One of the most polemic, intricate, worst and largest cases of corporate distress in Brazilian history, the Varig Airlines case came to an end last week. The first case resolved under Brazil’s new bankruptcy law has left numerous lessons for its stakeholders as well as billions of dollars of destruction in its wake. It also leaves many questions regarding (i) acts of management and decision-making, (ii) the question of substance vs. form, (iii) concrete effects and results, and (iv) responsibilities. The outcome of this case poses a risk to the credibility of the new bankruptcy statute, as well as the players involved in future cases if these issues are not properly adjusted.
Those who follow the aviation industry – including many of Varig Airlines’ workers, unions, pension funds, suppliers and creditors – believe that its downfall came from more than a decade-long period of uninterrupted financial stress, which had worsened in the past five years, and unsuccessfully trying to revert the dramatic crisis that reached its peak recently when its operations practically stopped – in other words, a general failure of all its organs.
Most of the blame falls on the shoulders of management and governance. Their actions and efforts (or lack thereof) did not restore the financial health and stability of the company despite the large sums of financial resources spent on countless top domestic and international advisors (Alvarez and Marsal acted as its most recent CRO and Deloitte as its judicial trustee). During its bankruptcy, the company endured many management changes, including more than 10 CEOs.
What could have been missed for Varig’s governance not to realize that the best alternative for its shareholders was to either sell the company or attract new investors? Its financial statements clearly demonstrated it was in a free-fall (estimated negative net worth of $3.5 billion (U.S.), $5 billion in debt for sales of $3 billion and losses of $700 million in 2005; 13 aircraft in operation; a domestic market share of 10 percent and an international market share of 53 percent). Why let the company sink so far as to reach a liquidation bankruptcy situation, with all characteristics of a true liquidation, because it no longer had the strength or credibility to carry out a real reorganization by itself? The fact that there was only one interested party with capital to do a buyout in the judicial auction at salvage value, and at substantially less than the minimum price of $860 million (U.S.) set out by the court, leaves no doubt as to the severity of the mistakes that were made.
The second aspect deals with the universal legal issue of substance over form. The New Varig Airlines and Old Varig structure design was the formula developed to allow the liquidation of Varig Airlines’ main business in an effort to avoid the labor and tax-succession problems and the sentencing of the liquidation by the court, which was more than factually characterized, and the respective legal consequences to those responsible for its breakdown.
Naming real receivable financial assets as “rotten assets” left everyone astonished, as it constitutes a violation of the legitimate rights of creditors and enhances the insecurity of investors with respect to the issue of legal enforceability and respect. The corresponding creditors’ rights are not always observed in Brazil. Furthermore, the recent words of one of its executives during this past week expressed that if Varig Airlines broke down, it would be the fault of one of its creditors – an argument commonly used by the management group of a company that has reached the end of the line. The treatment given to Varg Airlines’ stakeholders did not observe some of the key dispositions of Brazil’s New Bankruptcy Law of 2005.
The enormous time lapse negatively affected a large number of stakeholders. The fleet was reduced to a minimal number, the routes were restricted to Rio de Janeiro/Sao Paulo shuttle flights, the company’s prestige and credibility with its clients was seriously hurt, the domestic and international market share was drastically reduced, the majority of its workers – pilots, crew members and staff who made sacrifices for the company in order for it to recover its financial strength – will lose their jobs, and the creditors are due to receive their credits in 20 years. That makes up its “judicial recovery plan” (“liquidation plan” would be more appropriate)! This is unfortunate, mainly because this massive destruction of value could have been avoided.
Finally, there is an aspect of extreme relevance that we have not seen mentioned and that cannot be left out. It is the case of responsibilities, which must include a forensic study to identify the possible irregularities to allow for the appropriate legal measures to be taken. Equally important is to use all materials and irregularities committed in this case to improve the regulatory and legislative adjustments to avoid such corporate tragedies from happening in Brazil again. The Judiciary must review the possible mistakes it made in both the central and impartial roles it played in this case and in the way the case was conducted.