New legislation went into effect in Brazil on January 23, 2021 that made improvements to its judicial reorganization and bankruptcy law. The amendments are known as Federal Law No. 14,112/2020 and modify Federal Law No. 11,101/2005. Federal Law No. 11,101/2005 introduced the recuperacão judicial (RJ) proceeding, which is designed to promote restructuring of insolvent businesses under court supervision. The introduction of RJ in 2005 was the last major insolvency in reform in Brazil until this year.
Chapter 11 is a source of inspiration for RJ. Yet Brazilian courts and parties in interest have still struggled with areas of uncertainty and inefficiency in RJ’s implementation over the last 16 years.
From a creditors’ perspective, RJ did not give them the ability to wipe out equity or propose a plan even if the debtors’ proposal was unworkable. The only right creditors seemed to have was attempting to force a liquidation. Also, insufficient guidance in RJ on substantive consolidation created unpredictability in credit decisions, the ability to vote on plans, and protecting entity-specific claims.
RJ posed challenges for debtors who lacked financing options to fund their reorganization efforts or the ability to sell assets free and clear in order to generate cash. Debtors also did not have the ability to file an insolvency proceeding in another jurisdiction and have it recognized in Brazil.
The COVID-19 pandemic revived dormant legislation to improve RJ, as the Brazilian government considered measures to alleviate the disease’s severe public health and economic impacts. The amendments in Federal Law No. 14,112/2020 were signed into law on Christmas Eve 2020 (with some presidential vetoes). The new law attempts to remedy the previous ambiguities and has the potential to improve outcomes for creditors and debtors. The changes to the RJ statute include, among other things:
(1) empowering creditors to file a plan of reorganization,
(2) regulating procedural and substantive consolidation,
(3) enabling debtors to obtain debtor-in-possession financing,
(4) permitting the sale of assets free and clear, and
(5) recognizing foreign insolvency proceedings involving Brazilian debtors.
Under the 2005 RJ law, only debtors had the ability to propose a plan of reorganization, and they were not bound by any firm deadline for submitting such a plan. Debtors also had the ability to indefinitely suspend the formal meeting of creditors, where votes are taken to approve plans. The 2021 RJ law requires debtors to file a plan within 180 days, subject to only one 180-day extension; debtors cannot suspend the creditors’ meeting for a period longer than 90 days.
The new law allows creditors to propose plans if certain conditions are met. If the debtor’s plan is rejected at the creditors’ meeting, and a majority of the creditors in attendance support the concept of submission of a creditors’ plan, creditors will have 30 days to file one. If such a plan has sufficient creditor support, it will go to a vote at a new creditors’ meeting. The law also gives creditors the ability to attend the meetings remotely by electronic means. The right to file a plan, however, does not make creditors all-powerful, because shareholders cannot be forced to capitalize the company or remain if their shares are diluted, and individual guarantors must be released.
Consolidation of debtors and their assets and liabilities will now be governed by the RJ statute. As an administrative matter, debtors may obtain procedural consolidation so that members of the same corporate group can proceed in a joint case. A court may also impose substantive consolidation of assets and liabilities, but the court must find that there was interconnection and commingling according to statutory standards rather than on an ad hoc basis.
The 2021 updates may facilitate additional liquidity for business operations in the RJ process. Debtors will now have the right to seek debtor-in-possession financing in a way that may be more appealing for lenders. Such loans will be junior only to certain administrative expenses, labor claims incurred only three months before liquidation, and holders of security interests. However, priming liens are not available without consent of the senior parties. Anyone, even shareholders and prepetition creditors, may be approved by the court to make postpetition loans. If loan disbursements have been made, the lender will maintain priority even if the approval is reversed on appeal.
The new law allows assets to be sold free and clear. One way debtors can accomplish this is by selling shares in new entities known as “isolated business units” in which any kind of assets may be deposited, including the business as a going concern. In such sales, creditors who would otherwise be unaffected by the RJ proceeding must remain entitled to payment on conditions no worse than they would have in a liquidation. Yet a presidential veto created an important limitation on these sales that affects the debtor’s ability to generate proceeds quickly: unlike sales under Section 363 of the Bankruptcy Code, RJ sales may only be conducted if approved in connection with a confirmed plan, which could add months to the process.
Under the 2021 RJ law revisions, insolvency proceedings in other countries can now be recognized by Brazilian courts, so that assets in Brazil can be protected from creditors without requiring the enterprise to go through RJ. The amendments incorporate the provisions for cross-border cooperation of the UNCITRAL Model Law. Debtors may now do the equivalent of a Chapter 15 in Brazil while pursuing Chapter 11 in the United States (if venue is available) for their overall restructuring.
The timing of these amendments is opportune in light of the harsh impacts of the pandemic on Brazil. Over a quarter-million Brazilian lives have been lost, and our sympathies are with Brazil’s citizens. Enlightened and science-based governmental action can improve outcomes, in health and economics. We hope that the revised RJ will allow Brazilian enterprises and their investors to dar um jeito (find a way) in these difficult circumstances.