Vol 6 (2009) - Issue 6

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Distressed Investment in Brazil

Introduction

As a result of the most recent economic downturn, numerous companies burdened with overleveraged capital structures have voluntarily resorted or have been forced to resort to bankruptcy proceedings in order to restructure their debts and operations. Typically, these financially troubled businesses are in need of cash to fund their ongoing business and operations. In the absence of new financing, the sale of the debtor’s assets has become an instrumental form of capitalising these companies. In other instances, without prejudice to contentious processes, financial creditors with their own issues have pressed for monetisation of debtors’ assets in order to have them (re)pay their loans. Indeed, insolvency proceedings have somehow been consolidated as a useful mechanism for implementing merger and acquisition transactions involving distressed companies or their assets.

In Brazil, the vast majority of financially troubled businesses have sought relief by way of judicial reorganisation regime established by Law No. 11101/05 (‘BRL’). The BRL replaced Decree-Law No. 7661/45 and completely overhauled the insolvency system in Brazil. Judicial reorganisation is one of the three insolvency regimes contemplated by the BRL. In short, it is a court-supervised process – analogous to Chapter 11 under the US Bankruptcy Code – aimed at enabling the debtor-in-possession to overcome an economic, financial and/or operational crisis based on a reorganisation plan negotiated with and ultimately approved by its pre-petition creditors. Upon confirmation of the approved plan of reorganisation, its terms and conditions will be binding on the debtor, its creditors and all other interested parties. The debtor-in-possession will typically enjoy discharge of the claims subject to the plan.

The distressed market in Brazil was impaired for a long time, mainly due to certain successor liability issues. Especially within the context of bankruptcy proceedings, there was a significant risk that purchasers of distressed businesses or their assets would be held liable for payment of certain existing or contingent liabilities associated with the purchased businesses or assets. This has been especially critical in connection with succession of employee-related claims. Numerous transactions – which would provide creditors and other stakeholders with better recoveries – were never consummated because of the succession liability risk. In other instances, the deal was done but the price paid was significantly discounted as a form to provide the purchaser with a cushion for contingent or hidden liabilities, always to the detriment of the debtor, the creditors and other stakeholders.

Under these circumstances, when reformulating the Brazilian bankruptcy law, the legislators took into account the importance of fostering the development of a distressed market as a key part of effective corporate restructuring, seeking to maximise recoveries for interested parties in insolvency cases, notably creditors. Legislative history supports the proposition of the conscientious option of incorporating the concept of free and clear sales into the revised insolvency legislation as a mechanism to facilitate the maximisation of value of a debtor’s assets.

Sale of assets free and clear

When under judicial reorganisation, the debtor-inpossession is generally permitted to continue selling property of the estate in the ordinary course of business. Conversely, it is generally prohibited from selling or encumbering any of its permanent assets (except with a prior approval of the courts, any Creditors´ Committee, or the Trustee), unless the sale is established in the reorganisation plan. Generally, the sale will be approved by the court if and when the need and utility of the proposed sale is properly demonstrated.