Brazil: The Corporate Insolvency Law and New Perspectives
The current Brazilian legislation on corporate insolvency law entered into force in 2005 by Federal Law 11,101, which represented a long-anticipated mindset change in regard to the to the previous Decree-Law 7.661, which had been enacted in 1945. Law 11,101 incorporated principles of the World Bank and the IMF, and its purpose was to create an efficient insolvency system and to allow negotiations between debtor and creditors to take place. As such, Law 11,101 provided for three court proceedings: judicial reorganisation, expedited reorganisation and bankruptcy liquidation. Only debtors engaged in business activities are subject to those proceedings; the insolvency of consumers and civil associations, as well as other entities such as financial institutions and cooperatives, is regulated by other statutes.
Law 11,101 represented a huge improvement over the 60 year-old legislation that preceded it. However, it has been heavily criticised as it has shown to be inefficient both for credit recovery and for the reorganisation of businesses. In December 2016, the government designated a work group to propose amendments to the provisions of Law 11,101 and revamp corporate insolvency proceedings in Brazil.
Reorganisation proceedings are court-supervised arrangements between a debtor and its creditors. Debtors under financial distress are allowed to file voluntary petitions for judicial reorganisation; creditors are not entitled to do so. It has become common, even though not specifically provided by law, that groups of debtor companies file joint petitions for reorganisation, and such requests have been widely accepted by the courts.
A debtor’s request for judicial reorganisation must include, inter alia, a statement of the causes of its financial distress, financial statements for the previous three years of operations, the list of creditors and claims, and the list of employees and their claims. Among other conditions, Law 11,101 provides that in order to qualify to file for judicial reorganisation, the debtor must, at the time of the application is made, have been doing business regularly for over two years.
All claims existing at the time of the filing, even if not yet due, are affected by the reorganisation proceeding, with some exceptions, such as tax claims, advances on foreign exchange (ACCs) and claims secured by chattel mortgages, or fiduciary assignments. Claims incurred after the filing are also not affected by the reorganisation proceeding and may be paid by the debtor or enforced by the relevant creditor.
If the eligibility requirements are met, the court will issue a decision allowing the commencement of the proceedings, appointing a judicial administrator to monitor the debtor’s activities, and ordering a stay of all enforcement actions against the debtor for a period of 180 days. Such period is usually extended by the courts upon the request of the debtor, in many instances with the consent of the creditors.
A reorganisation is a debtor-in-possession proceeding, and management remains in control of the assets and the activity, under the supervision of the judicial administrator (and of the creditors’ committee, should there be one). However, the debtor is not allowed to sell its fixed assets unless such sale is authorised by the court or by a court-approved plan of reorganisation.
Plan of reorganisation
The debtor shall propose a plan of reorganisation within 60 days following the commencement decision. The plan provides for the means by which the debtor intends to reorganise its business and satisfy the affected claims, and must also include an appraisal of the assets and a financial assessment confirming that the plan is viable. It has become common for plans to provide for payment extensions, haircuts, debt-to-equity conversions, mergers and acquisitions, sales of assets, issuance of new debt, and so on.
Although labour creditors are included in the reorganisation proceeding, Law 11,101 requires that the plan shall not provide for a term longer than one year for the payment of labour-related claims or occupational accident claims that are due by the filing date.
The plan may provide for the sale free and clear of branches or isolate production units of the debtor. In such cases, the purchaser acquires the branches or isolates production units, as the case may be, without being held liable for the debtor’s debts and contingencies, including tax and labour liabilities. In addition to being provided for in the plan, courts usually require such sale to be carried out by means of a judicial auction or a similar competitive procedure. It has become common practice for investors to acquire assets such as isolated production units under a judicial reorganisation proceeding, in order to avoid successor liability, especially in respect to labour and tax debts and contingencies (which, under Brazilian law, are prone to spill over to equity holders). The non-succession rule does not apply if the acquirer of the branch or production unit is an equity holder of the debtor, an entity controlled by the debtor, a direct or collateral relative up to the fourth degree, by blood or affinity, of the debtor or of a shareholder of the debtor, or an agent of the debtor.
Although tax claims may not be affected by the plan, legislation enacted in November 2014 allowed companies under reorganisation to apply for a tax instalment plan to pay federal tax debts in 84 monthly instalments.
Voting and confirmation of the plan
After the plan is submitted to court, creditors may file objections thereto. If no objections are filed, and the plan is not otherwise unlawful, the court will confirm the plan without a creditor voting. If, however, one or more creditors object, which happens in the vast majority of cases, the court will call a creditors’ general meeting to consider and vote on the plan. The plan may be modified or amended at any time before or at the creditors’ meeting, subject to the debtor’s consent, but it may not be modified in a manner that unfairly discriminates against creditors not attending the meeting.
For the purposes of voting on the plan, creditors are divided into four classes: holders of labour claims; holders of secured claims, up to the limit of the collateral; holders of unsecured claims; and creditors that qualify as micro and small-sized companies. Creditors whose claims are unimpaired by the plan shall not have the right to vote. Related parties, such as equity holders of the debtor, are also not allowed to vote.
In order to be considered regularly approved by the creditors’ general meeting, the plan must have a favourable vote of more than 50 per cent of the claims, in number, in the class of labour claims; more than 50 per cent of the claims, in both number and amount, in the class of secured claims; more than 50 per cent of the claims, in both number and amount, in the class of unsecured claims; and more than 50 per cent of the claims, in number, in the class of claims held by micro and small-sized companies.
If the plan is approved by the required majorities, it will be confirmed by the court and, therefore, becomes binding on the debtor company and on all affected creditors. If the required majorities are not met, the court may still confirm the plan if there is an alternative quorum. Such cramdown confirmation requires the following cumulative requirements: a favourable vote of holders of a simple majority in amount of all claims affected by the plan; the approval of the plan in at least two of the classes (or one, if there are only two classes), according to the same criteria used for a regular approval; a favourable vote of at least one-third of the creditors in the dissenting class; and absence of discrimination among the creditors of the dissenting class. If cramdown confirmation is not possible, the debtor will be declared bankrupt and its assets will be sold in a liquidation proceeding.
Majorities are calculated based on the creditors attending the general meeting of creditors to which the plan is submitted. Creditors not attending the meeting, as well as unimpaired creditors and related parties, as mentioned above, are disregarded. In addition, creditors who abstain from voting are also not considered for calculating the required majority.
After court confirmation, the debtor remains under judicial reorganisation for up to two years following court confirmation of the plan in order to allow the court to monitor whether the plan obligations that become due during such period have been duly complied with. However, it is common for debtors to remain under judicial reorganisation until the court rules on all challenges to the list of creditors and claims.
If, during this period, the debtor breaches the plan, Law 11,101 provides that the court shall convert the reorganisation into a liquidation in bankruptcy. However, and although it is not provided for in Law 11,101, it has become common practice for the company to submit amendments of the restructuring plan to the general creditors’ meeting. If the amendments are approved at the meeting, such amendments become valid and binding on the debtor company and on its creditors.
The purpose of expedited reorganisation proceedings is to seek court confirmation of pre-negotiated and approved arrangements between a debtor and a class of creditors, or group of creditors with similar economic interests. After obtaining approval of the plan by such creditors, the debtor files a proceeding seeking court confirmation. If at least 60 per cent of the claims belonging to any such class or group approve the plan, it becomes binding on all affected creditors upon confirmation.
Any claim, secured or unsecured, matured or not, may be subject to a pre-packaged reorganisation plan, with the exception of labour claims and of all the other claims not affected by a court-supervised reorganisation.
After the debtor obtains the relevant approvals and files a voluntary petition for expedited reorganisation (again, creditors are not allowed to do so), and even though it is not provided by Law 11,101, the court usually orders a stay of 180 days during which holders of impaired claims cannot perform enforcement measures. The court also orders the publication of a notice allowing any dissenting creditor to file objections to the plan within 30 days. After the expiration of this deadline, the court will confirm the plan if the quorum requirements are met and if the plan does not infringe the law.
Although expedited reorganisations are fast-track proceedings, less complicated and less value destructive for the debtor company, they are still not widely used in Brazil.
Bankruptcy liquidation proceeding
Bankruptcy liquidations are court-supervised proceedings in which the assets of the debtor are sold with the purpose of paying its creditors according to the priority rule set forth by Law 11,101. Although they are perceived to be inefficient and value destructive, they are also the most common insolvency proceedings in Brazil.
Commencement and declaration
Voluntary bankruptcy proceedings (ie, bankruptcy proceedings filed by the debtor) are commenced by the applicant by filing a petition with the court, stating the reasons for the impossibility of the company to carry on its business, accompanied by certain documents, as provided by Law 11,101. However, voluntary petitions for bankruptcy liquidation are rare. In the majority of the cases, creditors file involuntary bankruptcy petitions, and they are allowed to do so if the debtor fails to pay a claim in the amount of at least 40 minimum wages at the due date.
Upon bankruptcy being declared, the court will appoint a judicial administrator, who will manage the bankrupt estate until its liquidation is completed. The management of the debtor company is removed and the judicial administrator takes over the administration of the estate. Among other effects, the decision declaring the debtor bankrupt also forbids any act of disposal or encumbrance of the debtor’s assets without prior authorisation by the bankruptcy court and the creditors’ committee, should there be one.
The bankrupt estate may continue to operate (managed by the judicial administrator) during the bankruptcy proceeding so that the business may be sold as a going concern. However, in the vast majority of cases, the bankrupt company ceases to operate, its facilities are locked down by the judicial administrator, and the assets are collected to be sold under a judicial auction.
In some circumstances, the court may disregard the legal entity and extend the effects of the bankruptcy proceeding to the equity holders or administrators of the debtor company, or even to other entities considered to be part of the same corporate or economic group of the debtor company. Although the extension of the effects of the bankruptcy to third parties is an exception applicable to cases in which there is fraud or commingling of assets, there is a risk associated with the fact that some courts may apply such measure in a broader manner. As a result, there is a risk, even though it may be remote, that the effects of a bankruptcy proceeding is extended to equity holders, administrators or other entities belonging to the same corporate or economic group.
Classification of claims
In a procedure similar to the one found in a reorganisation proceeding for verification of claims, a general list of creditors will be prepared by the judicial administrator, and creditors may challenge such list in court according to Law 11,101.
The claims will be classified according to the rules of Law 11,101, and creditors will be paid pursuant to a waterfall, as follows:
- labour-related claims, limited to 150 monthly minimum wages per creditor, and occupational health claims;
- secured claims (ie, claims secured by a mortgage or pledge) up to the limit of the value of the collateral;
- tax claims, regardless of their nature and date on which they arose, except for tax fines;
- special privileged claims, including claims held by micro-enterprises and small-sized enterprises;
- general privileged claims;
- unsecured claims, including labour claims exceeding 150 minimum wages, and claims exceeding the value of the collateral in case of secured claims;
- contractual penalties and fines for breach of criminal or administrative law, including tax-related fines; and
- subordinated claims, such as those stipulated by law or contract, as well as the claims held by the debtor’s equity holders or officers who are not employees of the debtor.
Certain claims, as defined in Article 84 of the insolvency law, shall take priority over all claims listed above, such as fees payable to the judicial administrator and his or her assistants, labour-related claims or occupational health accidents referring to services rendered after the bankruptcy decree and amounts lent by creditors in favour of the estate.
In addition, there are claims that are not affected by a bankruptcy proceeding and that may be enforced by the creditor, such as claims deriving from ACCs, claims secured by chattel mortgages and fiduciary assignments and claims deriving from certain leasing transactions.
Sale of assets
The liquidation of the estate should be effected in one of the following forms, in the order of preference set forth in Law 11,101: disposal of the business, with the block sale of its establishments; disposal of its branches or manufacturing plants as separate units; disposal in block of the assets constituting each of the debtors establishments; or disposal of the assets considered individually. In the majority of the cases, and even though the law pushes for the sale of assets as a going concern, they are sold piecemeal.
The general rule for the sale and liquidation of assets within bankruptcy proceedings, as contemplated by Law 11,101, is that the court will order a public auction of the assets, preceded by the publication of a notice in a widely circulated newspaper. However, the court may authorise or the creditors’ meeting may approve (by a voting of creditors holding two-thirds of the claims) any alternative form of sale.
The assets that are disposed of are free and clear of any encumbrance, the successful bidder not being held liable for the debtor’s past obligations and contingencies, including tax and labour-related obligations and liabilities, and occupational accident obligations, except when the successful bidder is a shareholder in the bankrupt company or a legal entity controlled by the bankrupt debtor, a direct or collateral relative up to the fourth degree, by blood or affinity, of the debtor or of a shareholder in the bankrupt company or identified as an agent of the debtor for the purpose of defrauding creditors.
Emergence from bankruptcy and discharge
Upon the realisation of the estate’s assets and distribution of the proceeds among the creditors, the judicial administrator must submit his or her accounts to the court. After the judicial administrator’s accounts have been approved, he or she must submit the final report on the proceedings, stating the value of the assets and of the proceeds of their realisation, the value of liabilities and the value of payments made to creditors, and specifying the outstanding liabilities of the bankrupt estate. The court will extinguish the proceedings upon the final report being submitted. It is common for a bankruptcy proceeding to take five to 10 years or longer to finalise.
The debtor company may request that it is declared discharged of its debts when all claims are fully paid or more than 50 per cent in amount of the unsecured claims are paid, after full payment of all claims that are senior to them (including tax claims). The debtor may also apply for discharge after five years following the termination of the proceeding, if there is no conviction of a bankruptcy crime, or 10 years in case of conviction.
After the bankruptcy proceeding is terminated and the debtor company is discharged of the debts, it may continue to operate or may be liquidated. In practice, given the lapse of time between the commencement of the bankruptcy proceeding and the discharge of the debtor company, most bankrupt companies are abandoned or irregularly liquidated.
The perspectives for reform
After more than 10 years since its enactment, and although it represented a major improvement over past legislation, Law 11,101 has room for enhancement. And, following the economic crisis triggered by the Operation Car Wash, which unveiled the world’s largest corruption scheme involving governmental entities and some of the largest companies in the country, a reform of the corporate insolvency system is expected.
The amendments to Law 11,101, which still have to be approved by the Brazilian Congress, are expected to include, among others, features such as clearer rules for sale of assets free and clear; for stimulating debtor-in-possession financing; treatment of groups of companies; faster and more efficient liquidation proceedings; and the incorporation of the UNCITRAL Model Law on Cross-Border Insolvency. Although there is no time frame for the amendments to be enacted, they are expected to represent a much-needed significant makeover of the Brazilian insolvency system.