Rafael Tridico Faria
Lawyer at Marcos Martins Advogados
The last few months have required many companies to use up their financial reserves and take on new debts in order to survive the COVID-19 pandemic. Although we are already seeing the reopening of commerce and the resumption of activities, we are still far from returning to the economic level prior to the pandemic. Companies will have to face the new challenges of the “new normal”.
The debts taken on by companies and the benefits provided by the government may have given them a breather so far, but in this new moment it is important for companies to think about and plan their recovery.
At the moment, both creditors and debtors are struggling to meet their commitments and are experiencing similar problems and situations. The manufacturing sector has suffered a major disruption in its supply due to the closure of numerous borders around the world, the retail sector has suffered from closures and interruptions in its activities, and the banking sector has seen defaults rise and credit become more expensive. They all have a common goal: to get back on their feet and survive.
Debt restructuring as a planning tool
In this scenario, debt restructuring is an important tool for companies to be able to plan their next steps with greater certainty . Through debt restructuring, payment terms can be lengthened, fines and interest reduced or even forgiven, with creditors and debtors working together to reach an agreement that will benefit both.
Debt restructuring is the process in which a company’s debts are mapped and prioritized, taking into account the risk of default, the essentiality of the service provided and the company’s strategy. In this way, the company that is restructuring its debts can view its spending on suppliers in a structured way and equalize the most onerous contracts for the new situation it finds itself in. Renegotiating prices, terms and product volumes can be a way of resizing the original contract, making it less costly or even more profitable according to the company’s capacity.
At all stages of a debt restructuring, it is important that creditors are informed and brought into the debate so that they have an understanding of the company’s business situation and the efforts made to reach a consensus. Negotiating a debt restructuring allows creditors to participate in the planning of debt repayment, ensuring greater certainty of repayment.
After mapping out the debts, a proposal must be developed for the creditors, detailing all the points that led the company to request a debt restructuring, so that they can then negotiate a payment plan or contractual adjustment that allows the debt to be paid off in a way that does not overburden the company. It is important to note that debt restructuring also includes an analysis of contracts and default clauses, which can generate fines for breach of contract.
Default fines can generate huge liabilities for a company that is struggling to meet the terms of a contract that had been negotiated in a more favorable situation than the one the company is now facing. The principle of the economic balance of the contract creates the need to renegotiate the contract if its execution becomes excessively onerous. Therefore, the renegotiationof contracts and debts arising from their breach is a way provided for in the legal system to seek security in relationships and avoid the insolvency of the debtor.
Out-of-court reorganization – a legal measure for restructuring debts
Most of the time, when you think of a business recovery plan, you have the instruments of Bankruptcy and Judicial Recovery in mind. However, there is another, lesser-known route: out-of-court reorganization. Established in the same Bankruptcy and Reorganization Law – Law No. 11.101/05 – (“LFR”), Out-of-Court Reorganization allows a company to homologate in court the reorganization plan negotiated out-of-court with its creditors, in order to guarantee compliance with it, providing even more security in its execution.
The requirements for a company to apply for approval of an out-of-court reorganization plan are the same as those for a judicial reorganization, i.e. (i) regular exercise of activities for more than 2 years; (ii) not having already been declared bankrupt; or (iii) not having been granted a judicial reorganization in the last 5 years. Another point of note is that out-of-court reorganization does not apply to tax or labor claims.
Out-of-court reorganization can be an extremely useful tool because it makes it possible to partially renegotiate debts with certain classes of creditors, enabling a much more assertive negotiation with a reduced group of creditors, which facilitates the construction of a plan for paying off the company’s debts . This also brings another advantage: the speed with which an out-of-court reorganization plan can be put into practice, since the negotiation and design of the reorganization plan is done exclusively between private individuals, without the interference of the judicial system.
Once the out-of-court reorganization plan has been approved by the creditors, the company may or may not have it ratified by the courts. Judicial approval is only mandatory when creditors do not unanimously approve the plan. In this case, if at least 3/5 (three-fifths) of the creditors agree, the plan can be ratified in court, binding all the creditors covered by it under the terms of the approved plan.
The procedure for judicial approval of the out-of-court reorganization plan is very simple: once the petition for judicial approval has been submitted, accompanied by all the necessary documents, the judge will order the publication of a notice in the official gazette and in a newspaper with wide circulation nationwide or in the locations of the debtor’s headquarters and branches, calling on all the debtor’s creditors who will be subject to the plan to submit any objections.
The creditors will then have 30 days to object to the plan, which will be limited to just three matters (i) failure to meet the minimum percentage of approval by 3/5 of the creditors; (ii) the practice of bankruptcy acts provided for in art. 94, III, of the LFR or acts practiced with the intention of harming creditors; and (iii) non-compliance with any other legal requirement provided for in the LFR. If there are no objections, the case file will be closed for the judge to approve the plan.
Out-of-court reorganization is therefore much quicker and more affordable in terms of costs, as there is no need to initiate reorganization proceedings, nor is there any major bureaucracy involved in putting it into practice. Another advantage is the lack of involvement of the Public Prosecutor’s Office or a court-appointed administrator in out-of-court reorganization, which means that the company seeking to restructure its debts does not have the exposure and interference of third parties in its day-to-day activities.
On the other hand, out-of-court reorganization does not suspend the rights, actions or executions of creditors who are not included in the out-of-court reorganization plan. Although it is not explicitly stated in the LFR, case law understands that creditors who are subject to the out-of-court reorganization plan will have their collection and enforcement rights suspended as a result of the out-of-court reorganization, providing greater security for the company that has resorted to this institute.
Extrajudicial reorganization is designed to renegotiate debts with a specific class of creditors, so that the company has time to adjust to a new economic situation. Debts that are not covered by the out-of-court reorganization plan will not be affected in any way and in this sense the plan cannot provide for the early payment of debts or unfavorable treatment of creditors who are not subject to it.
Conclusion
Debt restructuring and the use of out-of-court reorganization for this purpose is a very interesting way to readjust contracts and debts due to the new economic situation that many companies have found themselves in during 2020. The agility that out-of-court recovery procedures bring is a great ally for entrepreneurs looking for a quick solution to negotiate with their suppliers and creditors.
Although it does not cover labor and tax credits, Extrajudicial Recovery can be very useful for negotiating a restructuring of debts with a specific group of suppliers or even banks, which at this time are very interested in having a payment plan for their credits that is complied with by the debtor company.
