Bankruptcy in Brazil

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Law 11.101/ 2005 and Complementary Law 118/2005 Introduce the concept of corporate recovery for insolvent companies in Brazil.

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Bankruptcy in Brazil

  1. 1. Bankruptcy in BrazilCourse: EMBA E# 9: April 16th 2005• Corporate Finance  Andre Schussel  Edward WalkerProfessor:  Flávio Kakimoto• Thomas Brull  José Outeiro  Marcelo Rigoni
  2. 2. Bankruptcy – The Beginnings• In medieval Italy, when a businessman did not payhis debts, it was the practice to destroy his tradingbench. From the Italian for broken bench, "bancarotta," comes the term bankruptcy.
  3. 3. Bankruptcy – Early Years•Prior to 20th century, bankruptcy lawsfavoured the creditor and were very harshtoward the bankrupt.•The first laws were passed in England in 1542,under Henry VIII. A bankrupt individual wasconsidered a criminal and was subject tocriminal punishment.•In the U.S., early bankruptcy laws weretemporary responses to bad economicconditions such as the Civil War and GreatDepression.
  4. 4. Bankruptcy – Modern Laws• Modern bankruptcy laws in the U.S. emphasizerehabilitating (reorganizing) debtors in distress.• From WW II through the 1970s, bankruptcy wasnot a major issue. There were no notable businessfailures in U.S.•The Bankruptcy Reform Act was passed in theU.S. in 1978. This act revamped bankruptcypractices.• In general, the Reform Act of 1978 made it easierfor both businesses and individuals to file abankruptcy and to reorganize.
  5. 5. Bankruptcy – The Breakdown in US• Chapter 7 - "straight bankruptcy" allows the debtor to"wipe the slate clean" and start all over. Who have no hopeof ever repaying their creditors.• Chapter 11 - allows business to continue normal businessactivities while reorganizing its finances.•Chapter 13 - is the reorganization of an individualconsumers debt with a new payment schedule. The debtorreaffirms to pay all or a part of their debt
  6. 6. Bankruptcy – Some Global Facts• Since the 1980s there have been record numbers ofbankruptcies. Ten of the largest bankruptcies ever werefiled between March 2001 and July 2002. 5% of USGDP!•Companies included: WorldCom ($107 billion), Enron($63 bn), Texaco ($36 bn), Kmart, United Airlines,Conseco.• One-third of companies that file will emergesuccessfully from bankruptcy.• Only about 7 percent of companies emerge frombankruptcy and go on to become a thriving concern.
  7. 7. Brazilian History• Código Comercial (Lei 556 de 1850)• Regulamentos 757 (processual) e 738 (falimentar)• Código Comercial Francês• Decreto n-917/1890• Lei n- 859/1902• Lei n- 2024/1908• Lei n- 5746/1929• Decreto Lei 7661/1945 – More rigid Laws and more liberal Laws.
  8. 8. The ISSUE in Brazil today• Companies need money (investment) in order to grow.• Who lends this money to the companies? Banks and Financial Institutions.• The ISSUE: companies goes BANKRUPT…and the Bank never sees the money again!• Banks need to have confidence that they will receive the money + interest, otherwise…
  9. 9. The ISSUE in Brazil today…..… they will charge a High Interest Rate to compensate for theHIGH RISK.The higher the risk, the higher the Required Rate of Return.This is called the Banks Spread.
  10. 10. The ISSUE in Brazil today• In practical terms, the current Brazilian Law structure makes it very difficult for the creditor to retrieve their money and for the debtor to recover their business. There is no “win-win” solution.• Experts comment that the current law is similar to a “revenge law”, because the creditor will usually break the debtor in court, but will never get their money back…
  11. 11. The New Law• New law 11.101/ 2005 and Complementary Law118/2005.• Introduces the concept of corporate recovery (80% ofinsolvent companies in Brazil fail to recover from theirfinancial difficulties).• Presidential sanction on February 9, 2005 the lawwill become effective on June 19, 2005.
  12. 12. Objectives of the New Law• Reduce loan interests rates, given the reduced risk under thenew law.• New law is modeled on foreign bankruptcy laws, especially theChapter 11 filing in the USA Bankruptcy Code, aiming tosupport the restructuring of companies that are economicallyviable.• Greater speed in addressing bankruptcy cases.•Avoid unnecessary shut-off of productive entities.•When a company is not viable, a expedited asset transfer istaken to avoid depreciation.
  13. 13. Main Characteristics• The new law isn’t applicable to financialinstitutions or public owned companies.• Credits are to be verified by an officialadministrator nominated by a judge (thisadministrator is responsible for information, reports,evaluation of the recovery plan, and so on).
  14. 14. Main Characteristics• Committee of Creditors composed byrepresentatives from the following interestgroups: employees, real guarantee creditorsand other creditors.• Committee of Creditors are required tomonitor judicial administrators performance,analyze complaints and approve the recoveryplan.
  15. 15. Main Characteristics• Main executives remain within the company during therecovery plan implementation.• Legal responsibility lies with the company partners andmain executives.• Tax authorities allowed to enact specific rules grantingspecial tax payment schedules for companies under judicialrecovery.
  16. 16. The Path to Bankruptcy Troubled Company Extra JudicialJudicial Bankruptcy
  17. 17. Recovery Plan• Extra-judicial: allows the debtor to undertakefriendly negotiations with most important creditors. •No interference from the Judge. •No mandatory order for payments.• Judicial: following the law. Recovery plan,approved by the Committee of Creditors. •Innovation: no liabilities succession if judicial liquidation process ( similar to US Chapter 7 ). •Allow selling part of the “business”. •Supervised for 2 years. Issues, court can declares bankruptcy.
  18. 18. Bankruptcy• Debtor can request own bankruptcy if don’t see conditionsfor recovery.• Company’s assets and rights will be evaluated as fast aspossible to avoid depreciation.• Employees can use labor credits in order to purchase thecompany.• Bankrupted company can be acquired by another companywithout obligation for previous fiscal and labor debts.•Bankruptcy can only be requested if debt is higher than 40minimum wages.
  19. 19. Complementary Law 118/article 185-A• Permit a judge to freeze a debtor’sasset.•Before law 118/Article 185-A, debtswere not secured with assets and courthad to search and lien ( penhor ) debtorassets.
  20. 20. Comparison New vs. Old Law• The New Law ensures that creditors (Banks and Financial Institutions) have a higher priority to recover the money.• Under the old law, creditors appeared 4th in the payment priority order. Usually, they will never receive the money they invested.• Now creditors are second in the payment priority order with Fiscal Debts. Distribution of money to the employees has been limited.• This is very important because it allows creditors to invest with more certainty and therefore with a lower interest rate - spread (we hope!).
  21. 21. Credit Priority Order Old law 7,661/1945 New law 11,101/2005Taxes (Fiscal Debt) Employees (up to a maximum of 150 minimum wages)Pension Programs (Fiscal Debt) Creditors (Banks and Financial Institutions) and Fiscal DebtsEmployees (no limits) Other CreditorsCreditors (Banks and FinancialInstitutions)Other Creditors
  22. 22. Comparison New vs. Old Law Old law 7,661/1945 New law 11,101/2005Purchase of a bankrupted Possibility for acquisition ofcompany implied portions of the companyresponsibility for previous without succession of fiscalfiscal and labor liabilities. or labor liabilities. A party may only file forAny creditor can file for debtor’s bankruptcy if thedebtor’s bankruptcy credit against the debtor is atindependent of payment least equivalent to 40values. Brazilian minimum wages
  23. 23. Conclusions• The New Law has been modernized - Brazil has advanced towards a more stable and reliable economy – the law is good!• Investors will now have more confidence in lending money to companies and therefore should reduce the Interest Rate (spread).• However, concerns still exist……
  24. 24. Some Concerning Points• Most Brazilian states (São Paulo included) do not have legal specialized systems in bankruptcy legislation. Thus, it is not clear yet how Judges will behave.• Mexico has recently adopted a very similar Law and is facing huge difficulties to implement it, given structural problems in the Judiciary system (Brazil has a similar judiciary system).• In most WTO countries, creditors payments are located first in the credit priority payment order after bankruptcy is established. In Brazil, creditors appear second together with fiscal debts.
  25. 25. Final ThoughtTherefore, only time will tell if the New Law will really work or not………..

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