If you compare practices adopted in more mature markets – such as the US – to the ones adopted locally, judicial recovery in Brazil is still a very slow process.
The Bankruptcy and Reorganization Act of 2005 Dis still relatively recent and does not provide sufficient legal protection, not only to creditors but also to debtors. In practice, they face an inefficient process that reduces companies' real chances to recover, and merely postpones payments, hampering both the generation of cash flows and the receipt of outstanding debts by creditors.
Further clarification needed
There is a consensus among market participants and companies that some legal procedures used in the judicial recovery must be further disseminated and clarified by the Judiciary to ensure greater legal certainty. They are also unanimous in saying that other processes, such as communication between creditors and companies, need modernisation. Currently this communication takes place through a public notice and, in the case of decision making by creditors, the process takes place at a face-to-face meeting, which makes the process extremely slow.
With the aim of modernising processes and ensuring greater legal certainty to market players, the Ministry of Finance led by Minister Henrique Meirelles, announced that it will bring to the National Congress many changes to the Bankruptcy and Reorganization Act. The proposed changes aim, among other aspects, to boost and promote the use of DIP Financing.
An important option
DIP Financing (debtor-in-possession) is a new financing for companies in judicial recovery ie. companies that have either approved a plan, or are discussing a plan with their creditors for the payment of their outstanding debts. Its main purpose is to compensate for the lack of cash for finance operating expenses such as payment of suppliers, salaries, administrative expenses, etc. In this sense, DIP Financing ensures that the company continues to generate cash to maintain its operation and pay all other creditors, ensuring the necessary conditions to comply with the recovery plan. Because of its characteristics, this type of financing should have priority over the payment of the other credits of the recovery plan and should share the guarantees on an equal basis with other creditors under the same conditions.
Although the 2005 Bankruptcy and Reorganization Act already considers DIP Financing as an option for new financing in Brazil, a few issues described below prevent wide use by companies experiencing financial difficulties, which include:
- The company's delay in entering into the judicial recovery process, which deteriorates the company's ability to honor its commitments on a large scale, even after approval of the plan
- A lack of precedence and dissemination in the Brazilian courts regarding the process, giving creditors uncertainty in the exercise of their priority of receipt and guarantees
- Delay in the approval of the new financing terms, as well as the exchange of the guarantees by the current creditors
- Due to the company's current credit status, creditors are required to pay not only the cost of borrowed funds, but also the expenses resulting from credit in their balance sheet.
Bankruptcy and Reorganization Act review
Motivated not only by the issues described above, but also by other concerns raised in discussions with companies, the legal community, banks and others involved in the review of the Bankruptcy and Reorganization Act, Minister Henrique Meirelles will present a revised text to the National Congress with the following goals:
- Provide legal certainty to new financing of existing creditors and new creditors
- Reduce the approval period for DIP Financing
- Ensure the priority of new funding in order to disseminate the practice in the market.
The text has not yet been officially presented to the National Congress, but it is already generating high expectations among companies and financiers as it is crucial for companies in situations of recovery. Although issues such as the approval of the recovery plan itself, with the extension of the existing debt, sale of assets, and/or even the haircut are very important for companies to generate conditions for their existence, new credit is essential to maintain a company's production flow and provide conditions for the generation of new revenue.
TMF Brazil's view is that these improvements, if accepted by creditors, tend to make more successful judicial recovery plans for both parties (debtors and creditors), providing the Brazilian market with successfully cases of judicial recovery. Nevertheless, we believe that creditors, companies and legal advisors alike will need the time and expertise to understand all the benefits of using DIP Financing in debt restructuring plans in general.
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.