The second round of voting in the Brazilian presidential elections took place on 30 October 2022. It has been reported that approximately 118 million Brazilians voted in that round. Former president and left-wing candidate Luiz Inácio Lula da Silva defeated rival Jair Bolsonaro, who had been in office since 2019, marking one of the most astonishing comebacks in political history. In the end, Lula da Silva received 50.9 per cent of the vote, while Bolsonaro won 49.1 per cent.
The cost of living and inflation in Brazil is increasing which is why many voters turned towards a Lula da Silva government, with his strong policy focus on tackling extreme poverty and hunger. However, Lula da Silva's rhetoric has unnerved some investors, with a clear focus on past achievements, rather than details of his fresh economic agenda. There are concerns he has not focused on the structural changes needed to improve productivity and generate long-term growth in the country, such as a more progressive tax regime to overhaul Brazil's infamously complex tax system.
Although inflation is rising, the Brazilian economy reportedly expanded more than expected in June. The central bank's economic activity index rose by 0.69 per cent from May. It also reported that activity increased by 3.09 per cent year on year. Bolsonaro's social program was approved by government, which will see lower income households receiving monthly payment increases of R200, coinciding with the election campaign. Lula da Silva has suggested he would maintain this recently approved social welfare program. Forecasters predict unemployment could hit a seven-year low of 8.5 per cent. More generally, market commentators are predicting that inflation could reach 7.02 per cent as the increase in social spending keeps pushing it higher, however, they also believe that the key SELIC rate should remain at 13.75 per cent this year and drop to 11 per cent by the end of 2023.
SPECIAL THANKS
We appreciate the assistance of Eduardo Mattar, Renata Machado Veloso, and João Pedro Nascimbeni, of Padis Mattar Advogados, with the following discussion of Brazilian law, regulation and practice.
BRAZILIAN LEGAL SYSTEM
Brazilian law derives mostly from continental European (Portuguese, German, French, Italian) civil law. It is based on statutes and recent constitutional reform. The Federal Constitution, in force since 21 October 1988, is the supreme law of the country and organises the country as a Federative Republic. There are 26 federative states (and the federal district) in Brazil, each of which have the powers to adopt their own Constitutions and laws, subject to the rules and principles provided for under the Federal Constitution.
Accordingly, Brazil has a very complex legal system, with a set of specific laws - issued by the Federal, State and Municipal Governments - and regulations - issued by administrative governmental authorities, such as the Central Bank of Brazil and the Brazilian Securities and Exchange Commission (Comissão de Valores Mobiliários) - governing a variety of situations and environments, including rules applicable to the members of the Brazilian financial and security system, to credit/debt environment, and to local and foreign investments. Most aspects of private law are governed by federal statute or regulations issued by federal governmental authorities.
Among these laws and regulations, the most relevant for the purchase and sale of credit and foreign investments in Brazil are the Brazilian Civil Code, Federal Law No. 4131/1962, and National Monetary Council Resolution No. 4373/2014.
KEY POINTS FOR TRADERS
- Transfer of credit is generally carried out through a simple written assignment from the seller to the purchaser. Foreign entities do not require any government or local authority consent or authorisation to acquire credits in Brazil, even if such credit is already being enforced in court or out of court.
- In order to be enforceable against third parties, the assignment must be entered in writing, inform place and date of its execution, the identification of assignor and assignee and (where applicable) be registered with the competent registrar agent.
- Debtor's consent is not required; however, an assignment only becomes enforceable against the debtor once notified thereto, or formally acknowledged thereby.
- Any inflows or outflows of cash to/from Brazil require prior registration with (not authorisation by) the Central Bank of Brazil. As such, an assignment of credit will typically trigger electronic registration requirements with the Central Bank of Brazil, to facilitate remittance of funds (e.g., from the debtor to the assignor for payment of the claim). Absent such electronic registration, future remittances under the credit may be more cumbersome. F/X agreements are required to allow the inflow and outflow of cash. No Central Bank authorisation is required, but F/X operators (banks, brokers) are typically rigid in reviewing and scrutinising the underlying transactions as a requirement to engage in such F/X agreements.
- Brazil has usury rules that restrict the amount of interest rate that a non-banking institution may charge a debtor. However, some credit instruments, such as debentures or bank notes, may be issued or assigned to non-banking institutions without such restrictions applying to the assignee.
- Credits secured by fiduciary transfer/assignment (alienação e cessão fiduciária) enjoy the best protection in case of insolvency of the borrower (the law provides that such security is bankruptcy remote, although depending on the nature of the asset subject to the security, it may not be enforced during the stay period).
BANKING LICENCE REQUIREMENTS
In Brazil, local lending with interest above the usury law limits, and other credit transactions are restricted to banking institutions duly incorporated and authorised to operate as such by the Central Bank of Brazil.
The basic rules and regulations regarding foreign investments in the Brazilian financial and capital markets are set out in Resolution No. 4373/2014 of the National Monetary Council and Law No. 4131/1962, which generally provides that an investor who is not a Brazilian resident may freely invest in any financial instrument or security available to an investor who is a Brazilian resident, establishing a regulatory environment to allow for such investment. In some circumstances, foreign investors even have tax benefits (compared to local investors) for trading credits that are documented in the form of securities.
Cross-border lenders are not required to hold a banking license, but the Brazilian borrower must register a cross-border credit transaction in the Registry of Financial Transactions (Registro de Operações Financeiras - "ROF") through the Central Bank of Brazil's electronic information system (SISBACEN) prior to any disbursement.
To obtain the ROF, the borrower must inform the Central Bank of Brazil of, amongst other things, the basic financial terms and conditions of the loan such as principal amount, interest rate, fees, penalties, maturity of principal and interest.
As long as the terms of the transaction fully comply with regulations of the Central Bank of Brazil and the costs are within those currently practiced by the market, the ROF will be issued automatically. The ROF will then enable the borrower or issuer to make remittances in respect of scheduled payments of principal, interest, fees, penalties, and expenses, as specified in the ROF.
In case of assignment of the credit to third parties, the ROF must be updated to reflect the assignee as new creditor and amendments to the basic financial terms and conditions of the loan, if any, to allow the remittance of the proceeds of the loan to outside of Brazil. F/X agreements are required to allow the remittance of the proceeds of the loan to outside of Brazil.
In addition, foreign entities acquiring local credit should register the transaction with the Central Bank of Brazil as direct investment in a local asset, in order to facilitate remittance of cash and payment of capital gain taxes in the future.
METHOD OF TRANSFER
ASSIGNMENT AND NOVATION
The transfer of a credit in Brazil is generally carried out through an assignment of credit. Unless any restriction is provided under the loan agreement, the consent of the borrower/guarantor will not be required to assign the credit and, as a general rule, the respective collateral.
If the new lender becomes a creditor as a result of an assignment of an existing loan, generally no further action with respect to the collateral is necessary as it is deemed transferred as a result of the assignment of the credit itself (although it is recommended to amend the collateral documents to reflect the change of creditor in order to facilitate and expedite enforcement procedures). Exception is made to collateral granted over real estate, which requires the assignment to be registered with the applicable real estate registry.
As a general rule, in order to be effective against third parties the assignment of a loan must either be implemented by means of a public deed or the private instrument should be filed with the public registrar of titles and deeds.
The assignment of credits in Brazil may be with or without recourse against the assignor in case of default of the debtor thereof. An assignment does not affect the security or the guarantee. An amendment to the terms and conditions of the debt may, however, affect, and even void in certain circumstances, the guarantee if the guarantor does not consent to such amendment.
A novation occurs under Brazilian law when; (i) a debtor assumes a new debt with the original creditor to settle and replace an existing debt; (ii) a new debtor assumes the obligation of the original debtor, with the creditor's consent, and the original debtor is therefore released from such obligation; or (iii) as a result of a new obligation assumed by the debtor before a new creditor, with the consent of the original creditor, such original creditor's claim is released in exchange for the new obligation towards the new creditor.
Novation is not presumed, and the parties must clearly express their "intention to novate" in the new transaction documents.
USURY RULES
Brazil has usury rules that restrict the interest rate that a lender that is not a banking institution may charge. Brazilian courts have issued different decisions regarding the applicable interest rate limit in such situations. In some circumstances, courts limit such interest to 12 per cent per year; in others, to the "SELIC rate" (the basic rate accrued by sovereign bonds). As of 1 November 2022, the SELIC rate was 13.75 per cent per year.
However, as mentioned above, some credit instruments, such as debentures or bank notes, may be issued or assigned to non-banking institutions without such restrictions applying to the assignee. Some disputes have arisen with respect to such exception, but recent court decisions have typically upheld the no-limitation rule in favour of assignees. However, this discussion is still not finally settled by Brazilian courts.
This is relevant in the context of purchasing loans governed by Brazilian law. It is common for assignors not to give any express or implied representations or warranties with respect to interest in relation to the underlying loan.
SECURITY AND TRUSTS / AGENCY
Brazil does not have statutes or regulations with respect to trusts. However, trust and agency arrangements governed by foreign law are generally recognised by Brazilian courts.
Brazil has a similar concept to trusts in the context of issuance of local debt instruments (debentures), under which Brazilian law requires the appointment of an agent (agente fiduciário) to represent the holder of the debentures in their dealings with the issuer.
Under the agency concept in Brazil, it is usual for creditors of a syndicated loan to appoint an attorney-in-fact (similar to a security agent) to represent the creditors in the execution and performance of collateral documents, also with the power and authority to represent creditors in foreclosure and enforcement procedures.
TAX AND STAMP DUTY CONSIDERATIONS
Pursuant to Brazilian tax law, all payments of interest, fees, commissions and expenses made in respect of foreign-credit transactions are subject to a 15 per cent withholding tax (or 25 per cent in case of payments made to a person who is a resident of a low or Negative Income Tax jurisdiction), or such other lower rate, as may be contemplated in a treaty to avoid double taxation between Brazil and the country where the beneficiary of the payment is domiciled. As a general rule, the payment/remittance to the non-resident creditor will only be allowed pursuant to proof of withholding.
Withholding of income tax will not generally apply but may be relevant if the proceeds of the foreign-sourced loan are used to finance the borrower's exports and such loan is repaid with exports from Brazil made by the borrower or by entities that make up part of the borrower's economic group. This is typically the case with export prepayment transactions, a form of financing broadly used by Brazilian exporters.
No stamp duty is levied on the transfer of a loan where the security is real estate but there are costs and expenses associated with the registration of the security and the mortgage. The transfer of real estate is subject to taxation in Brazil.
Under current Central Bank rules, there is no minimum term-to-maturity for a foreign-sourced loan. However, for purposes of the tax on foreign exchange transactions ("IOF/Exchange") if the final maturity of a foreign-sourced loan or a put or call in respect of debt securities is scheduled for a date that is equal to or less than 180 days, then a 6 per cent IOF/Exchange tax on the inflow of proceeds of the loan or issuance of notes will apply (there are penalties and interest in case of cross-border loans or financings or international notes with minimum average term longer than 180 days with respect to which an early redemption/payment occurs affecting such minimum average term).
Notwithstanding, the outflow of proceeds on such cross-border loans or financings or international bond issuances currently remains subject to the IOF/Exchange tax at a rate of 0 per cent. The Brazilian government can increase such rate at any time up to a rate of 25 per cent, but only with respect to future foreign exchange transactions. In any event, any IOF/Exchange relating to cross-border loans and financings or international notes issuances would be borne by the Brazilian borrower/issuer.
NOTARY REQUIREMENTS
Security documents perfected in Brazil pursuant to Brazilian law do not need to be notarised but must be registered with the appropriate registrar for perfection.
Requirements for enforceability and admissibility of foreign documents in Brazil:
- Documents from countries that are not signatories to the Hague Convention: foreign documents must be legalised by the Brazilian Consulate in the country of origin; translated into Portuguese by a sworn translator; and recorded (original and respective translation) with a Notary Public Office of Titles and Documents in Brazil.
- Documents from countries that are signatories to the Hague Convention: the signature of the parties signing outside Brazil must be notarised by a notary public licensed to act as such under the laws of the place of signing; the signature of such notary public must be authenticated by a consular official of Brazil, followed by the apostille; the duly notarised and apostilled document must be translated into Portuguese by a sworn translator, and then recorded (original and respective translation) with a Notary Public Office of Titles and Documents in Brazil.
NOTABLE TRANSACTIONS
Cielo SA ("Cielo")
Cielo, formerly Companhia Brasileira de Meios de Pagamento, is the largest Brazilian payment processing company for credit and debit cards and is controlled by Banco do Brasil SA and BancoBradesco SA. After four years of consecutive losses, Cielo's stock was up 129 per cent in the second quarter of 2022 and as at 1 November 2022, had a price of 5.56BRL. The change in the company's fortunes has been put down to it being able to deal with the rising interest rate in Brazil better than many of its rivals, which has increased from 2 per cent to 14 per cent over the last two years and the recent sale of its stake in U.S. firm Merchant e-Solutions Inc, which was concluded in April and added R282m to its bottom line. Operating net revenue fell by 9.7 per cent to R2.54bn, which reflects the sale, as revenue excluding Merchant e-Solutions increased by 33.7 per cent.
Tuesday Morning Corp ("TMC")
TMC is an American discount store chain headquartered in Texas with 490 stores in 40 states. It is reportedly exploring possible restructuring plans, including the possibility of filing for bankruptcy. If it does file for bankruptcy it will be the second time it has done so in less than two years. Piper Sandler is reported to be advising TMC on potential restructuring options.
Some of TMC's lenders granted an additional USD5m loan in July to assist with ongoing working capital and the company entered into a supply agreement with Gordon Brothers Retail Partners, an affiliate of one of its lenders. Earlier in the year TMC refinanced an asset-based lending facility with a new ABL due in 2024.
Lumileds Holding BV ("Lumileds")
Lumileds is a company that develops, manufactures, and distributes LEDs, light bulbs and other types of lighting products. It is headquartered in the Netherlands and has approximately 7,000 employees across 30 countries.
It has been given court approval to borrow USD175m of new money financing to assist with ongoing capital costs as well as to help repay some existing financiers. It has been reported that prior to receiving the green light for the new financings, Lumlileds only had USD6.6.m cash available.
This comes after the company had to file for Chapter 11 in the United States on 29 August 2022. Lumileds also filed a 5-year restructuring plan to allow the company to restructure and repay its debts with a view to emerging from bankruptcy. Documents filed at the bankruptcy court show that Lumileds has debt of approximately USD1.7bn owed to more than 1000 different creditors.
Existing lenders who opt to advance fresh credit to the struggling company will share in a participation fee that totals approximately 37 per cent of the company's equity, according to the court papers in relation to the approval of the new financing.
This bankruptcy package and restructuring plan will mean majority owner, Apollo Global Management LLC, cedes control of Lumileds to existing secured lenders.
The bankruptcy plan was passed, following the solicitation period which commenced 29 August 2022, by approximately 92 per cent of Lumileds' first lien lenders. Lumileds emerged from the Chapter 11 process on 31 October 2022 when the restructuring plan was made effective after it was confirmed by the United States Bankruptcy Court for the Southern District of New York.
Great Panther Mining Limited ("GPM")
GPM is a Canadian primary precious metals and silver mining producer with a diversified asset portfolio in Brazil, Peru, and Mexico. The company wholly-owns a large land package of almost 200,000 hectares of the Vila Nova Greenstone belt, with its operations primarily focused on the operation of the Tucano Gold Mine in Brazil. In March 2019, GPM acquired the Brazilian mining subsidiary, Mina Tucano, in order to expand mining operations.
On 6th September 2022, judicial reorganisation proceedings were filed in the 1st Business Court of Rio de Janeiro. The proceedings were filed by Brazilian miner Mina Tucano, alongside two of its Australian shareholders - Beadell (Brazil) and Beadell (Brazil 2) - in order to allow for the company to reorganise business operations following a situation of distress.
Simultaneously, Mina Tucano's indirect parent GPM entered into a notice of intention to file a proposition under section 50.4(1) of Canada's Bankruptcy and Insolvency Act (BIA). The notice provides companies in financial difficulty the opportuning to restructure their operations.
Following this initial notice, it was announced by GPM on 4 October 2022 that more flexible proceedings had been approved by the Supreme Court of British Columbia. An initial order was granted converting proceedings of the company under the BIA to proceedings under the Companies' Creditors Arrangement Act (Canada). Proceedings under this federal law are more adaptable and enable a company to avoid bankruptcy whilst maximising returns for creditors.
LEGAL UPDATE
UK Supreme Court Rules on 'Creditors' Interest Duty'
The Supreme Court of the United Kingdom in BTI 2014 LLC v Sequana SA [2022] UKSC 25 has ruled on the point at which company directors must have regard to the interests of creditors (the so-called "creditors' interest duty") as set out in section 172 of the Companies Act 2006 (the "2006 Act"). Section 172(3) of the 2006 Act extends such duty when insolvency of a company is inevitable in order to encompass not only the interests of shareholders, but the general body of a company's creditors.
The judgment modifies the previous Court of Appeal decision in BTI 2014 LLC v Sequana SA [2019] EWCA Civ 112, which provided that the creditors' interest duty applies when the directors know or ought to know that a company is or is likely to become insolvent and/or if there is a real and not a remote risk of insolvency.
The Supreme Court's much anticipated judgment not only provides company directors and their advisors with some breathing space, but it also provides welcome clarification of company directors' duties which, as Lord Reed described in his judgment in the case, "go to the heart of our understanding of company law."
The Facts
In May 2009, the directors of Sequana's subsidiary, AWA, made the decision to pay a ?135m dividend to Sequana, which extinguished the majority of the larger debt owed to AWA by Sequana (the "Dividend"). When the Dividend was paid, AWA was solvent (on both a balance sheet and cash flow basis) and the payment was compliant with Part 23 of the 2006 Act. At the time, however, AWA had long-term pollution related contingent liabilities of an uncertain amount and there was a real risk that AWA may become insolvent in the future.
AWA entered insolvent administration approximately 10 years after the Dividend. BTI, as an assignee of AWA's claims, sought to recover an amount equal to the Dividend from AWA's directors on the basis that their decision to pay the Dividend breached the creditors' interest duty.
Following consideration by the High Court, the Court of Appeal concluded that the creditors' interest duty was only applicable when a company is insolvent; on the verge of insolvency; when insolvency is likely; or where there is a real risk of insolvency. This led to BTI appealing to the Supreme Court.
Decision
In the 159-page judgment, the Supreme Court considered, amongst other matters, whether the creditors' interest duty existed and, if so, the timing for such duty to apply and its effects once applied.
The Supreme Court unanimously dismissed the appeal on the basis that, at the time of the Dividend, AWA was not actually insolvent, bordering on insolvency, or likely to become insolvent and that the creditors' interest duty should not apply purely as a result of a company being at a real - not a remote - risk of insolvency.
The Supreme Court did, however, reconfirm that the creditors' interest duty arises when company directors know or ought to know that a company is insolvent, is bordering on insolvency, or is likely to become insolvent (i.e. probable, being where there is more than a 50 per cent chance of insolvency based on a balance sheet or cash flow test).
Furthermore, the Supreme Court made it clear that the creditors' interest duty is not a separate duty owed directly to creditors but that such duty forms part of company directors' general fiduciary duty to act in the interests of the company. The judgment also reinforced that company directors should continue to be conscious of other statutory obligations, such as the wrongful trading regime in section 214 of the Insolvency Act 1986 (the "1986 Act") and avoidance provisions in sections 238 and 239 of the 1986 Act.
Comments and the Practical Implications
In her judgment, Lady Arden described the case as a "momentous decision for company law," providing long-awaited clarification that company directors are indeed required to consider the interests of creditors in certain circumstances.
The Supreme Court's decision will be welcomed by company directors who are particularly concerned with contingent and/or unqualified liabilities as the decision confirms that the trigger point for the creditors' interest duty occurs later than was previously stated. The decision also appears to recognise that an onerous duty arising as early as where there is a "real" risk of insolvency could damage rescue efforts and lead to excessively cautious decisions by directors, whilst acknowledging that creditors deserve some protection when it is their interests that are primarily at risk.
The trigger point for, and content of, the creditors' interests' duty will continue to be matters on which directors will need to take legal advice in order to ensure statutory and case law obligations are fully complied with.
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.
