Brazil: Creditors - Organize! Alignment Of Interests In Brazilian Judicial Reorganization Procedures.

The judicial reorganization or recovery (recuperação judicial) provided for in the Brazilian Bankruptcy and Reorganization Law (Law 11.101/05) ("BRRL") is comparable to the Chapter 11 of the United States of America Bankruptcy Code. The goal of the Judicial Reorganization is stated in Section 47 of Brazilian Bankruptcy Act as follows:

"Article 47. - The purpose of the judicial reorganization is to make it possible for the debtor to overcome its economic and financial crisis in order to be able to maintain the production source, employment of workers and interests of the creditors, thus contributing to preserve the company and its social function and to foster economic activity."

We will not discuss the benefits of keeping the company alive, instead of forcing its liquidation, particularly when its creditors believe in the company capacity to revert the financial difficulties it is facing.

One of the most common approaches to rescue any company in financial risk/peril, is the re-sizing of the company with the sale of certain plants and business units, the injection of capital either by investors or even by its creditors, aiming to gain more (or loose less) from the restructuring as opposed to an asset liquidation.

However, such initiatives require a certain stability, which the present scenario of the conduction of Judicial Reorganization ("JR") in Brazil does not offer.

The JR procedure is usually long, expensive and quite emotionally demanding by creditors and debtors, renegotiating in long and tense sessions discoursing about the company´s feasibility and the great disparity between the creditor's expectations and the debtors' proposals under the Judicial Reorganization Plan ("JRP").

Add to such scenario the costs with legal and additional advisers hired by various parts individually, negotiating on the best interest of their individual clients, interests which frequently are conflicting. Not uncommonly those negotiations take longer than the legal stay period of 180 days .

Ad Hoc groups of creditors trying to form an influent force in the process usually fail, because the negotiations do not depart from a joint approach to the problem of the recovery but from an individual point of view. They fail because creditors hold credits with different seniority, because certain creditors do not wish to assume the cost of a joint counsel representation or a joint financial consultant to conduct the negotiations, and for any number of reasons, whose grounds are the inability to compromise among themselves. And such compromise is necessary to find common solutions to present to the debtor.

Also, government development banks, such as BNDEs (Brazilian National Economic and Social Development Bank) and BANRISUL (state of Rio Grande do Sul) have limitations to agree to certain flexibilities towards the debtor. Therefore, they tend to contribute for the inefficiency of negotiations.

Another fact that adds to the inefficiency of the JR is that suppliers of the debtor very rarely try to approach the financial creditors to negotiate under the context of the JR and vice-versa.

The fact that the debtor always has (legal provision) the last word on the contents of the JRP, puts a tremendous amount of power in its hands and permits "sweetheart deals" with certain creditors, similar to purchase of votes.

You also have secured creditors not bound by the JR nor the 180 day stay which manage to impose attachments and injunctive measures on certain company assets given as collateral to those creditors. However legitimate, said measures may compromise the reorganization and future investments or even impose a harder burden over the company already in financial distress.

Due to lack of central unified information and interest, fragmented multi negotiations among various creditors and debtor, will make risk assessment and return perspective quite hard to achieve. As a result it will make potential high yield investors to lose their attraction/interest on companies under JR, creating a difficult environment, for instance, for the concession of DIP (Debtor In Possession) Financing. Based on the same hurdles, potential investors (could be current creditors or new investors) with interest in equity participation or acquisition of assets would not be incentivized to approach, invest or reinvest in the company.

Also, considering the same issues and the uncertainty they generate, the secondary market for "distressed assets" shall work with higher discounts that do not reflect than company´s real recovery capacity.

The debtor, of course, takes advantage of this situation and manages to approach creditors with the capacity to influence the vote and result of creditors general meetings. Aiming those credits, it is common the occurrence of "auctions" for special treatment of certain creditors in order to gain support for the approval of company judicial recovery plan ("JRP").

This commonly results in the approval of recovery plans with relevant haircuts on credit payments or even unrealistic payment plans, causing creditors to stop supporting any effort of recovering or perpetuation of the company, causing great damages to the company, its creditors and even the JR procedure.

Even in this scenario, one could think that financial institutions, therefore professional suppliers of credit, would act in an organized, unified way, but the reality is that, sooner or later, they get caught in the individual negotiation trap, go astray from any "ad hoc" group and search for their "sweet-heart" deals as well.

While watching these situations occur again and again, it struck us that, as a result of the protection under the BBRL and the prospect of a JRP that will likely substantially alter the payment conditions, or even the amounts to be paid, of their credits, all these creditors are starting to negotiate with the debtor a large syndicated transaction, and what is worse, of a credit that they have already disbursed or granted.

And, if it is so, why all these creditors do not act in an organized way, trying to harmonize their interests?

The reasons are above, without speaking of asymmetries of information about the debtor and its situation, different sizes of creditors, different interests, different kinds of stake-holders (bond-holders, suppliers, banks, factoring companies, etc...).

We are not suggesting that all the creditors get organized and harmonized, this would be pure wishful thinking, what we are asking, with a certain surprise, is why sophisticated lenders, big trading companies, global suppliers, large financial institutions, government development banks and bond-holders (let's call them "Sophisticated Creditors"), do not act, in this situation, with the same degree of organization as they would in an original new transaction?

We could search for reasons, one of them being the simple fact that a deal gone bad should not get more money and time investment, internal policy reasons, etc..., but we prefer to show the advantages and the feasibility of a joint approach to a common distressed debtor, as if it were a brand new financial transaction.

Although we believe that this approach would also improve results in a liquidation scenario (the Brazilian "Falência" (Bankruptcy)), we prefer, for a matter of scope, to examine only the JR, assuming that the Sophisticated Creditors, based on sound business information, believe that the debtor may recover in a way that enables it to repay them more than in a liquidation scenario.

For such, the Sophisticated Creditors should work on choosing a first rate financial consultant or investment bank to make the necessary evaluations and projections, structure repayment and negotiate with debtor. They should also hire one law-firm with transactional and litigation capabilities, preferable household names known to the group of Sophisticated Creditors, with muscle to proceed to due diligence and have partners available to help in negotiations and drafting.

With this settled, they should work on a Term-Sheet (the "JR Term Sheet") which would replicate the normal standard of the market for new transactions, adapted to the JR scenario, and would only be signed by the Sophisticated Creditors. The following vital provisions should be included in the JR Term Sheet:

  1. The parameters of negotiation for the whole group (term, haircut, interest), and different sub-groups.
  2. The seniority among the Sophisticated Creditors.
  3. The sharing of the collateral and guarantees.
  4. The treatment of sale of assets or business units by the debtor.
  5. The broad lines for the way out by the signatories.
  6. Rules for the adhesion of new financial creditors or suppliers.
  7. Debt to Equity Swaps rules.
  8. The sharing of expenses.
  9. The hiring and dismissal of consultants and investment bankers.
  10. And, last, but not least, rules on the representation (common attorney-in-fact) and vote in the creditors meetings, particularly the approval or rejection of the JRP, change proposals, etc...

Having this set, the Sophisticated lenders should enter into the document that is usually signed in a syndicated transaction, the Intercreditors Agreement, that should reflect, in a more detailed manner, the principles set in the JR Term Sheet.

The Intercreditors agreement is a useful tool in syndicated loans and other collective banking transactions, but not very common in Brazilian bankruptcy and JR procedures.

The Intercreditors agreement is a powerful instrument for align different and conflicting interests of Sophisticated Creditors in a JR. By adopting an intercreditors agreement a group of Sophisticated Creditors (with different goals and priorities) could align their interests, establishing clear sharing rules and seniority among their credits, making the whole process more efficient and more cost effective (they would use one set of advisers i.e. legal and financial during the entire process).

The intercreditors agreement is a private agreement/instrument, executed by creditors of one person, with pre-established rules concerning their rights and obligations and the impact over existing debts with such debtor and other credits. Usually those agreements already establish the applicable rules related to seniority and priority of credits repayment upon the titles and credits negotiated under this group.1

Should a substantial number of Sophisticated Creditors (in number and in value) organize as suggested in this article, this would not only increase their chances of negotiating a reasonable JRP, but also creating an environment of stability and visibility that may lure attract investors and DIP lenders.

Other creditor cooperative structures could be set up, such as investment funds to which the credits subject to the reorganization could be transferred. A structure of seniority of the fund's quotas could be established, reflecting the hierarchy of the credits and the possible recovery under a liquidation scenario. Lower ranking credits could be attracted to the structure by having a minimum recovery possibility, which would have been null in a non-organized liquidation procedure (this is true also in the intercreditor structure).

These could be Non-Standard Receivables Investment Funds, (in Portuguese "Fundos de Investimento em Direitos Creditórios Não Padronizados- FIDC", as established by the Resolution No. nº 2.907/2001 issued by the National Monetary Council and the Brazilian Security Commission, CVM instruction 444/2006) and the Private Equity Funds, known as FIP (in Portuguese "Fundo de Investimento em Participações", as per Brazilian Security Commission, CVM instruction 391/2003, as amended) expressly allows for the payment of quotas with credits against companies under judicial reorganization.

The issuance of bonds or debentures with different series also according to the same seniority criteria could be used as well.

The main common traces of such alternatives, could be listed as follows:

(i) stronger position in creditors meetings and creditors committee;

(ii) corporate governance for the vote on specific matters;

(iii) one set only of fiduciary agent, fund manager, custodian, financial consultant and lawyers after the structure is up and running, with significant reduction of cost;

(iv) sharing of security, guarantees and collateral;

(v) more liquidity of the new instruments owned by the creditors (such as to vulture funds);

(vi) a clearer scenario for DIP financings;

(vii) a clearer and simple structure for the purchase of assets, or to join in with investors in debt or in cash;

(viii) possible tax advantage, depending on the chosen structure, if the credits are transferred to the new vehicle at a discount.

We firmly believe that, if the stake holders evaluate the cost of the time and focus spent, counsel fees and negative impacts on capital requirements and net worth entailed in the present manner the judicial reorganization and liquidation are being carried out, the cooperative approach with the use of intercreditor agreement is certainly the best solution in order to obtain the best recovery and the least cost procedure.

An intercreditor agreement is an agreement among creditors that sets forth the various lien positions and the rights and liabilities of each creditor and its impact on the other creditors. Intercreditor agreements are often used financing companies and lenders to determine relative rights of multiple creditors and establish priorities in payments and other issues. It is common for the intercreditor agreement to include buy-out rights that give the second lien lender the option to acquire, at par, the first lien lender's claims and liens. That purchase option is typically triggered by specified events, such as the filing of a bankruptcy case by or against the borrower (Source:

The content of this article is intended to provide a general guide to the subject matter. Specialist advice should be sought about your specific circumstances.

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