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The Brazilian Bankruptcy Law (Law No. 11,101/05) was recently amended by Law No. 14,112/20, which came into effect in early 2021 and brought significant changes to the Brazilian insolvency framework. This article highlights such major changes and features, especially those applicable to asset sale and debtor-in-possession financing transactions, including permission for creditors to propose competing reorganisation plans, mechanisms to expedite liquidation and reorganisation proceedings, as well as rules on substantive consolidation, mediation, cross-border insolvency and certain tax incentives to companies under judicial reorganisation.
- Reform of the Brazilian Bankruptcy Law
- Insolvency proceedings
- Competing reorganisation plans
- Debtor-in-possession (DIP) financing
- Exit financing
- Distressed M&A transactions
- Reorganisation of football corporations (SAF)
Referenced in this article
- Brazilian Bankruptcy Law (Law No. 11,101/05)
- Law No. 14,112/20
- Insolvency proceedings
- Judicial reorganisation
- Extrajudicial reorganisation
- Bankruptcy liquidation
- DIP financing
- Distressed M&A transactions
- SAF Law (Law No. 14,193/21)
- reorganisation of football clubs
The current Brazilian Bankruptcy Law was enacted in 2005 and revoked the previous bankruptcy law from 1945. The 2005 Brazilian Bankruptcy Law is considered to be an important milestone for the modernisation of the Brazilian insolvency system, introducing important mechanisms for the in- and out-of-court reorganisation of distressed companies, preservation of recoverable firms and liquidation of unrecoverable ones. In fact, the 1945 bankruptcy law did not provide any efficient mechanism for the reorganisation of distressed businesses. The concordata (a former judicial proceeding once available for the reorganisation of distressed businesses in Brazil) just granted a two-year moratorium on unsecured claims or the option to pay the debts with a discount in a shorter time. Tax, labour and secured claims were excluded from the proceeding.
During the past few years, intensive discussions have been held among law professors, legal and financial experts and practitioners regarding the need to reform the Brazilian bankruptcy law in order to reflect the most current issues and complexities faced in insolvency cases in Brazil, as well as to consolidate certain customs and practices, and to create a more appropriate and efficient process in Brazil for companies in distress.
As a result of such studies and discussions, Law No. 14,112 was enacted in 2020, effective as of 23 January 2021. It introduced important amendments to the Brazilian Bankruptcy Law, such as new rules and legal protections for investors in asset sale and debtor-in-possession financing transactions, the ability of creditors to propose a competing reorganisation plan, mechanisms to expedite liquidation and reorganisation proceedings, substantive consolidation rules, cross-border insolvency rules, tax incentives for companies under judicial reorganisation in cases involving capital gains on the judicial sale of independent production units (UPIs), and the reduction of tax impacts in the event of renegotiation (haircut) of the company’s indebtedness.
This article aims to present an overview of the main features of the insolvency proceedings available for companies and business owners in Brazil, and two important mechanisms available for investors willing to do business in Brazil: debtor-in-possession financing and distressed M&A transactions.
There are three insolvency proceedings available in Brazil for companies and business owners: judicial (or in-court) reorganisation proceedings, extrajudicial (or out-of-court) reorganisation proceedings and bankruptcy liquidation proceedings. While judicial reorganisations and extrajudicial reorganisations are available for recoverable companies that intend to restructure their indebtedness and preserve their business, bankruptcy liquidations are available for unrecoverable companies that intend to cease operations and promote liquidation of their assets and payment of their creditors according to a priority rule provided for in the Brazilian Bankruptcy Law.
A judicial reorganisation is the most commonly used proceeding for the reorganisation of companies in Brazil. It is similar to a reorganisation proceeding under Chapter 11 of the US Bankruptcy Code, as the debtor remains in possession of its assets and continues to run the business during the process, with certain limitations. For instance, the debtor cannot sell fixed assets without a court’s authorisation, unless the sale is expressly provided for in the reorganisation plan. The commencement of the process imposes a stay period of 180 days, extendable for an equal period, during which all lawsuits and foreclosure measures against the debtor are stayed to enable the debtor to negotiate a reorganisation plan with its creditors. Following the 2020 reform of the Brazilian Bankruptcy Law, if the debtor fails to obtain approval of a plan within the stay period or if the plan is rejected at the general meeting of creditors, creditors may present a competing reorganisation plan. If the reorganisation plan is approved at the general meeting of creditors and confirmed by the bankruptcy court, the debtor and creditors are bound by its provisions and the bankruptcy court may determine that the debtor will remain under judicial reorganisation until it has fulfilled all obligations provided for in the plan due within two years.
An extrajudicial reorganisation is an expedited reorganisation similar to pre-packaged arrangements under Chapter 11 of the US Bankruptcy Code. The debtor negotiates a reorganisation plan with its creditors out of court and, once the required majority of creditors approves the plan, the debtor files the plan for court confirmation. The extrajudicial reorganisation may be negotiated with all creditors or a particular group of creditors, and now negotiations may also include the debtor’s employees provided that there is a collective negotiation with the labour union of the respective professional category. An extrajudicial reorganisation is recommended for debtors with a less severe crisis and with indebtedness concentrated with a particular group of creditors (eg, bondholders, suppliers, financial institutions). The 2020 reform introduced important amendments to the extrajudicial reorganisation in an attempt to foster its use. For instance, the quorum for approval of the plan was reduced from 60 per cent to 50 per cent of the claims restructured by the extrajudicial reorganisation plan. Also, the reform permits the debtor to start the restructuring process with the approval of one third of the affected claims and obtain the required majority within 90 days. Once the process is initiated, the debtor enjoys the protection of the stay period, which should provide for a better environment to obtain the approval of the plan by the required majority.
A bankruptcy liquidation, in turn, is a liquidation process similar to a liquidation under Chapter 7 of the US Bankruptcy Code. Once a bankruptcy liquidation is declared by the bankruptcy court, the shareholders and managers are removed from the debtor’s management and the bankruptcy court appoints a judicial administrator that will manage the liquidation of the bankrupt estate by selling the assets, conducting pending lawsuits and making all relevant decisions related to the bankruptcy liquidation. Historically, bankruptcy liquidations are very inefficient proceedings in Brazil and may take more than 10 years to be closed, with an extremely low recovery rate for creditors. The 2020 reform introduced important mechanisms to expedite and increase efficiency of bankruptcy liquidations in Brazil. For instance, the reform established a maximum period of 180 days for the judicial administrator to proceed with the sale of all assets of the bankrupt estate. Also, the ‘fresh start’ principle was introduced in the Brazilian Bankruptcy Law, allowing business owners and entrepreneurs to be discharged from their obligations and reintroduced into business activities within a shorter period of time (three years from the bankruptcy decree). Also, with respect to subordinated creditors, the reform clarifies that partners without an employment relationship hold this classification only in relation to claims taken on without observing strictly fair conditions and market practices.
Competing reorganisation plans
Before the enactment of Law No 14,112 of 2020, the debtor was the only stakeholder in reorganisation proceedings entitled to submit a reorganisation plan. The plan proposed by the debtor was submitted to the general meeting of creditors and, if the required majorities approved and the bankruptcy court found no illegalities, the plan was confirmed. On the other hand, if the plan was rejected by the general meeting of creditors and the requirements for court confirmation by way of cramdown were not met, the judicial reorganisation would be converted into a bankruptcy liquidation proceeding.
Following the 2020 reform of the Brazilian Bankruptcy Law, the debtor has an exclusivity period to submit and obtain approval of the reorganisation plan. In this sense, the debtor has a 60-day period to submit a reorganisation plan and must obtain approval of the plan by the general meeting of creditors within the stay period (180 days, extendable for an equal period). If the debtor fails to obtain approval of the plan within the stay period or if the plan is rejected at the general meeting of creditors, creditors may present a competing reorganisation plan.
For creditors to propose a competing reorganisation plan, the following requirements should be met:
- the debtor’s plan does not obtain approval of the required majorities and is not confirmed by way of cramdown;
- the competing plan contains a description of the measures that shall be adopted for the reorganisation of the debtor, supported by technical appraisals attesting its economic viability and valuation of the debtor assets;
- the competing plan obtains the approval of creditors representing more than 25 per cent of all claims subject to the judicial reorganisation or, alternatively, more than 35 per cent of the claims held by creditors attending the general meeting of creditors that rejected the debtor’s plan;
- the competing plan should not impose additional obligations on the debtor that are not provided by law or in existing contracts;
- the personal guarantees granted by individuals to the creditors that supported or approved the competing plan should be released; and
- the competing plan should not impose a greater burden to the debtor and its shareholders than the respective burden attributed to them in the case of bankruptcy liquidation.
In addition, the reorganisation plan proposed by the creditors may provide for the capitalisation of the claims or credits, including the consequent change of control of the debtor, therefore allowing the exercise of the right of withdrawal by the debtor’s partners.
The introduction of competing plans in insolvency proceedings in Brazil should certainly contribute to encouraging the debtor to negotiate better payment conditions with its creditors during the stay period, and to dispose of certain assets to satisfy obligations to creditors under the judicial reorganisation plan in an attempt to obtain the approval of the proposed reorganisation and avoid losing the company to its creditors. In fact, before the 2020 reform, the fact that the debtor had the exclusive right to submit a plan provided significant leverage to the debtor in plan negotiations and often led creditors to approve unsatisfactory reorganisation plans to avoid a bankruptcy liquidation (which historically is a very ineffective process in Brazil, with low recovery on claims).
Debtor-in-possession (DIP) financing is an essential component of judicial reorganisations, as most debtors lack sufficient liquidity to continue to operate when they file for a reorganisation proceeding. The 2020 reform of the Brazilian Bankruptcy Law introduced important rules that grant greater protection to investors in DIP financing transactions.
Even before the 2020 reform, DIP financing transactions were developed and consolidated as an important financing resource for distressed companies in Brazil. The main players involved in these transactions range from local and foreign strategic investors to local banks and distressed investment funds. Clearly, considering the local aspects of the Brazilian market and legal system, local DIP financing has different characteristics and faces different challenges as compared to DIP financing transactions carried out in other jurisdictions, such as in the United States.
Brazilian bankruptcy law does not impose limitations on a company undergoing a judicial reorganisation for obtaining unsecured post-filing financing. However, financing secured by fixed assets of the debtor must be authorised by the bankruptcy court or expressly provided for in the reorganisation plan.
DIP lenders benefit from two important protections. First, their claims are not impaired in a judicial reorganisation proceeding, which means that the DIP financing is not restructured by the reorganisation plan and may be enforced against the debtor during the judicial reorganisation proceeding in the case of default (even the collateral could be foreclosed on). Second, in the case of a bankruptcy liquidation of the debtor, the DIP financing is paid with priority over other claims, with a few exceptions.
The 2020 reform of the Brazilian Bankruptcy Law introduced a new section to regulate DIP financing granted during the judicial reorganisation proceeding. The reform brought additional protection against the risk of the DIP financing and collaterals created thereunder being declared null or revokable due to fraudulent conveyance issues, fraud against creditors, fraud against foreclosure and other similar provisions under Brazilian law (effectiveness or clawback risks), by the introduction of article 66-A in the Brazilian Bankruptcy Law, which provides that collaterals granted by the debtor to a DIP lender acting in good faith may not be declared null or void after the consummation of the transaction, with the disbursement of the funds to the debtor. For this protection to be effective, the DIP financing must have been authorised by the bankruptcy court or provided for in the judicial reorganisation plan.
Also, article 69-B introduced the ‘mootness doctrine’ in the Brazilian Bankruptcy Law, by stating that the review of the court order authorising the DIP financing by the superior courts may not change the nature and collaterals granted by the debtor to the DIP lender acting in good faith, if the funds were already disbursed.
Article 69-C introduced a new feature regarding the possibility of the bankruptcy court to authorise the creation of a subordinated collateral over encumbered assets of the debtor without obtaining the authorisation of the existing creditor, limited to the excess value resulting from the sale of the encumbered asset. The purpose of this new rule is to enable debtors with all – or almost all – of their assets encumbered to obtain a secured DIP financing. Despite the good intentions of this provision, the second paragraph of article 69-C excludes assets encumbered by fiduciary liens from the application of the rule. Since most of the financial debt in Brazil is secured by fiduciary liens over assets of the debtor, in practice the scope of this provision is limited.
In the same vein, article 69-D states that if a bankruptcy liquidation of the debtor is decreed before the funds are fully released, the contract is automatically terminated and the lender will not be obliged to disburse the remaining amount. The sole paragraph of the same article reinforces the preservation of the collateral and guarantees granted to the DIP lender up to the amounts effectively disbursed before the bankruptcy liquidation decree.
Also, in the event of a bankruptcy liquidation, the 2020 reform upgraded the priority of payment of the amounts disbursed by the DIP lender during the judicial reorganisation, such that they are now paid only after the essential administrative expenses of the bankrupt estate and labour claims due three months before the bankruptcy decree, up to five minimum wages per employee.
One specific modality of DIP financing is called ‘exit financing’. Exit financings are granted to a company undergoing a judicial reorganisation for the specific purpose of paying off claims as restructured by the reorganisation plan and financing the debtor’s operations following the closure of the judicial reorganisation proceeding.
This modality of financing is different from DIP financings granted throughout the reorganisation proceeding and intended to finance the debtor until a reorganisation plan is approved, or even during the implementation of the plan. Exit financings are generally granted after the plan has been approved to enable the payment of creditors, closing of the proceeding and reinsertion of the company into the market under normal competitive conditions. However, although DIP financing is already widespread in judicial reorganisation proceedings in Brazil, exit financing is rarely used.
The use of exit financing in judicial reorganisation proceedings in Brazil may help to expedite the closure of judicial reorganisation proceedings and emergence from bankruptcy. In fact, the Brazilian Bankruptcy Law provides that a company may be kept under judicial reorganisation until all obligations set forth in the plan that are due up to two years after confirmation of the plan have been fulfilled. During this period, the company is kept under the supervision of the judicial administrator and the bankruptcy court, and must comply with all the formalities provided for in the Brazilian Bankruptcy Law. The company also continues to suffer all the limitations and difficulties intrinsic to a company undergoing a judicial reorganisation, such as difficulty obtaining credit in the financial market and negotiating contracts with customers and suppliers.
Thus, obtaining exit financing for the payment of the claims restructured by the plan allows for a faster and more efficient end to a judicial reorganisation proceeding, and allows the company’s return to the market under normal competitive conditions, facilitating access to lines of credit and financing under better conditions.
The recent changes made to the Brazilian Bankruptcy Law, mentioned above with respect to DIP financing during judicial reorganisation, certainly provide greater legal certainty to the DIP lender and, therefore, may promote an increase in the use of different financing modalities in judicial reorganisation proceedings, including exit financing.
Distressed M&A transactions
Although the distressed credit market in Brazil is developing and growing at a fast pace, the sale of assets (regardless of their nature) still stands out as the main source of funding for companies in financial distress.
In this context, the innovations brought by the 2020 reform of the Brazilian Bankruptcy Law regarding legal certainty in the acquisition of distressed assets were highly welcomed by investors, and are expected to boost distressed M&A activity in Brazil. The likelihood of increasing distressed M&A activity has also been strengthened by the high level of liquidity available in the global financial markets and the devaluation of the local currency against the US dollar, which makes many foreign investors interested in opportunities of this kind in Brazil, either directly or through investments in investment funds managed by local asset managers focusing on special situations.
In addition to typical M&A risks, from a buyer’s perspective, the main risks involved in distressed M&A transactions are:
- the risk of the transaction being declared null or revokable due to fraudulent conveyance issues, fraud against creditors, fraud against foreclosure and other similar provisions under Brazilian law (ie, effectiveness or clawback risks); and
- the risk of the buyer being held liable for contingencies and liabilities of the debtor (ie, succession risk).
Although some of these risks also exist in regular M&A transactions, they are particularly aggravated in distressed M&A transactions. Carrying out an M&A transaction during a judicial reorganisation proceeding may mitigate some of these risks.
The Brazilian Bankruptcy Law protects a buyer of the debtor’s assets in a judicial reorganisation proceeding against both succession and clawback risks if the transaction is implemented as an acquisition of an independent production unit (UPI). Pursuant to article 60-A of the Brazilian Bankruptcy Law, a UPI may be composed by assets (both tangible and intangible assets), rights and shares of the debtor. A UPI sale must be expressly provided for in the judicial reorganisation plan and, therefore, it may only be implemented after formal approval of the plan by the general meeting of creditors and confirmation by the bankruptcy court. In addition, a UPI sale must be preceded by an auction or other competitive process organised by a specialised agent, and the buyer shall not be a related party to the debtor.
The innovations brought by the 2020 reform of the Brazilian Bankruptcy Law also extended application of the protections against succession and clawback risks to M&A transactions that are not implemented as an acquisition of a UPI under judicial reorganisation proceedings, making a free and clear acquisition possible even before the approval of a reorganisation plan. This is an important innovation for distressed M&A transactions in reorganisation proceedings, considering that the sale of a UPI may take several months to be implemented, and the timing for the transaction may discourage some investors to move forward. In this sense, article 66-A, introduced by the 2020 reform, brought additional protection against clawback risks by establishing that any sale of assets authorised by the bankruptcy court or provided for in the approved reorganisation plan may not be declared null or void after the consummation of the transaction. Also, the reform introduced a third paragraph in article 66, stating that any asset sale authorised by the bankruptcy court and performed in accordance with the first paragraph of article 141and article 142 of the Brazilian Bankruptcy Law (ie, conducted by a competitive process and where the buyer is not a related party to the debtor) will be carried out free and clear from any liens and liabilities of the debtor, also mitigating succession risks in transactions that do not involve the acquisition of a UPI provided for in the reorganisation plan.
Reorganisation of football corporations
Most Brazilian football clubs are still organised as non-profit civil organisations and lack professional management, which contributes to inefficient financial management and the over-indebtedness. As civil organisations are not entitled to file for reorganisation proceedings under the Brazilian Bankruptcy Law (which is reserved for business entities), there has been no efficient mechanism available for the reorganisation of football clubs in Brazil. In this context, the professionalisation of management in football and the incorporation of ‘football companies’ have been regular topics in Brazilian sports discussions. Such discussions resulted in the enactment of Law No. 14,193 in 2021, which introduced football corporations (SAFs) in Brazil. The new SAF law proposes to establish mechanisms for the reorganisation and restructuring of debts of football clubs, and to boost investments in the football market through issuance of debentures and other regular financing mechanisms by the SAF.
In short, the SAF law provides for the drop-down of assets, rights and contracts of football clubs strictly related to the football activity to a new company (the SAF), and the SAF will not be liable for debts of the club that are not strictly related to football activity.
The SAF law provides for two different regimes for the restructuring of the remaining indebtedness of the football club: the first is a specific proceeding created by the SAF law called the ‘centralised foreclosure regime’, which enables the club to concentrate all revenue and foreclosure actions before one court and facilitates the distribution of proceeds to creditors in an orderly manner. The second is a specific provision allowing the filing of a reorganisation proceeding by the football club, pursuant to the Brazilian Bankruptcy Law.
If the football club opts for the centralised foreclosures regime, the court will grant six years for the payment of creditors. If the club pays at least 60 per cent of the debts within six years, the regime may be extended for additional four years. The debt shall be paid by the club with its own resources and with certain funds that shall be transferred by the SAF to the club constituted by:
- 20 per cent of the revenue obtained by the SAF; and
- 50 per cent of the dividends or other payments received by shareholders of the SAF.
Alternatively, the club may opt for filing a judicial reorganisation proceeding or an extrajudicial reorganisation proceeding, in which case the provisions of the Brazilian Bankruptcy Law shall apply.
Although before the enactment of Law No. 14,112 of 2020 conciliation and mediation were not provided for by the Brazilian Bankruptcy Law, in practice, mediation had already been adopted in some judicial reorganisations, especially to speed up procedures related to verification of claims and define the means for reorganisation and payment conditions to be provided for in the reorganisation plan.
The 2020 reform introduced specific rules to encourage the adoption of mediation before and during a judicial reorganisation proceeding. Now it is possible to obtain urgent relief to stay enforcement actions against the debtor for a period of up to 60 days prior to the filing of the judicial reorganisation in an attempt to reach a settlement with creditors in a mediation or conciliation proceeding already instituted before the Judicial Conflict Resolution and Citizenship Center. Also, in the event of a subsequent request for a judicial or extrajudicial reorganisation, the time limit will be deducted from the stay period provided for in article 6 of the Brazilian Bankruptcy Law.
After the commencement of a judicial reorganisation, conciliation and mediation on the legal nature and classification of claims, as well as on voting criteria at the general meeting of creditors, are not allowed (article 20-B, paragraph 2). Settlements reached through conciliation or mediation must be approved by a competent court (article 20-C).
 According to research conducted by the Brazilian Association of Jurimetry (ABJ) in association with the Nucleus of Studies of Insolvency Proceeding (NEPI) of PUC-SP in 2022, a bankruptcy liquidation in the State of São Paulo may take more than 10 years from its commencement until the closure and creditors recover on average 6.1 per cent of their debt (https://www.conjur.com.br/dl/observatorio-insolvencia-fase-falencias.pdf).
 Article 84 of the Brazilian Bankruptcy Law provides that essential administrative expenses of the bankrupt estate and labour claims due three months before the bankruptcy decree are paid with priority over the DIP financing.