Although the predictions of the market tend to be exaggerated for good and bad, the fact is that Brazilian economy is going through a recession with some sectors being more affected than others.
Amid this scenario of crisis, a large number of Brazilian companies have been filing for judicial recovery[1] and the Brazilian M&A practitioners have been involved in a wave of acquisitions structured under this judicial procedure.
Different factors have been generating this wave of acquisitions within the judicial recovery procedures. Some of them are related to economic aspects, such as the devaluation of the currency, lack of finance in the market and the reduction of revenues in certain sectors. In the scenario of crisis assets tend to change hands to new players. Consolidation in certain sectors by large groups are also common as only certain companies are well structured to survive through rough times.
On top of all different economic aspects which lead to this M&A activity in judicial recovery, the legal aspects of such procedure are contributing for this new trend. The practitioners are learning the benefits of such acquisitions and the local lawyers play a key role in such transactions.
The main benefit of an acquisition within a judicial recovery procedure is the possibility of such sale being structured without succession of liabilities for the buyer. This is a superb advantage for the Brazilian market which has liabilities as a major issue in M&A. Many different deals do not go through because of unsuccessful negotiations regarding liabilities. The complex tax system and the strong pro employee legal framework are among the challenges of liabilities presented to investors which in many cases do not accept the risk.
As some precedents start to harmonize this concept[2], the market is learning how to put in practice negotiations with buyers and the courts are contributing being flexible and understanding the nuances of the M&A negotiation. The law clearly states: "Section 60. If the approved judicial recovery plan involves the judicial selling of subsidiaries or isolated unit production of the debtor, the court will order its selling under provisions of section 142 of this Law.
Sole paragraph. The object of the sale will be free of liabilities and succession for the buyer in the obligations of the debtor, including tax, respected the provisions of § 1 of art. 141 of this Law".
The discussions which still pend of harmonization from courts are if the acquisition needs be under a bid process for avoiding succession and up to what extent the parties can freely negotiate the terms of the deal without creditors approval[3].
The assets of a company in judicial recovery can be sold in different ways, but depending on the nature of the asset the sale needs court approval. In order to avoid any risk of interpretation regarding succession, many transactions have been structured under a bid process. Such alternative with the creation of an isolated unit production ("UPI") is well accepted by courts and doctrine as a form of sale which the buyer does not succeed the liabilities of the distressed company.
In terms of the negotiation, we could say that courts and practitioners are in a learning process. On one side, the courts are starting to deal with financial advisors and fast pace of a transaction. On the other side, the M&A players have to deal with two new interests on the table. The social interest of keeping the business alive and the jobs in place and the other which is the creditors who wants the best deal for recovering the most they can. The company in judicial recovery cannot make decisions by itself, it needs to align the interest of the creditors, the public prosecutor and the judge (assisted by a judicial trustee[4]).
The whole judicial recovery process must be approved by the creditors in a recovery plan. As part of this plan the sale of relevant assets, creation of a UPI and a bid process must also be approved. At this point many variables can differentiate one transaction from the other. A straight forward process can involve the approval of the plan with a bid process and the company running the auction without any negotiation with the interested parties.
Unless the asset is very attractive and there are many interested parties, it is difficult to sell relevant assets without any sort of negotiations with the interest parties. The conditions of the agreement, the due diligence and other commercial factors may impose the seller a need for negotiating with potential buyer(s). The law is silent on many aspect of such negotiation and courts have been flexible in accepting different alternatives and structures.
A negotiation of a binding offer under a bid of a judicial recovery process is not provided for in our law. Different from other places such as the United States where the stalking horse[5] is well known and constantly used, this practice is new in Brazil. There are not so many precedents, but it seems the courts will approve any deal which will not harm the social interests involved and the rights of the creditors.
The main questions will be what is the correct time for the negotiations with interested buyers and up to what extend such terms need to be approved in a judicial recovery plan. The law is silent and the precedents have not drawn the definitive orientation.
In some cases, we see the distressed company negotiating a binding offer with an interested party so it can it go to the creditors meeting and have a full approval of all terms. In other cases, it would be more advisable to have general acceptance of the sale in a creditors meeting and having a negotiation with the interested parties afterwards. The legal deadlines and judicial terms also play an important role in the definition of the strategy. The definition of what exactly needs to be approved by creditors in the recovery plan is not yet defined by courts. It seems that if no interested party is harmed, courts will be flexible in this context.
Another important aspect is up to what extent conditions can be negotiated with interested parties. Taking the premise that it would be necessary a bid auction for avoiding succession, an example would be the question of what benefits a party presenting a binding offer can get. Recent cases giving the stalking horses the right to match or the right to top other offers have been approved by courts. The same concept has been applied by courts in these cases. If there is no harm to interested parties, conditions can be freely negotiated.
Many other different legal aspects must be considered in M&A transactions of distressed companies under judicial recovery procedures. It is a field of new opportunities where creativity and legal knowledge will make the difference for transactions to close. Such acquisitions are also a very important resource that will enable businesses to continue operating and new investment come into the country in this time of recession. This a great alternative for companies to have access to the Brazilian market, which is one of the largest in world, being in a safe harbor of not dealing with the complex past liabilities.
[1]The Brazilian judicial recovery was introduced in Brazilian legal framework by Federal Law nº 11.101, 2005. Inspired by the U.S. bankruptcy code's Chapter 11 procedure, it consists in a court-supervised restructuring process destined to recovery of ailing companies by a judicial recovery plan prepared by debtor and submitted to creditors approval, under a General Meeting, and to judge homologation. The introduction of the judicial recovery proceeding in Brazilian legislation represented a true alternative for ailing companies. According to Serasa Experian, the number of ailing companies requesting for judicial recovery has more than quadrupled in last 10 years, from 252 in 2006 to more than 1.015 in 2015.
[2] In this sense the following syllabus:
"CIVIL PROCEDURE. (...) Judicial Recovery. Tax Enforcement. Bid procedure. Asset Sale. No succession by the purchaser. Direct Unconstitutionality Action n. 3934-2-DF. section. 60, sole paragraph, and section 141, II, of Federal Law no. 11.101/2005. Constitutionality proclaimed by Supreme Court. Jurisdiction of the Commercial Chamber of State Court. Precedents of this Superior Tribunal de Justiça". (Superior Tribunal de Justiça, CC 87214, Min. João Otávio de Noronha, j. 03/18/2011).
[3]"JUDICIAL RECOVERY. Disposal of isolated unit production. Although authorized by the General Meeting of Creditors, the selling was held without observing the bidding proceeding. Form and procedures laid down in sections 60 and 142 of Law No. 11.101/2005, explicit rule without possibility of modification by agreement between parties. Disrespect of explicit rule that does not entail the invalidity of the sale, but its effectiveness in face of creditors. Succession maintained. Appeal partially approved". (COURT JUSTICE OF SÃO PAULO STATE: Interlocutory Appeal n. 0151283-56.2012.8.26.0000. Des. Rel. Francisco Loureiro, First Chamber of Trade Law. j. 04/23/2013).
[4]Although the debtor remains in control of the business under judicial recovery, the court appoints a judicial trustee to work with debtor on the judicial recovery procedure. The judicial trustee is responsible for monitoring the debtor's activities, provide reports of its financial statements, presides the General Meeting of Creditors and other administrative duties. In relevant judicial recovery proceedings, the judicial trustee appointed is frequently an audit and consulting firm.
[5]Stalking Horses are third parties which make a certain and public proposal to acquire an asset from debtor, thus establishing a floor price and basic conditions for next proposals to purchase that asset in a bid-like procedure.
The content of this article is intended to provide a general guide to the subject matter. Specialist advice should be sought about your specific circumstances.
