The slowdown in the Brazilian economy, together with the repeated scandals involving the infrastructure and oil & gas sectors, have brought about successive drops on São Paulo’s stock exchange and a sharp devaluation of the securities and commercial papers of the companies involved. On top of this, one can also add the acceleration and greater liquidity of the US economy, the devaluation of the Brazilian currency and the desperate need for infrastructure development. Given this scenario, the market witnessed a number of transactions, driven mainly by foreign capital, aimed at acquiring companies or the assets of Brazilian companies in financial difficulty.
Distressed M&A transactions only became viable with the reform of the Brazilian Bankruptcy Law in 2005 which provides that a company in financial difficulties can file for a court-supervised reorganisation, proceedings which resemble a Chapter 11 case under the US Bankruptcy Code, and structure the sale of productive units free and clear of the liabilities of the debtor company, including those of a tax or labour nature.
In other words, Brazil’s Bankruptcy Law provides legal mechanisms that make it possible to separate the business activities from the liabilities and, therefore, a potential investor can acquire goods at the price they are effectively worth on the market, without having to pay the debt in full. Due to such features of the revamped Bankruptcy Law, distressed M&A transactions became one of the great attractions for acquisitions within reorganisation proceedings in Brazil.
For the purpose of benefiting from such a free and clear sale, the target company has to file for judicial reorganisation, which is a court-supervised arrangement between the debtor and its creditors. All claims existing at the time of the filing, even if not yet due, are subject to the effects of the judicial reorganisation proceeding, with some exceptions, such as tax claims, advances on foreign exchanges and claims secured by chattel mortgages or fiduciary assignments. Claims incurred in after the filing are also not affected by the judicial reorganisation proceeding and may be enforced by the relevant creditor.
If the eligibility requirements are met, the court will order the stay of all enforcement actions against the debtor for a period of 180 days (with exceptions). In addition, the debtor must propose a reorganisation plan, addressing the treatment of the affected claims, within 60 days following the issuance of such court decision. The plan is then submitted to be voted at a creditors’ meeting – providing that at least one creditor files an objection to the plan, which happens in virtually all cases. If the required majorities in each of the four classes of creditors votes in favour of the plan – or if one or two dissenting classes can be crammed down – the court will confirm the plan, making it binding on the debtor and all affected creditors.
If the plan provides for the sale of a production unit under a competitive process, such sale is free and clear of all claims and interests in such assets. A production unit is composed of a pool of assets (such as a business line), which may be grouped together in a branch or a subsidiary of the debtor company. The competitive process is usually a judicial auction, under the provisions of the Bankruptcy Law, but it may also be under other means provided by the plan and authorised by the court. In any case, the competitive process must bring transparency to the transaction, accelerate the sale, maximise the amounts to be distributed to creditors, and allow greater security for potential investors.
Unsurprisingly, the prospective investor that wins the competitive process is the one that acquires the productive unit. If an investor wants to make the first bid, and act as a ‘stalking horse’, such an investor may well benefit due to having entered the ‘race’ for the assets of an insolvent company early on. In such cases, the investor has the opportunity to tailor the structure of the competitive process, and develop the relationship with the target company, creditors and the judicial authorities. The investor also has more time to carry out an extensive due diligence process, even though it tends to be much more limited in terms of its scope and, depending upon the investor’s appetite for risk, even non-existent. The stalking horse may also negotiate some advantages in the competitive process in consideration for making the first bid, such as the right to match any other offers.
Apart from a sale provided for in a court-confirmed plan, and unlike what happens under a Section 363 sale under the US Code, the Brazilian Bankruptcy Law does not contain any provision allowing assets to be sold free and clear in a shorter period of time. Sales of fixed assets are only allowed with a court decision, but the law does not provide the protections afforded by a sale free and clear of pre-existing liabilities in these cases.
In any event, distressed M&A deals are risky transactions. They attract investors who are willing to accept a higher degree of risk in exchange for greater and faster return. Therefore, the solidity of the legal mechanisms employed for the acquisition are the investor’s only guarantee, which clearly requires great care and creativity from the professionals involved, including transaction planning and risk management. Regardless of these challenges, the increase of distressed M&A in Brazil is clear. It is certainly a collateral effect of Brazil’s economic recession and the corruption scandals appearing repeatedly in the news, but it is also a by-product of a more straightforward and solid bankruptcy regime.
Evy Marques, Paulo Campana and Pedro Bianchi are partners at FELSBERG Advogados. Ms Marques can be contacted on +11 3141 9172 or by email: firstname.lastname@example.org. Mr Campana can be contacted on +11 3141 9168 or by email: email@example.com. Mr Bianchi can be contacted by email: firstname.lastname@example.org.
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Evy Marques, Paulo Campana and Pedro Bianchi