Contributed By Thomaz Bastos, Waisberg, Kurzweil Advogados
Due to political and economic factors that culminated in uncertainty regarding the outlook for the national economy, certain lenders and borrowers have reduced their activities and many distressed borrowers have resorted to corporate or debt reorganisations to sell all or part of their activities to local and foreign players.
Another important topic relates to the entrance of new players in the local financial market. Although the Brazilian financial industry is highly concentrated, new competitors, such as Fintech firms, have been quickly gaining market share. The increase in competition generated by high tech companies will continue to create new challenges to the banking and financing industries, as well as to the Brazilian authorities (please refer to 1.3 Alternative Credit Providers below for more details).
Over the past years, there has not been an increase of regulation regarding high-yield transactions, although the Brazilian Securities and Exchange Commission (CVM) regularly reviews securities issuers’ obligations, notably those regarding disclosure rules.
CVM and other regulators are currently focused on KYC (know-your-costumer) and better-disclosure practices. Because of this, underwriters and lenders have required more detailed data from their customers.
Additionally, enhanced due diligence and disclosure patterns from high-yield investors are also being required – which impacts the provisions involving representations, warranties, covenants and defaults set forth in the relevant loan documents.
Numerous companies known as Fintechs have been disrupting traditional financial services models by intensively applying modern technologies, like blockchain and artificial intelligence. They are growing in Brazil and nowadays the authorities are discussing a regulatory framework that promotes innovation, protects consumers and grants the required supervision over financial market players.
Regarding credit Fintechs, the applicable regulation established two categories of institutions: the direct credit company (Sociedade de Crédito Direto) and the peer-to-peer (P2P) loan company (Sociedade de Empréstimo entre Pessoas).
The Sociedade de Crédito Direto is authorised to grant loans and funding, in addition to acquiring receivables through electronic platforms, but only with its own capital, while the Sociedade de Empréstimo entre Pessoas is authorised to connect lenders and borrowers and to intermediate the negotiation of loans and financing transactions through electronic platforms, and to make loans itself, limited to BRL15,000, notwithstanding certain exemptions.
Trade and corporate finance transactions have been the most common sources of financing for economic players in Brazil. Notwithstanding this, there has been an increase of alternative sources of funding for Brazilian borrowers, especially involving capital markets transactions.
The issuance of domestic bonds is commonly chosen by certain local companies to finance their activities. Private placements and public offerings with restricted placement efforts of securities, including domestic bonds, are exempt from registration or other requirements with CVM, which greatly simplifies those transactions and turn them into an attractive funding source.
Following the issuance of domestic bonds, two of the most issued securities in the local capital markets are certificates of real estate receivables (CRIs) and certificates of agribusiness receivables (CRAs).
A new proposal for a broad tax reform is under discussion with both in the executive and legislative branches of government. According to the most recent proposal, a number of federal, state and municipal taxes, such as the federal social contributions on revenues (PIS and COFINS), federal tax on financial transactions (IOF), federal industry tax (IPI), federal contribution for funding basic education, federal contribution on fuels (CIDE-Fuels), state tax on goods and services (ICMS) and municipal service tax (ISS), would be replaced by one single VAT, known as IBS (Imposto sobre Bens e Serviços). This consolidated VAT would be levied on transactions involving goods and services, and would be non-cumulative, with a broad tax credit system.
As a requirement to operate and provide financing in Brazil, an applicant must obtain an authorisation before the Brazilian Central Bank. The documents that must be filed with the Brazilian Central Bank include, among others: a formal letter of application for authorisation; a statement presenting the intent of the applicant; a statement of the non-existence of restrictions imposed by law; an assessment of financial or economic feasibility, including a business plan; a definition of the corporate governance structure; details on the controllers of the applicant; and evidence of its financial or economic capability.
Please refer to1.3 Alternative Credit Providers above regarding non-bank's requirements to operate.
Foreign lenders are not restricted in any way from granting loans. Please refer to 3.3 Restrictions and Controls on Foreign Currency Exchange below to see restrictions and controls to foreign lending transactions.
Generally, there are very few restrictions on foreign lenders being the beneficiary of any kind of security or guarantees.
Notwithstanding this, ownership of rural real estate property is restricted to persons residing in Brazil or to foreign entities authorised to function in Brazil. Therefore, foreign lenders might not be able to benefit directly from fiduciary liens (alienação fiduciária) of such assets (please refer to 5.5 Other Restrictions below for a more detailed description).
If a lending transaction is entered into between a Brazilian entity and a foreign financial institution, that transaction must comply with the terms of Law No 4,131/1962, Brazilian Monetary Council Resolution No 3,844/2010, and Brazilian Central Bank Circular No 3,691/2013.
These regulations expressly allow legal entities situated in Brazil to enter into loans with legal entities located overseas. Considering that as long as the financing is pursuant with the applicable regulation, it will not represent an undertaking of banking activities in Brazil, nor will the foreign financial institution be subject to supervision by the Brazilian regulatory authorities. Furthermore, loan transactions do not require any approval from any Brazilian banking authority.
There are Brazilian laws on loans and debt securities which typically require borrowers to use proceeds either for the specified purpose mutually agreed upon by the parties thereunder (eg, to finance an expansion of its industrial plant) or for “general purposes” that would include investments, capital expenditure, etc, subject to other covenants in the relevant credit instruments.
Nevertheless, loans and debt securities proceeds shall not be used in violation of Brazilian law and/or public policy. In order to assure compliance with Brazilian law and/or public policy, lenders usually insist, through appropriate representations and covenants, that borrowers do not use the proceeds in violation of such provisions.
Brazilian law recognises the agent concept. Commonly, lenders nominate an agent in the security documents to act on their behalf to enforce the loan, the guarantees and other security interests, granting to the agent enough powers to represent them. Usually, the guarantee and security interests are created in favour of the lenders themselves. However, there is no restriction in Brazilian law that forbids (albeit there is also no law that expressly allows) the creation of a security interest in favour of an agent acting on behalf of a certain lender (as long as the underlying documentation grants to that agent powers to so act).
The concept of a trust as it exists in common law jurisdictions is not fully recognised under Brazilian law. However, a trust created under instruments governed by foreign law, as well as any foreign entity, shall be recognised in Brazil if it is not deemed to be contrary to Brazilian law, national sovereignty, public policy or morality.
The most common transfer mechanism is the assignment of loan receivables. Such receivables can be assigned without the borrower’s consent, unless the relevant documentation provides otherwise, albeit the debtor must always be notified about the assignment. Except if agreed upon differently by respective parties, the assignment of loan receivables embraces the assignment of the security package created in relation to the loan.
In practice, it is common to insert in the relevant loan documentation provisions that oblige the borrower and/or security provider to co-operate with the assignment of loan receivables and underlying security package. In cases where the security package includes in rem security interest over assets, the assignment agreement of loan receivables must also be registered with the relevant Public Registries (please refer to 5.1 Assets and Forms of Security below).
Debt buy-back transactions directly carried out by a borrower or sponsors are permitted under Brazilian law, hence, parties to loan documents can mutually agree on the matter. Lenders may also demand, from the borrower or the sponsor, the payment of certain break funding costs to allow the debt buy-back.
Additionally, loans granted under specific tax benefit programmes usually restrict such possibilities by means of a lock-up period before the buy-back is allowed, otherwise the relevant tax benefit might be lost.
Public acquisition finance is mainly provided by local banks, although internationally syndicated loans and domestic bonds are becoming more common as a source of funding for this kind of transaction.
Nevertheless, going-private transactions or those involving the change of control of publicly traded companies have to comply with the requirements set forth by CVM Instruction No 361/2002, which governs tender offers.
Interest owed by a local borrower to a foreign lender is generally subject to withholding tax at a rate of 15% or 25% if the creditor is in a low-tax jurisdiction, as identified in the applicable regulations. Interest owed by a local borrower to a local lender is also generally subject to withholding tax (not applicable to financial institutions) based on a regressive rates system that may change from 22.5% to 15% according to the days passed since the loan was granted and the payment date. In such a scenario, the tax withheld will be considered a payment in advance of the income tax locally due by the local lender.
Local loans with principal previously specified are impacted by Tax on Financial Transactions (IOF/Credit), which is usually imposed at a daily 0.0041% rate, limited to 365 days, plus a flat 0.38%, therefore leading to a combined 1.88% rate for operations longer than one year. Foreign loans whose average maturity term is longer than 181 days take advantage of the 0% rate of the Tax on Financial Transactions, foreign exchange transactions (IOF/FX), which is triggered upon the execution of inflow/outflow foreign currency trades. Nevertheless, the IOF/FX rate is increased to 6% if the average maturity term of the loan is lower than 181 days.
The federal Decree No 22,626/1933 imposes certain limitations on the amount of interest payable under loan agreements. The scope of the Decree is controversial, but the general understanding of the Decree adopted by the Brazilian courts is the one that sets forth that loan transactions entered by and between non-financial entities are subject to an interest rate up to 1% per month, plus monetary adjustment of the principal due. Loans granted by lenders that are not financial institutions are subject to interest limitation imposed by Brazilian laws.
It is important to mention that the Brazilian Civil Code expressly sets forth that when the parties of an agreement have not agreed on the applicable default rate, that rate shall be the same as the index accruing over defaulted taxes owed to the Brazilian National Treasury. In these cases, there is a discussion on whether the relevant default rate should be SELIC (Special Settlement and Custody System), which reflects inflation and is currently defined by the Brazilian Monetary Policy Committee, or 1% per month.
Broadly, all the assets of a company are available as collateral to lenders and usually the security over such assets include pledges, mortgages (hipoteca) and fiduciary liens (alienação fiduciária em garantia or cessão fiduciária em garantia), which create in rem security interests over the underlaying assets. Generally, the security documents take the form of private instruments, however, mortgages over real estate assets with an individual value equal to or greater than 30 times the current minimum wage must be entered into by a public deed executed by a public notary. The security documents must describe the parties thereto, the secured obligation (including facility amount, interest rate, penalty rate, maturity date and amortisation schedule) and the assets over which the security interest shall be granted. In order to perfect the creation of the security interest over a certain asset, the security document shall be registered with the competent public registry, which may be the Registry of Titles and Deeds of the location of the grantor thereof (if the security is granted over rights), or the Registry of Titles and Deeds of the location of the assets thereunder (if the security is granted over movable assets), or the Real Estate Registry of the location of the real estate property (if the security is granted over real estate property). The failure to register the security documents impedes the creation and perfection of the security interest over the underlying asset.
In Brazil, the costs regarding the registration process with the public registries are subject to state law and may vary considerably.
As a general rule, Brazilian law does not recognise floating charges or security interest over all present and future assets of the debtor or third-party grantor. Brazilian law carves out an exception to such restrictions when the debtor issues domestic bonds (debêntures), regulated by Brazilian Corporate Law (Federal Law No 6.404/1976).
Debêntures can be issued with a floating charge over a debtor’s assets, which grants to creditors a general privilege over the company’s assets. In cases where there is a new issuance of domestic bonds with floating charges over the issuer’s assets, the domestic bonds of that new issuance will be subordinated to the bonds of the previous one. Notwithstanding this, the security interest created due to the floating charge over a debtor’s assets does not forbid the company from selling or encumbering such assets.
In Brazil, downstream, upstream and cross-stream guarantees are all permitted. In order to do so, it is necessary to observe the relevant procedures and quorum approvals set forth in the guarantor’s bylaws. In cases where the guarantor is obliged to pay the guaranteed obligation, the guarantor subrogates the correspondent creditor and shall be able to collect from the debtor the amount paid.
The controlling shareholders and/or the management of the company may be held liable if they cause it to engage in activities that do not benefit the company and/or conflict with company interests. In this case, the doctrine of separate legal entity could be disregarded in order to pierce the corporate veil and cause the controlling shareholders of the company to be held liable for the obligations on the company that arose from those activities which did not comply with its best interests. In this case managers may also be held liable for breaking the corporate by-laws. In practice, the documents creating a guarantee expressly set forth that the entity providing the guarantee has received reasonably equivalent value as a member of the same group as the borrower, in order to justify the downstream, upstream and cross-stream guarantees granted.
Under Brazilian law there are no restrictions on a target granting guarantees or security or financial assistance for the acquisition of its own shares.
Brazilian law restricts the acquisition of rural estate properties by foreign entities. Therefore, foreign lenders might not be able to directly benefit from fiduciary liens (alienação fiduciária) of such assets. The consents and respective deliberative quorum required to approve a security interest over certain assets are set forth in guarantors’ bylaws and must be respected in order to prevent the security interest from being voided.
The release of any security interest must comply with the procedures agreed by the parties in the relevant security document. Usually, the relevant security document provides for a draft of the release statement that must be executed by the lender or the beneficiary of the security and presented to the debtor within the term established in the relevant security document.
Once received, the release statement must be registered in the relevant public registry (please refer to 5.1 Assets and Forms of Security above).
Additionally, security interests created over shares or quotas are registered in the issuer's share records or issuer's articles of association, respectively. In such cases, the security interest must be cancelled from the issuer's share records or issuer's articles of association.
The priority of competing security interests is prescribed by law; hence, it cannot be contractually varied, albeit creditors may enter into intercreditor agreements regulating the use of proceeds derived from the collateral. A previous security interest duly perfected (ie, registered with the competent public registry) grants to the secured party thereof a priority in the foreclosure of that security interest. In cases where there is more than one security interest created over certain asset, the secured party who benefits from the second-degree security interest shall only be entitled to foreclose the asset after the first-degree security interest is accelerated. Contractual subordination provisions will not survive the insolvency of a borrower incorporated in Brazil.
Notwithstanding this, an asset fiduciarily transferred (alienado fiduciariamente em garantia), insofar as it entails the transfer of title, is not be subject to any other security interest.
A secured lender can enforce its collateral if the underlying obligation matures (whether by acceleration or otherwise) and the debtor does not comply with its obligations.
Automatic enforcement of collateral is not allowed in Brazilian law and provisions to that effect are invalid.
In the absence of insolvency events, the security interests can be enforced as follows:
After a debtor's default, the secured lender can carry out an extra-judicial sale of the asset with the express consent of the debtor or pledgor, or if the pledge agreement expressly allows it. In addition, the pledge agreement should contain a power-of-attorney clause, by which the debtor or pledgor grants special and irrevocable powers to the creditor to carry out all measures associated with the selling of the asset, as well as establishing standards for determining the price of the asset in such circumstances. If not, the lender must petition a court to begin the foreclose on the asset. If the public sale of the asset in the enforcement proceeding does not raise enough money to satisfy the creditor, additional properties of the debtor can be seized and/or auctioned until the obligation is fully repaid.
The lender must request that the court start the enforcement measures to foreclose on the real estate asset. If the public sale of the asset does not raise enough amount to satisfy the lender, additional assets of the debtor can be seized and auctioned until the debt is fully repaid.
Real Estate Fiduciary Lien
Once a debt has matured but not been repaid, a grace period, set out in the relevant agreement, starts. If the grace period expires without the satisfaction of the debt, the lender acquires the real estate unconditional title. At this point, the creditor must pay income tax related to the transfer of the asset. Following this, the creditor must arrange the first extra-judicial auction. During this auction, the minimum price of the real estate is the value set forth in the agreement. If the real estate is not traded, a second extra-judicial auction occurs where the minimum price of the real estate is the value of the secured debt, plus any expenses incurred during the enforcement. If the real estate is still not sold, the creditor can retain full ownership of the asset and the debt is deemed settled.
Fiduciary Property and Fiduciary Lien
The lender can sell the asset, regardless of any auction, or legal or extra-judicial proceeding. The creditor then uses the sale proceeds to satisfy its claim any residual money must be given to the borrower.
A foreign governing law will be recognised, and Brazilian courts will enforce a contract that has a foreign governing law, provided that such a law is the applicable law pursuant to Brazilian conflict of law rules and that the foreign governing law is not against Brazilian national sovereignty, public policy or morality. The governing law of an obligation is the law of the jurisdiction in which the obligation has been created, which in the case of a contractual obligation, is typically the law indicated as such in the agreement or the country in which it was entered into.
Regarding the waiver of immunity, under Brazilian law a state could consent to the exercise of Brazilian jurisdiction through arbitration clauses, contractual provisions or pursuant to international treaties.
A foreign judgment (including a foreign arbitral award) will be enforceable in Brazil without retrial of the merits if previously recognised by the Brazilian Superior Court of Justice. Such recognition only occurs if:
In a judicial procedure to enforce its rights, foreign lenders who do not own real estate in Brazil must offer certain guarantees, to the satisfaction of the court, in order to guarantee the payment of debtor’s legal fees and court expenses. Such guarantees may change and can be a deposit in a judicial escrow account or a performance bond.
The Brazilian Bankruptcy Law (Brazilian Federal Law 11,101/2005) provides for three different insolvency proceedings:
Bilateral or multilateral out-of-court negotiations are also possible and common, but there is no stay available nor any means to impose the terms of the negotiations on hold-out creditors.
For judicial reorganisation, the Brazilian Bankruptcy Law indicates that the bankruptcy filing does not terminate the security or guarantee (unless expressly consented to by the creditor), albeit it impedes the creditor from foreclosing, even though there may be exceptions with fiduciary liens.
Also, it is common that in judicial reorganisations the debtors include in their reorganisation plans provisions regarding the release of guarantees, either upon confirmation of the plan by the court or upon full payment of amounts due thereunder. Lenders may oppose to this kind of provision and case law usually considers this opposition valid, although a recent decision of the Brazilian Superior Court of Justice ruled in the opposite direction.
Regarding securities, the Brazilian Bankruptcy Law provides for a safe harbour for many types of security interest, when the ownership of the collateral is somehow transferred to the creditors, even when possession remains with the debtor. This safe harbour includes security interests provided in fiduciary liens, retention of title and leasing.
This exclusion rule is applicable even in liquidation, although the creditor may have to exercise its rights in the liquidation case, if the collateral is, by mistake, considered part of the estate.
In judicial reorganisations it is possible to limit the lender’s access to the collateral during the automatic stay, if property, plants and equipment (granted as collateral) are considered as essential assets for a successful corporate reorganisation.
Brazilian Bankruptcy Law only establishes a payment order in the case of liquidations. Article 84 establishes payment priority for (a) costs inherent to the liquidation proceeding (eg, fees for the liquidation trustee, debtor financing, expenses for sale of assets, etc.), (b) post-petition judicial reorganisation claims, and (c) claims not subject to the liquidation procedure (mainly beneficiaries of fiduciary liens and creditors of loan agreements based on advances on foreign exchange agreements). After said creditors, claims are paid in the order provided for in article 83 of the Brazilian Bankruptcy Law, indicated below:
There is no concept of equitable subordination under the Brazilian Bankruptcy Code or any other insolvency related legislation in Brazil. Although under liquidation shareholders and affiliated claims are subordinated, in judicial reorganisation they rank pari passu with unsecured claims (or secured claims if there is any collateral securing the claim).
Lenders must pay special attention to the perfection of security interests.
Different types of security interest, over different kinds of assets, require different perfection measures. Issues that prevent perfection of the security interest are the main reason for secured creditors to become unsecured creditors in bankruptcy proceedings.
Additionally, many defence strategies have developed for nullifying security interests or limiting their effects during the automatic stay, as a mean of allowing for a more successful debt restructuring. For the majority of Brazilian companies, there is no availability of unsecured credit lines, so it is common for distressed companies to give all their assets (including receivables) as collateral and, if such collateral is taken from the debtor, the company will not survive, much less restructure its debts.
The Brazilian Development Bank (Banco Nacional de Desenvolvimento Econômico e Social - BNDES) still plays a major role in long-term financing in Brazil, although it has announced that it shallwill reduce disbursements for the next years. Local commercial banks’ presence in project financing is historically limited to providing bank guarantees to long-term facilities and bridge loans.
Currently, BNDES requires project companies to prospect for new sources of long-term financing, including from local commercial banks, export credit agencies and project bonds. The key issue has been to identify local banks willing to grant such long-term loans, and also investors aiming to subscribe to project bonds.
Discussions in connection with the recourse that lenders may have against sponsors during the construction phase of the project have been more frequent in recent years, shedding some light on the difficulties regarding optimal risk allocation amongst the parties. Considering current market conditions, however, lenders are expected to demand full recourse structures against sponsors during the pre-operational phase.
Public-private partnership (PPP) are arrangements in which the financing of a project is shared between public and private entities. PPPs are alternatives to customary models of financing in which the totality of the costs and risks of the project remains either with the public or private sector.
A PPP is a public investment wherein the government contracts with a private party for the providing of a public service or of a service to the government. PPPs have a wide range of purposes, such as the financing of roads, ports, sanitation structures and of public health and education services.
The Brazilian federal law creating the public-private partnership programme was enacted in 2004 and establishes the following guidelines:
Except for compliance with the respective regulatory framework, and applicable rules regarding utilities, project financing transactions are not required to obtain government approvals or otherwise to be valid or enforceable. In addition, projects financed by domestic bonds issued under the terms of Federal Law No. 12.431/11 must be filed with and approved by the ministry of the relevant sector so that the project can be deemed as eligible for certain tax benefits (please refer to 8.6 Typical Financing Sources and Structures for Project Financings below).
There is no restriction regarding governing law for the project financing documents. However, usually the security documents are governed by Brazilian law.
Projects involving the oil and gas, power and mining sectors are regulated by means of regulation and inspection by each of the specific applicable regulatory authority agencies, which are, the National Agency of Electric Energy (Agência Nacional de Energia Elétrica – ANEEL), the National Agency of Oil, Natural Gas and Biofuels (Agência Nacional do Petróleo, Gás Natural e Biocombustíveis – ANP), and the National Agency of Mining (Agência Nacional de Mineração). Each of these sectors is highly regulated and has their own regulatory framework and applicable procedures.
The costs relating to structuring a project finance deal can be higher compared to other traditional financing mechanisms (eg, secured corporate loans), depending on the financing structure's complexity. There is also exposure to the risks inherent to greenfield projects in general (eg, construction risks, geological risk, etc).
Usually, sponsors incorporate a new private entity – typically incorporated in the form of a company (sociedade por ações), which takes the form of a special purpose vehicle created only to develop the project.
Brazilian regulation allows remittances of funds to and from foreign countries at any value, provided that the payments are legal, as well as are supported by the appropriate documents. Registration of the foreign investment before the Brazilian Central Bank is mandatory to ensure access to the foreign exchange markets for any remittances in connection with such inflows.
The main source of long-term financing in Brazil is BNDES, the Brazilian development bank, although private banks also grant loans to finance project activities with shorter maturities (eg, bridge loans). There are no restrictions to export credit agency financing in Brazil.
As a general rule, domestic bonds issued to finance certain project are offered in Brazil to the general public and institutional investors pursuant to CVM regulation. Since domestic bonds, issued pursuant to Federal Law No. 12,431/11, grants tax benefits to the investors, this finance structure has been broadly used in Brazilian markets in recentyears. Notwithstanding this, to be eligible for such tax benefits, the project and the project company must comply with certain requirements in connection with the use of proceeds and the terms and conditions of the issued bonds.
Natural resources are owned by the federal government according to Brazilian law. The exploration of natural resources by private entities thus requires previous governmental authorisation, licensing, or the grant of concession rights. In these cases, natural resource development may only be performed by a company incorporated under Brazilian law and having its head office in Brazil. Such companies may be controlled by foreign entities; provided, however, that companies exploring certain specific sectors must be controlled by Brazilians.
Depending on the applicable structure, a project is usually subject to an environmental licencing process, which involves a provisional authorisation, an installation authorisation and an operational authorisation, according with the applicable environmental legislation. In cases where the project is expected to impact archeological sites and/or indigenous groups, other authorities, such as the Archeology and Historical Heritage Authority (IPHAN) and the National Indigenous People Foundation (FUNAI), may be called to participate in the environmental licencing process. In this regard, further research and assessment may be requested from the project company.
Health and safety laws may be applicable depending upon the nature of the activity involved in the project.
There have been no recent important developments in Islamic finance in Brasil, the sector is small.
There is no regulatory and tax framework, specific to Islamic finance, in Brazil.
There is greater availability of shari'a-compliant products in Brazil, notably in connection with traditional economic sectors such as real estate and agribusiness.
There is no relevant legislation on the claims of sukuk holders in insolvency or restructuring proceedings in Brazil.
There have been no recent notable cases on any aspect of Islamic finance in Brazil.