Focus on: 2020 CHANGES TO THE BRAZILIAN BANKRUPCTY LAW – CREDITORS’ ALTERNATIVE PLAN OF REORGANIZATION
Thomaz Bastos, Waisberg and Kurzweil AdvogadosView Firm Profile
Overview of the Brazilian Bankruptcy Law and recent amendments
The Brazilian Bankruptcy Law (Federal Law No. 11,101/2005, recently amended by Federal Law No. 14,112/2020) regulates the bankruptcy and debt-restructuring process for financially distressed companies in Brazil. It was enacted in 2005 and replaced the previous bankruptcy law (which had been in force for more than sixty (60) years, and was considered outdated and ineffective), by introducing turnaround mechanisms through collective negotiations between the debtor and its creditors, with the purpose of providing debt-distressed companies the possibility to revamp their activities and effectively address liabilities.
Similar to the Chapter 11 of the United States Bankruptcy Code, the primary alternative afforded to debtors created by the Brazilian Bankruptcy Law is the collective judicial corporate restructuring process called “recuperação judicial”, commonly known as “RJ process”, or simply “RJ”. It aims to allow viable but financially distressed companies to recover their financial health by collectively negotiating with creditors and developing a plan for restructuring their debts and operations, instead of liquidating their assets and ceasing operations (in other words, instead of simply bankrupt). Furthermore, the judicial reorganization process provides an opportunity for the debtor to collectively restructure its operations and repay its debts, while also protecting the interests of creditors and employees. Negotiations among creditors are formalized through a plan of reorganization, which is voted during a general meeting of creditors, by classes of claims established by law – labor claims, secured claims, unsecured claims and claims owned to small business.
Although the Federal Law No. 11,101/2005 brought important advances to the Brazilian insolvency legal framework, after seventeen (17) years of its enactment, the practice demonstrated that several updates were necessary. One of these main necessary updates was the increase of creditors bargaining power, as the Brazilian Bankruptcy Law was considered highly debtor friendly.
As part of the efforts to change this scenario, Federal Law No. 14,112/2020 introduced the possibility that, under certain conditions, creditors present an alternative plan of reorganization of the debtor.
Judicial Reorganization main steps
Before analyzing the situations in which a creditor may present a plan of reorganization and the procedure for doing so, it is useful to understand the main stages for filing and approval of the plan of reorganization under Brazilian Bankruptcy Law, which are:
- Filing for judicial reorganization – in Brazil, only the debtor can file a judicial reorganization. The debtor shall file its petition before the court, including a list of creditors, assets and liabilities, financial statements, in addition to several documents and information about its business, litigation, employees and directors;
- Commencement order – if the debtor fulfills the initial legal requirements, the court grants a commencement ruling, initiating the RJ process, and granting the stay period. It is possible that the court demands an expert’s opinion on whether the debtor meets the requirements for having its judicial reorganization processed before the commencement order;
- Stay period – The stay period lasts 180 days and the Brazilian Bankruptcy Laws provides for one extension for the same period. Case law has allowed further extensions. Claims not subjected to the proceeding are not affected by the stay period, but the bankruptcy court may suspend, during the stay period, the collection and sale of assets essential for a successful restructuring of the debtor;
- Plan of Reorganization – in sixty (60) days after commencement ruling, the debtor shall file the plan of reorganization detailing to the creditors how it intends to pay its debts and continue its business operations. The plan shall be accompanied by a financial report and an asset appraisal report that support the payment plan;
- Classes of creditors – Brazilian Bankruptcy Law stablishes four predefined classes of claims – labor claims, secured claims, unsecured claims and claims held by small business. The plan of reorganization shall be approved in all classes, but cramdown rules may apply in specific cases; and
- General meeting of creditors – the plan of reorganization shall be voted during a general meeting of creditors, which may start in up to one hundred and fifty (150) days after the commencement order.
Before the amendments provided by the Federal Law No. 14,112/2020, if the creditors reject the plan of reorganization and cramdown rules were not applicable, the bankruptcy court would decree the liquidation of the debtor.
The creditors’ alternative plan of reorganization
Federal Law 14,112/2020 added article 6, paragraph 4-A and article 56, paragraph 4, into the Brazilian Bankruptcy Law, permitting that, under certain circumstances, the creditors present an alternative plan of reorganization, which, if voted upon and approved, would permit that the debtor avoids its liquidation.
This is one of the few amendments to the Brazilian Bankruptcy Law that are not applicable to ongoing bankruptcy cases, being applicable only to judicial reorganizations filed after the Federal Law 14,112/2020 took effect. The main reason for that is clear: it was intended to greatly affect the bargain power among the stakeholders involved in a judicial corporate restructuring case.
Legal requirements of the Creditors’ Alternative Plan of Reorganization
Brazilian Bankruptcy Law now provides for two (2) situations in which creditors may propose a plan of reorganization:
- if the plan of reorganization the debtor proposed is not voted during the stay period, which may last up to three-hundred and sixty (360) days (article 6, paragraph 4-A); or
- if the plan of reorganization the debtor presented is rejected in the general meeting of creditors (article. 56, paragraph 4) and creditors vote, by majority of claims present at the meeting, for allowing an alternative plan to be presented in up to thirty (30) days.
The proposed plan must comply with the following requirements to be voted in a general meeting of creditors:
- it shall have the written support of more than (a) twenty-five percent (25%) of total claims subject to the judicial reorganization, or (b) thirty-five percent (35%) of the claims present at the creditors meeting in which the plan of reorganization of the debtor was rejected;
- It shall describe, in details, the methods and steps for restructuring the debts and operations of the debtor, demonstrating its economic feasibility;
- It shall be accompanied by a financial feasibility report and an asset appraisal report (which are also a requirement for the plan of reorganization of the debtor);
- It shall not impose obligations to the shareholders of the debtor that were not legally or contractually previously provided for; and
- It shall not impose to the debtor, nor to its shareholders, more burdens than the liquidation of the debtor would impose.
Consequences of the presentation of creditors’ plan of reorganization
If the creditors decide to allow an alternative plan to be filed, the stay period may be extended for another period of up to one hundred and eighty (180) days, in addition to the two periods of one hundred and eighty (180) days the Bankruptcy law already provides for – so the stay may last up to five hundred and forty (540) days.
Additionally, the creditors that present, support or vote in favor of the creditors’ plan of reorganization shall discharge all guarantees individuals may have granted in favor of the debtor.
If the creditors’ alternative plan provides for the capitalization of the claims and the possibility of changes the control of the debtor, the shareholders of the debtor are granted withdraw right, which, if exercised, allows the shareholders to receive the amount correspondent to the value of theirs shares, computed in accordance with general corporate law rules (article 45 of the Brazilian Corporate Law , Brazilian Federal Law no. 6,404/1976).
Case Law – Samarco bankruptcy case
The amendments introduced by the Federal Law No. 14,112/2020 are relatively new and the filling of a creditors’ alternative plan of reorganization is possible only in bankruptcy cases filed after January/2021, so these new provisions have not been tested in many cases yet.
Case law is also scarce due to the hurdles involved in filing an alternative plan of reorganization: creditors shall be sophisticated and organized among themselves for meeting the requirements for the proposal of an alternative plan, and this is not the reality in most bankruptcy cases in Brazil.
To this day, the biggest case in which the creditors tried to present an alternative plan of reorganization was the judicial reorganization of Samarco Mineração S.A. – Em Recuperação Judicial, processed before the Second Commercial Court of Belo Horizonte, State of Minas Gerais (court dockets No. 5046520-86.2021.8.13.0024). Samarco is a joint adventure between BHP Billiton and Vale S.A., whose dam collapsed in 2015, resulting in numerous deaths and environmental damages. Main creditors in the case are the shareholders of Samarco – which are not allowed to vote in the general meeting of creditors, as per article 43 of the Brazilian bankruptcy law – and international bondholders. The total claim discussed is around fifty billion reais, equivalent to roughly ten billion U.S. dollars.
After filing for judicial reorganization in 2021 and failing to reach an agreement with its bondholders on the terms of debt restructuring proposal, the plan of reorganization of the Brazilian mining company was rejected in the general meeting of creditors held in April 2022. In the same opportunity, creditors – in which bondholders represented the vast majority, as shareholders are not part of the voting process – voted to allow creditors to present alternative plans of reorganization within thirty (30) days.
Two different plans of reorganization were presented: one of them filed by some of the bondholders and the other filed by two unions representing the employees of Samarco. Involved parties pointed allegedly illegalities in both plans, specially that the bondholders plan would violate the legal prohibition that new obligations are imposed on the shareholders of the debtor and that the employees’ plan of reorganization was, in fact, prepared by the debtor.
In parallel, Samarco and its shareholders defended the bondholders abused their voting rights when rejecting the plan of reorganization Samarco presented, which would lead to the need that their votes would be disregarded. Considering that without the votes of the bondholders the plan of reorganization would be approved, Samarco requested the court confirmed the plan of reorganization previously presented.
Additionally, the shareholders of Samarco defended that the voting restrictions the Brazilian bankruptcy law imposes to shareholders should not be applicable for the voting process of the alternative plan of reorganization the creditors filed, as the fact that the debtor had not intervened in the proposal would be enough to cease the conflict of interests of having the shareholders both influencing the terms of the plan of reorganization and voting it. Furthermore, it was defended that the legal voting restrictions would be applicable for the creditors presenting the plan of reorganization – which means that the creditors that would propose a plan of reorganization would not be allowed to vote it.
Bondholders defended the correct exercise of their voting rights, as well as their right to vote on the plan of reorganization some of them presented. Additionally, they defended that voting restrictions legally imposed to shareholders are applicable regardless of who presented the plan of reorganization, as (i) the voting restriction is a formal rule, applicable regardless the existence, in each specific case, of a real conflict of interest, and (ii) in this case, the creditors’ alternative plan of reorganization provided for debt-equity swap, which leads to a substantial conflict of interest with the shareholders who intend to keep ownership of the debtor.
Involved parties presented different opinions issued by most important commercial and insolvency laws scholars in Brazil, defending their arguments.
In November 2022, the lower bankruptcy court in charge of the case decided (i) the bondholders validly exercised their voting rights when rejecting the plan of reorganization the debtor presented, (ii) the shareholders of the debtor cannot vote any plan of reorganization, regardless who presented it, and (iii) those who presented an alternative plan of reorganization cannot vote its own plan (which is a nonsense limitation that Brazilian bankruptcy law does not impose).
Debtor, creditors, and shareholders filed appeals against such decision to the Minas Gerais Courts of Appeal, and, before they were ruled, debtor and most relevant creditors reached an agreement for a consensual plan of reorganization that shall be voted on soon.
Only a lower court order was issued in the case, which cannot be considered a leading case or a precedent regarding the creditors’ alternative plan of reorganization (nor even guidance for new cases). At most, the Samarco case is an example of all issues that debtor and creditors might raise in future cases. Due to the agreement among the interested parties, the appeals will be probably withdrawn, and the Court of Appeals will not rule on the matter.
In view of the scenario, many major issues regarding the creditors’ alternative plan of reorganization are unclear at this point – for example, who is allowed to vote the plan of reorganization in still undefined.
So, in addition to the initial difficulties for the proposal of an alternative plan by the creditors – the need for sophisticated creditors, who can organize themselves to find a common ground for a successful restructuring of the debtor –, the stakeholders of bankruptcy cases now see all these uncertainties as additional risks when considering whether a creditors’ plan of reorganization is a possible solution for a given bankruptcy case.
It may take a few years until case law evolves and the Brazilian courts establish jurisprudential standards regarding the creditors’ alternative plan of reorganization, allowing it to become a viable solution for existing bankruptcy cases and to give the creditors superior bargain power when negotiating the terms and conditions for the restructuring of the debtor.