Brazil Rewrites Its Bankruptcy Laws

Article excerpt

A After a decade of struggle, the Brazilian government is now finalizing sweeping reforms of the country's bankruptcy laws. The original draft of the proposed reforms was completed in the House of Representatives in October of 2003 and sent to the Senate. In July 2004, the Senate passed amendments to the bill. It is now back in the House, where a commission has been appointed to recommend changes to the Senate version and conduct a conciliation vote. Enactment will create a new business environment for Brazilian companies and their creditors.

The existing Brazilian bankruptcy law has been on the books since the mid-1940s, essentially in its current form. "The new reform bill, when signed into law by President Lula, should bring substantial reforms to the bankruptcy process, which today, incredibly, often takes as long as 10 years to complete," says Randel R. Young, partner in the Houston office of Gardere Wynne Sewell LLP. "Although numerous amendments were proposed, the Senate rejected the majority of those amendments and approved the bill in a form very similar to the earlier House version. Because it originated in the House and was supported by the Lula administration, observers are generally optimistic that something fairly close to the Senate version of the bill will soon be enacted into law."

President Luiz Inacio Lula da Silva is determined to make Brazil's $525 billion economy more attractive to investors. He has pushed for bankruptcy reform as part of his broader program for attracting capital. Brazil's economy dipped into recession in 2003 and is still fragile. Renewed growth in the first half of this year stemmed primarily from higher exports. Domestic spending improved but remained tepid. Coface, the French risk assessment and ratings organization, reports that the economic outlook for the rest of 2004 and 2005 appears brighter but still depends on financial market sentiment. The interest rate hikes in the United States could make it more difficult for Brazil to cover its external financing needs, which are declining but still high. In addition, higher oil prices could fuel inflation and make it difficult for Brazil to pursue the monetary easing it needs to buoy the economic recovery.

President Lula turned his attention to bankruptcy reform early on to address demands for legal reforms and concerns about excessive levels of risk for creditors. The bankruptcy reform bill will establish new creditor priority criteria, which will improve the view of the default risk currently associated with Brazilian companies. "While labor claims remain at the top level of creditor priority under the new law, labor claims are followed by secured credits, which now rank ahead of tax and other types of credits," Young says. "Labor claims themselves, which are unlimited under the current law, are subject under the reform law to very significant new recovery caps set for each employee at the equivalent of the national minimum wage (currently, 260 Brazilian reals, or U.S.$81, per month) multiplied by 150 months."

Also, importantly, the reform law proposes to eliminate successor liability for tax and labor debts for purchasers of assets of Brazilian companies in bankruptcy. "Since there are still a fair number of distressed assets on the market in Brazil, particularly in the energy sector, this new feature is likely to be an important consideration for U.S.-based 'vulture funds,' merchant banks and other purchasers looking to pick tip Brazilian assets at distressed prices, in that it substantially reduces a potential buyer's concerns over residual liabilities from the bankrupt debtor's operation of the business prior to bankruptcy," Young reports.

Similarities to U.S. Code

Under current law, a Brazilian company may pass through three types of distress situations--insolvencia, falencia or concordata. "While a concordata proceeding is a type of debtor-in-possession proceeding similar to Chapter 11 of the U. …