|Rafael Baleroni||Fábio Rosas|
The current economic downturn has caused many Brazilian companies to file for judicial reorganisation in local courts (a procedure similar to Chapter 11 of the US Bankruptcy Code). Many of these filings involve multiple companies from the same economic group, whose reorganisation – it seems – must be completed together to be successful. However, Brazilian bankruptcy law does not have clear rules for these situations and the case-law is still evolving to address insolvency proceedings involving economic groups. The following discussion addresses joint filings and substantive consolidations.
Joint filing is becoming more popular and is increasingly accepted by courts in Brazil. It occurs when two or more entities request their judicial reorganisation together in one filing, so that the reorganisation is processed in the same casefiles, with the same judge and trustee. In principle, it is simply a matter of procedural convenience, to avoid each entity starting its own process. By itself, it does not authorise substantive consolidation or any other disregarding of capital structures.
Substantive consolidation is currently one of the most sensitive bankruptcy issues in Brazil. It relates to the amalgamation of assets and debts of the entities subject to the insolvency proceeding, by presenting a single reorganisation plan to be voted on by the creditors. Although each legal entity in the debtor group continues to exist separately, substantive consolidation treats the economic group as a single enterprise with respect to capital structures, and disregards any structural subordinations that existed. In order to vote on the plan, creditors are uniquely listed in classes as per their legal classification. This can cause a dilution of creditors' voting rights or grant an unfair position regarding the nature or classification of the credit against different companies.
Many decisions authorising joint filings and substantive consolidations do not engage in a proper analysis of the corporate structure, financial situation and capital structure of the entities involved, nor do they make a detailed investigation of matters such as the commingling of assets. They often take the view that banks that lend to an entity that is part of a larger group rely on the financial strength of the group, and therefore know, or should know, that the borrower may be involved in a joint insolvency. In practice, cash-rich entities have been amalgamated into insolvency proceedings with cash-strapped or irrecoverable entities, jeopardising the interest not only of their creditors, but also a larger number of stakeholders, sometimes in a bid to preserve the enterprise, whatever the cost.
The lower bankruptcy courts in São Paulo tend to require expert evidence on a company's economic viability before authorising a judicial reorganisation. A similar approach would be desirable before authorising joint filings and substantive consolidations.
Brazilian case-law on insolvency is still developing. Lenders should be aware that there will be a degree of uncertainty for some time, and should look into not only the debtor but the whole economic group to which the debtor belongs.
Rafael Baleroni and Fábio Rosas
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