As the seventeenth century dawned on the business world, so too did a new era. In 1602, theDutch East India Company was founded as the world's second multinational corporation(the first one was the British East India Company) and the first company to issue stock, amove which would shift the organisation of companies and investment forever (cf. José Engrácia Antunes,'The Liability of Polycorporate Enterprises', Connecticut Journal of International Law, vol. 13,p. 197, 1999, at 198.).
Of particular interest in this event was the subsequent implementation of a system which regardedcorporate and personal capital invested in the company stock as separate. The notion of limited liabilitywas born.
Limited liability meant that, for the first time, it was now possible to invest in an uncertain orrisky business safe in the knowledge that one's personal assets could not be considered as assets in theevent of company problems. "Risk capital" entered the business vocabulary (cf. Philip I Blumberg,'The Transformation of Modern Corporation Law: The Law of Corporate Groups', Connecticut LawReview, vol. 37, p. 605-617, 2005.
From such momentous beginnings, the majority of business environments and legislation aroundthe world have evolved to a position of clearly separating the obligations of the corporate entitiesfrom the personal obligations of their respective shareholders and administrators.
This is also the case in Brazil, although there are a few exceptions, notably in the labour law area,which represent in certain instances an obstacle to corporate restructuring. In addition, the tax legislationhas adopted a rather broad concept of succession of tax debts, which compounds the mentionedissue of attributing to parent and affiliated companies, administrators and shareholders certainresponsibilities for contingencies.
Restructuring in Brazil
In legal terms, this state of affairs in Brazil is known as succession, joint liability, or disregard of corporateentity. This means that if a company or a business activity is acquired, certain of the seller'sdebts may become the responsibility of the buyer. Four main areas have to be dealt with in this areaand a thorough due diligence is required to determine exactly the size of a potential spill-over effectto a purchaser or parent company. These areas are labour, tax, environment and consumer rights.Prevalent case law has taken the position that parent companies, administrators and officers in thetax area are only jointly and severally liable with a debtor if a violation of the law or a fraudulent activityhas taken place. Simply not paying a tax when due, although clearly a violation of the law, isnot considered a reason for piercing the corporate veil. However, a healthy D&O insurance policy isthe usual way of protecting officers and directors if future controversies arise in this area.
In terms of succession of liabilities, simply acquiring an asset from a debtor does not trigger a successionof tax obligations to the buyer. However, if an acquisition entails any element of a businessactivity, such as the transfer of clients, employees, trademarks, know-how, and so on, the acquiringentity will be responsible for any tax liabilities of the seller.
In the labour area, such succession of obligations is also automatic, but even more severe, as allcompanies of the same economic group are jointly and severally liable in respect to any unpaid labourrights. In the civil and commercial arena, except for the normal fraudulent conveyance, twilightperiod and avoidable transactions and similar rules, a purchaser will not inherit the debts of the seller.
These circumstances create certain obstaclesto the reorganisation of companies andof business activities and must be dealt within each case in order to find solutions whichwill mitigate such risks.
A new horizon?
After more than a decade's efforts to moderniseBrazil's bankruptcy laws, Law Nr.11,101, which brought a brand-new regulationfor corporate insolvency law, came intoeffect on June 9 2005. This new BankruptcyLaw aims to preserve business activity, and bydoing so, to protect jobs, GNP and tax receipts.By preserving the going concern valueof businesses, it also allows for a more efficientrecovery for creditors and at the sametime provides the debtor with the opportunityto benefit from the preservation of valuein the process of settling its debts (see ThomasFelsberg, Filho Campana and Paulo Fernando,'Corporate Bankruptcy and Reorganizationin Brazil: National and Cross-borderPerspectives', Norton Annual Review of InternationalInsolvency, 2009).
The novelties introduced by the newBankruptcy Law were the adoption of therule of the majority of creditors (divided intothree classes) to vote, under a restructuringproceeding, on a restructuring plan submittedby the debtor and the possibility given tothe debtor to sell branches or productive unitswithout transferring any liabilities to the purchaser(Law 11,101/2005, article 60).
These elements have proven to be extremelyuseful and they created a new era forthe turnaround of companies in Brazil. As theexperience with implementing in new insolvencylaw grew, however, the restructuringcommunity perceived that two aspects of thelaw were not being applied as originally intendedby Congress and could or should beimproved: the liquidation in bankruptcy, andcertain insolvency-proof credits.
Liquidation in bankruptcy
The rationale behind the new BankruptcyLaw is to allow the debtor an opportunity toreorganise the company by obtaining the approvalof the majority of its creditors in eachof three classes of claims (secured, unsecuredand labour) (articles 45 and 58). To do so, thelaw protects the debtor for 180 days (a stayperiod during which enforcement actionsagainst the debtor are suspended) (article6(4)). If this fails, the creditors could takeover, and through a court-appointed administrator,the bankrupt estate is entitled to sellits assets and business without the successionof any liability to the purchaser, preferably asa going concern (articles 141-145). Shouldthis also fail, the judicial administrator ischarged with liquidating the company andpaying the creditors in accordance with theorder of preference established by law.
This second leg of the law structure is notworking well, because the creditors avoid assumingany responsibilities in respect to insolventcompanies, as the law does notprotect them against the spill-over effects describedabove and also has rigid standards ofpersonal responsibility of administrators ofbankrupt estates (the liability of judicial administratorsand of creditors' committees isregulated by article 32 of Law 11,101/2005).
In other words, creditors and administratorsof insolvent companies are not properlyshielded against liabilities, the result of whichis that it is safer for a judicial administratornot to accept an appointment or to abstainfrom doing what is required to sell or reorganisethe business.
The net result of this situation is that creditorsmost of the time approve unrealistic oreven bizarre restructuring plans, for lack of aviable alternative. As the debtor is not trustedby the creditors, however, the restructuredcompany has no future and it has becomequite common to approve one ore more subsequentrestructuring plans, because the planoriginally approved could not be implemented.
When the law was conceived, the secondleg seemed to be quite efficient within theBrazilian context as companies in poor situationswere accumulating tax liabilities whichthey were entirely unable to pay off. To allowthe law to work, the order of preference wasaltered so that secured creditors (usuallybanks) would be paid before the Treasury; assuch, it was believed that such creditorswould have an economic interest in the insolvencyprocess, thus guaranteeing its effectiveness.But this did not happen because of theissue mentioned above.
Certain credits are not affected by insolvencyproceedings. Such exclusions encompasscreditors which have the property of assetsgiven as security (chattel mortgage, leasing,conditional sales and security assignment ofcredits) (Law 11,101/2005, article 49(3)) andforeign exchange advances (ACCs and ACEs)(articles 49(4) and 86(II)). The reasons forsuch exclusions are well-known. ACCs andACEs finance Brazil's international trade at acompetitive price and conditional sale andchattel mortgages are effective guaranteeswhich contribute to a healthy expansion ofcredit.
Due to the economic incentives created bysuch exclusion, however, the number of casesin which a significant number of creditors arenot affected by insolvency proceedings hasgrown, meaning that finding a solution betweenthe debtor and a majority of the creditorshas in many cases become unviable.Therefore, some solution should be found allowingsuch super-preferred creditors to participatein an organised restructuring,subjecting them also to a majority rule, albeitin their own classes.
Finally there is the threat of tax debts, allof which are excluded from restructuring (article6(7)). The law foresees a special instalmentsystem of payments for these debts butsuch system has not yet been enacted (article68). There is also a lack of clarification on thevarious fiscal aspects relating to restructuring,including those relating to the possibility ofoffsetting past losses with possible discountsprovided by the creditors.
A better future
The matters raised in this article point to thepossibility of building on the successes alreadyachieved by the new Bankruptcy law. Shieldingproperly acquirers of insolvent businesses,administrators and creditors, enlarging theuniverse of creditors participating in restructuringproceedings and adjusting the tax lawscould certainly create conditions for an evenmore efficient treatment of insolvency inBrazil, which in a modern economy is essentialfor the rational reallocation of assets of insolventcompanies. There are of course othermatters which are being discussed in orderimprove the institutional framework of insolvencyin Brazil. Such matters could be resolvedin the context of the issues outlined here.