2017 – a year to renegotiate debt
March 2017 | SPECIAL REPORT: EMERGING MARKETS – OPPORTUNITIES AND RISK MANAGEMENT
Financier Worldwide Magazine
As far as the Brazilian economy is concerned, 2016 was a disaster. After the downturn recorded in 2015, the two-year period spanning 2015 and 2016 will go down in history as one of Brazil’s worst ever economic performances, in terms of consumption, productive investment, production by industry and the services sector and the employment level. There are very low expectations for economic recovery in 2017 and the most optimistic forecasts are for GDP growth of 0.5 percent, with some people expecting zero growth and others another year of retraction. One of the main reasons for this is the current unemployment rate of 12 percent, which is a deterrent to consumption.
One reason for the delay in economic recovery is the level of indebtedness of the private sector, which leads to the postponement of investments and a rash of company failures.
The Serasa Experian Index of Bankruptcies and Reorganisations indicates that in 2016, 1863 companies filed for judicial reorganisation, up 44.8 percent on 2015. In 2015, 1287 companies filed for reorganisation, and there were 828 in 2014. This escalation in reorganisations is a clear indicator of the deterioration of the economy.
As reported in the newspaper Valor, the International Monetary Fund (IMF) has issued a warning about the rate of growth of debt held by non-financial companies and families in Brazil over the last 10 years, which is nearly twice that of other emerging countries. The IMF report calls this expansion of private debt, by more than 35 percent of GDP between 2005 and 2015, a source of “significant vulnerability” in the economy.
In theory, the prospect of a steeper fall in the SELIC rate, the Brazilian Central Bank's overnight rate, should alleviate the financial difficulties of the private sector, as rate cuts mitigate the effects of this indebtedness. Lower interest rates should help improve the delicate financial situation of companies and consumers.
However, many private sector companies are up to their necks in debt, and need an immediate solution. For these companies, the forecast made by certain banks that the SELIC rate will be down to around 9.5 percent by the end of 2017 is of no help at all. These companies cannot wait for the next meeting of the National Monetary Council in the hope of a cut in rates. One reason for this is that interest rate cuts are not likely to affect existing loan agreements. Moreover, the political situation casts serious doubt on the likelihood of approval of the reforms that are essential for growth to take off (pensions, outsourcing and so on).
What is becoming commonplace for companies, however, is that working capital itself is starting to be eroded by debt service. Company owners therefore face the need to renegotiate their debts immediately if they want to save their business.
However, debt renegotiation, under the laws on bankruptcy and judicial reorganisation, faces a huge obstacle in the shape of the intransigence of a majority of financial institutions on the terms of debt repayments with a fiduciary guarantee of assets.
In the case of the debtors, there is a great deal of ignorance about the effectiveness of fiduciary guarantees, apart from the perception that the holder of fiduciary security has the power of life and death over a company.
Although the holder of fiduciary security is indeed the owner (the so-called conditional ownership of specific assets), this situation is tempered to the extent that in the current depressed economic conditions, the value of security corresponds precisely to the market value of the assets themselves, rather than to the amount of the debt.
In any event, in view of the intransigent posture of financial institutions, there are few openings for an amicable restructuring of loans. The banks look at the fiduciary security they hold (which is not always well documented) and appear, wrongly, to think that they are immune to a judicial reorganisation.
The law provides for three different regimes for fiduciary security: (i) the Civil Code regulates fiduciary ownership of non-fungible movable property, when the creditor is not a financial institution; (ii) Article 66-B of Law No. 4.728/65, supplemented by Law No. 10.931/04 and Decree-Law No. 911/69, regulates fiduciary ownership of fungible and non-fungible movable property, when the fiduciary creditor is a financial institution; and (iii) Law No. 9.514/97, also amended by Law No. 10.931/04, regulates fiduciary ownership of fixed assets, whether the creditors are financial institutions or not.
Case law would suggest that the banks need to negotiate and adjust repayments to their customers’ cash availability.
In the case of fixed assets, Law 9.514/97 regulates the creation and the execution of a fiduciary guarantee. Article 27 defines the procedures of the creditor in executing the fiduciary transfer of a property. This includes the requirement for the property to be sold, for the proceeds of the sale to be calculated and for any surplus to be returned to the debtor. Thus at the first auction, the creditor must offer the property for sale at the original amount of loan. If no bid is received for this amount or more, a second auction takes place over the following 15 days. At this second auction, the property will be offered at a minimum price equivalent to the outstanding balance of the loan/financing agreement plus expenses, insurance premiums, legal charges including tax and condominium fees. If at this second auction no bid is received for at least this amount, the debt is considered to be extinct and the debtor is released from the obligation to pay any remaining balance to the creditor. Additionally, the creditor must give a discharge to the debtor within five days of the date of the second auction. This release of the debtor is known as legal forgiveness.
Accordingly, in a real estate market that is also depressed, the chances of selling a property for the amount financed tend to be remote.
In the case of movable property, case law exists to the effect that once a creditor has executed a guarantee, the balance of the loan not covered by the value of the asset or the security of contracts under Article 49, paragraph 3, of Law No. 11.101/2005 (contracts for the fiduciary transfer of assets) is unsecured debt, subject to judicial reorganisation.
In the same way as for real estate guarantees, the sale of movable property for the value of a loan is extremely unlikely, and the remaining debt will be included in the mass of unsecured creditors in a judicial reorganisation process.
Fiduciary assignment of debt under a trava bancária (sometimes translated into ‘banker padlock’, a loophole in the law allowing the receivables assigned to be excluded from a judicial reorganisation), in the form in which this is commonly used, represents abuse of economic power by the banks, since the law does not allow financial institutions to block even the sums to be used for repayment of maturities in a specific month. The surplus must be transferred to the debtor, or the transaction will be jeopardised. The courts should therefore review the trava bancária.
Another highly controversial issue is the fiduciary assignment of future credit, and this should be more thoroughly examined by the courts. There should be a case-by-case assessment of existing agreements under which repayments are to be made in the future, provided that the legal requirements are met and that the trava bancária is not used abusively. As for receivables that do not yet exist, it is obvious that they should be formally assigned and the assignment registered.
Finally, according to a decision rendered on 7 February 2016 by the 2nd Bankruptcy Court of the City of São Paulo, foreign financial institutions which are not registered to operate in Brazil are not entitled to obtain fiduciary guarantees which were declared null and void by the judge.
Thus the courts have been creating very clear rules which, although not making loans any less onerous, should be adopted by the banks; and if this happens, the result should be more flexibility by the financial institutions in renegotiating debts.
Instead of handing the keys to their business to the bank, company owners should be looking for competent professionals to advise them and help them identify the best renegotiation options. So the time has come to renegotiate debt, without waiting for a real fall in the SELIC rate.
Antonio Mazzucco is a partner at Mazzucco Donelli Mello. He can be contacted on +55 11 3090 9195 or by email: antonio.mazzucco@mdmlaw.com.br.
© Financier Worldwide
BY
Antonio Mazzucco
Mazzucco Donelli Mello
Emerging markets – opportunities and risk management
FORUM: Managing and resolving commercial disputes in Africa
Financial restructuring and insolvency challenges in emerging markets
Mexico: emerging market, opportunities for new investments
Venture capital transactions in Mexico
2017 – a year to renegotiate debt
Virtual share plans: the right tool for Hungarian startups to attract and keep talent?
Factors driving emerging market investment activity
India – a front runner among emerging markets
Exits by foreign investors: decoding the pricing norms
Legal sanctity of ‘cherry picking’ assets in slump sale deals
How investors ought to think about investing in Africa
African diamonds: challenges, risks and opportunities in the African emerging markets
Risks associated with investing in emerging markets – Nigeria in focus