational leasing arrangements, and tax obligations all remain exempt (extraconcursais) from insolvency proceedings.  Under the new law, however, debtors are required to list all their exempt liabilities (previously, only debts subject to judicial restructuring were required to be disclosed), which gives potential investors a much better picture of the financial condition of the distressed company, which is crucial for more accurate pricing of any potential investment in a distressed debtor under a judicial restructuring. 

Asset Sales

Asset sales can be a major feature of any restructuring plan. Article 60 of the new law reinforced the policy of allowing any “isolated production unit” (unidade produtiva isolada – UPI) to be sold without successor liability – including environmental and anti-corruption, in addition to those already foreseen, namely tax and labor liability. Only now there is significantly more flexibility in specifying the assets that will compose the UPI – which can include rights or assets of any kind, whether tangible or intangible, isolated or grouped together, and even equity held by the debtor.

The new law also provides for more expeditious sale of debtor assets in the event of a liquidation.  Once the debtor’s assets have been accounted for, the judicial trustee has 180 days to sell them off unless it can provide justification for an extension.  

In either restructurings or liquidations, assets may be sold at live or on-line auctions (or a combination of both), but oral bidding is no longer permitted. Sales may also be executed in a competitive process pursuant to a tactical blueprint prepared by reputable experts, provided the blueprint is attached to the asset realization plan (in the case of a liquidation) or the restructuring plan (in the case of a judicial restructuring).  In this sense, the asset realization or restructuring plan can already contain a detailed description of the competitive process by which the sale of a subsidiary or independent production unit will take place – which could include, for example, the use of a stalking horse bidder.

Federal Tax Authorities

The treatment of tax obligations and the powers reserved to the tax authorities in Brazilian insolvency proceedings merits special attention.  First, as before, no restructuring may be granted by the judge (after the plan is approved by the creditors) until the tax authorities have issued a type of clearance certificate (Certidão Negativa de Débito – CND), although jurisprudence has allowed the granting of restructurings without CNDs for the last 15 years. The CND certifies that the debtor has either paid all its tax obligations or formalized a plan for their repayment. 

Outstanding federal tax debt is now allowed to be repaid in 120 monthly installments. While this is more generous than the 84 months that a 2014 amendment had permitted, it is less generous than the 180 months allowed under the frequent Tax Regularization Incentive Programs. Prior year tax loss carryforwards, and any negative basis resulting from calculation of the Social Contribution Tax on Net Profits, can be fully deducted from the debtor’s total federal tax liability, yet where such deductions are claimed, the repayment period is reduced to 84 months.  Moreover, up to 30% (the precise percentage should be negotiated on a case-by-case basis between the debtor and the tax authorities) of the proceeds of all assets sales in a judicial restructuring must be set aside for tax debt amortization.

These provisions of the amended law are complemented the recently enacted Tax Transaction Law (Law nº 13.988/20) which allows a taxpaying entity to negotiate a federal tax deal with the Office of the Attorney General of Internal Revenue (Procuradoria Geral da Fazenda Nacional). For taxpayers facing judicial restructurings, it may include a 70% haircut and a 120-month repayment period.

However, if the debtor defaults under the tax repayment plan, or if the federal tax authorities determine that the debtor is engaged in asset depleting transfers, the tax authorities have the right to demand the liquidation of the debtor. On the other hand, as far as the latter is concerned, a new paragraph XVIII to Article 50 provides that the sale of the entire company is a permissible means of judicial restructuring if the creditors that are exempt from the proceeding (which would include the tax authorities) are afforded the same treatment they would have received in the event of a liquidation. Therefore, an investor who confirms through due diligence that the tax authorities are not being harmed by the debtor, is afforded a good degree of legal certainty that it can acquire a distressed company in its entirety without worrying that the tax authorities may later try to nullify the sale. 

Additionally, the bankruptcy judge is empowered to stay any tax foreclosure actions on any assets of a restructuring debtor that are deemed essential to its operations (though they must be replaced with non-essential ones).  

Extrajudicial Restructurings 

The new law contains provisions that clearly aim to expand the use of pre-packaged, pre-negotiated debt restructurings (Recuperação Extrajudicial), which can be carried out with greater speed, fewer legal technicalities and lower costs than their judicial counterparts. These provisions include the application of the stay period to extrajudicial restructurings, which begins with the filing of the petition (in contrast, the stay period for judicial restructurings begins only upon the granting (deferimento) of the petition and the ability to negotiate labor claims extrajudicially – provided negotiation must be carried out through the relevant union and not directly with workers.  

New “cram-down” provisions allow the debtor to petition for the homologation of the extrajudicial restructuring plan with only a simple majority (of value, not heads) of each class of creditors affected by the restructuring (previously it had been three fifths).  The debtor can even initiate extrajudicial restructuring proceedings with the approval of only one third of the affected creditors if it undertakes to get the remaining creditors necessary for a simple majority on board within 90 days. 

DIP Financing

In contrast to the previous law, the new law specifically contemplates the use of DIP financing in Brazilian restructurings.

Prior to the enactment of the new law, debtor-in possession (“DIP”) financing (i.e., an injection of money into an insolvent company that remains under pre-petition management) was essentially unavailable in Brazil. The only advantage to fresh money lenders under the old regime was the right to be listed in last order of priority with the other exempt (extraconcursais) creditors in case the restructuring was converted into a Chapter 7 type liquidation (unless, of course, the DIP financing had been secured by a superior fiduciary lien). In a judicial restructuring, however, providers of DIP financing enjoyed no advantages or incentives whatsoever beyond the hope that the additional cash would enable the company to remain a going concern and ultimately repay its outstanding debt – in other words a defensive DIP financing.

Unsurprisingly, no DIP financing market ever developed in Brazil. During the 15 years that the prior law remained in effect, only eight DIP financings figured in the roughly 4,500 restructuring plans that were approved during the period, of which only 6 were ultimately effectuated. In fact, last year LATAM Airlines Brasil ultimately chose to join the rest of the Latam Airlines Group’s already ongoing Chapter 11 proceeding in the United States specifically to avail itself of the foreign DIP financing market, where it found multiple money sources competing to extend DIP financing.

It remains to be seen if the new law will result in DIP financing becoming more widely available in Brazil.  Certain provisions of the new law appear to encourage DIP financing.  Both legal entities and individuals can extend DIP financing. The presiding judge can approve a DIP financing proposal without creditor approval and DIP financing does gain second repayment priority (in the waterfall that kicks in after payment of the exempt creditors) in the event of a liquidation (behind the repayment of expenses necessary to administer the bankruptcy estate and labor claims in arrears three months prior to the liquidation decree). No subsequent judicial decision may alter this repayment priority – or diminish the collateral that secures it – once the DIP financing has been approved.

While DIP financing can be guaranteed by any assets of the company or third parties, nothing in the new law affects the absolute exemption of fiduciary liens, either in a restructuring or a liquidation – and many of the assets of a distressed debtor will more likely be subject to fiduciary liens and therefore may not serve as collateral for DIP financing (unless the creditor with title to the asset covered by a fiduciary lien decides to open up senior security space for the new DIP lender).

Given the limited scope of collateral that will be available to secure DIP financing on a priority basis, the net effect of the new law will probably be the expanded use of defensive DIP financing, where pre-petition creditors will provide additional DIP financing with the goal of providing the debtor a lifeline to continue to operate as a going concern that will eventually emerge from restructuring and be positioned to repay both its pre-petition debts and its DIP loans.

Creditor Proposal of Restructuring Plan

The prior law had no provisions that would allow for creditors to formulate a restructuring plan.  Although it mandated that debtors negotiate an acceptable restructuring plan to be voted at the Creditors’ Meeting within a non-extendable 180-day stay period, court decisions progressively relaxed this seemingly draconian timeline to the point that debtors were regularly afforded multiple 180-day extensions and judicial restructuring proceedings would drag on for years.

Under the new law, if the debtor does not complete the negotiation of a restructuring plan to be voted on at the Creditors’ Meeting within the 180-day stay period (which may be extended only once if the delay in presenting the plan is not the fault of the debtor), or if the voted plan is not approved by the required number of votes at the Creditors’ Meeting, the creditors will have the right to present an alternative plan.

Creditors will have only 30 days to draw up the alternative plan, which must include a detailed description of the mechanisms that will be employed to accomplish the restructuring along with expert reports on matters such as the economic viability of the debtor and asset appraisals. No alternative plan may be submitted to a vote of the Creditors´ Meeting unless it has, ab initio, the written support of 25% of all the creditors or 35% of the creditors present at the original Creditors’ Meeting. But once the right for the creditors to present their alternate plan is granted, another 180-stay period begins.

There are more requirements: The alternative plan must release all personal guaranties of obligations of the debtor, may not impose new obligations on debtor affiliates and may not put the debtor or its affiliates in a worse position than they would have been in the event of a liquidation.

On the other hand, the alternate plan may provide for debt-to-equity conversions – even if the conversions result in a change of control of the debtor.  Furthermore, the new shareholder/former creditor is not subject to successor liability after the conversion.

UNCITRAL Model Law on Transnational Insolvency

The practical effect of Brazil’s adoption of the Model Law is that in cases where Brazil is not the COMI (Centre of Main Interest) of the debtor´s activities, Brazilian courts are now required to cooperate with foreign courts and representatives of both foreign main proceedings and foreign non-main proceedings. This did not happen before because there was no law mandating or even permitting such cooperation. On the other hand, where Brazil is the COMI of the debtor’s activities, it continues to enjoy the right to enforce its decisions in countries such as the United States that had already adopted some version of the Model Law.Ultimately, the adoption of the Model Law allows for cross-border insolvencies involving Brazil to be resolved in a comprehensive, consistent and timely manner. 

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