In January 2021, Law 14.112/20 introduced a new section into the Brazilian Bankruptcy Law (the "BBL") regulating financing for companies which are the subject of a court-supervised reorganisation.
Prior to the introduction of Law 14.112/20, whilst DIP financings should have ranked ahead of pre-petition debts in the priority of payments waterfall, this was not always the case. By way of example, DIP loans ranked behind pre-petition creditors holding collateral in the form of a fiduciary lien and behind to some other statutory administrative post-petition obligations of the company, including the fees of court-appointed trustees and the ordinary expenses of the running the estate.
The new provisions of the BBL aim to facilitate and expand the use of DIP financing for distressed companies.
New statutory provisions
Pursuant to Article 69-A of the BBL, in order to finance a debtor's activities and the expenses for the reorganisation and for the preservation of its assets, the Bankruptcy Judge can now authorise the execution of a DIP financing and the creation of liens (including fiduciary liens and fiduciary assignment1) over the assets of the debtor company or a third party after hearing representations from any Creditors Committee2.
The Bankruptcy Judge has the power to authorise the DIP financing and it is not necessary either to schedule a general meeting of creditors to approve the transaction or to deal with it in the reorganisation plan.
As per Article 69-B of the BBL, any decision by a higher Court overturning the lower Court's authorisation of the DIP financing will not affect the seniority, privileges and guarantees afforded to a good faith lender to the extent that these have already been disbursed. This is a very significant change, inspired in the US Bankruptcy Code, which gives certainty to lenders. It is especially important given the slowness of Brazilian Courts and the time required to reach a final decision which cannot be further appealed.
The BBL also provides that the privileges granted to the DIP financing lender are available to any type of lender, including shareholders, partners and entities in debtor's economic group. This widens the range of potential DIP financing lenders and enables related parties to inject new money into a distressed business.
As regards guarantees, the Bankruptcy Judge can authorise a subordinated lien without the consent of the lender with the original security interest unless the asset is encumbered by a fiduciary lien. However, as a fiduciary lien is the most common type of guarantee in Brazil3, this reform may be of little practical assistance in circumstances in which the debtor has no unencumbered property.
The BBL does not a permit a priming lien (i.e. there is no priority or super priority over pre-bankruptcy secured creditors), even if the debtor demonstrates that financing could not be obtained on any other basis. The BBL states only that, if there is a sale of the collateral, the subordinated lien will be limited to the amount that exceeds the original debt.
Article 69-D provides that, in the event that a reorganisation is converted into a liquidation, the financing agreement will be deemed automatically terminated and the guarantees provided and privileges afforded will be preserved up to the limit of the amounts actually paid to the debtor before the conversion date.
In this regard, Law 14.112/20 also amends the order of payments in a liquidation. Article 84, I-B, provides that a DIP financing lender will be paid after indispensable expenses of the proceeding4 and after labour claims related to the services rendered three months prior to the decree (limited to an amount equivalent to five times the statutory minimum wage per employee).
However, the guarantees provided and the preferences afforded apply only to those amounts actually paid to the debtor company. This means that some interests and penalties (i.e termination fees, breakup fees and others penalties common in DIP financing transactions) will not benefit from the exact same privileges which apply to payments of principal.
Brazil's new DIP financing regime has a number of features which distinguish it from DIP financing under the US Bankruptcy Code. We will need to wait and see if the incentives provided by the new regime will be sufficient to facilitate access to credit for distressed companies in judicial reorganisation.
1 The fiduciary sale/assignment is a type of security interest pursuant to which the debtor assigns to the creditor the title and the “indirect possession” of a certain asset. The debtor will recover full title and indirect possession after fulfilling with all of its obligations under the credit agreement.
3 Claims secured by a fiduciary lien are not subject to the effects of a judicial reorganisation and the terms of the plan (Article 49, § 3). Therefore, the automatic stay does not prohibit their enforcement.