In August 2020, the Brazilian House of Representatives approved the Bill of Law No. 6,229/05, which introduces material changes to the Bankruptcy Law. The bill aims to improve the efficiency of the Brazilian insolvency environment, thereby enhancing its attractiveness to distressed business transactions. This chapter draws a comparison between certain aspects of the current regime and the features of the bill, especially with respect to debtor-in-possession financing, distressed asset sales, competing plans, prepackaged reorganisations and cross-border insolvency.
- Bill of Law No. 6,229/05
- Debtor-in-possession financing
- Asset sale in judicial reorganization proceedings
- Competing plans of judicial reorganisation
- Prepackaged reorganization
- Cross-border insolvency
Referenced in this article
- Brazilian Bankruptcy Law (Law No. 11,101/05)
- Bill of Law No. 6,229/05
- Debtor-in-possession financing
- Asset sales
- Competing plans
- Judicial reorganisation proceeding
- Prepackaged (or out-of-court) reorganisation
- UNCITRAL Model Law on Cross-Border Insolvency
The Brazilian Bankruptcy Law was enacted in 2005 and represented a significant improvement to the Brazilian corporate insolvency environment when compared to the previous bankruptcy law (dated 1945). It is a consensus among practitioners, however, that several aspects of the Brazilian Bankruptcy Law could be enhanced.
In this context, on 26 August 2020, the Brazilian House of Representatives approved the Bill of Law No. 6,229/05 (the Bill), which introduces material changes to the current Brazilian Bankruptcy Law (Law No. 11,101/05). The Bill was sent to the Senate for consideration and scrutiny and is expected to pass the vote on Senate’s floor relatively quickly and eventually be sanctioned by the President.
The Bill provides for various amendments and new features to the Brazilian Bankruptcy Law with the purpose of bringing greater legal certainty and efficiency to reorganisation and liquidation proceedings and, ultimately, foster transactions and investments to allow a fresh start of viable distressed businesses.
The Bill introduces various features to the Bankruptcy Law, such as:
- creditors’ ability to submit a competing plan of judicial reorganisation;
- new rules for asset sales, both in reorganisation and liquidation scenarios;
- certain protections and enhancements for debtor-in-possession financings;
- significant changes to the prepackaged reorganisation regime;
- mechanisms to expedite and increase the efficiency of bankruptcy liquidation proceedings, which in Brazil typically drag on for one or more decades and lead to very low recoveries to the creditors;
- cross-border insolvency rules seeking to incorporate UNCITRAL’s Model Law; and
- new methods for restructuring of the tax liabilities of companies under judicial reorganisation, as well as new tax regimes applicable to transactions and impacts associated with reorganisation proceedings.
Out of such new features, this chapter focuses on the comparison between the existing practice under the current Brazilian Bankruptcy Law and the potential changes to be introduced by the Bill if approved by Senate, mainly with respect to:
- debtor-in-possession financing;
- asset sales;
- competing plans;
- prepackaged reorganisation; and
- cross-border insolvency.
Brazil’s corporate insolvency framework
The Brazilian Bankruptcy Law provides for three types of insolvency proceedings.
- Judicial reorganisation is a proceeding designed to promote effective restructuring and reorganization of viable distressed companies. It is similar to Chapter 11 reorganisations. Under this proceeding, the debtor enjoys certain protection through the stay period to have the appropriate time to prepare, submit, negotiate and eventually obtain creditor approval of a plan of judicial reorganisation (the Plan). The Plan generally rescales the debtor’s operations and capital structure. Upon creditor approval and court confirmation of the reorganisation plan, the prepetition claims are discharged and debtor enjoys a fresh start.
- A prepackaged reorganisation is a proceeding comparable to prepackaged arrangements under the US Bankruptcy Code. A reorganisation plan is negotiated and accepted by the required creditors out-of-court and the debtor files this proceeding seeking court confirmation of the pre-agreed plan. Upon court confirmation of the plan, the claims subject to the proceeding are effectively restructured.
- In a court declaration of bankruptcy liquidation, shareholders and management are removed and a bankruptcy trustee is appointed by the court to manage the bankruptcy estate. With court supervision, the trustee takes all necessary measures to schedule, appraise and sell the assets of the bankruptcy estate. Sale proceeds and funds of the estate are used to pay creditors and management costs pursuant to a ranking of payments set forth under the Brazilian Bankruptcy Law.
The downturn of the Brazilian economy in the recent years has tested several aspects of the Brazilian insolvency market and the legal framework of the Brazilian Bankruptcy Law. As insolvency cases became more complex and sophisticated, it became clear that amendments and enhancements to the Brazilian Bankruptcy Law were required.
In this context, in 2016, the former Ministry of Finance formed a working group with the purpose of presenting a draft bill to amend the Brazilian Bankruptcy Law. The draft bill was subject to several changes until its final form was approved by the House of Representatives in August 2020.
Despite the countless advances, the Bill received a lot of criticism from practitioners and there is a general perception that it has left extensive room for discussion and improvement in various topics. In this sense, it is possible that the Bill will suffer changes throughout its legislative process in the Senate.
The current Brazilian Bankruptcy Law sets forth essentially two protections for providers of new financings to debtors under judicial reorganisation (debtor-in-possession (DIP) financing):
- the respective claim will not be impaired by the judicial reorganisation; and
- in case the debtor goes into bankruptcy liquidation, the DIP financing claim will rank higher than the prepetition claims.
Practice has shown that lenders generally perceive such protections as insufficient incentives to give new money to companies under judicial reorganisation. This is because, among other reasons, in a bankruptcy liquidation the DIP financing claim still ranks lower than several claims and expenses of the bankruptcy estate (eg, certain post-petition claims, the fees of the trustee and expenses related to the sale of assets).
In this context, DIP financings are provided mainly in situations where the debtor has strong collateral to secure the DIP financing (which is rare in a judicial reorganisation scenario) or where the lender has another specific purpose for the DIP financing (eg, to convert the claim into equity or to bridge and use the claim to acquire assets). In addition, collateral securing existing claims cannot be primed or shared to serve as collateral for the DIP financing without the consent of the existing creditors.
In case the DIP financing is secured by non-current assets of the debtors, court approval or authorisation under the plan is required for the security to be completed. The test to obtain court approval for the granting of the security by the debtor is expected ‘evident utility’. The Bankruptcy Law does not set forth a definition or guidelines to assess ‘evident utility’, but it has been established that new money is often useful to the restructuring and granting security to consummate the transaction would be appropriate.
Creditors and other parties in interest are entitled to challenge the court authorisation, including by means of filing of appeals with injunctive relief requests to stay the effectiveness of the authorisation order. In order to avoid the negative impact of the order being stayed or overturned by the relevant court of appeals, DIP lenders tend to condition the disbursement of the new money to a certain level of stability of the authorisation order. Frequently, disbursement is conditioned to the inexistence of appeals against the authorisation order or, in case an appeal is filed, to the denial of any injunctive relief request to stay the effects of the authorisation order. The Bill aims at fostering new DIP financings. Accordingly, the Bill improves the position of DIP financing claims in the ranking of claims applicable in a bankruptcy liquidation. Under the Bill, DIP financing claims will have preference over all pre- and post-petition claims (including claims for restitution of cash), except for those expenses essential to the administration of the bankruptcy estate, and proceeding and labour-related claims made up of wages during the three months before the bankruptcy decree (limited to five minimum wages per worker).
In addition, pursuant to the Bill, the debtor would be able to obtain court authorisation to grant collateral over non-current assets upon demonstration that the DIP financing proceeds will be used to ‘finance its activities and expenses for restructuring or preservation of value of its assets’. Such test is more flexible than the current test of ‘evident utility’ and, therefore, seems to make it easier for debtors to obtain court approval. In this sense, creditors may have less room to effectively oppose the granting of the debtor’s non-current assets to secure DIP financing transactions.
According to the Bill, if a DIP financing is authorised by the court, the perfection of the collateral and the priority in a bankruptcy liquidation will be preserved (up to the amount of funds disbursed) even if the authorisation order is later overturned on an appeal. The adoption of the mootness doctrine tend to give lenders more certainty to grant DIP financings.
Distressed asset sales
The Bankruptcy Law already provides for a very good level of protection to buyers of distressed assets in an attempt to foster sale transactions within insolvency proceedings. The Bill proposes to expand buyers’ safeguards.
In the current framework, buyers are able to acquire debtor’s business units during judicial reorganisation (the isolated productive units) and assets of the bankrupt estate in bankruptcy liquidation free and clear of successor liabilities of the selling debtor, provided that the relevant sale meets certain other formal requirements, is authorised or ratified under the Plan and occurs through a competitive process (seeking maximisation of value).
This protection to buyers has been consistently confirmed by court precedents and has led to numerous successful transactions during the past decade. Such transactions have allowed debtors to raise essential new cash and has allowed the continuation of viable business operations in the hands of new investors
The changes proposed by the Bill aim to bring even more legal certainty to the these transactions and to broaden their scope. In judicial reorganisation, the existing protection now extends to cases of sale of the debtor entity itself. The Bill confirms that the isolated productive units may encompass the debtor’s goods, rights or other assets, whether tangible or intangible, taken separately or jointly, including equity interests, and that protection against succession extends to environmental, regulatory and administrative, criminal, anti-corruption, tax and labour liabilities.
In addition, the Bill proposes certain changes that seem protective of buyers while potentially concerning to creditors. For instance, it extends the concept of free and clear sale to the sale transactions approved by the court (ie, regardless of authorisation or ratification under the reorganisation plan). However, the Bill eliminates the test of ‘evident utility’ for court approval and sets no other test to replace it. It also limits creditors’ tools to challenge such sales by setting forth conditions for creditors to be able to call a general creditors’ meeting to deliberate on sale transactions after court approval.
The Bill also provides for changes regarding asset sales in bankruptcy liquidation proceedings, which mainly aim to foster an expedited liquidation phase in order to preserve value for the benefit of the estate and creditors.
Competing plan of reorganisation
The Brazilian Bankruptcy Law currently provides that the debtor is the only stakeholder entitled to submit a plan of reorganisation to the vote of creditors. In addition, the incorporation of any changes to the proposed plan depends on debtor’s consent.
Pursuant to the Brazilian Bankruptcy Law, debtors have 60-days following the order that authorises to processing of the judicial reorganisation to submit a plan of reorganisation to the Bankruptcy court. Following the submission of this plan of reorganisation, the Bankruptcy court summons creditors to present objections to the proposed plan. If any creditor files an objection, a general creditors’ meeting must be convened to deliberate and vote on the plan of reorganisation. In theory, this meeting should be held within 150 days from the processing order, allowing the debtor to finalise negotiations and have a plan approved within the 180-day stay period during which lawsuits and enforcement measures and actions are stayed.
In practice, however, in the vast majority of cases, the plan of reorganisation filed by the debtors within the initial 60-day deadline hardly resembles what ends up being the plan voted and eventually approved by creditors. In many of these cases, this deadline is seen as a pro forma obligation of the debtor, which then uses the submitted plan only to outline its initial proposal and commence negotiations with creditors.
Practice also shows that debtors tend to seek adjournments of the general creditors’ meeting to the extent they need extra time to negotiate the terms of such a plan with creditors. In other words, in practice, debtors do not submit a plan of reorganisation to vote until they have secured the support of creditors representing the requisite majorities for approval at the general creditors meeting.
Evidently, this dynamic provides significant negotiation leverage to the debtors, which, depending on the size and profile of the debt and business at stake, may lead to creditors abiding to plans of reorganisation that do not necessarily represent the maximum payment capacity of the debtor and do not maximise their recovery value. The lack of rules governing the submission of competing plans by the creditors, following a certain statutory exclusivity period conceded to the debtors, often result in creditors accepting suboptimal plans way under debtor’s repayment capacity just to avoid a bankruptcy liquidation process where creditors (mostly unsecured) are unlikely to receive any distributions.
Mirroring the dynamic provided for by the Chapter 11 of the US Bankruptcy Code, the Bill aims to introduce a relevant change to the status quo by providing for a specific scenario where creditors will be entitled to submit a competing plan of reorganisation.
Pursuant to the Bill, if no settlement is reached with regard to the debtor’s judicial reorganisation plan until the end of the stay period, creditors may put forward an alternative (competing) plan. In addition, if the debtor’s judicial reorganisation plan is rejected (which rules out its confirmation by the court, even by way of cramdown), creditors holding more than half of the claims represented at the general meeting of creditors may approve an additional 30 days for submission of an alternative competing plan by the creditors. In these cases, the stay period will be extended for another 180 days from its initial term or from the date of the general meeting of creditors approving the period for submission of the alternative competing plan.
To qualify for deliberation, the alternative competing plan must have obtained written support from more than 25 per cent of all claims, subject to judicial reorganisation or, alternatively, from more than 35 per cent of claims held by creditors represented at the former general meeting of creditors that had rejected the debtor’s judicial reorganisation plan. The alternative competing plan must meet the same formalities in place for the debtor’s reorganisation plan and cannot inflict on the debtor or its equity holders a greater burden than that otherwise ensuing from bankruptcy liquidation. The alternative competing plan must also provide for discharge of existing personal guarantees tendered in favour of the creditors that approve the alternative competing plan.
Incentives to prepackaged arrangements
For at least a decade since the enactment of the current Brazilian Bankruptcy Law, prepackaged reorganisation proceedings were almost unheard of in practice. More recently, debtors have often resorted to this type of proceeding.
While the prepackaged reorganisation is designed to be much simpler than a judicial reorganisation – and therefore cheaper and less time-consuming – the current regime imposes certain limitations, which include:
- no clear statutory stay period (though it is normally granted upon filing in respect of all claims impaired by the plan);
- a variety of creditors that cannot be impaired by its plan (eg, tax claims, labour-related claims); and
- mandatory support of creditors representing at least 60 per cent of claims of each impaired class or group of creditors with similar deb instruments and payment terms in order to cramdown such a plan onto dissenting creditors of such class or group of creditors.
The Bill brings changes to all such limitations in an effort to further incentivise the use of prepackaged reorganisations. Some of the proposed changes mirrors and incorporates what practitioners have already construed in practice.
In particular, the Bill provides that debtors filing for prepackaged reorganisation will benefit from the protection of the stay period in respect of all creditors whose claims are impaired by the plan. More significantly, the minimum quorum to seek the plan confirmation and cramdown onto dissenting creditors will drop from 60 per cent to more than 50 per cent. The sale of assets will also be free and clear in certain circumstances.
In its current form, the Brazilian Bankruptcy Law does not have any provisions governing cross-border restructurings and bankruptcy liquidations proceedings. There are no provisions governing the administration of insolvency proceedings involving or affecting a Brazilian debtor or any of its property or interests located in different jurisdictions.
In view of the lack of special provisions regarding cross-border proceedings in the current law, the coordination of cross-border cases depends on the ability and the interest of the judge in charge of the case in Brazil. In practice, Brazilian courts have played a key role in addressing cross-border insolvency matters up to this point, when they have often adopted innovative and ad hoc solutions, based even on the UNCITRAL Model Law on Cross-Border Insolvency, to try to effectively address the challenges of complex cross-border cases.
The most emblematic example concerns the discussion about jurisdiction of Brazilian courts to process prepackaged and judicial reorganisation requests of foreign entities controlled by Brazilian entities. Throughout the years, Brazilian courts have accepted jurisdiction to process reorganisation proceedings of foreign entities in cases where such entities were understood to hold their centre of main interests in Brazil. In those cases, actions by debtors and creditors were coordinated simultaneously in Brazilian main proceedings and ancillary foreign proceedings (where such a feature is available). For instance, in a number of these cases, Brazilian reorganisation or liquidation proceedings were recognised as the main insolvency proceeding and Chapter 15 (of the US Bankruptcy Code) proceedings were sought in US courts to enforce a plan of reorganisation approved in Brazil onto the creditors of foreign entities.
Notwithstanding the bench and practitioners’ creativity, the trends of the past years show that jurisprudence alone offers a suboptimal solution that cannot substitute codified specific legislation. Changes to the Brazilian Bankruptcy Law regime have been long awaited and expected by a demanding market and investors (local and foreign) looking for legal certainty and predictability when it comes to treatment of cross-border insolvency matters.
The Bill has an entire new chapter dedicated to the subject and seeks to incorporate the UNCITRAL Model Law on Cross-Border Insolvency into the Brazilian legal system. As a result, practitioners expect that the Brazilian Bankruptcy Law will provide solid grounds for cooperation in both directions – both when Brazil is recognised as the centre of main interests, but also when Brazil jurisdiction may serve foreign main proceedings.
With respect to the latter, from a formal standpoint, recognition of foreign insolvency proceedings in Brazil is currently subject to the general rule whereby the foreign award requires confirmation by the Superior Court of Justice through an exequatur proceeding. According to Brazilian law, the exequatur shall not be granted and the foreign decision will not be recognised if it violates the national sovereignty, a Brazilian public policy or good morals. The exequatur is a time-consuming proceeding that does not fit into the dynamics and urgency of an insolvency proceeding.
The Bill sets out specific rules on access of foreign representatives to courts in Brazil, the method and requirements for recognition of foreign main and ancillary proceedings, authorisation for the debtor and its representatives to act in other countries, methods of communication and cooperation between foreign authorities and representatives and the Brazilian jurisdiction, and the processing of concurrent proceedings. This set of new legal provisions will change the existing scheme dramatically and will expedite cross-border proceedings in Brazil.