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back to index backLATINtalk May,  2005


Brazil's Revamped Bankruptcy Law: In Pursuit Of Modern Times...

After more than ten years of deliberations, Brazil's Congress has finally approved a new Restructuring and Bankruptcy Law. The fact that 80 percent of insolvent companies in the country fail to recover from their financial difficulties, by itself, would warrant the urgent revision of the entire system.

The new law aims at introducing a fresh policy in Brazil, similar to the existing rules in the United States, allowing for the restructuring of troubled companies that are nevertheless economically viable, thus avoiding the unnecessary shut-off of productive entities and the loss of jobs. The law promotes the recovery and maintenance of productive activities.

On the other hand, if a company is not viable, a transfer of assets must be expedited to avoid their depreciation, thus maximizing their usefulness to Brazilian society. A fast and efficient recovery of credits, favoring the productive investment and generation of jobs, ultimately will contribute to reduce default costs, and help to shrink Brazil's outrageously high interest rates – the benchmark rate currently sits at 18.25 percent.

The current law has two forms of dealing with businesses in trouble: the so-called concordata, which attempts to allow for the recovery of a company, and falência, which aims at promoting the liquidation of a company and payment of its creditors.

While the concordata allows temporary safeguards for companies in trouble, over the years it has proven to be an inflexible method for restructuring businesses because its tools do not envelop all creditors, and do not allow for negotiation between debtors and creditors. The law still in effect contains pre-established percentages, and a strict timeframe for payment of creditors. In practice, the concordata is so rigid that it results in the debtor's bankruptcy in most cases, rather than a recovery.

In practice, the new law offers three options for insolvent companies. The existing concordata procedure will be replaced by what is called recuperação, or recovery, which may take place in court or out-of-court. The falência will remain, albeit totally revamped.

The restructuring procedure has been modeled after modern foreign bankruptcy laws, especially the Chapter 11 filing of the United States Bankruptcy Code, and aims at rehabilitating the debtor while encouraging solutions created and negotiated directly with creditors, thus allowing them to reach their own agreement.

Recuperação Extrajudicial”

In the extra-judicial restructuring, an insolvent debtor that has been in business for at least two years, among other requirements, may present a recovery proposal to its creditors, which will be taken to court for ratification. In fact, to negotiate this plan, the debtor may select and invite creditors – one sole class or several classes or group of creditors of the same nature, and subject to similar payment conditions – including: (i) matured and not matured debts, except for labor and tax obligations; and (ii) any amount in discussion in a collection procedure.

The granting by the court of the extra-judicial restructuring does not suspend rights, lawsuits or collection procedures against the debtor. Nor does it prevent the initiation of a bankruptcy procedure by creditors not included in the extra-judicial restructuring plan. The extra-judicial restructuring plan is binding even on the non-participating creditors if (a) the credits of the non-participating creditors are dealt with in such plan, and (b) it is signed by creditors representing three-fifths of each class of credit included in the plan.

As seen, in this case, the interference of public authorities will be limited to the verification of the legality of the procedure, as well as of the agreement. The court will examine eventual challenges by dissatisfied creditors and, after due course, will ratify the agreement leaving the management of the company to the parties involved, without direct interference of the court. The court will only be heard again in case of breach of the agreement.

Recuperação Judicial”

As mentioned, the restructuring may be extra judicial or judicial. The latter involves almost all existing credits against the debtor on the filing date, even if not matured, except that labor, labor accidents and tax obligations will have special treatment.

The restructuring may be requested from the court by a debtor under certain conditions and, if granted, the failing company will have 180 days in which the statute of limitations for all lawsuits and collection procedures will be suspended (except for tax collections which will also be given more flexibility through a special procedure). The debtor must provide the court with evidence that the proposed restructuring is feasible, together with financial, economic and valuation reports on the company's situation.

The restructuring feasibility will by and large be evidenced by the use of several mechanisms to solve the debtor's financial troubles, such as changes in its management, corporate and asset structures. Among other options, the ongoing business, divisions and branches of the debtor may be sold without assumption by the buyer of existing tax and other liabilities, especially labor. This is indeed a significant innovation of the new law: the acquisition of portions of the business without succession of liabilities.

Another innovation worth noting is the creation of creditors' committees, elected by a general meeting, which will include representatives of each class of creditors, but with different duties.

The judicial restructuring plan must be approved under certain conditions by all creditors' categories, but in no event with discrimination of creditors in the class that does not accept the plan. In case the general meeting does not approve the plan, restructuring may still be granted by the court subject to compliance with certain conditions, thus binding all other creditors.

During a two-year period, the court will supervise compliance with the restructuring plan. In case of breach, the court will declare the bankruptcy of the company.

Falência”

In the bankruptcy provided by the new law, a party may only file for a debtor's bankruptcy if the credit against the debtor is at least equivalent to forty Brazilian minimum wages (approximately US$3,500 in January, 2005). But the real, significant change brought by the new law is in the credit ranking priority and its limitations, so that ranking first are labor credits up to 150 minimum wages (around US$13,000) per creditor and labor accidents.

Second in rank come credits secured by assets – up to the value of the asset itself – followed by tax credits, regardless of their nature and age (except for tax penalties). There are other credits with special treatment, including funds granted to the debtor during the restructuring process, which will be considered as credits out of the creditor's agreement, in case of bankruptcy adjudication.

When a debtor's situation is irreversible, the new law intends to expedite bankruptcy procedures to avoid depreciation of tangible and intangible assets. The efficiency of the process maximizes the value generated by the sale of the assets, which allows for the payment of labor and tax debts, in addition to other credits.

The new law allows for the sale of whole companies, still in operation and with active employees, instead of just the assets of the bankrupted company, as provided by the current law. In fact, the existing procedure is so lengthy that, in many cases, assets lose their value and deteriorate as the process drags on.

The new law is part of an orchestrated plan by the current federal administration to allow Brazil to become a real player in the global economy, attracting more investment and dealing with business in a more efficient manner.

Although approved, the new law still requires presidential sanction, which may push its final enactment to mid-February 2005. President Luiz Inácio Lula da Silva is under a great deal of pressure to veto the individual ceiling for employees' credits. Whichever the result, the country will already have benefited from an improved legal framework, which allows a fair second chance for companies to attain their social purpose without the interruption of their activities, thus contributing to a more stable economic environment in Brazil.

Source: InfoBrazil - GAI


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