The possibility of raising funds by issuing real estate receivables certificates (certificados de recebíveis imobiliários or CRI) was introduced in Brazil in 1997 with the enactment of Law 9,514, which created the Real Estate Finance System (SFI).

Securitization of mortgage-backed receivables was already possible, but Law 9,514 enhanced transparency and efficiency in these transactions.

The SFI establishes the assignment, acquisition and securitization criteria for real estate financing. This system seeks to develop the primary (loans) and secondary (trading of asset-backed securities) markets for financing real estate by creating advantageous compensation conditions and special instruments for the protection of the creditors' rights. One of the main innovations of this system was the establishment of compound interest rates, which were previously forbidden (although the prohibition concerning the application of monetary restatements for periods of less than 12 months was maintained).

Law 9,514 introduced the real estate receivables securitization company, a special purpose company created for the acquisition and securitization of receivables. Securitization companies are the sole entities authorized to issue CRI. To issue CRI, these companies must be registered with the Brazilian Securities Commission (CVM), making them subject to several disclosure requirements.

Real estate receivables certificates (CRI)

CRI are securities backed by receivables originated in transactions of real estate financing. Law 9,514 refers to credit rights originated in transactions of real estate financing but the Brazilian Securities Commission also accepts the issue of CRI backed by credit rights arising from the lease of real estate properties.

Public offerings of CRI are subject to registration with the CVM. The procedures and requirements applicable to registration vary according to the individual face value of the CRI. There are no limitations to the face value of a CRI, but the registration and distribution procedures might vary according to the face value of the CRI being issued.

The CVM allows the placement of CRI with individual face value equal to or greater than, R$300,000 ($156,000), based on a temporary registration granted by the CVM upon receipt of a form describing the terms and conditions of the CRI. The temporary registration is valid for a limited period of time and the securitization company is required to present additional information and documents necessary for the definitive registration.

Specific and more stringent requirements apply to the registration of CRI bearing face value lower than R$300,000, including a rating agency report on the CRI. Also, the temporary registration does not apply for these CRI. In determining more stringent requirements for registration of CRI according to their individual face value, the CVM intends to protect the rights of individual and non-institutional investors, which require a greater degree of attention based on the assumption that they are not qualified investors.

The public offering of CRIs must be intermediated by a financial institution or a broker-dealer. The intermediation requirement may be exempted for public offerings of CRI with an aggregate amount no higher than R$30 million.

A prospectus is required for all public offerings of CRI. The CVM may waive the prospectus on a case-by-case basis, based on the characteristics of the CRI and on the target investors.

Guarantees and foreclosure

CRI may be guaranteed by: (i) mortgage; (ii) cessão fiduciária (fiduciary assignment) of real estate receivables; and (iii) alienação fiduciária (fiduciary transfer of ownership) of real estate property.

Mortgage

A mortgage is a security interest over real estate property. The procedures for the creation of a mortgage depend on the value of the relevant real estate property. Usually, mortgages are documented by a public deed certified by a notary. However, if the value of the real estate is lower than 30 times the lawful minimum wage, the mortgage can be documented by a private instrument. The minimum wage is equivalent to R$350. The mortgage deed must be registered with the Real Estate Registry Office of the real estate district where the real estate property is located. The mortgage deed must be executed in Portuguese and must be governed by Brazilian law.

The mortgage creditor may only initiate the foreclosure of the mortgage upon a default on the secured obligations. The foreclosure must be carried out through a judicial procedure, which ends with the public auction of the mortgaged property.

Under Brazilian law, the creditor may not receive the mortgaged real estate property in consideration for its credit. However, if no third party bids during the auction, the creditor may receive the real estate property as payment, provided the value of the mortgaged real property is not lower than the minimum price offered on the auction, which should have been based on an appraisal conducted by an appraiser appointed by the judge or on the value agreed upon by the parties.

The debtor may delay the judicial procedures for the foreclosure of a mortgage by filing certain remedies. Only after all remedies filed by the debtor have been decided may the procedure continue. A procedure for the foreclosure of a mortgage can take at least four years and may extend to seven to 12 years.

The proceeds arising from the auction of the mortgaged real estate property must be used to satisfy the secured obligations, including principal, interest and fees, court expenses and attorney's fees. Any excess proceeds must be returned to the grantor and any shortfall in the proceeds may be recovered by the mortgage creditor against other assets of the grantor.

Given that they are subject to an expensive and time-consuming execution proceeding, lenders are shifting to different guarantee instruments, such as the cessão and alienação fiduciária guarantees.

However, the mortgage is still used by some Brazilian financial institutions because loans guaranteed by mortgage have a 50% risk-weighting ratio under the capital adequacy regulation in force. This scenario may change in the near future given that, according to the proposed new capital adequacy regulation submitted for public consultation by the Brazilian Central Bank, residential real estate financings secured by alienação fiduciária that have a total outstanding amount higher than 50% and lower than 90% of the amount of the guarantee will bear a 50% risk-weighting ratio.

Cessão fiduciária of receivables

Cessão fiduciária of receivables is a security interest over real estate related receivables, created by means of provisional transfer of ownership of the receivables to the creditor until the payment in full of the guaranteed obligations. Through the assignment, the creditor receives title to certain receivables as a guarantee for the debtor's payment obligations until the debtor pays off the guaranteed debt. The receivables originate in real estate sale contracts relating to the real estate property financed by the creditor's loans. In the specific case of CRI, the securitization company transfers to investors, represented by the CRI's trustee (agente fiduciário), the ownership of additional receivables.

The provisional assignment of receivables originating from real estate sale contracts must be documented by a written agreement and registered with the competent Registry of Titles and Deeds to be valid and effective against third parties.

Upon the assignment, the creditor is entitled to certain rights relating to the assigned receivables. These include the right to receive any payments made by the respective debtors of the debtor of the assigned receivables, preserve and recover possession over the title of these receivables from any holder, including from the assignor/debtor. During the term of the assignment, the creditor is also entitled to provide notice to all debtors of the receivables that do not pay the amounts due.

To receive payments from the debtor's debtors, the creditor must give notice of the assignment to the debtor, instructing them to make payments directly to the creditor's account indicated in the notice. The provisional assignment agreement must also indicate which party will be responsible for collecting the receivables. Usually, due to its commercial relationship with clients, the debtor is appointed as the collection agent for the creditor. In these cases, it is advisable to have a detailed collection procedure described in the assignment agreement.

Once the debtor pays off the borrowed sums, title to the receivables reverts to the debtor. If, however, the debtor defaults and is unable to satisfy its payment obligations, the amounts received from payments made by the debtor's debtors on the assigned receivables will be used to pay off the amount owed to the creditor, including collection and administrative expenses. The creditor will hold any amounts that exceed the amounts owed for the debtor, as trustee.

If the amounts received from the payments are not enough to satisfy the debtor's obligations and any applicable charges, as well as collection and administrative expenses, the debtor remains obligated to pay off all remaining sums in accordance with the provisions of the assignment agreement.

If the debtor is bankrupt and the assigned receivables have not been delivered to the creditor, the creditor will be able to obtain restitution in the manner provided for by applicable bankruptcy legislation, at which time the creditor will be entitled to the rights discussed above.

When used as a guarantee for the payment of CRI, the cessão fiduciária structure might impose a burden on the securitization company and/or the originator of the receivables, as an additional volume of receivables (other than those backing the CRI) will be needed as collateral to pay investors.

Alienação fiduciária

Alienação fiduciária is one of the most important innovations created by Law 9,514. Using this mechanism, the debtor, as a guarantee for its payment obligations, transfers an extinguishable property right over certain real estate property to the creditor. This right reverts back to the debtor upon satisfaction of its respective obligations towards the creditor.

With CRI, the securitization company transfers to investors, represented by the CRI's trustee (agente fiduciário), the ownership of the real estate to which the receivables refer. So the real estate itself will guarantee the payments due by the debtor to the securitization company and, consequently, the payment by the securitization company of the CRI.

To be effective, the provisional transfer must be perfected. This requires that the transfer be registered with the Real Estate Registry Office of the real estate district where the real estate property is located. As the transfer is provisional, no taxes will apply at the moment the transfer is registered.

Once the payment obligations are satisfied, the creditor must provide the debtor with a release, authorizing the cancellation of the registered provisional transfer. If the creditor fails to deliver a release within 30 days of the satisfaction of the debt, the creditor could be required to pay a penalty to the debtor of up to 0.5% a month of the value of the secured obligations, as set out in the provisional transfer agreement.

Provisional transfers entitle the assignee/creditor to all rights over the immovable property transferred by the assignor/debtor as guarantee, essentially making the creditor the legal titleholder of the property. Although alienação fiduciária transfers the ownership of the real estate property to the creditor, it is common practice that the debtor keeps the direct possession of the real estate, using the property for its ordinary purpose.

The foreclosure of the alienação fiduciária does not depend on a court procedure. The enforcement procedure, as well as the public auctions, may be held without any court interference.

If the debtor does not satisfy its payment obligations, in whole or in part, it will be given an opportunity to cure its default. Upon default, the creditor must notify the debtor through the applicable Real Estate Registry Office to cure the default within 15 days. The debtor is obligated to pay the owed amounts, as well as any amounts that become due in the 15-day period, in addition to interest payments, penalties and other charges set out in the agreement, legal expenses, real estate charges attributable to the property, and any collection and notice expenses. Within three days from the date the debtor forwards the owed monies to the Real Estate Registry Office, the Registry will deliver these sums to the creditor, deducting any necessary collection and notice expenses. Once cured, the original provisional transfer agreement will no longer be in default.

If the debtor fails to cure the default by making the necessary payments within the deadline, the transferred legal title will be considered permanently made to the creditor, upon the payment of the Real Estate Transfer Tax (ITBI), a municipal tax levied on the disposal of real estate properties and/or the transfer of rights related to properties. ITBI calculation (tax basis and rates) varies depending on the city in which the property disposed is located. ITBI basis corresponds to the greater of: i) the market value, given by the Municipal Finances Office or ii) the value on the purchase agreement. In São Paulo, the ITBI rate is 2%.

The creditor then has 30 days from the date of default to hold a public auction. At this auction, the winning bid may not be less than the value of the real estate property as set out in the agreement.

If no bid exceeds the agreed-upon value, the creditor must hold a second auction within 15 days. The winning bid need not match the above value but must, at a minimum, be enough to cover the aggregate amount of the payment obligations, including interest payments, penalties, and other contractual charges, legal expenses, real estate charges attributable to the property, and notice and auction expenses.

If the proceeds from the auction exceed the amount owed by the debtor, including all related costs and expenses, the creditor must deliver these excess amounts to the debtor within five days from the auction. However, if none of the bids is enough to satisfy the above sums, the creditor remains with the ownership of the real estate property and the debtor's payment obligations under the agreement are deemed fully satisfied.

The creditor, its successors and assignees or the winning bidder in a successful auction, in turn, may seek to occupy the transferred property by means of expedited proceedings to reclaim possession of the property to which it is legally entitled.

Rather than proceeding with the auction process outlined above, the debtor has the option of, with the creditor's consent, transferring its rights to the immovable property in question to the creditor as payment for its debt obligations.

The debtor would remain liable for the payment of all taxes, contributions and charges relating to the real estate property, up to the date when the transfer of legal title is considered permanently made to the creditor. As of that date, the creditor will become liable for those payments, as the owner of the real estate property.

As with provisional assignments of receivables, if the debtor becomes bankrupt, the creditor will be able to obtain restitution for the transferred property in the manner provided for by applicable bankruptcy legislation.

Alienação fiduciária has some advantages over a mortgage. Law 9,514 provides for a simplified procedure for the execution of alienação fiduciária. So the enforcement of the alienação fiduciária tends to be less expensive and less time-consuming than the execution of a mortgage. It is estimated that the enforcement of alienação fiduciária takes from 12 to 18 months.

The segregation regime

Securitization companies often adopt the fiduciary segregation regime a mechanism to establish asset segregation. The fiduciary segregation regime consists of the segregation of receivables linked to a given securitization transaction from the assets and liabilities of the securitization company, including the receivables linked to a different CRI transaction.

The purpose of the segregation regime is to ensure that the funds arising from the receivables linked to the CRI are used exclusively to support the payment due by the securitization company to the CRI holders. Neither the fiduciary regime receivables nor the fiduciary regime funds will be available for the securitization company creditors, even in bankruptcy. The segregation of the fiduciary regime receivables and the fiduciary regime funds cannot be opposed to tax, social security and labour creditors of the securitization company.

The fiduciary segregation regime delimits the assets to which CRI holders will have recourse to receive payments in connection with a certain issue of CRI. When the receivables are subject to fiduciary segregation, CRI holders would have no claim on the securitization company's assets other than the fiduciary regime receivables linked to the respective CRI, unless the securitization documents expressly provide otherwise or the issuer fails to properly create, operate and control the fiduciary segregation mechanism.

The securitization company is liable for any loss caused by it as a consequence of (i) its failure to comply with any legal or regulatory provision relating to the fiduciary regime receivables and (ii) negligence, improper management or misuse of the fiduciary regime receivables.

Under the securitization transactions, the fiduciary segregation means that the receivables are segregated from issuer's assets and are not available to issuer's creditors (not even the investors holding a different series of CRI issued by the issuer), even if the issuer goes bankrupt, except for the creditors of tax, social security and labour debts.

Framework promotes growth

As well as the macroeconomic changes that have enabled the increase of credit availability, the development of the legal framework has contributed to the growth of the real estate receivables securitization market in Brazil. Offerings of CRI have increased substantially over the past few years. In 2003, the CVM registered 17 CRI offerings, with an aggregate amount of about $130 million. During 2006, 77 transactions were registered with an aggregate amount of about $550 million. As of June 2007, 24 securitization transactions have been registered with the CVM, with the total amount of about $270 million.

Author biographies

José Eduardo Carneiro Queiroz Mattos Filho, Veiga Filho, Marrey Jr e Quiroga Advogados José Eduardo Carneiro Queiroz is a partner in the firm's capital markets and banking practice. He is a graduate of the School of Law at University of São Paulo (1997) and the School of Business Administration of Fundação Getúlio Vargas (1993), and specialized in economics and political science at Georgetown University (1994). He is a professor of banking law and capital markets law at the School of Business Administration of Fundação Getúlio Vargas. Marina Anselmo Schneider Mattos Filho, Veiga Filho, Marrey Jr e Quiroga Advogados Marina Anselmo Schneider is a senior associate in the firm's capital markets and banking practice. She is a graduate of the School of Law at the Catholic University of São Paulo (1997), specialized in corporation law at the Catholic University of São Paulo (2000) and holds a master's degree in law from London University (2004).