Deloitte Brazil on the country’s business environment

The arrival of the Company Recovery and Insolvency Law 10 years ago changed the business culture in Brazil, but no law is perfect and enhancements should be made to maintain its effectiveness

 

This year, the Company Recovery and Insolvency Law, which governs bankruptcy processes in Brazil, will have been in effect for 10 years. There is much to celebrate, but at the same time we should also take a moment to consider the results and advances achieved over this period, such as the cultural change that has occurred, the enhancements in the law’s text, and also the participation of all agents involved.

Replacement of the former bankruptcy regime for the current one represented a drastic change in company reorganisation practices in Brazil. A cultural transformation of those involved was necessary for companies to take advantage.

Starting at the beginning of the 2000s, efforts were intensified to conclude the text and the law took effect in 2005. Representatives of various sectors were involved in this initiative, all working toward the same objective, such as the legislative branch – especially deputy Osvaldo Biolchi, sponsor of the bill; the federal government, mainly the ministers of justice and finance; the World Bank and all civil society.

The arrival of the company recovery and insolvency law contributed to the start of a major cultural transformation in the Brazilian business environment

These agents were engaged in the process of preparing the new law so that it could meet the demands of a modern economy, following the natural flow of society, by which laws accompany the transformations of the economy, business, and human relations. In the establishment of that legislation, we worked, primarily, focused on three principal points that would positively alter the bankruptcy rate in Brazil, which is measured by a combination of three factors. These were celerity, respect for guarantees, and respect for the priorities of obligations. One of the main objectives of this law was to increase the supply of credit in relation to GDP and consequently it was necessary to create a favourable legal environment.

In relation to the increased supply of credit to the private sector, we can see a significant rise. In 2004, the amount of credit granted to the private sector was 23 percent of GDP. Just 10 years later, it rose to 54 percent – more than doubling. The credit balance to the private sector in this same period jumped 589 percent.

Main advances
Since it was implemented, a significant number of companies have been able to find the path to their continuity, thanks to the environment created by the new law. Among the main advances of this law, we can mention the greater involvement of creditors in the process; legal protection granted to companies during the first 180 days of the process; the creation of general meetings of creditors, through which the company, its creditors and other interested parties discuss related topics; the distinction between a company and a businessperson or shareholders, making it possible to remove shareholders from management under certain conditions; and the cram down in the voting process during general meetings of creditors, thus minimising the possibility of abusing voting rights.

Further key advances include the obligation to present a legal recovery plan, which should indicate the recovery measures to be taken by the company and that are discussed with its creditors; greater payment priority for loans not subject to bankruptcy rules, those offered to the company after it enters the recovery process, as a way to stimulate the offer of credit to these organisations; the possibility of selling isolated productive units without any transfer of tax or labour liabilities; and the possibility of having companies declared bankrupt as a block, also without any type of transfer, which implies a greater collection of funds from transferred goods in favour of creditors.

Cultural shift
The arrival of the law contributed to the start of a major cultural transformation in the Brazilian business environment. Financial institutions and creditors in general began to understand that the recovery process for a company is a natural and healthy step in its lifecycle. An organisation that enters the pre-bankruptcy stage obviously experiences a situation of weakness, requiring legal protection, as well as the support of the market agents with which it relates. When it does not receive this support and suffers from the stigma of a company in crisis, the tendency is for its survival prospects to diminish even further, causing negative impacts that will certainly exceed its own borders.

For this reason, it is essential that creditor agents, investors and other stakeholders of a recovering company adequately understand this peculiar and delicate situation, taking a collaborative stance that allows, as a last resort, the organisation to restore its financial health. After all, these are not only interested parties, but also, to a certain extent, jointly responsible for its history of development. Understandably, a company in the process of restructuring should create an environment of confidence and transparency – with the highest level of governance possible – in order to be able to obtain the collaboration of the largest number of those involved.

Furthermore with regard to the cultural change, it is essential that companies that realise they are facing declining operations – caused by internal or external events – take corrective steps, as quickly as possible, while they still have a larger number of alternatives, do not have a damaged image and, most importantly, have cash available.

These warning signs are not always perceptible, but signs of decline are quite well known. Some of these signs are seen when, for example, the corporation begins to miss its profitability targets, or when it loses market share and has a decline in profitability. If the company does not take corrective measures in time, signs of crisis may begin to appear: it becomes impossible to pay taxes, its payments to employees and suppliers are delayed, its lines of credit are cut and its most talented employees abandon their posts, in addition to having its image weakened internally and externally.

When an organisation reaches this point the only path available is that of recovery, which needs to begin as soon as possible, before it suffers significant damage to its image, when it has cash available and still has some alternatives to reposition itself.

Necessary enhancements
Despite the undeniable benefits provided by the Company Recovery and Insolvency Law, some enhancements are still necessary. One of them involves incentives for lenders not subject to bankruptcy rules. The law exempts credit of suppliers to companies in recovery from bankruptcy rules, providing a great incentive for financing organisations in recovery, increasing their real chances of success. These should have absolute priority in payment in cases of bankruptcy, stimulating the financing itself and recovery.

Another important point relates to the need for greater balance of powers and responsibility between debtors and creditors during the recovery process. It makes sense to allow creditors to present alternative recovery plans to those created by companies in difficulties. In this way they no longer act as mere approvers of an offered plan that may not be the most suitable. This is certainly a factor that merits consideration to promote improvement of restructuring plans and, consequently, increase the company’s chances of success, since it opens the path for construction of better-structured solutions. Another relevant aspect for change is related to the need for the goods to be sold as quickly as possible in the case of bankruptcy, ensuring greater speed in the processes.

The judiciary, in turn, needs to create more courts specialised in the subject, in addition to intensifying the work of technical training of judges, continuing an effort that has already been underway for at least a decade. As judges begin to understand more comprehensively the economic aspects and those related to the business environment and corporate management, which are increasingly complex, the ability of the judiciary to ensure the effectiveness of the achievements and the benefits provided by the law improves.

Moreover, in the wake of the increasing internationalisation of Brazilian companies and the very globalisation of business – with a growing number of transnational restructurings – it becomes essential for the country to gradually adopt the most modern practices of the legislation of other countries.

Undoubtedly, when evaluating the results of the last 10 years, it is clear that the law has brought many important advances to Brazil. However, as occurs in all markets, the achievements are part of a continuously evolving process, which requires the legislation that affects business to respond with increasing efficiency to the demands of the economic environment.

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