The Brazilian Bankruptcy Law was amended in 2021, through Law 14,112/2020, which changed the rules for liquidation proceedings, aiming to make it more efficient as to preserve enterprise value for the payment of creditors, and regulated issues that were not addressed yet in the Bankruptcy Law, such as DIP financing, substantive consolidation, and transnational insolvency.
One of the goals of these amendments was to provide tools that could ensure greater certainty and speed up the insolvency proceedings, which would create a more effective bankruptcy proceeding for distressed companies which avoided filing for bankruptcy in recent years.
This was effective for the extrajudicial reorganisation procedures which increased 200% from 2021 to 2022 – probably due to the changes in the quorum for approval of the plan of reorganisation from three fifths of the claim amount to simple majority of the claim amount, in each class of creditors.
However, the bankruptcy market remained less active than expected. The total number of insolvency proceedings – liquidations, judicial reorganisation, and extrajudicial reorganisation – remained roughly the same in 2020, 2021 and 2022. Extension of credit and low interest rates are indicated as causes for this situation. Additionally, new rules for more strict treatment of tax debt, and the possibility that creditors present a plan of reorganisation led to the decrease of the number of judicial reorganisations, which was “compensated” with the increase in liquidation cases in 2022.
Brazilian insolvency proceedings are regulated by Law No 11,101, enacted on 9 February 2005, as amended, which encompasses three different insolvency judicial proceedings. Only entities and individuals enrolled with the relevant Board of Trade may use these proceedings. Financial institutions, insurance companies, and other especially regulated activities, in addition to government-owned companies, are subject to specific insolvency regimes. Recent amendments to the Bankruptcy Law allow healthcare co-operatives (cooperativas médicas) and rural producers to file for bankruptcy.
The Brazilian Civil Code (Law 10,406/2002) and Corporate Law (Law 6,404/1976) also establish the proceedings for out-of-court wind downs, which solely demands shareholder’s approval. In these cases, if assets are not sufficient to pay off all debts, a liquidator is appointed and may recommend for the shareholders to approve filing for bankruptcy.
Any financial restructuring outside the context of insolvency is regulated under general civil and commercial laws.
Brazilian insolvency legislation encompasses three different proceedings:
Both the judicial and the out-of-court reorganisations are voluntary proceedings, whereas liquidation may be either voluntary or involuntary.
Brazilian law does not provide for any circumstances in which an entity is obligated to commence a formal insolvency proceeding except for liquidation, which may be filed against the debtor by creditors in certain conditions.
As per Brazilian Bankruptcy Law, creditors and other specific third parties (as listed below) may file for liquidation, but not a judicial or out-of-court reorganisation, which may be filed solely by and at the discretion of the debtors.
Details of Liquidation
The liquidation of a debtor may be required by:
Creditors may file for liquidation if the debtor:
Insolvency, for the Brazilian insolvency proceedings purposes, is not a financial or business concept, but a legal one, and is characterised by either:
Even if the company’s liabilities exceed its assets, which may result in a financial insolvency, the debtor would only be insolvent, in the legal sense, if it incurred in one of the items mentioned above.
The Brazilian Bankruptcy Law, as a rule, is not fully or partially applicable to government-owned entities, financial institutions, credit co-operatives, consortiums, pension funds, healthcare and other insurance companies and special savings companies.
The insolvency regimes of such entities are regulated by specific laws. Regarding all the businesses mentioned, if the debtor goes into in-court liquidation according to the rules of the applicable specific legislation, the liquidation proceeding will be governed by the Brazilian Bankruptcy Law.
Public or private financial institutions, as well as credit co-operatives and consortia, are subject to Law 6.024/1974, which establishes:
Insurance companies are subject to Decree-law 73/1966 and Regulatory Decree 60.459/1967 and may be liquidated voluntarily or compulsorily in case of violations to applicable law or regulations from the Federal Insurance Agency (SUSEP). Special savings companies are subject to Decree-law 261/1967, and to the Decree-law 73/1966, which also regulates their out-of-court liquidation.
Pension funds are subject to Complementary Law 109/2001 and may suffer government intervention (in case of violation to applicable laws or insufficient economic and financial conditions necessary to preserve the liquidity and solvency of each benefit plan) or liquidation (when the impossibility of recovering the supplementary pension entity is recognised or in the absence of conditions for its operation).
Healthcare insurance companies are subject to Law 9.656/1998 and may suffer liquidation whenever economic-financial or management abnormalities are detected that endanger the continuity or quality of healthcare. Recent changes in the Bankruptcy Law allow co-operatives which operate hospitals and healthcare plans to file for corporate restructure under the Bankruptcy Law.
In Brazil, it is not mandatory, prior to the commencement of insolvency proceedings, for the debtor to maintain negotiations with its creditors. In practice, however, most insolvency proceedings are preceded by extensive negotiations among debtor, creditors, and relevant stakeholders.
Filing for bankruptcy is usually the last option taken by stakeholders due to the bureaucratic and lengthy proceeding which entails, in addition to the stigma related to the involvement of a debtor in insolvency proceedings, the costs involved, the limitations on the sale of assets and the difficulty to access new funding.
Out-of-court negotiations tend to be faster, cheaper, and less burdensome not only for the debtor, but also for creditors and suppliers, since debtors may reach different agreements with different creditors, which would be impossible under a collective proceeding, in addition to affording the debtor better access to new credit lines and funding alternatives.
In this context, there is a general perception that consensual negotiations are preferable to insolvency proceedings, but, depending on the nature and amount of the debtor's liabilities, the number of creditors and the willingness of all relevant creditors to reach an amicable solution, the proceedings provided for in the Brazilian Bankruptcy Law are recommendable to allow a more comprehensive debt or business restructuring.
Debt restructuring negotiations typically involve the concession of waivers and formal or informal standstills throughout the negotiations, while some restrictions to the debtor may also be imposed. It is common that creditors perform extensive diligence during the negotiations, requesting the disclosure of information related to indebtedness, regularity before the public authorities, assets, labour practices, tax indebtedness, etc, retaining experts and advisers, often at the debtor’s expense.
Usually, these renegotiations lead to new and additional guarantees and collateral being offered to creditors, if feasible, in compensation for extensions or longer and better payment terms. In many circumstances the debtor is allowed to sell relevant assets while giving relevant creditors priority over the proceeds. Likewise, the release of collateral is usually allowed if they are being sold to facilitate the repayment of creditors or as a means to increment the company’s cash flow.
In Brazil, it is neither common nor there is regulation regarding the creditors' committees for consensual restructuring, so negotiations happen individually among debtor and creditor or collectively as a result of the debtor and relevant creditors’ efforts in reaching common terms or in view of common features, such as syndicated loans or shared collateral.
There is no special regulation for granting new money to distressed or nearly insolvent companies outside insolvency statutory proceedings in Brazil, although regular rules for fraudulent transfer would apply – which means that any collateral or priority granted to the new lender would be subject to court scrutiny if the company ends up in liquidation.
Laws and Doctrines
The Brazilian Bankruptcy Law is based on the principle of parity among creditors subject to an insolvency proceeding; that is, creditors in the same class or group must be treated equally. A recent amendment to the Brazilian Bankruptcy Law consolidated previous case law with the understanding that strategic suppliers which continue to do business with the debtor are entitled to beneficial treatment.
There is no legal provision indicating any special duty for creditors, other than ordinary duties to negotiate in good faith. Creditors are prohibited from some practices, such as assisting the debtor in practicing fraudulent acts or giving preferential privilege to a creditor. Case law has admitted, in specific situations, the imposition of restrictions over some creditors' rights to ensure the prevalence of the common and majority interest, aiming to preserve the value of the ongoing business. This is the case, for example, of the vote exercised at a general meeting of creditors exclusively for the purpose of harming the business or obtaining personal advantages at the expense of the company or other creditors, which, once recognised as abusive, can be disregarded by the court. Recent amendments to the Bankruptcy Law legally recognise the possibility that a vote is disregarded under such circumstances.
Equal treatment among creditors presupposes a transparent process based on good faith. All acts that are contrary to equal treatment or that have been practised in a manner that would induce creditors or the court to be in error are prohibited, such as favouring a specific creditor over others of the same class or group and providing false information. Such acts constitute bankruptcy crimes and liability may be imposed not only to the debtor, but also to the creditors and third parties which took part and abided by such acts.
In order to ensure the applicability of its basic principles, the Brazilian Insolvency Law imposes certain obligations and conditions on the debtor, such as presentation of an economic and financial report attesting the feasibility of the plan of reorganisation, the obligation to add to the corporate name the expression "in judicial reorganisation", the need for prior authorisation for the sale or encumbrance of any non-current assets and the sale of isolated production units mandatorily through a judicial sale.
Outside the insolvency proceedings provided by the Brazilian Bankruptcy Law there is no mechanism to drag dissident creditors into an out-of-court financial restructuring, nor do credit agreements typically contain terms permitting a majority or super majority of lenders to bind dissenting lenders to changed credit agreement terms.
Informal consensual collective negotiations are common and require voluntary adherence of involved creditors. These processes are perceived to work well for financial debt restructuring, since usually few financial creditors hold a major part of the debtor’s indebtedness and can organise themselves collectively.
For dragging dissenting creditors into an out-of-court renegotiation, the debtor may file for out-of-court reorganisation (recuperação extrajudicial), in which case the plan of reorganisation may be imposed to dissenting creditors, provided that at least more than half of the claims of this type have already adhered to the plan. A cram-down of dissenting creditors requires that the bankruptcy court ratifies the reorganisation plan.
Secured Creditors and Real Estate
As per Brazilian law, there are four different types of in rem security interests: pledges (penhor), antichreses (anticrese), mortgages (hipoteca) and fiduciary liens (propriedade fiduciária).
Mortgages and antichreses (the latter being very uncommon) are established over real estate property. Pledges are established over movable property.
Fiduciary liens constitute a type of security that involves temporary ownership relative to the asset to the creditor solely to secure the debt. Within the financial system, fiduciary liens may be established over all kinds of assets, movable or immovable, tangible or intangible, fungible or not. Outside the financial system, some restrictions for imposing fiduciary liens over fungible assets, such as receivables and crops, may apply.
Outside a formal insolvency proceeding, secured creditors may take all legally available measures for the purposes of executing and foreclosing assets, including forced sale of assets judicially or extrajudicially (allowed for some types of security interests). The security agreements may provide for different rights and limitations on creditor legal rights, with the general rule that creditors are not entitled to retaining ownership of the collateral for the payment of a debt without a prior selling attempt.
In a formal insolvency proceeding, the possible measures to enforce a lien/security will depend on the nature of the security. Certain claims and types of security interest, such as fiduciary liens, are not subject to the effects of a judicial or out-of-court reorganisation and therefore, in principle, may be enforced in accordance with the terms of the security agreements. Please note Brazilian Bankruptcy Law provides that, during the stay period (inherent to judicial reorganisation and out-of-court reorganisation), it is not permitted to sell or remove from the debtor’s establishment any asset essential to its business.
Case law has admitted that, even after the stay period ends, assets considered essential to the debtor's activities shall not be constrained. The essentiality or not of the asset should be discussed on a case-by-case basis.
Judicial and Out-of-Court Restructuring
The claims subject to the effects of a judicial or out-of-court reorganisation, regardless of the nature of any collateral they hold, can only be paid in accordance with the terms of the respective approved and confirmed plan of reorganisation; that is, no act of enforcement, foreclosure and expropriation is permitted during the bankruptcy proceeding outside of the plan. In addition, the Brazilian Bankruptcy Law does not establish any mandatory payment order among the classes of creditors (ie, there is no absolute priority rule) in a judicial or out-of-court reorganisation, leaving it to the debtor’s discretion as long as the creditors approve the plan of reorganisation. Release of liens over the collateral is allowed only after payment of the secured claim, in accordance with the terms provided for in the plan of reorganisation.
Due to the frequent need of releasing liens over collateral and the fact that in a potential liquidation proceeding such secured creditors will be privileged in relation to unsecured creditors, secured claims usually enjoy better payment terms than those provided for unsecured creditors.
In liquidation, creditors secured by fiduciary liens may seek direct restitution at any time during the proceeding, while creditors holding other types of security interests will be subject to the payment order established by Brazilian Bankruptcy Law, which gives them priority in relation to unsecured credits, but not in relation to labour claims, for example. This means that, in a liquidation, the secured creditor may not necessarily be entitled to receive the collateral or the proceedings of its sale for their payment.
Regardless of the insolvency proceeding and the nature of the security interest the creditor holds, they may not disrupt or block a formal voluntary or involuntary insolvency proceeding but only vote against a plan of reorganisation, which needs to be approved also within the secured creditor class.
As per Brazilian Bankruptcy Law, there is no privileged treatment of secured creditors that are subject to a judicial reorganisation or an out-of-court reorganisation, observing that, in the sale of the encumbered asset, the withdrawal of the collateral or its replacement will only be allowed with the express approval of the secured creditor.
In liquidation there is no privileged treatment, but creditors with fiduciary liens may claim restitution prior to the payment of the creditors with the proceeds of the bankrupt estate. Any other type of security interest will be subjected to the payment order established by Brazilian Bankruptcy Law.
As per Brazilian Bankruptcy Law, there are no distinct rights and priorities among classes of creditors in a judicial reorganisation or an out-of-court reorganisation, provided the rights the secured creditors have over their collateral are respected. The only obligation to be observed is in relation to the payment of labour claims in a judicial reorganisation, which must occur within one year as of the confirmation of the plan of reorganisation, extendable for another year if the debtor posts collateral to secure the payment and claims are paid in full.
In a liquidation, on the other hand, the payment priority order is established by law. Claims considered vital for the continuation of the liquidation procedure are paid first in priority and creditors, owners of fiduciary liens, or creditors of special types of foreign exchange agreements (ACC) may seek their underlying collateral or direct restitution, as applicable, at any time during the procedure. Payments are made in a waterfall manner, insofar as one class is only paid if the previous one has already been paid in full.
Unsecured claims generally suffer haircut (it is more common for smaller claims to be kept whole) and are paid within the timeframe that the debtor and creditors agree upon.
Unsecured creditors are bound by the plan of reorganisation and have the same rights as any other creditor subject to the insolvency proceeding.
Any decisions rendered in the insolvency proceeding – including the confirmation of a plan of reorganisation – may be challenged by the unsecured creditors (and by any other creditor) in accordance with the applicable appeal procedure, but there is no specific mechanism for the purpose of postponing or suspending any act, even liquidation.
Pre-judgment attachments are available in Brazil and recent case law has admitted that creditors who are able to access the assets of the debtor in this manner are treated as secured creditors in a bankruptcy proceeding.
Brazilian Bankruptcy Law establishes priority claims in liquidation proceedings (falência), but not in judicial reorganisation (recuperação judicial) or out-of-court reorganisation (recuperação extrajudicial).
The priority claims are restitution in cash, fees payable to the bankruptcy trustee in charge of the estate, court costs, sums provided to the estate by the creditors and expenses of the estate with recovery of assets, asset sale and distribution of the proceeds. Such claims have priority over secured creditor claims, as they are considered vital for the continuation of the liquidation procedure.
Brazilian bankruptcy law provides for two different judicial procedures for debt restructuring:
In an out-of-court reorganisation (recuperação extrajudicial) the plan of reorganisation must be adhered to by more than half of the claims of each class encompassed by it, then brought to court for ratification, so the debtor may impose it to dissenting creditors of the same class. Solely the debtor, represented by its directors and officers, with shareholder approval, may file for out-of-court reorganisation. The debtor may choose which class or classes of creditors will be subject to the proceedings and is free to include just part of its unsecured or secured creditors, provided that they have the same characteristics among them (for example, all unsecured financial creditors). The debtor remains in possession.
Secured, unsecured, and labour creditors may be subject to an out-of-court reorganisation and solely the debtor may decide if the proceeding will include all the classes or just a group of creditors in the same situation (tax creditors may not be included).
Upon ratification of the out-of-court reorganisation plan, its effects are binding on all creditors of the relevant class. To oppose ratification of the plan of reorganisation, creditors may only argue:
As one of the requirements is the simple majority credit approval of the plan of reorganisation, it is common that these procedures involve long discussions of the claims’ amount.
Judicial reorganisation (recuperação judicial) can only be filed by the debtor, represented by its directors and officers, with shareholder approval, in the court jurisdiction where the company has its centre of main interest. It involves submitting to its creditors a plan of reorganisation to be voted during a general meeting of creditors, which shall detail the conditions for the debt restructuring, sale of assets and other restructuring measures the debtor may take.
The Brazilian Bankruptcy Law was amended in 2021 to introduce the possibility for the creditors to present their own plan of reorganisation in case the plan the debtor presented is rejected or not voted within the stay period. This rule applies only to bankruptcy cases started after this amendment to the Brazilian Bankruptcy Law.
Upon filing a judicial reorganisation, and once the court has ascertained that the company has presented the documents required by law, the following main effects occur:
Brazilian bankruptcy law establishes some safe harbours against the automatic stay, which are claims secured by fiduciary liens, claims arising from advance of foreign exchange agreements, claims subject to compensation in clearing houses and tax claims. However, the law also establishes that the bankruptcy court has jurisdiction over the assets of the debtor, having powers to stay a freezing or seizure order rendered by another court if the related assets are essential to the activities of the debtor.
Debtors remain in possession as a rule. The debtor may manage its affairs freely, except the debtor may not sell or encumber assets classified as non-current in its accounting without prior authorisation from the bankruptcy court or the general meeting of creditors.
The debtor under judicial reorganisation (recuperação judicial) or out-of-court reorganisation (recuperação extrajudicial) remains in possession of all its assets, continues to operate its business and the fiduciary duties of the directors and officers continue to be directed to the company.
In a judicial reorganisation, a bankruptcy trustee is appointed as an assistant to the court for the main purpose of helping the court with financial and economic issues, being also responsible for reporting to the court the fulfilment of all obligations by the debtor, as well as for co-ordinating the acts of the proceeding, such as presiding the general meeting of creditors. The trustee does not take any part in the debtor’s management. In an out-of-court reorganisation, although not mandatory, a trustee may also be appointed for the same purpose as in the judicial reorganisation, respecting the particularities of each proceeding.
A stay period of 180 days as from the acceptance of the case is mandatorily granted in both judicial and out-of-court reorganisations, during which all actions and executions against the debtor, including those of private creditors of the jointly liable partner, as well as the course of the statute of limitation of each action, will be suspended. The stay period may be extended for another 180 days period if the debtor is not responsible for the delay of the case.
The creditors in judicial or out-of-court reorganisations are separated into classes, according to the nature of their claims.
In a judicial reorganisation, there are four classes of creditors defined by law, and that may not be changed in debtors' nor creditors' discretion:
All classes of creditors mentioned above will be submitted to the proceeding.
Labour and small business classes approve the plan by a simple head count majority of creditors present at the meeting, while secured and unsecured claims require majority of head count and of the claim amount, also present at the meeting. An approved plan of reorganisation is subject to court confirmation, which happens without a hearing. Cram-down rules are also applicable in special circumstances.
Creditors may present their own plan of reorganisation if the debtor’s plan is not approved by the general meeting of creditors.
If the debtor is unable to approve a reorganisation plan or if the debtor defaults its obligations under the approved plan within the supervision period (which is fixed by the court and may last for two years from the confirmation of the plan), the judicial reorganisation is converted into a liquidation proceeding.
In an out-of-court reorganisation holders of secured, unsecured, labour-related claims and claims held by small business may be subject to the proceeding, and only the debtor may decide if it will include all four classes or just a group of creditors in similar situations within such classes. Tax claims, fiduciary liens and any other credit that does not fit the above classifications are not subject to the proceeding.
For classification purposes, the debtor will present a list of creditors when filing for bankruptcy. Creditors and even the debtor may present proofs of claim. In judicial reorganisations, the proofs of claim are filed administratively to the bankruptcy trustee, which presents its own list of creditors. Creditors, debtor and interested third parties may oppose this list through proofs of claim filed to the bankruptcy court. In out-of-court cases, the creditor may file proofs of claim directly to the bankruptcy court, if no trustee is appointed.
Similarities Across Proceedings
In both proceedings, creditors may be represented by an attorney or by its legal representative (except for exclusively legal procedural acts, which require an attorney). Only in a judicial reorganisation a creditors' committee may be formed by resolution of any of the classes of creditors at the general meeting of creditors, and each class of creditors will be entitled to appoint one representative with two alternates.
It is important to note that:
In judicial reorganisations, the debtor shall present its monthly financial reports. The bankruptcy trustee shall analyse them and oversee the continuation of the debtor’s operations, including through site visits.
Modification of Claims
In the judicial reorganisation and in the out-of-court reorganisation proceedings, the approved and confirmed plan of reorganisation binds the dissident creditors to its terms, which means claims of dissenting creditors may be modified without the consent of such creditors, as per the plan.
In the judicial reorganisation, as a rule, the plan of reorganisation shall be approved by all classes of creditors for the judicial restructuring to be granted and to effectively novate and bind all subject claims. Nevertheless, the Brazilian Bankruptcy Law does provide for a cram-down mechanism by which judicial restructuring may be granted even if the plan that has not been approved by all classes of creditors, obtained, cumulatively, at the same general meeting:
Credits subject to insolvency proceedings can ordinarily be assigned or traded in accordance with general civil and commercial law. Other than the duty to inform the claim assignment to the court, Brazilian Bankruptcy Law does not impose any additional obligations, but the assignee will be subject to all terms and conditions of the insolvency proceeding in relation to its claim. In general, the debtor shall be notified about the transfer, so it is effective against them. Claims assigned remain under their previous classification in the insolvency proceeding.
Brazilian Bankruptcy Law, as recently amended, expressly provides for the possibility that debtors of the same economic group file for bankruptcy under procedural consolidation (one bankruptcy case for all debtors) and under substantive consolidation (one plan of reorganisation for multiple debtors under the same bankruptcy case). The court shall decide whether a case shall proceed to procedural consolidation, and both the court and creditors may decide if substantive consolidation is acceptable. Creditors may authorise substantive consolidation in any case, but the court may do so if the debtors presenting a unified plan of reorganisation meet at least two out of the legal requirements – ie, the existence of cross guarantees, control/dependency relationship, similarity of corporate structure or joint operations.
If substantive consolidation is to be a decision of the creditors, they shall vote, each debtor separately, in a general meeting of creditors, whether the plan of reorganisation shall be consolidated for all or part of the debtors (as substantive consolidation may be approved for only some debtors).
If the debtor files for a judicial reorganisation, it shall not dispose or encumber any non-current assets or rights, unless these transactions are allowed under the plan of reorganisation or useful to the debtor and the bankruptcy case, as recognised by the court, after having the opinion of the creditors' committee (if existent). Such restriction has been applicable analogously to out-of-court reorganisation as well.
In practice, the debtor is expected to demonstrate the need to sell or encumber the asset, as well as the destination of the proceeds obtained. Some courts have determined the disposal through a competitive judicial process, to maximise the value of the asset.
The Brazilian Bankruptcy Law does not restrict the sale of assets by the debtor but imposes the need for prior judicial authorisation or authorisation under the plan of reorganisation if the assets being sold are non-current assets under debtors accounting.
The debtor may set forth in the plan of reorganisation the sale of assets individually or organised in an isolated productive unit, which consists of a block of tangible and/or intangible assets, or even the debtor itself (as long as legal requirements are met), that, acquired by a third party, allows it to maintain the development of the business. If all the legal requirements for the sale are met, the investor who acquires the productive unit is not a successor of any of the debtor’s liabilities.
Among the conditions for the characterisation of an isolated productive unit – and not merely the ordinary sale of a set of assets – is the obligation that all rules for its constitution and sale are provided for in an approved and confirmed reorganisation plan.
As per the Brazilian Bankruptcy Law, secured in rem interests and liens may not be released within the scope of an insolvency proceeding without express approval of the creditor holding the respective right over the collateral.
The Brazilian Bankruptcy Law does not impose restrictions on the borrowing of new money. Any person or entity, including creditors, debtor’s relatives, partners, and companies of the same group, may grant new money to the debtor. And any person or entity may guarantee the new money granted to the debtor. The granting of security interests on non-current assets, however, must be previously authorised by the court or provided for in the judicial plan of reorganisation. In case the asset to be encumbered is already encumbered in favour of another creditor, the original creditor, as a rule, will have priority in receiving any proceeds or foreclosure relative to the collateral, under the terms of applicable law.
The new money granted to the debtor under judicial reorganisation qualifies as post-petition claim and in case the proceeding is converted into liquidation the grantor will have priority in payment.
The Statutory Process
The claim verification process in insolvency proceedings is carried out by the court-appointed trustee and aims to verify the correct amount and classification of the claims, in accordance with the contractual terms or as determined in an autonomous judicial process.
In general, the claim verification process occurs according to the following steps:
In judicial and out-of-court reorganisations, the claim verification process will only consider claims subject to such procedures, excluding non-subject claims from the assessment.
Both in judicial reorganisation and out-of-court reorganisation, the restructuring plan will be subject to court confirmation. The court will analyse only compliance with the legal rules, but not economic or financial aspects of the plan of reorganisation, nor its feasibility. The legality control can be exercised in whole or in part, which means the court may annul a certain clause considered illegal while maintaining the validity of the others and confirming the plan.
In Brazil, the reorganisation procedures are a means to deal with debt restructuring, mainly through refinancing, discounts and grace periods, the sale of assets or a combination of all the aforementioned. Debtors are not entitled to assume or reject executory contracts, nor renegotiate the terms of commercial agreements.
The Brazilian Bankruptcy Law provides that the reorganisation plan shall have no effect over third-party guarantees or guarantors. Other than that, there is no clear disposition about the possibility of releasing non-debtor parties from liabilities and this is a controversial topic.
The release of non-debtor parties can be provided for in the reorganisation plan (under the assumption this is a right creditors may waive), but such provision, if approved by majority of creditors, will still be submitted to legality control of the bankruptcy court. Such provision used to be considered valid only for those creditors who voted in favour of the plan of reorganisation without reserves to this kind of disposition.
The Superior Court of Justice, however, has changed this understanding, under the premise that it is inappropriate to restrict the suppression of guarantees only to creditors who have voted in favour of the plan of reorganisation – as a rule, the dispositions of a plan of reorganisation are binding to all creditors, regardless of their vote, and admitting the contrary would characterise different treatment among creditors in the same situation.
According to the Brazilian Civil Code, set-offs occur automatically if two people are both creditor and debtor of money claims at the same time. If debts and credits existed prior to the case commencement, they should have been automatically compensated and any balance in favour of the creditor, if existing, would be submitted to the insolvency proceeding.
Once the insolvency process has started, any form of payment of the subject claims, including through set-off or offsetting, must be provided for in the approved and confirmed plan of reorganisation.
Thus, at first, if provided for in the plan, offsetting may occur between the claim as restructured in the plan and any credit the debtor holds against the creditor. Case law, however, has already voided this type of provision, as it may lead to unequal treatment among creditors.
In a judicial reorganisation (recuperação judicial), once the restructuring plan is confirmed, the court may set a supervision period for the debtor, during which it continues under judicial reorganisation. This supervision period may last until all obligations established in the plan that fall due in the two years following the concession of the judicial restructuring have been performed, regardless of grace period. During such period, the non-performance of any obligation established in the plan will entail conversion of the restructuring into liquidation.
After the judicial supervision period in a judicial reorganisation, and in any case in an out-of-court reorganisation, any unfulfilled obligation can be legally demanded, as the decision that confirms the restructuring plan constitutes a judicial enforcement instrument, pursuant the Brazilian Code of Civil Procedure.
Equity holders may keep its ownership over the debtor. This is the most common situation, as many creditors, especially financial institutions, are afraid of being held as successors in liabilities of the debtor if they gain any type of ownership or equity participation in the debtor. For this, the 2021 amendment to Bankruptcy Law established the possibility to sell equity stake as an isolated production unit, which permits transferring equity participation to investors/creditors without risk of being held successor in liabilities.
Additionally, in certain cases, case law has voided plans of reorganisation that provided for mandatory debt/equity swap under the assumption that parties may not be required to partnership with one another.
An Overview of Pros and Cons
Brazilian bankruptcy Law provides for only one liquidation procedure, which may commence voluntarily or involuntarily.
Liquidation is an in-court procedure in which the bankrupt estate, under the responsibility of a court-appointed bankruptcy trustee and the supervision of the bankruptcy court and the Public Prosecutor’s Office, is collected and sold for the payment of creditors pursuant to the legally determined claim priority. It may be filed voluntarily by the debtor, in the jurisdiction of its main establishment, or by one of its creditors or another legitimate party (a far more common scenario).
There is no legal requirement for the financial or economic insolvency of the debtor to be demonstrated. Creditors may file for liquidation if the debtor:
All assets of the debtor are subject to liquidation and only the bankruptcy court may seize, attach, or allow the sale of the debtor’s assets. All lawsuits against the debtor shall proceed with the replacement of the debtor by the bankruptcy estate.
Administration of the Estate
Upon issuing the liquidation decree, the bankruptcy court shall appoint a bankruptcy trustee, who is responsible for managing and representing the bankruptcy estate. Management of the debtor is removed as soon as liquidation is declared, including in relation to any ongoing litigation with labour tax creditors.
It is important to note that when the bankruptcy decree is issued, the debtor is dissolved, management is removed, and all assets and liabilities are transferred to the bankrupt estate. The debtor may not engage in any corporate activities until all its liabilities are deemed extinct or lifted by the bankruptcy court. The decree of liquidation subjects all creditors and claims to the procedure (even those with special priorities may file claims within the bankruptcy court).
Liquidation entails a look-back period of at least 90 days prior to the liquidation petition, the judicial reorganisation, or the initial official protest for lack of payment, during which several transactions may be rendered ineffective for the bankruptcy estate.
Under the liquidation proceeding, the bankruptcy trustee is responsible for the sale of assets of the estate, through competitive process as to ensure the best price is reached for the benefit of the estate and its creditors. Upon decree of liquidation, the bankruptcy trustee must present a plan for the collection and sale of the assets. Assets are sold free and clear of liabilities and credit bid is not usual, although not forbidden. Assets may be sold individually or productive unit. A bankruptcy trustee must sell the assets within 180 days from their collection.
Creditors may be represented by an attorney or by its legal representative (except for exclusively legal procedural acts, which require an attorney). No creditors' committee is formed in liquidation. The trustee in charge of the case shall provide periodical information about the financial situation of the estate.
The Brazilian Bankruptcy Law was amended in 2021 to include a new chapter regarding transnational insolvency, which aims at promoting co-operation between Brazilian authorities and foreign authorities in insolvency cases, following the rules and principles of the UNCITRAL Model Law on Cross-border Insolvency.
The Brazilian Bankruptcy Law, as amended, now provides for regulation of cross-border cases. Brazilian courts shall co-operate, directly or through a bankruptcy trustee, with the foreign authority and/or foreign representatives in order to promote, to the maximum extent possible, co-operation among jurisdictions in cross-border insolvency cases, legal certainty, fairness and efficiency to protect creditors and debtor’s interests, best value of the debtor’s assets, protection to investments, and preservation of jobs. Brazilian law provides for recognition of foreign insolvency and, if foreign proceeding is recognised as the principal proceeding, actions, executions, freezing and seizing orders against the debtor are stayed in Brazil, and any act of disposition of debtor’s assets is considered null and void.
According to the Brazilian legislation about territorial applicability of law, the Brazilian Bankruptcy Law is the relevant legal rule for all bankruptcy procedures within the Brazilian territory and foreign laws and court orders are not recognised unless the latter goes through the recognition procedure within the Superior Court of Appeals or a foreign bankruptcy case is recognised within the Brazilian territory.
Brazilian Bankruptcy Law states that the courts of the venue of the centre of main interest of the debtor or the branch of a company headquartered outside Brazil have jurisdiction over the bankruptcy case in Brazil.
Foreign and domestic creditors shall be treated equally in insolvency proceedings. Brazilian Bankruptcy Law allows the claim to be kept in foreign currency in out-of-court and judicial reorganisations, and demands claims are converted into Brazilian reals in case of liquidation on the date liquidation is decreed.
In Brazil, the Federal Constitution states that the recognition of foreign judgments or rulings is made through a confirmation proceeding before the Superior Court of Justice, which analyses whether the legal requirements for recognition are met. Upon recognition, the enforcement of the foreign decision shall be requested before the competent lower federal court, according to the same rules established for the enforcement of the national orders.
In addition to this process, considering the adoption of the UNCITRAL Model Law on Cross-border Insolvency in 2021, foreign representatives may seek recognition of foreign bankruptcy proceedings directly in the lower court where the centre of main interest of debtor in Brazil is located. Upon recognition of the foreign bankruptcy proceeding as the main bankruptcy proceeding of the debtor, the Brazilian bankruptcy court shall commit to the foreign bankruptcy orders directly.
As per Brazilian Bankruptcy Law, a trustee is mandatory in liquidation and in judicial reorganisation and may or may not be appointed in an out-of-court reorganisation (depending on the court and the complexity of the case).
The bankruptcy trustee in judicial or out-of-court reorganisations is considered an assistant to the court, who helps the court to deal with financial and economic matters (as even in specialised bankruptcy courts, only legal education is mandatory to the judges). In liquidation, the bankruptcy trustee is responsible for managing the estate and the payment of creditors.
In judicial reorganisations, a special manager may be appointed for running the businesses of the debtor if the court decides to remove previous management due to fraudulent actions.
In judicial reorganisation and in out-of-court reorganisation, the bankruptcy trustee is an assistant to the court and owns its fiduciary duties to the court. The trustee’s main duties are to oversee the accounting of the debtor, to prepare the list of creditors, and to preside over the general creditor’s meeting.
Shareholders, directors, and officers in any case continue with their regular duties and obligations before the debtor and its shareholders.
In liquidation, the trustee assumes the representation of the bankrupt estate and performs all the acts required for realisation of assets and payment to creditors. The shareholders and directors and officers are revoked from their regular capacities and the bankruptcy estate is entirely administered by the trustee.
The trustee is appointed by the bankruptcy court. The trustee must be a reputable professional, preferably a lawyer, economist, business manager or accountant, or a specialised legal entity. Due to potential conflict of interest, creditors may not serve as trustees.
The court, on their own initiative or at the substantiated request of any interested party, may order the dismissal of the trustee even without cause. Destitution is mandatory if the trustee fails to perform its duties, especially if they fail to provide periodical reports about the business of the debtor.
As a rule, directors and officers of a company under an insolvency proceeding or approaching the zone of insolvency have the same fiduciary duties towards the company. There is no requirement for directors and officers to file for an insolvency proceeding, which ultimately is a shareholder’s decision.
Officers and directors do not owe any duty or responsibility directly to the creditors. They shall act diligently and comply with their duties before the debtor.
In liquidation, directors and officers are automatically removed from their offices. In judicial reorganisations, directors and officers may be removed by the bankruptcy court in the event there is evidence of having committed a crime under bankruptcy legislation or fraud against the debtor or its creditors.
The shareholders have standing to sue directors and officers for breach of fiduciary duties, but in specific situations third parties may also seek the directors’ and officers’ liability, specifically through the piercing of the corporate veil doctrine.
If an insolvency proceeding has commenced, the personal liability of directors and officers may also be ascertained before the bankruptcy court.
In any liquidation proceeding, the bankruptcy court may scrutinise and seek clarifications on any transactions undertaken prior to the insolvency proceeding, especially if they involve transferring assets or granting new collateral to existing claims. A transaction may be set aside or voided if in violation of law or in case of fraud, which includes granting beneficial treatment to any creditor.
A look-back period is applicable in liquidation proceedings, and it is established by the bankruptcy court at the beginning of a case. It can retroact up to 90 days as from the start of the liquidation procedure, the date the company filed for judicial reorganisation or the first public protest (protesto) against the debtor for non-payment of a claim.
Once the look-back period is determined, the following transactions are ineffective to the bankrupt estate, regardless the knowledge of the contracting party about the financial condition of the debtor and regardless the intent of the debtor to defraud creditors:
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Contributions of the 2021 Amendments to the Brazilian Bankruptcy Law to Distress Investment Market
Brazilian insolvency proceedings are regulated by Law No 11,101, enacted on 9 February 2005, as recently amended by Law No 14,112, enacted on 24 December 2020.
The recent amendments to the Brazilian Bankruptcy Law aimed to overcome some inefficiencies of the 2005 law and it was particularly successful in improving the rules for debtor-in-possession financing, and sale of assets and business under bankruptcy, leading to a more attractive market for distressed investments in Brazil.
Among the changes implemented by Law No 14,112, it might be observed that the most evident were those relating to the protection of investors for distressed assets, the expansion of the definition of assets that could be sold without succession in liabilities, and the regulation of debtor-in-possession financing, including its treatment under liquidation. Additionally, many legal provisions in the liquidation procedure were amended as an attempt to expedite and favour the process for sale of assets under such proceedings.
Although permitted by the previous Brazilian Bankruptcy Law, there was no legal provision regulating the details involved in the financing of companies under judicial reorganisation. Further, the priority for this kind of financing was limited in the event of liquidation.
The lack of a strong and clear priority limited offers from investors, and some have claimed that in a potential liquidation scenario it would be subordinated to several other claims, which could lead to a zero recovery for the DIP financing.
As per the amendments to the Brazilian Bankruptcy Law, debtor-in-possession financing shall be paid with priority, being subordinated only to amounts deemed indispensable for the estate’s management and labour wages due during the three months prior to liquidation decree (limited to five minimum salaries per employee).
Further, even if the court order authorising the financing is reversed after the funds have already been disbursed, the creditor of a DIP financing shall keep its payment priority.
If the judicial reorganisation is converted into liquidation before the full disbursement of the financing, the corresponding agreement will be automatically terminated but the collateral granted, and the legal priority will remain enforceable up to the disbursed amount.
The amended law also clarifies that any person may provide financing, including creditors, family members, shareholders, and members of the same economic group of the debtor. Any person may also grant collateral for the financing through a lien or fiduciary transfer of assets, including the debtor itself (provided the bankruptcy court authorises it) and members of its group.
The court can also authorise second-degree security interest over the same assets (except collateral granted under fiduciary security agreements), regardless of the consent from the first ranked creditor.
Such amendments to Brazilian Bankruptcy Law represent a huge evolution to corporate restructuring and investments in distressed assets in Brazil, insofar as it aligns the premises and intentions of the law with those already widely adopted in other jurisdictions and fills the gapsregarding the DIP financing priority and its certainty even in a litigious case.
Before the amendment of the law there was no provision regarding the potential reversion of a decision authorising a sale of assets to a third party. The effect of such reversal was regulated case by case, which implied legal uncertainty to distressed investors.
Now, Brazilian Bankruptcy Law expressly protects third parties who bought or received as collateral an asset of a company under bankruptcy, providing that, as long as the payment or extension of credit has already been made and the parties acted in good faith, the transaction previously approved (by the bankruptcy court or the plan of reorganisation) may not be voided or annulled.
Sale Business Unit
When enacted in 2005, Brazilian Bankruptcy Law provided that the sale of “isolated business unit” (unidade produtiva isolada – “UPI”) of the debtor could be undertaken without any succession of any liabilities (in opposition to the regular corporate sale of a business unit in Brazil, in which the buyer is normally responsible for all the labour and commercial liabilities of such unit). The law, however, did not provide a concept of an “isolated business unit”, nor did the law exemplify the assets or rights that could compose it.
Usually, an isolated business unit is part of the plan of reorganisation negotiation, as the proceeds from such sale usually go to debt payment; thus, its sale usually occurs after the approval of a plan of reorganisation in a general meeting of creditors and its confirmation by the bankruptcy court. That said, the new amendments to the lawclarified that not only business units could be sold under this definition, but also rights or assets of any kind, whether tangible or not, individually or collectively, including equity interest, giving investors more certainty that the asset will be sold free and clear of any liens and liabilities.
The amendments to the law alsoclarified that the absence of succession includes all kind of liabilities, specifying that the environmental, regulatory, criminal, anti-corruption, tax and labour liabilities of the debtor shall not contaminate the asset being sold.
On the other hand, the amended law now provides that the debtorunder a reorganisation proceeding who is willing to sell assets (including a sale) must retain sufficient assets or cash flow generation to ensure that creditors not subject to the judicial reorganisation proceeding (especially tax authorities) are given at least equivalent conditions to a liquidation situation.
Sale of business and debt/equity swap
The Brazilian Bankruptcy Law, since its enactment in 2005, has established, in a non-exhaustive way, means of judicial restructuring that could be adopted by the debtor in judicial reorganisation. Among those means of corporate restructuring there was no express provision for the conversion of debt into equity (only the increase in share capital) or full sale of the debtor - important restructuring alternatives in the bankruptcy market over the world.
Although such mechanisms were not prohibited, they were not common in Brazil due to the complexity and superficiality of their legal treatment, which could lead to practical problems relating to succession of liabilities.
In that sense, the amended Brazilian Bankruptcy now expressly provides for such means of judicial restructuring – debt/equity swap and sale of the debtor – ensuring that there will be no succession nor liability of any kind of obligation for the creditors, investors, or new manager (provided that the only cause for such succession is the conversion of debt into equity). Therefore if a creditor accepts the debt/equity swap, it will not be affected by previous obligations if acting in good faith.
The rule of absence of liability and succession is also applicable for the managers and directors appointed by the creditors or investors who become the new shareholders of the debtor in the context of a bankruptcy sale or a debt/equity swap.
Additionally, if the plan of reorganisation presented by the creditors provides for debt/equity swap, it may include the change of control of the debtor, giving the existing shareholder the choice between becoming a minority shareholder or transferring its shares to the new shareholders and being reimbursed for their book value computed in accordance with Brazilian Corporate Law (direito de retirada).
Favouring the sale of assets in liquidation
In a liquidation proceeding, a sale shall no longer be denied based on the concept of negligible pricing. Further objections to asset sales based on the sale amount will only be accepted if accompanied by a firm offer from the party making the objection, or a third party for the acquisition of the relevant asset, in an amount that exceeds the sale’s amount, together with an escrow deposit of 10% of the offered amount.
An unfounded objection will be considered an act against the administration of justice, subjecting the author to paying damages and to the penalties for similar situations provided for in the Brazilian Civil Procedure Code (bad faith litigation).
It is important to note that Law No 14,112 was enacted during the COVID-19 pandemic, a period during which a decrease in insolvency proceedings in Brazil was observed due to economic uncertainties, which led companies to await until they could better assess the economic effects of the pandemic.
As Brazil recovers from the economic crisis, the advances brought by Law No 14,112 have become more evident, with significant increase of investment operations involving the new legal restructuring mechanisms, assurances, and facilities.
With the new amendments, the expectation of practitioners and scholars is that the search for distressed assets in Brazil becomes more frequent, in accordance with the behaviour already identified in other jurisdictions, providing more investments and restructuring opportunities for debtors in financial distress.
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