Brazil: How Far Is The Bankrupcty Court Entitled To Go When Revisiting A Judicial Recovery Plan Approved By Creditors?

Since the enactment of Federal Law n. 11.101/05 (the so-called Brazilian Bankruptcy Act), some very important issues have been debated, most of them related to circumstances surrounding judicial recovery proceedings, which by far is the most important remedy brought by said statute.

Because such law introduced in the country very new concepts, to which Brazilian practitioners were not used to, it could be said that the principles derived from such statute have been extensively used to fill out some gaps left opened by the legislator.

Depending on the side the practitioner is, principles such as the "preservation of the company" and "sovereignty of the creditors' assembly" are very often highlighted to support legal interpretations, a few of them in some occasions not expressly contemplated by the Bankruptcy Act.

One of the hot topics, which has to do with the "sovereignty of the creditors' assembly" principle, is whether the Court has discretion not to approve a recovery plan which has been approved by all the classes in the context of a judicial recovery proceeding.

As a matter of fact, majority of scholars comments that the Bankruptcy Court has no discretion to assess the merits of the recovery plan, and has to validate that if the creditors have validly approved it. In other words, it should only check out the formalities surrounding the plan approval by the creditors, but not the terms and conditions of such plan. Such terms and condition could only be discussed and, approved or rejected, by the creditors.

Such understanding had been poorly debated until a decision by the Court of Appeals of the State of São Paulo, one of the most reputable and skilled Appellate Courts in the country, held the invalidation of a plan which had been previously approved by the creditors (Interlocutory appeal n. 0136362-29.2011.8.26.0000, involving the judicial recovery of Cerâmica Gyotoku Ltda.).

In such case, the Court of Appeals held that the "sovereignty of the creditors' assembly" principle could not cure illegal terms and conditions found in the recovery plan. In other words, the creditors could only approve a plan whose content does not violate the applicable legislation. It also held that the Bankruptcy Court does not exist only to "stamp" the result of the creditors' assembly, but also to carefully assess whether such a plan is in compliance with the applicable laws.

In the aforementioned Gyotoku case, the plan had not set up dates and accurate amounts to be paid to the creditors, since they would depend on Gyotoku's net revenues. Likewise, the part of the debt which had not been paid within 18 years would be considered waived by creditors.

Although the violation of certain principles of law has been invoked by the Court of Appeals of the State of São Paulo to invalidate such recovery plan, the opinion clearly discussed the economics of the plan. For example, it held that "if the debtor requires a very long term to initiate the payment of the proposed installments, and if the percentage to be paid is too low, such situation evidences that the company has no condition to recover on its own, but only by virtue of the excessive sacrifice unfairly imposed on those who have given credits to it, under the premise that debtor would honor its word".

Assuming the recovery plan in such case was approved by Gyotoku's credit (which was the case), and that such creditors had the adequate opportunity to assess how bad the plan was from a purely financial perspective, it could be said that the aforementioned opinion clearly analyzed the financial situation of the plan when deciding about its invalidation.

Such precedent was strongly criticized under the premise that the financial rationale of the recovery plan has only to do with the creditors, and the Court should only assess whether the plan would be in compliance with the applicable legislation. The Court could never invade the discretion of the creditors to consider the plan a good or bad alternative.

Very recently the impact caused by Gyotoku has been sensibly softened. The Superior Court of Justice ("STJ"), the highest Court to decide on Federal Law issues, handed down an important opinion reported by Justice Luis Felipe Salomão (Recurso Especial n. 1.359.311-SP).

The discussion which reached the STJ was about the boundaries of the Bankruptcy Court's discretion to analyze and possibly reject a recovery plan which had been approved by creditors, under the rationale that the plan would contemplate very bad payment conditions.

By an unanimous decision the STJ held that (i) provided that the legal formalities have been met, the Court has to validate the recovery plan which has been approved by the creditors; (ii) the Court is prevented from assessing the financial feasibility of the plan, which has to be assessed by the creditors only; and (iii) the Court has to oversee the legality of the plan to avoid any fraud or abuse of rights, but not its financial viability.

As a matter of fact, in some occasions it is hard to separate the legal from the financial assessment of the recovery plan. A purely legal assessment is likely to touch the economics of the recovery plan in some occasions and vice-versa.

However, we understand that the Bankruptcy Court shall not control whether the payment conditions are good or bad, or if the liquidation would be most favorable to creditors than the recovery plan. This would go beyond the Bankruptcy Court's discretion and should be exclusively dealt with by the creditors.

Nevertheless, the Bankruptcy Court has to pay careful attention to the very commonly seen techniques used by debtors to get a recovery plan approved. For example, it is not rare to see creditors belonging to the same class to be paid differently, without any reason that would differentiate them from the other members of its class.

Since such issues deal with principles of law, an assessment by the Bankruptcy Court would not be prevented in light of the recent STJ's opinion mentioned above. To the contrary, such issues are within the limits of such Court discretion and could justify a recovery plan approved by creditors not to be validated.

Therefore, in essence this is still an issue that will constantly give rise to different decisions and interpretations, particularly because the recovery plans are always distinct and based upon different factual background. The lesson, however, is that Brazilian Courts are becoming more skilled and warned that bankruptcy proceedings could not be used as a means to by-pass creditors.

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.