Brazil: Court-Supervised Reorganizations: Capital Market Protection Mechanisms

The court-supervised reorganization of corporations introduced by Law 11101/05 (the Brazilian Reorganization and Bankruptcy Law - "LRF" in the Portuguese acronym) arose as one of the changes needed to lower credit risk and achieve greater reductions in interests accrued on financial loans. However, little has been said about the fact that the LRF has introduced several capital market protection mechanisms, which we will discuss in this article.

Securitization and Court-Supervised Reorganization - One way in which to invest in corporate debt is by directly purchasing securities representing loans (banknotes - CCB in the Portuguese acronym1, or debentures2), which may be collateralized by the credit rights (receivables) of the issuer against third parties, in the form of either a pledge or an assignment.

Another way is through a Receivables Securitization. This is achieved by creating securities backed by credits and placing them in the Capital Markets. These securities include, among others: (i) Certificates of Real Estate Receivables ("CRI", in the Portuguese acronym3);(ii) Certificates of Agribusiness Receivables ("CRA", in the Portuguese acronym4); and (iii) Credit Rights Investment Funds ("FIDC", in the Portuguese acronym5).

Therefore, when acquiring any of these papers, one should consider the legal strength of this investment in case the entity originating the credit runs into financial difficulties or even goes bankrupt.

Articles 129 and 130 of the LRF set forth that certain acts, when performed close to the insolvency event, may be annulled so as to protect the creditors' estate. One such case is the sale of a business establishment without the consent of all creditors. Inspired in this provision, the position adopted by the courts is that the sale of all (or substantially all) of the company's sales revenue, or the sale of agreements which are essential to the company's sales revenue, might be annulled, given that it is potentially dangerous to the company's survival and continuity.

Consequently, if a hypothetical company "X", which is facing difficulties, sells all or part of its current or future sales revenue, either through a CRI (in the case of revenue from real estate), a CRA (in the case of revenue from agribusiness) or a FIDC (overall credits and revenues) on the eve of its bankruptcy, one would expect that the annulment of this sale would be sought and/or ruled so that the aforementioned credits are returned to the remaining assets and made available to all creditors.

This possibility would obviously cause significant legal insecurity to those investing in these securities, having a tremendous impact on the concept of "true sale", with adverse effects on the issues ratings and the securitization market in general.

To avoid this, Article 136, paragraph 1 of the LRF establishes that the assignment of credits between the receivables originator, which went bankrupt, and the securitizer will be held valid and cannot be rendered non-effective or void. In other words, should an investor participate in a securitization transaction in the capital markets, and should the originating entity (which assigned the credit) go bankrupt, the assignment of the credits backing the securities acquired will always be upheld, regardless of the situation of the company facing difficulties and of the creditors' estate.

Bank Credit Securitization - The protection provided for in Article 136 is not only valid for business and civil credits, but also for bank credit securitizations. The rules imposed by the National Monetary Council ("CMN" in the Portuguese acronym), the Accounting Chart for Institutions of the National Financial System ("COSIF", in the Portuguese acronym) and the Central Bank ensure the separation between assigned credits and the financial institutions' other assets, in addition to the guarantee provided by the Brazilian Payment System, which is a sistemic structure securing the capital and financial markets by legally segregating assets included in the system through the collaterals supplied by the clearings and financial institutions that are a part of it (Law 10214/01).

Even though financial or similar institutions are not, in principle, submitted to those procedures set forth by the LRF, their crises being regulated by Law 6024/74, in accordance with Article 34 of such law, the provisions of the LRF secondarily apply to these institutions . Thus, the same provisions in article 136 of the LRF also protect investors in the case of securitization of bank credits originated by an institution that is subsequently liquidated or goes bankrupt, also preventing the assignment of financial credits from being revoked.

The payment system and the reinforcement of asset seggregation under the LRF - Article 7 of the aforementioned law 10.214 already determines that those obligations assumed within the sphere of the Financial Clearing and Settlement Houses (which are an integral part of the SPB) are not subject to the rules of bankruptcy proceedings. In addition, Articles193 and 194 of the LRF upheld and reinforced this principle. Accordingly, the entity participating in the SPB whose bankruptcy is adjudicated will have its clearings and settlements conducted in accordance with the regulations of the clearing system. This is translated into the assertion that all assets, whether cash or securities, associated with transactions backed and recorded by the SPB, through one of its clearings or institutions, will be used solely to comply with the existing agreements and commitments at such time, and will not be used to pay for other obligations of the bankrupt entity. In bankruptcy terms: these assets will not be part of the estate. Thus, the enactment of the LRF doubled the protection of capital and financial markets in this aspect.


Considerable progress has been made toward protecting and encouraging the circulation of credits and debt securities in the financial and capital markets, not only by creating securities backed by credits unaffected by other debts (Rural Producer Notes, Certificate of Agribusiness Credit Rights, etc...), but also by establishing, within the insolvency legislation, protections that encourage investments in such papers, especially those resulting from securitization structures.

1 Articles 26 to 42 of Law 10931/04

2 Article 52 and subsequent articles of Law 6404/76

3 Law 9514/97 and CVM Instruction 414

4 Law 11076/04:

5 CMN Resolution 2907/01, CVM Instruction 356

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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