After nearly 16 years, the Brazilian legal framework for corporate insolvency went through significant changes effective from January 2021. This chapter highlights some of the most significant features of the new insolvency framework from the perspective of foreign investors and creditors with respect to debtor-in-possession financing, distressed asset sales, competing plans, pre-packaged reorganisations, alternative dispute resolution mechanisms and cross-border insolvency.
- Recent reform of the Brazilian Bankruptcy Law
- Debtor-in-possession financing
- Distressed asset sales
- Judicial reorganisation proceedings
- Pre-packaged (or out-of-court) reorganisation
- Alternative dispute resolution
- Cross-border insolvency
Referenced in this article
- Brazilian Bankruptcy Law No. 11,101 of 2005
- Brazilian Federal Law No. 14,112 of 2020
- Measures in response to the covid-19 crisis
- 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). The downturn of the Brazilian economy in 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 Federal Law No. 11,101 of 2005 (the Brazilian Bankruptcy Law). Discussions around the draft bill went on and off and regained speed during the course of 2020, amid the covid-19 pandemic and public demand for measures to address the economic crisis deriving therefrom. Congressional debate around provisional measures to address the crisis eventually fell through and reignited discussions about the comprehensive law reform. The outcome of this process is Federal Law 14,112 of 2020 effective since 23 January 2021.
The law reform introduced 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, fostering transactions and investments to allow a fresh start for viable distressed businesses. The reformed framework also introduced more tools for extrajudicial workouts through alternative dispute resolution mechanisms and more flexible requirements for the confirmation of pre-packaged plans of reorganisation.
The reform 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 pre-packaged 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 these new features, this chapter focuses on some of the most noteworthy amendments to the Brazilian Bankruptcy Law, mainly with respect to:
- debtor-in-possession financing;
- asset sales;
- competing plans;
- pre-packaged reorganisation; and
- alternative dispute resolution mechanisms.
Brazil’s corporate insolvency framework
The Brazilian Bankruptcy Law provides for three types of insolvency proceedings for businesses and business owners: judicial reorganisation, pre-packaged reorganisation and bankruptcy liquidation.
Judicial reorganisation is a proceeding designed to promote effective restructuring and reorganisation 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 the debtor enjoys a fresh start. The reform introduced amendments and new provisions to the judicial reorganisation framework in a clear attempt to address challenges faced in practice, by bringing greater legal certainty and efficiency to restructuring efforts within the judicial proceedings.
A pre-packaged reorganisation is a proceeding comparable to pre-packaged 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. Since the enactment of the Brazilian Bankruptcy Law in 2005, the pre-packaged reorganisation had the purpose of serving as an expedited and cost-efficient proceeding to seek court confirmation and binding effects of an out-of-court debt workout. In practice, however, debtors seldom sought the extrajudicial route for various reasons, including cultural aspects affecting parties’ ability to engage in out-of-court negotiations, but mostly due to practical limitations deriving from the original framework. The reform introduced particular but material modifications to the pre-packaged reorganisation framework as an attempt to foster the use of such tool.
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. Historically, bankruptcy liquidation proceedings in Brazil are extremely lengthy and ineffective, commonly lasting for almost a decade or even more and returning little to no value to creditors. The reform introduced rules to expedite asset sales in bankruptcy liquidation proceedings thereby incentivising more efficient liquidation processes and preservation of value on behalf of creditors. New provisions also intend to allow debtors a fresh start thereby seeking to mitigate debtors’ fear of filing for bankruptcy liquidation.
The Brazilian Bankruptcy Law as enacted in 2005 set forth essentially two protections for providers of new financing to debtors under judicial reorganisation (debtor-in-possession (DIP) financing):
- the respective claim will not be impaired by the judicial reorganisation; and
- if the debtor goes into bankruptcy liquidation, the DIP financing claim will rank higher than the prepetition claims.
Practice has shown that lenders generally perceived such protections as insufficient incentives to give new money to companies under judicial reorganisation.
This was because, among other reasons, in a bankruptcy liquidation the DIP financing claim still ranked 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). The revised legal framework aims to foster new DIP financings. Accordingly, it improved the position of DIP financing claims in the ranking of claims applicable in a bankruptcy liquidation. DIP financing claims will now 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 the practice under the 2005 framework, DIP financings were provided mainly in situations where the debtor had strong collateral to secure the DIP financing (a rare scenario in judicial reorganisation) or where the lender had another specific purpose for the DIP financing (eg, to convert the claim into equity or to bridge and use the claim to acquire assets). Where the DIP financing was to be secured by non-current assets of the debtors, court approval or authorisation under the plan was required for the security to be completed. The condition remains, but the criterion for the authorisation has changed.
Under the original framework, the test to obtain court approval for the granting of the security by the debtor was ‘evident utility’, which in practice has been established as useful to the restructuring efforts. The test was dismissed in the revised regime, which now provides for a more flexible test, where a debtor may seek 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’. This test seems to make it easier for debtors to obtain court approval and may leave less room for creditors to effectively challenge the granting of the debtor’s non-current assets to secure DIP financing transactions.
Creditors and other interested parties 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. 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, if an appeal is filed, to the denial of any injunctive relief request to stay the effects of the authorisation order. The reform adopted the mootness doctrine and now expressly provides that 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 appeal. This provision tends to give lenders more certainty to grant DIP financings.
The reform has been subject to well-grounded criticism by failing to add other features to the DIP financing that would encourage investors to finance debtors undergoing insolvency proceedings, such as the court’s ability to determine priming liens to serve as collateral for the DIP financing without the consent of the existing creditors.
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 2005 framework, buyers were already able to acquire debtors’ 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, was authorised or ratified under the Plan and occurred through a competitive process (seeking maximisation of value).
The changes included by the reform bring even more legal certainty to these transactions and broaden their scope. In judicial reorganisation, the existing protection now extends to cases of sale of the business (going concern) itself, which solves a debate existing under the original regime. The revised legal framework also expressly confirms that the isolated productive units may encompass all types of 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, as a mechanism to foster pre-packaged reorganisation, the reform also included express provisions in the sense that the sale of assets will also be free and clear, in certain circumstances, if carried out as per pre-packaged plans of reorganisation, which solves a debate existing under the original framework. The reform also adds noteworthy features to 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.
In addition, similarly to what has been done with DIP financing, the reform adopted the mootness doctrine for asset sales that close (with respective payment) even if the relevant authorisation order is later overturned on appeal.
These provisions tend to strengthen protection to buyers that has been already and 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.
On the other hand, the reform does include 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), while it 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.
Competing plan of reorganisation
The Brazilian Bankruptcy Law originally provided that the debtor held exclusivity to submit a plan of reorganisation to the vote of creditors. In addition, the incorporation of any changes to the proposed plan depended on the 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 on 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 by 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 results 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 Chapter 11 of the US Bankruptcy Code, the legislative reform introduced 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. Creditors may put forward an alternative (competing) plan, if no settlement is reached with regard to the debtor’s plan of judicial reorganisation until the end of the stay period, or if the debtor’s plan of judicial reorganisation is rejected (which rules out its confirmation by the court, even by way of cramdown). In these cases, 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. If that is the case, 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 pre-packaged arrangements
For at least a decade since the enactment of the current Brazilian Bankruptcy Law, pre-packaged reorganisation proceedings were almost unheard of in practice. More recently, debtors have often resorted to this type of proceeding.
While the pre-packaged reorganisation is designed to be much simpler than a judicial reorganisation – and therefore cheaper and less time-consuming – the original regime under the Brazilian Bankruptcy Law imposed certain limitations, which included:
- 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 debt instruments and payment terms in order to cramdown such a plan onto dissenting creditors of such class or group of creditors.
The reform brought changes to all such limitations in an effort to incentivise further the use of pre-packaged reorganisations. Some of the proposed changes mirror and incorporate what practitioners have already construed in practice.
In particular, under the modified regime, debtors filing for pre-packaged reorganisation will benefit from the protection of the stay period in respect of all creditors whose claims are impaired by the respective 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. Also, such requisite majority of creditors may be obtained through a post-filing consent solicitation procedure instead of pre-filing by means of bilateral negotiations between the debtor and creditors. The sale of assets will also be free and clear in certain circumstances.
Alternative dispute resolution mechanisms
Another noteworthy aspect of the revised legal framework of the Brazilian Bankruptcy Law is the inclusion of provisions dealing with alternative dispute resolution mechanisms. This innovation aligns with the growing efforts by practitioners, Congress (notably since the enactment of the revised Civil Procedure Code in 2015) and Brazilian courts to foster alternative dispute resolution mechanisms in a jurisdiction that is characterised by a substantially high number of in-court disputes.
The Brazilian Bankruptcy Law regime now expressly provides for mediation and conciliation procedures that may be commenced ancillary to a judicial reorganisation proceeding or even prior to the filing thereof. More specifically, if the pre-filing conciliation or mediation procedure regards the renegotiation of debts and their respective repayment terms, a debtor may seek injunctive relief to stay enforcement actions for a period of 60 days, in order to seek an out-of-court debt restructuring workout.
In its original version, the Brazilian Bankruptcy Law did not have any provisions governing cross-border restructurings and bankruptcy liquidations proceedings.
In view of the lack of special provisions regarding cross-border proceedings in the current law, the coordination of cross-border cases depended 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 pre-packaged 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 legislative reform introduced 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. The revised regime now comprises 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. 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 may serve as the jurisdiction for foreign main proceedings.
Despite the countless advances, the legislative reform introduced to the Brazilian Bankruptcy Law received a lot of criticism from practitioners due to a general perception that it has left extensive room for discussion in various topics. Similarly to what happened to Federal Law 11,101 of 2005, it is reasonable to assume that bankruptcy courts and practitioners will play a significant role in shaping the applicability of the various innovations brought by Federal Law 14,112 of 2020.
 A study by Fernanda Jupetipe indicated that bankruptcy liquidation proceedings in Brazil lasted an average of nine years with an average of 12 per cent of recovery to creditors. Jupetipe also concludes that costs and expenses deriving directly from the proceedings represented an average of 39 per cent of the value of the assets at the commencement of the bankruptcy liquidation proceedings (Jupetipe, Fernanda K N. Custos de falência da legislação falimentar brasileira. University of São Paulo. 2014. p p. 47–49).