Overview on Recent Changes to Insolvency Law in Brazil

2020 was undoubtedly a massive challenge for all countries, but it was especially dramatic for Brazil, which has been severely hit by coronavirus outbreak. Among the most affected countries, Brazil is fighting one of the biggest battles of its history, with a little over 10 million cases so far and a case-fatality rate of 2.4%.

The pandemic has definitely burdened the Brazilian economy, which was still recovering from a crisis that started in late 2014. The Brazilian Institute of Geography and Statistics (IBGE) revealed that the year ended with an unemployment rate above 14%, a record level since 2012 and representing more than 14 million unemployed people.

In the midst of it, the Brazilian government approved some important changes to the Brazilian Bankruptcy Act. Nevertheless, the necessity of amendments to the legislation was not brought about as a result of the pandemic; the issue had actually started to be discussed long before the outbreak, and it was predominantly associated with an inefficient insolvency system.

The Brazilian business scenario has been far from advantageous. According to Doing Business 2020 Indicators,[1] Brazil ranks 124th out of 190 economies, and its recovery rate in insolvency proceedings (18.2%) is considerably below the (already low) average rate in Latin America (31.2%).

We cannot deny, however, that the economic environment and the changes in the way of life after the emergence of the pandemic were incentives for speeding up discussions and approval of the Bill of Law by the Senate in November.

The Brazilian Bankruptcy Act Reform

The Brazilian Bankruptcy Act was enacted in 2005, inspired to a great extent by U.S. chapter 11. Despite being considered a remarkable progress at that time in comparison with former bankruptcy laws, soon after it was in force insolvency professionals realized that it needed improvement in several aspects.

Several projects have been presented to Congress over the years aiming at amending different aspects of the law, including one presented by the Federal Government in 2018. On Dec. 24, 2020, President Jair Bolsonaro sanctioned the Bill of Law 4,458/2020, introducing material changes to the Bankruptcy Act, which became effective on Jan. 23, 2021.

The reform’s purpose is to reduce bureaucracy — and, consequently, the costs associated with insolvency proceedings — and to promote an attractive context for operations involving distressed business. Although it introduced some innovative provisions, it also incorporated some courts’ precedents about certain aspects of the law.

The key new features introduced to the Bankruptcy Act are:

• Stay Period: The stay period of 180 days can be extended exceptionally only once, for an equal period, as long as the debtor had not contributed for the delays during the proceeding. Previously, the stay was 180 days and was not able to be extended, although it was frequently extended by bankruptcy courts.
• Reorganization Plan Presented by Creditors: If the stay period ends without deliberation about the plan presented by the debtor, or if the creditors reject the plan, the creditors have the option to present and negotiate an alternative reorganization plan. The rule is not clear, however, and the courts will have to decide whether the right to present an alternative plan will exist after 180 days no matter whether there is an extension, or after 360 days or the term determined by the bankruptcy court if an extension of the stay beyond 360 days is considered acceptable. This new provision expanded the creditors’ powers in the reorganization of the company and introduced an important mechanism for the balance of powers in the negotiations about the plan between creditors and debtor. This new provision has been criticized because it requires, as a condition for the presentation of the plan by creditors, that creditors who present and those who approve the plan must release individual personal guarantees;
• DIP Financing: New specific provisions concerning financing to companies under judicial reorganization include (1) that the financing agreements are not subject to the judicial reorganization proceeding in case of default; (2) in the event that the decision authorizing the financing is reversed, that the guarantees remain protected if the funds have already been transferred to the debtor; (3) that subordinated guarantees can be given in favor of the lender without the consent of the original secured creditor (except in fiduciary-lien cases); and (4) that DIP financing can be granted by any person, including creditors, the debtor’s relatives, partners or any other related party.
• Procedural Consolidation: Affiliated companies of a corporate group can file for judicial reorganization under procedural consolidation — i.e., in the same proceeding — but each debtor’s assets, liabilities and legal status are treated independently.
• Substantive Consolidation: A corporate group under procedural consolidation reorganization can also be granted substantive consolidation when the assets and liabilities of the debtors are interconnected and commingled to such an extent that it is not possible to segregate the assets and liabilities of each one of the debtors without excessive expenditure of time or resources, and the debtors must meet at least two of the following requirements: (1) the existence of cross-guarantees; (2) control or intercompany dependency relationship; (3) totally or partially identical shareholders; and (4) the debtors operate jointly in the market. In this case, the assets and liabilities are combined, and ultimately, the creditors will be paid from a single asset pool.
• Cross-Border Insolvency: The Bankruptcy Act adopted the United Nations Commission on International Trade Law (UNCITRAL) model law to regulate the recognition and enforcement of foreign insolvency proceedings in Brazil and the cooperation with foreign courts. The objective is to facilitate communication among courts and authorities, preserve the value of assets, increase legal certainty and avoid competition among different jurisdictions.
• Successor Liability and New Asset Sale Arrangements: The sale of the whole business as a going concern was introduced, with no successor liability for the purchaser, and a new rule was included in the law to eliminate successor liability in cases of conversion of credit into equity.
• Extrajudicial Reorganization: This hybrid procedure, whereby an agreement by the debtor and the required number of creditors from each of the subjected classes of claims can be enforced to the dissenting minority after homologated by the bankruptcy court, may now include employment claims upon negotiation with the corresponding union; the plan has to be approved by more than 50% of the creditors of each affected class (before the amendment of the law, the quorum was 3/5); the debtor may file the extrajudicial reorganization plan with the approval of at least 1/3 of the creditors of each of the subjected classes and has 90 days to meet the more than 50% requirement; the stay period is now applicable to extrajudicial reorganizations.

Future Prospects

Experts estimate a weak and slow recovery in 2021 in Brazil, so we can expect a long period of uncertainty ahead. The impact of the insolvency legislation changes is yet to be revealed — especially considering the end of COVID-19 financial aid from the government — but it is hoped that it can shake off a difficult year for Brazilian businesses.

The amendments to the Bankruptcy Act can be seen from a positive perspective, although it is still too soon to predict how effective they will be as a mechanism for companies to overcome financial distress. We believe, however, that Brazil still needs a reform of its security laws eliminating certain differences among the kinds of securities, creating centralized tools to allow third parties to easily be aware of the existence of certain encumbrances, and to allow creditors to enforce their rights more effectively.