Brazil: The Corporate Insolvency Law and New Perspectives
The current Brazilian legislation on corporate insolvency law entered into force in 2005 by Federal Law No. 11,101 (Law 11,101). It represented a long-anticipated change of mindset in regard to the previous bankruptcy law (Decree-Law 7,661), which had been enacted in 1945 and no longer reflected the current social and economic goals of insolvency law.
Incorporating many modern tendencies concerning international insolvency law, and heavily based on some of the procedures set forth by the American Bankruptcy Code, Law 11,101 incorporated principles of the World Bank and the International Monetary Fund, and its main purpose was to create an efficient insolvency system and to allow negotiations between debtor and creditors to take place, with the primary goal of preserving viable economic activities while allowing for a more efficient credit recovery.
It is generally held that Law 11,101 was a huge improvement on the 60-year-old legislation that preceded it. However, since its enactment, it has been heavily criticised as it has proved to be inefficient both for credit recovery and for the reorganisation of businesses. In December 2016, the government appointed a working group to propose amendments to the provisions of Law 11,101 and revamp corporate insolvency proceedings in Brazil. The group's findings were consolidated and presented as a bill to Congress in May 2018 (the 2018 bill). Although the bill encompasses most of the changes proposed by the working group, it was subject to the review and influence of the tax authorities during its proposition, and many of the proposed changes are considered to be highly controversial, especially in regard to the treatment of tax claims and rights of the treasury in insolvency proceedings.
Fundamentally, however, Law 11,101 remains the same, especially when it comes to the different procedures it establishes. It provides for three different 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, are the object of other statutes.
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, even in substantive consolidation, 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 to qualify to file for judicial reorganisation, the debtor must, at the time 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, appoint a judicial administrator to monitor the debtor's activities, and order a stay of all enforcement actions against the debtor for 180 days. This 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 the 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 of 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 of more 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 (UPIs) of the debtor. In such cases, the purchaser acquires the branches or UPIs, 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 the 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 UPIs under a judicial reorganisation proceeding, in order to avoid successor liability, especially in respect of 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. The 2018 bill aims to expand the number of instalments to 120 and allows companies to off-set taxes derived from any haircut granted by creditors against accumulated tax losses. Although the system proposed by this bill is more flexible than the system set forth by the 2014 legislation, both are considered to be insufficient to deal with the tax claims of insolvent companies, and are also restricted to federal taxes (not dealing with state and municipal taxes).
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 currently 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 companies. Creditors whose claims are unimpaired by the plan do not have the right to vote. Related parties, such as equity holders of the debtor, are also not allowed to vote. The 2018 bill aims to change this system of fixed statutory classes, establishing that the classes of creditors shall be divided and organised by the reorganisation plan, based on criteria of similarity. However, until the bill is approved, the regular system of four fixed classes of creditors remains applicable.
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 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 to allow the court to monitor whether the obligations of the plan that arise during this period have been 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 the Law, it has become common practice for the company to submit amendments to the restructuring plan to the general creditors' meeting. If the amendments are approved at the meeting, they become valid and binding on the debtor company and on its creditors.
The 2018 bill proposes to eliminate the two-year oversight period, and there are already some precedents and work of commentators that support this, as long as the creditors agree with it or it is set forth in the approved plan.
The purpose of expedited reorganisation proceedings is to seek court confirmation of pre-negotiated and approved arrangements between a debtor and one or more classes of creditors, or groups 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 each of the impaired classes or groups approve the plan, it becomes binding on all the creditors of each classes or groups 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 (such as tax claims).
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 directly 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 (i.e., 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 effects of bankruptcy can extend to third parties, this generally only occurs in cases concerning fraud or commingling of assets. However, if a court chooses to apply this measure, and does so in a broader manner, there is a risk (albeit remote) that the effects of the bankruptcy will extend 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 this 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 structure, 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 and small 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 Law 11,101, 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 debtor's establishments; or disposal of the assets considered individually. In the majority of 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 these 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. The 2018 bill proposes to reduce this time lapse to two years (when there is no criminal 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.
Despite the rigidity of the deadlines established by Law 11,101 for the discharge, there are some recent judicial precedents that tend to attenuate the rule, hence decreeing the discharge of the obligations of the debtor company and its shareholders and directors five years prior to the termination of the liquidation proceeding.
The perspectives for reform
After more than 12 years since its enactment, and although it represented a major improvement on past legislation, Law 11,10 has room for enhancement. And, following the economic crisis triggered by Operation Car Wash, which unveiled the world's largest corruption scheme involving government entities and some of the largest companies in the country, a reform of the corporate insolvency system is expected.
Currently, the amendments proposed to Law 11,101 are consolidated in the form of the 2018 bill, which still has to be approved by Congress. Some of the changes proposed by the bill are favourable, and include clearer rules for the sale of assets free and clear; stimulation of 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.
However, although many of the changes proposed are positive, a significant number of other amendments are highly controversial, especially in regard to the treatment of the treasury and of tax claims in the insolvency proceedings. The power given to the treasury, which under the terms of the 2018 bill can even file for the bankruptcy liquidation of a restructured debtor if the tax claims are not dealt with during the reorganisation, may end up nullifying the positive effects of all the other changes, hence eliminating any real chances of turnaround. There is no time frame for the amendments to be enacted.
It is essential, therefore, that the proposed amendments to Law 11,101 by the 2018 bill be subject to rigorous analysis by Congress and by all professionals in insolvency law.
* This article was updated with the help of Thiago Dias Costa, senior associate of the restructuring and insolvency team at Felsberg Advogados.