The legal protection of the assets purchaser of companies under judicial recovery in Brazil
By Diego Montenegro
Posted: 17th July 2018 10:18The promulgation of Law No. 11,101/2005 (LRFE) has brought an undeniable advance to the Brazilian insolvency system, as it contemplates truly effective tools in order to make possible the upliftment of viable companies in temporary economic and financial difficulties.
Despite all positive aspects, the experience gained throughout almost 13 years of validity has revealed that there is still a crucial issue for the recoverability of companies, which has not been consistently treated in accordance with the market needs. It is a stimulus to lending to companies under judicial recovery, something equivalent to DIP Financing stated in Chapter 11 of the US Bankruptcy Code.
Resolution No. 2,682/99 of the Central Bank of Brazil imposes the worst level of risk rating (H rating) on transactions performed with the debtor under judicial recovery. As a consequence, should a bank comes to provide credit to companies in such condition, it shall be obliged to provide 100% of the amount borrowed; i.e., for each real lent to the recovering company, the bank should leave the same amount without any use.
If it were not enough, the credit protection system granted to legal entities that enjoy the benefits of Law No. 11,101/2005 proved to be, throughout the last years, absolutely fragile and insufficient to make DIP Financing feasible in Brazil. The timid art. 67 of the aforementioned Law contemplated only a simple priority of receiving such credit, applicable only in the event of bankruptcy of the debtor, even so, still after all the other items listed in sections I to IV of art. 84. It is a precarious level of security, which contrary to what it should be, has been a hindrance to the development of such market in the country.
In this scenario of scarcity (almost nonexistence) of credit supply in the context of judicial rehabilitation, the only remaining alternative to the companies undergoing restructuring to capitalise and to refinance their activities is the sale of assets. Moreover, the constant discipline of the Brazilian LRFE is praiseworthy.
Notwithstanding, on the one hand, Law No. 11,101/2005 has left undesirable gaps in terms of DIP Financing; on the other hand, with regard to the purchase and sale of assets of companies undergoing judicial recovery, the LRFE has successfully innovated as it established, in its art. 60, the absence of succession of the purchaser in the obligations of the alienating debtor, by stimulating the development of an interesting market of Distressed Assets Acquisition in the country.
However, it is important to emphasise that, in order to protect the purchaser against the seller's debts, it is essential that the alienation of assets shall be carried out in full compliance with the formalities established in Law No. 11,101/2005.
All things considered, the matrix rule of the protection regime for the assets purchaser of companies undergoing judicial rehabilitation is art. 60 of the LRFE, according to which "ifthe approved judicial recovery plan involves the judicial alienation of branches or an isolated productive unit (UPI) from the debtor, the judge shall order its execution, subject to the provisions of art. 142 of such Law" (emphasis added).
The sole paragraph of that same article, in turn, stipulates that "the object of the sale shall be free of any liens and there shall be no succession of the purchaser in the obligations of the debtor, including those of tax nature, subject to the provisions of paragraph 1 of art. 141 of such Law".
From a thorough reading of the above-mentioned legal devices, it is possible to infer the presence of certain requirements for the incidence of the protective norms in question.
First of all, (i) the alienation of the asset shall be stated in the approved judicial recovery plan. Such requirement arises from the need for prior agreement of the creditors, regarding the sale as well as the guarantee of transparency of the transaction, in relation to the market as a whole.
The second requirement prescribed in the law is that (ii) the asset subject to alienation, either a branch or an isolated productive unit (UPI) of the debtor. According to a doctrinal and jurisprudential understanding, UPI corresponds to a certain set of debtor’s assets able to generate operating revenues (e.g. specific production line, one of several business establishments or manufacturing unit, etc.), not falling within this concept, however, isolated assets or the debtor’s sole business establishment (the total operational assets).
The third requirement is that (iii) the sale of the asset is determined by the judge, in compliance with the provisions of art.142 of Law No. 11,101/2005. Hence, the asset shall be subject to judicial alienation, at the highest price, obtained by auction – sealed proposals or trading floor. It is also indispensable for the business to be valid, that the Public Prosecution Service has been previously summoned, so that it can legally monitor and control the act.
Finally, the incidence of the rule set forth in art. 60 also depends on the compliance with the negative requirements stated in art. 141, § 1º of LRFE,i.e., (iv) the purchaser cannot be a partner of the company under judicial recovery, or a partner of a company controlled by itself. Besides, the purchaser cannot either be a relative (up to the fourth degree) of a member of the company in recovery, or identified as its agent, with the aim of defrauding the succession.
Subject to the requirements described above, the purchaser of the assets belonging to the company under judicial recovery, shall be protected against succession by the debts and obligations of the recovering company – regardless of its nature, including tax and labour ones – in accordance with the Federal Supreme Court rules (ADI No. 3,934/DF).
The reiterated application of such interpretation has also resulted in the edition of Statement nº 47 of the 1st Conference of Commercial Law of the Federal Court of Justice, in the following terms: "in the alienations made pursuant to article 60 of Law No. 11,101/2005, there is no succession of the purchaser in the debts of the debtor, even those of tax or labour nature, and those arising from work-related accidents."
As seen above, the absence of legal stimulus to DIP Financing has directed companies in difficulties to the alienation of assets as a mechanism to obtain the necessary resources for their rehabilitation.
On the other hand, current insolvency legislation has included effective tools to ensure adequate protection and legal security for the assets purchaser of companies under judicial recovery.
As a result, what has been observed so far is that asset alienations have been the main alternative used by companies which enjoy the benefits of Law No. 11,101/2005 to make it possible the rehabilitation of their activities and to overcome the economic and financial crises.
In order to have a small sample of such reality, a survey conducted by ABJ – Brazilian Jurimetrics Association, together with NEPI – Insolvency Study and Research Center of PUC-SP, has found that among all rehabilitation plans approved at the Court of São Paulo, in the period between 2013 and 2016, 88.7% contemplated the sale or rental of distressed assets as the main recovery strategy for the companies in judicial rehabilitation.
The large supply of operational assets of companies in difficulties, with prices generally more attractive than under normal conditions, coupled with the protection afforded to the purchaser as to the risk of succession by the seller's obligations, has led to the development of an interesting Distressed Assets Acquisition market in Brazil.
In order to take full advantage of these opportunities, investors should be aware of strict compliance with all the requirements and procedures prescribed in Law No. 11,101/2005, ensuring the safety of the operations and the effective attainment of the expected return.
Diego Montenegro is a Brazilian lawyer with expertise in Companies Restructuring, graduated and specialized in Business Law at Universidade Católica do Salvador; MBA in Finances at Fundação Getúlio Vargas – FGV; attended courses of Judicial Recovering at INSPER and Insolvency Law at Summerville College, Oxford University.
He is also member of Turnaround Management Association – TMA Brasil and International Association of Restructuring, Insolvency & Bankruptcy Professionals – INSOL International.
Diego is founder and naming partner of Diego Montenegro Lawyers, law firm focused in Business Law and involved in relevant cases of Judicial Recovery; M&A and Business Structuring for both local and international investors.