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An analysis of reorganizing bankruptcies in Brazil: assessing and understanding

failure or success.

[Note: This is an advanced ‘work-in-progress’ draft, not a final version. This version is

not ready to be submitted for publication nor shall be cited without author’s permission]

Orlando Celso da Silva da Neto1

Introduction.

Brazil’s new bankruptcy act (Law 11.101/2005) is about to complete 12 years this

summer. The law it superseded was enacted in 1945 and was widely considered not to

present adequate tools for reorganizing a distressed yet viable firm. Its provisions about

the liquidation of a distressed and non-viable company were also considered non-

efficient.

The new law, enacted in 2005, has received wide praise as a modern, state of art

tool, one that had all it took to allow distressed companies to reorganize successfully

striving yet viable businesses. It was inspired by the U.S Bankruptcy Code and by

Germany’s InsolvenzOrdnung. The new law expressly states that its goals are to allow

the reorganization of distressed firms as going concerns, thus preserving jobs, production,

assets’ value and maximizing creditor’s recovery. I consider (as does the Brazilian Law)

that preservation of the company as a going concern is usually a better (in the sense that

it preserves more value) solution for a distressed company than its liquidation, as Warren

and Westbrook2 affirm:

“[Chapter 11] reorganization is held up as the alternative to liquidation, a

solution that can put more dollars in the pockets of the creditors, save more

jobs, and preserve local tax bases. At least as to the first objective, Professors

Bris, Welch, and Zho say the data back up the claim. In their study of

confirmed plans, they conclude that ‘the average Chapter 11 case retains

value seventy-eight percent better than the average Chapter 7 case’”

1 Adjunct Professor, The Law Department, The Federal University of Santa Catarina. Vice-president (2016-

2017), Brazilian Law and Economics Association. 2 Elizabeth Warren & Jay L. Westbrook, The Success of Chapter 11: A Challenge to the Critics, 107 Mich.

L. Rev. 603 (2009).

Available at: http://repository. Law.umich.edu/mlr/vol107/iss4/2.

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I argue in this essay that the goals set by the Brazilian bankruptcy have not been

achieved. In addition to my perception as a bankruptcy practitioner, there is a growing

consensus among practitioners, scholars, judges and even politicians3 that the law has not

achieved its stated purposes. Conventional wisdom, however, may sometimes be plainly

wrong. Data analysis, on the other hand, may give the scholar a much better understanding

of the facts and may lead to conclusions that demonstrate conventional wisdom is not

supported by the factual reality4.

I believe that in the topic analyzed in this essay conventional wisdom and

empirical analysis converge and end up in the same conclusion: the Bankruptcy Act has

failed to achieve its goals. I will demonstrate that and will point some of the reasons why

that has occurred.

Determining whether something, someone or some institution has failed or has

been successful requires establishing standards and goals that are both objective and

measurable. It is often a hard task, as Warren and Westbrook point:

‘The idea of success in an ongoing, viable business can be elusive. On the one

hand, a confirmed plan does not guarantee a successful future for the business.

The evidence that a number of companies return to Chapter 11 after

confirming a reorganization plan suggests that not all business will enjoy

smooth sailing post-bankruptcy. Even if a company does not soon return to

the bankruptcy court, the definition of ‘success’ in this context is subject to

considerable debate. How long does a company have to exist post-

reorganization before it is deemed a ‘success’? Must it be alive for ten years?

Five years? Two years? What if it shrinks in size? Must it be profitable all or

part of that time to be a success? What if it is purchased in year three? These

and many similar questions make it difficult to pinpoint what constitutes

success following confirmation.”

Trying to reduce both uncertainty and elusiveness and to avoid some pitfalls, the

methodology I employ assesses the success of failure of a law or institution by the degree

to which it achieves the goals stated explicitly in the text of the law (in this case, Article

47 of the Bankruptcy Act) using marks set in the Bankruptcy Act itself. It is a simple

metric but it was thought to work well for the purposes of this essay5. I considered:

3 Congress is currently discussing several proposals for amendment of the Bankruptcy Act. 4 Warren and Westbrook argue that ‘the claim of failure of Chapter 11 has been easy to make’ due to a

couple of early studies that have used poor data and wrong methodology, but have reached widespread

divulgation. 5 As it will become clearer with further reading, I later found that the analysis of success/failure is better

accomplished with analysis of more complete information.

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(a) Fully successful the reorganizing bankruptcy in which the reorganization plan

was approved by creditors and complied with by the debtor up to the date the

reorganization period was considered ended by the bankruptcy judge in charge of the

case, even if its total length exceeds the statutory 2 ½ years;

(b) Successful the reorganizing bankruptcy in which the reorganization plan was

approved by creditors and complied with by the debtor by the time the case was analyzed,

but there was no court decision closing the reorganization period, even if plan

confirmation has exceeded the statutory 180 days;

(c) Unsuccessful the reorganizing bankruptcy in which there was no plan

presentation, or on which plan was not approved by creditors or, if approved by creditors,

the plan’s obligations were later defaulted by the debtor and in either case court ordered

involuntary liquidation of assets.

I understood from the beginning that these criteria were objectionable because of

their limitations, as they do not consider the ‘financial’ and ‘operational’ success of the

reorganization. Analyzing success from this enlarged perspective would require extensive

analysis of balance sheets and other financial data. Such data, if obtainable6, would allow

for a ‘before’ x ‘after’ comparison of reorganizing companies’ financial health and would

allow for a more comprehensive understanding and ascertaining of the success of

reorganization procedures in Brazil. I did not have the resources to do such analysis at

this point, so had to settle for a more specific and limited analysis.

Analysis method and sample.

I analyze a sample composed of 15 bankruptcy cases, chosen accordingly to the

criteria below. I had to adjust7 the research group due to data gathering difficulties, but

managed to sort a sample with some or all of the following characteristics:

6 This data would only be obtainable after complete review of dockets. And even so, maybe not to the

necessary extent. Companies seeking reorganization need to present statements for the three years previous

to the filing and do not have to present a statement upon completion of reorganization. 7 If compared to the original project proposal, which was to analyze at least 30 cases.

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(a) Are easily accessible; meaning that case data is public information8 and can be

accessed through an available on-line court system;

(b) The initial petition has been filed before December 31st, 2014;

(c) Have been filed by companies located in the State of Santa Catarina or are

nationally relevant cases;

(d) Are considered (by the local legal community) a relevant local (State of Santa

Catarina) bankruptcy or are nationally relevant cases.

There is no readily available data for the purposes of this research, so I had to

‘harvest’ and ‘collect’ the necessary data from the case files9. This involved a thorough

examination of documents on the case dockets10, executed solely by me without any help

in a period of approximately 3 months.

Due to research and researcher’s time and resources limitations, the total number

of cases analyzed was limited to 15, but involving 51 companies in total. I divided the

research in two analysis groups, one containing 10 cases from my local state of Santa

Catarina and 5 involving big nationwide famous reorganization cases. The sample may

seem small, but it provided data consistent enough for a series of conclusions.

The analysis also convinced me that future research, to be executed with a larger

number of cases, should analyze other variables and data, such as financial indicators

(debt vs. assets ratio, debt vs. revenue, EBITDA, operational margins ex-ante and ex-post

reorganization and others). I acknowledge that the number of cases analyzed does not

allow me to consider the results of the research as representative of a countrywide reality.

I employ economic analysis of law methods to model the expected behavior of

agents under the law and to provide a better understanding of parties’ behavior (including

whether or not they behave strategically). I also use economic analysis to obtain a better

understanding of existing incentives for cooperation or conflict in the current legal

8 Not all case documents are available on-line. Some need to be consulted in court. 9 As Marcelo Guedes Nunes (Jurimetria, Saraiva, 2016, p. 174) points out: “Statistics research has always

been dependent on data collection. Collecting data is undoubtedly the most expensive part of any research,

because it depends on contracting, training and supervising the work of several field researchers, available

to travel to different places, which, through interviews and form filling, will obtain the necessary data. Costs

related to data collection were deterrent to a national level research, considering the amount of researchers

needed to collect data” [translation by author, original text in Portuguese]. 10 Some cases have over 10.000 pages and hundreds of documents.

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structure, as well as to propose legislative changes that may make the law more efficient

in the promotion of its stated goals.

Previous research and data on the subject.

To the best of my knowledge, there is no thorough research on the success/failure

of the reorganizing bankruptcies in Brazil. There are a number of ‘educated guesses’ but

as can be seen below, they are not based on any relevant data study.

In October 14th, 2013, the ‘Estado de São Paulo’ newspaper published a report

alleging that only 1% of the companies that applied for Bankruptcy reorganization had

successfully complied with all the plan’s commitments. The results are on a study

executed by a consulting company and a Law firm and affirms that from February 2005

until October 10th 2013 approximately 4000 companies had filed for reorganizing

bankruptcy but only 45 of them had successfully complied with all the plan’s

commitments. It also affirms that only 23% of the companies had their reorganizing

plans’ approved by creditors and 398 were liquidated. The remaining is said to ‘simply

drag in Court without a final definition’. I have not had access to the study and its

methodology.

The same newspaper published a later piece (June 20th, 2015) where then director

of private non-profit ‘National institute for corporate reorganization’ (INRE) and São

Paulo state appeals judge Carlos Henrique Abrão affirmed that INRE data showed that

around 30% of Brazil’s reorganizing bankruptcies were successful, compared to around

65% in the United States.

On an interview published on June 12th 2016 on the legal news site CONJUR11 ,

the same State Appeals12 judge Carlos Henrique Abrão, who specializes in bankruptcies

judgements and has written several books on the subject, affirmed that ‘the success rate

for companies that comply with their reorganization plans is 5%’.

I am not aware where or how any of the data mentioned above was collected, but

my belief is that it is not something empirically ascertained, rather a practitioner’s

feeling.

11 http://www.conjur.com.br/2016-jun-12/entrevista-carlos-henrique-abrao-desembargador-tj-sp,

Appendix _____. 12 In Brazil, while the Bankruptcy Act is federal law, bankruptcies are competence of state courts.

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The Bankruptcy Act: logical structure and public policy goals.

The Bankruptcy Act presents a very elegant logical structure and sequence of

procedural actions. Its structure is somewhat less extensive and less detailed than U.S

bankruptcy Code Chapter 11. It is, some could say, a simpler procedure, what is not, per

se, a bad thing.

If fully observed by the bankruptcy actors/stakeholders (debtors, creditors,

prosecutors, trustee) the sequence will lead to a quick approval or rejection of the

reorganization plan (as per statutory terms, no more than 180 days).

If rejected, an involuntary liquidation of assets will follow (unless the bankruptcy

judge issues a ‘cram down order’). If the plan is approved by creditors, the bankruptcy

judge will confirm the creditor’s assembly decision (unless it contains unlawful

provisions) and reorganization will commence according to the approved plan13. The

Bankruptcy judge will not apply any feasibility test or control, such as those of Section

1129 (a) of Chapter 11 of the U.S Bankruptcy Code.

Notwithstanding the fact that the plan may provide for arrangements that allow

debt to be repaid over a long period of time, the Bankruptcy Act considers the

reorganization to be fully implemented and complied with (for legal purposes) if debtor

complies with all obligations that come due within 2 years of creditors’ approval of the

plan. The bankruptcy Court will, at debtor’s request, consider reorganization to end after

this 2-year term. The end of reorganization, however, does not mean the right to a fresh

start, and all remaining past obligations will be due on their new maturity date, as

redefined by the confirmed plan.

The chart below provides the reader with a notion of the logical structure of the

Bankruptcy procedure:

13 For those not familiar with the liquidation/reorganization dichotomy, Michelle J. White [Economic

analysis of corporate and personal bankruptcy law. NBER working paper 11536] provides a concise

explanation: “when corporations reorganize rather than liquidate in bankruptcy, the reorganized corporation

retains most or all of its assets and continues to operate. The funds to repay creditors then come from the

reorganized’s firm future earnings rather than from sale of its assets. The rules for dividing the pie in

reorganization also differ from those in liquidation. Instead of dividing the assets so that creditors receive

either full payment or nothing, most creditors receive partial payment and pre-bankruptcy equityholders

receive some of the reorganized firm’s new shares. Bankruptcy law again provides a procedure for

determining both the size and division of the pie, but the procedure involves a negotiation process rather

than a formula.”

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Compliance with the Bankruptcy Act deadlines: analysis and comments.

As seen from the flow chart above, the plan should be approved or rejected on no

more than 180 days (not coincidentally, the same length as the ‘stay period’ granted when

the initial bankruptcy petition was filed by the debtor). Failure to achieve a creditors’

decision about the plan (and consequently a creditors’ decision about the feasibility of the

company’s reorganization) and Court confirmation of the plan (or the order to liquidate)

within 180 days will create uncertainty and other negative effects.

The excess may be justified by extended negotiations or court delays, as the

analysis shows to often be the case14, but not meeting the 180 days deadline is otherwise

considered a sign of a possibly defective procedure and of a non-reorganizable business

(i.e, non viable company).

I analyzed the following procedural marks to find whether this 180 days term had

been exceeded and then try to determine the reasons why it had been exceeded:

1 – (date of) Initial bankruptcy petition filing.

2 - (date of) debtor’s petition presenting the reorganization plan to Court

3 – (date of) creditors assembly

14 In fact, in all analyzed cases the term was not met.

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4 – (date of) bankruptcy judge’s decision concerning the results of the assembly.

5 - (date) reorganization was considered concluded by Court.

The results of the analysis are in the chart on Appendix A and C (Santa Catarina

state cases) and B and D (big national cases).

The results show that in all 15 cases the 180 days term was not met. On 5 cases

there was a court ruling (confirming the plan or ordering liquidation) within 270 days, on

3 within 360 days, on 5 within 720 days, on 1 on a longer than 2 years spam (737 days)

and on 1 there is no decision to date15, even if 1902 days have passed since filing. The

Bankruptcy Act clearly states that confirmation of the plan (or an order to liquidate) must

be obtained within 180 days, but a longer period is not an evil in itself.

Warren and Westbrook conclude that the United States experience shows it takes

longer for a successful reorganization to be confirmed than for a case to be dismissed.

They affirm16:

“Success carries its own costs, and taking the time to succeed is obviously one of

those costs. Cases can fail quickly, but the data suggests that the negotiations,

proposals, and strategies employed to resuscitate a failing business take time […]

failures move out of the system quickly, while {there is a] necessarily slower pace

of successful business reorganizations”

In my samples, I found no correlation between a longer confirmation span and a

higher success rate. I assume that longer confirmation spans relate more to poor plans

being presented to court and in creditors being tolerant with debtor non-compliance with

deadlines than with long and complicated negotiation efforts17.

Given the incentives structures at play, being tolerant is the rational attitude. The

tolerance from creditors is justified because, on one hand, they already consider their

credit ‘sunk’ (a loss) and on the other, because Brazilian Law does not allow creditors to

impose debtor the acceptance of a more rigorous plan, especially one that includes change

of management or loss of ownership.

Once I established that the deadlines set on the Bankruptcy Act are often not met

I then went on to try to understand why such deadlines are not being met and why does

‘not meeting deadlines’ matter (if it matters at all).

15 Considering to date as May 31st, 2017. 16 Warren and Westbrook, cit., p. 633. 17 This assumption comes from reading minutes of creditors’ meetings, where it becomes clear in most

cases that not all creditors have a clear understanding of the plan they are about to vote.

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It matters because the Bankruptcy Act’s clearly states its purposes on Article 47

of the Law. The Act states that reorganizations are meant ‘to overcome the economic-

financial crisis; allowing for maintenance of the productive entity, jobs and creditors’

interests, thus preserving the firm, its social function and fostering economic activity’.

Brazilian legislators clearly wanted the reorganizing company to go through an expedited

procedure to define whether it could be reorganized or not, not to dwell endlessly on a

pre-confirmation status. The Bankruptcy Act is clear: if not viable, the company should

then undergo a quick liquidation18.

Given that clear intention, failure to meet deadlines may indicate company’s

failure to identify its problems as well as the causes of its crisis. It may also send to

creditors a message that the company is striving to identify and develop a set of ‘turn

around’ measures and to convince creditors that the indebted company has the means and

the will to implement the measures proposed in the reorganization plan. The reorganizing

company may therefore not be a viable company.

Sure, not all deadlines depend exclusively on debtor. Several steps leading to

confirmation depend on creditors’ meetings and Bankruptcy judge’s decisions, but it is

undoubtable that debtor’s role is by far the most prominent. Most of responsibility for not

meeting the deadlines fall on debtor’s shoulders.

Meeting deadlines also matters (or should matter) because according to the

Bankruptcy Act, if plan is not presented within the deadline, the company is considered

‘unreorganizable’ and its liquidation will be mandatory, unless the Bankruptcy court finds

the delay to be justified. An unjustifiable delay can also mean an indicative that

liquidation, rather than reorganization may be the preferred legal solution for the

struggling company. Allowing the non-viable company to continue its strive for longer

than the statutory 180 days may be inefficient and market damaging, as the company is

18 In a way, the intention and purposes of the Brazilian Bankruptcy Act are pretty much the same as the U.S

Bankruptcy Code. As Michelle Arnopol (Why Have Chapter 11 Bankruptcies failed so miserably: a

reappraisal of congressional attempts to protect a corporation’s net operating losses after Bankruptcy, 68

Notre Dame Law Review, 133 (1992), p. 134 affirms: “When Congress enacted the Bankruptcy Reform

Act of 1978, and created the Chapter 11 bankruptcy provisions, it envisioned that troubled business could

use Chapter 11 as a tool to restructure and continue as viable concerns. The House committee report

emphasized that ‘the purpose of a business reorganization case, unlike a liquidation, is to restructure a

business’s finances so that it may continue to operate, provide its employees with jobs, pay its creditors,

and produce a return for its stockholders’.

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likely to increase its debt by continuing to default on its old (and sometimes even in new)

suppliers and other creditors1920.

In order to understand what causes this excess to happen, I then went on to a more

specific analysis, in order to assess how long the debtor had taken (after filing the initial

petition) to present to court its reorganization plan. This should happen, as mandated by

law (Bankruptcy bill, Article 53) within 60 days of the publication of the judicial decision

granting reorganization processing.

The failure to present a plan on the statutory term of 60 days is a likely indicative

that the company is not only struggling financially, but has no capacity to understand its

internal difficulties and the actual causes of its crisis. It can also mean that it does not

have the capacity and ability to propose the necessary and sometimes hard turn around

measures.

Even in the latter case, data shows that creditors will likely ‘look the other way’,

as long as plan is presented eventually. Worse than that, the ‘look the other way’ approach

is applied not only concerning missed deadlines, but also concerning the analysis of plan’s

content and substance.

It is worth noting that minutes of creditor’s meetings do not show any relevant

discussion about the efficiency of the turn-around measures and feasibility of plan in

general21. The main discussion points are discounts and payment dates. Not surprisingly,

plans with very little substance and consistency are approved by creditors. To make

matters worse, the Bankruptcy Act has no provision for judicial confirmation of the plan

based on its feasibility22.

19 I did not go deeply in this sort of analysis, what I intend to do in future research, but as an example,

Metalúrgica Duque, one of the analyzed cases, saw its debt increase approximately 12 million dollars in

2014, year it filed for reorganization. This is approximately 30% of its prior debt. The total amount of debt

continued to increase after the filing. Varig, Brazil’s then leading aircraft carrier, entered reorganization

with approximately 3 USD billion debt and was liquidated 4 years later owing approximately 8 USD billion. 20 Alan Schwarz. The law and economics approach to corporate bankruptcy. Doutrinas essenciais: Direito

empresarial. Volume VI, p. 26-27 states that. “such a {insolvent} firm may be experiencing economic

distress, financial distress or both. A firm that is experiencing economic distress cannot earn revenues

sufficient to cover its costs, exclusive of financing costs. A firm in financial distress would have positive

earnings were it not required to service its debt. Since the amount that firms borrow is sunk when insolvency

occurs, a firm’s debt is irrelevant to the question whether the firm should be continued or not. It then follows

that economically distressed firms should be liquidated because these firms have negative economic value.

Firms that are only financially distressed, however, should be continued as economic entities, with their

debts canceled or rescheduled.” 21 I analyzed minutes of meetings held in 9 out of the 15 cases in this research. Creditors express vague

concerns about the feasibility of the turn-around measures proposed in the plan. No plan is rejected because

creditors expressly affirm that plan is not feasible. 22 In the U.S, Section 1129 (a) of Chapter 11 of the U.S Bankruptcy Code mandates Courts to reject plans

that are not feasible.

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The analysis show that a missed deadline is of no consequences to debtors. On

only 2 cases23 the plan was presented on due time (within the 60 day period), on 6 cases

it was presented within 90 days, on 3 cases it was presented within 120 days, on 2 cases

within 180 days and on 1 case on a period superior to 180 days. These findings suggest

that Brazilian practice is quite different from U.S reality24, as in all cases a plan was

presented.

A relevant question that arises out of these findings is whether creditors can trust

a company to be able to reorganize itself and become a viable business if it cannot present

a plan within 60 days of its reorganization filing.

The intuitive answer is that they cannot, but oddly enough, that does not seem to

be a problem. I could not find any complaint by creditors in the minutes of creditor’s

assemblies about deadlines fixed in the Bankruptcy Act not being met by debtor. It is

worth registering that most discussions registered in the minutes of creditors’ meetings

are about proposed payment extensions and discount terms, not about failure to meet

deadlines, nor about the feasibility of the plan or the efficacy of turn around measures.

This observation led me to conclude that not meeting deadlines is not a problem

in itself. Not meeting deadlines is a symptom of the disease that leads to the failure of

reorganizing bankruptcies, not the disease itself.

Then, what is the ‘disease’? Why legal deadlines are not met by debtors and what

is the cause or causes of reorganization failure? Not meeting the deadlines is a symptom

of a broader problem, but it has been shown that most companies (all in the analyzed

sample) trying to reorganize end up presenting a plan eventually and that creditors tolerate

delays.

My conclusion is that the problem is not the delay in presenting plans, but their

quality and consistency. Simple presentation of the plan is not a sign that a company can

reorganize itself successfully, but only a sign it wants to continue to exist, even if not a

viable business. It is a well-known and generally established fact that a well-construed

plan is one of the most important reasons for the success of a reorganization25. A good

23 The sample is 14 cases, as I could not obtain plan presentation date for one of the analyzed cases. 24 Warren and Westbrook affirm that in many cases plans are never submitted by debtors. 25 Fowler Monteiro, Caleman and Pongeluppe (ACAD MANAGE PROC January 2016 2016 (Meeting

Abstract Supplement) 13746) point out that “The reorganization plan is one of the most important elements

in reorganization bankruptcy processes. It is a roadmap for the firm’s turnaround and the core element

whose feasibility the court assess in order to decide on the request for bankruptcy protection. (…) We find

that a good diagnosis of the factors causing the crisis and the clear identification of the competitive strengths

of the firm are positively related to the improvement of the financial situation of the company. On the other

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plan is no guarantee of success of the reorganization, but a bad plan is almost certainly a

guarantee of its failure.

Fowler Monteiro, Caleman and Pongeluppe26 affirm:

“one of the most important elements of reorganization bankruptcy is

reorganization plans. If a plan is consistent, there is a chance that the company can

restructure itself and overcome the crisis. If a plan is inconsistent, it is merely

pages devoid of meaning and has the sole purpose of meeting legal prerequisites,

then the recovery of the company can never occur”.

The failure to meet statutory deadlines, most likely, consist in poorly constructed

plans and in non-viable companies trying to reorganize. Both in Brazil and in the United

States the entrance door for reorganization is wide open27, but in the United States the

exit door is narrower. In Brazil, as the results of this research point out, it is easy to start

reorganization, but very hard to get out of it as a viable and healthy company28 and go on

with corporate life.

The observer’s first thought would be that poor unsubstantiated plans would not

get approved by creditors. The results of the research show otherwise, as on only 2 out of

14 cases plan was rejected29. The question then becomes how come these companies with

poor unsubstantial plans and no viability whatsoever to reorganize get their plans

confirmed (or at least avoid being liquidated right after first missed deadline, as is the

rule) by creditors?

That is where the application of some tools and tests of economic analysis of Law

come in handy. Creditor’s actions (or lack of action) are explained by simply looking at

the incentive structure created by the Bankruptcy Act. Reorganizing companies’ debt

generally exceed considerably its assets. In case of liquidation, only a few privileged

creditors will actually recover their money (at least a tiny part of it). These privileged

creditors are usually employees, which have a second interest, at least as relevant as their

hand, reorganization plans that bring only resource analysis are associated with the decline of the financial

situation of the company. 26 Cit, p. 3. 27 Warren and Westbrook (cit, p. 617) affirm that “the challenge for a reorganization system is to identify

those [companies] that do have a realistic chance to succeed. In effect, the large front door for Chapter 11,

which admits both companies that can be saved and DOAs, is likely to yield relatively lower total

confirmation rates, even if the system is wildly successful in dealing with business that have any hope of

reorganization.” 28 Although, as results of the research show, not so hard to simply get out of it. 29 Even in these 2 cases there were court battles where debtors tried to force confirmation through judicial

‘cram down’ confirmation orders.

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primary interest (securing payment), to maintain their jobs. They will not push or force

liquidation.

Brazilian Law does not allow a reorganization to continue in conditions imposed

by creditors and not accepted by debtor shareholders. Creditors’ choice is limited to

confirming the plan proposed by debtor or rejecting it, which will lead to liquidation. That

structure allows a kind of ‘chicken game’ between debtors and creditors and does not

incentive cooperation and good faith negotiations. That ‘lack of powers’ by creditors is

heavily criticized by scholars, but that is the rule of the game as it exists now.

Other creditors may have exclusively the interest of being paid, caring little or not

at all about continuance of the firm, but unsecured creditors (usually the majority of

credits and creditors) may fear that if liquidation occurs they will not get payment.

Therefore, they will not push for liquidation. Secured creditors, on the other hand, might

be willing to adopt a tougher, less permissive, stance, but they have no vote on what

concerns plan’s approval.

As no credible threat of forced liquidation haunts the debtor, it has no real

constraints or incentive to present a viable convincing plan on the strict deadlines imposed

by the Bankruptcy Act. True, meeting the deadline might come to its advantage,

especially if it is a company effectively viable and committed to reorganizing, but there

is no effective sanction or real risk if the date is missed.

Many times, however, the managerial mess is so big that the company cannot even

identify what is draining its resources, what are its competitive advantages, its strengths

and weaknesses, even if it means in good faith to reorganize. As mentioned before, in

Brazil, companies may not be able to identify its weaknesses, but they will nevertheless

present reorganization plans.

After the plan has been deposited, creditors’ assembly to approve/reject the plan

will convene. The assembly should happen no more than 90 days after the plan’s deposit

in Court and preferentially within 60 days.

Once again, there is no pressure on debtor to comply with statutory deadlines. The

sample analysis showed that on 10 out of 13 cases30 the time length between plan

presentation and first creditor’s assembly was superior to 90 days. In only 3 cases

creditors assembly happened in less than 90 days after plan presentation.

30 The sample for this comparison is 13 cases, not 15, as on one the plan was never presented (Ponte Aérea

Travel Agency) and in another (VASP) I did not have access to the date the plan was presented.

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Out of the 14 cases in which debtors had its plan confirmed by Court, 3 are still

on reorganization (2 year period has not expired), 5 are still in reorganization even if the

2 year statutory reorganization period has ended, 4 have come out of reorganization31 and

liquidation was ordered on 2 cases.

As seen above, all companies that presented plans had its plan confirmed by

Courts even when creditors’ assembly rejected it32. However, only 4 out of these were

considered to have complied with all its plan obligations that came due within 2 years of

plan’s approval33.

Conclusion.

While planning the research I expected to find that over half the cases analyzed

were unsuccessful. Such high rate of failure would support the general understanding that

the law does not achieve its explicit goals.

Considering the methodology originally proposed for assessing success/failure, I

found that 4 out of 15 cases were ‘very successful’, 8 are ‘successful’ and 3 were

unsuccessful. The ‘failure rate’, as per the proposed methodology is 20%, much lower

than anticipated.

The main finding of the research, however, is that the metric and the standards

chosen do not allow for a proper and thorough assessment of success or failure of

corporate reorganization under the Brazilian Bankruptcy Act.

The result obtained, far from making me conclude that the Bankruptcy Act is

achieving its expressed goals, makes me conclude that the measurement standards chosen

for this research are incomplete and do not serve as good metrics for measuring

reorganization success. The 80% success rate found is, to say the least, misleading.

Analyzing success and failure considering only compliance with statutory

deadlines does not give the researcher a thorough understanding of the actual success or

failure of a reorganization procedure. Just comparing the dates procedural events occurred

with statutory deadlines does not allow the researcher to know if the reorganizing

company has actually reorganized itself and become a viable healthy company; in fact, it

31 But in at least one of these cases (VARIG), coming out of reorganization was followed by liquidation

shortly (9 months) thereafter. 32 This has happened in 2 out of 14 cases. 33 Varig falls in this group, but can hardly be considered a success, as its liquidation was ordered only 9

months after completion of reorganization and its debt grew by 157%.

15

may have come out of the reorganization in worse financial shape, which goes against the

Bankruptcy Act stated goals34.

I will continue the research and in a sequel essay will appoint the main causes that

lead to plan rejection and/or plan default, using a broader, more complete, definition of

failure, including comparison of financial data prior and post reorganization. I am more

convinced now than I was before starting this research that the reorganization process in

Brazil fails more than it succeeds.

As a starting point for future research, the data obtained in this research has been

very useful. Data analysis already allow me to point out several probable concurrent

causes to companies not reorganizing successfully35:

- Debtor’s failures to present consistent and convincing plans in due time (60

days), helped by creditor’s tolerance to such delays, lead to statutory terms not

being met. The possibility that a missed deadline may lead to liquidation is not

a convincing threat;

- Creditors, with rare exceptions, do not have the information whether or not

reorganization is viable and do not seem to care. Rather, they seem to consider

that their credit is ‘already sunk’, so whatever comes out of reorganization is

considered a ‘plus’ and they will tolerate all sorts of missed deadlines;

- Companies that file for reorganizing bankruptcy are heavily indebted and,

with few exceptions, have been producing constant operational losses long

before filing for reorganization; as a result, the ‘point of no salvage’ has been

long crossed and there is no real possibility of transforming the struggling

business into a viable one;

- Minutes of creditors’ meeting do not show any argument about the efficiency

of the turn-around measures and feasibility of plan in general, rather the

emphasis is on discounts and payment dates. Not surprisingly, plans with very

little substance and consistency are approved by creditors.

34 As an example, I found that at least 4 companies that are classified as having a very successful or

successful reorganization had significant increases on its debt during reorganization. One of them is

VARIG, that came out of its reorganization on September 2nd, 2009 and had its liquidation ordered on

August 20th, 2010. During its reorganization (approximately 5 years), total debt grew by 157%, from

approximately 3 billion USD to approximately 8 billion USD. Hardly a good measure of success … 35 Considering a broader definition of success, including not only compliance with statutory deadlines but

also financial improvement of the reorganizing company.

16

- In Brazil, unlike the United States (as affirmed by Warren and Westbrook)

there is no correlation between a longer confirmation span for the plan and a

higher success rate for the reorganization. Longer confirmation periods are

only the result of debtor not meeting deadlines.

- Brazilian companies usually file late for reorganization, when its debt is

overwhelming and reorganization is simply not viable anymore36. There is no

sanction for such attitude.

- Most reorganizing companies do not effectively reorganize, even if they

submit a plan and obtain confirmation. During reorganization, their operations

continue to produce losses and total debt increases.

As a final note concerning the metrics used in this essay, in spite of its limitations

to determine actual success of reorganization, the metrics (and the data obtained) were

sufficient to determine that (a) the current legal structure does not provide an adequate

system of constraints, sanctions and incentives for debtors to comply with the statutory

deadlines; and (b) Creditors do not enforce and have no incentive to enforce strict

observance of such deadlines.

36 Commenting on why bankruptcies are usually only filed when the debtor is heavily indebted, Douglas

Baird (Elements of Bankruptcy, Foundation Press, 2001, 3rd ed, p. 34) affirms: “There is the social stigma

that attaches to those that do not pay their creditors. Many individuals would see their own filing of a

bankruptcy petition as a confession of failure. One can argue that neither stigma nor guilt should follow in

the wake of a bankruptcy petition but the fact that they do deters most from filing bankruptcy petitions until

their financial situation is desperate.”

1

Appendix A - Santa Catarina State Cases.

Bankruptcy case #

/ Debtor’s name

Number

of

debtors

Date

initial

petition

was filed

Date plan

was

presented

Creditors’

assembly

Court decision

confirming/rejecting

the plan

Debt1 Number of

Creditors

Did

creditors

approve

Plan?

Did

Bankruptc

y judge

confirm

plan?

0046851-

57.2011.8.24.0038

(BUSSCAR

group2)

8 10/31/11. 12/30/11 05/22/12

08/07/123

09/25/124

08/19/145

09/09/14

09/27/12

Determining

liquidation6

09/30/14

Determining

liquidation

Superior to

500 million

dollars.

Superior to 9000 N Yes

030744964201482

40045

(First S/A Group)

2 12/18/14 05/26/15 09.09.157 03.14.169

05.24.16

Confirming plan

Approximatel

y 40 million

dollars

126 Y

e

s

Y

e

s

1 Does not include tax debt, which is not subject to plan participation. 2 The case docket shows that on its prime time, the group employed over 5000 employees, exported to 5 continents and was responsible for over 20% 7 companies filed for

bankruptcy. 3 The first assembly was suspended so that the debtor could introduce changes to the plan. If the plan had been voted, it would have been rejected by the Assembly. 4 Creditors with liens to property (secured creditors) voted to reject the plan. 5 There were interim creditors’ assembly. I only mention assemblies that have convened to approve/reject the reorganization plan. 6 This sentence was appealed and on November 26th, 2013, the State Appeals Court annulled the 3rd Creditors’ Assembly, reversed the sentence and ordered the procedure to

proceed as a reorganization bankruptcy. 7 The Assembly was suspended by majority decision to allow for further negotiation of the plan between debtor and creditors. From the minutes of the meeting it can be inferred

that If the plan had been voted, it would have been rejected by the Assembly. 9 The judge did not confim the Assembly’s decision nor applied a ‘cram down’ nor determined liquidation. He preferred to request further information about viability of business

and declared null some conditions contained in the plan.

2

14.10.158

02.16.16

0012301-85.2014.8.24.0020

Manchester

Chemistry group

4 7/29/14 11.3.14 05.08.1510

05.19.1511

09.18.1512

11.06..15

Confirmin

g plan

08.04.16

Confirming plan

Approximatel

y 10 million

dollars

Superior to 250 Y

e

s

Y

e

s

0004041-

62.2014.8.23.0038

Metalúrgica

Duque

2 2.3.14 4.29.14 11.19.1413

12.03.1414

Rejecting

plan.

7.20.15

Determining

liquidation

02.18.16

(by the state appeals

court), applying cram

down and confirming

plan

Approximatel

y 50 million

dollars

Unknown/undis

closed

N

o Y

e

s

Bankruptcy case #

/ Debtor’s name

Number

of

debtors

Date

initial

Date plan

was

presented

Creditors’

assembly

Court decision

confirming/rejecting

the plan

Debt15 Number of

Creditors

8 The Assembly was suspended by majority decision to allow for further negotiation of the plan between debtor and creditors. From the minutes of the meeting it can be inferred

that If the plan had been voted, it would have been rejected by the Assembly. 10 Assembly was not installed because there were not enough creditors present 11 The Assembly was suspended by majority decision to allow for further negotiation of the plan between debtor and creditors. From the minutes of the meeting it can be inferred

that If the plan had been voted, it would have been rejected by the Assembly. 12 The Assembly was suspended by majority decision to allow for further negotiation of the plan between debtor and creditors. From the minutes of the meeting it can be inferred

that If the plan had been voted, it would have been rejected by the Assembly. 13 Assembly was not installed because there were not enough creditors present. 14 Plan was rejected by one class of creditors (creditors’ with liens to property). 15 Does not include tax debt, which is not subject to plan participation.

3

petition

was filed

0006965-

22.2012.8.24.0004

Angelgres

ceramics

3 7.30.12 10.29.12 4.4.1316

4.9.1317

6.7.1318 Superior to

40 million

dollars

250+ Y

e

s

Y

e

s

0002767-

83.2013.824.0075

Airela

Pharmaceutical

1 3.30.13 5.30.15 10.29.1319 11.26.13 Approximatel

y 3 million

dollars

100 Y

e

s

Y

e

s

028.11.002856-0

COPOSUL

Plastics

1 7.4.11 9.19.11 04.02.1220

04.09.1221

7.5.12 Approximatel

y 10 million

dollars

Unknown/undis

closed

Y

e

s

Y

e

s

0023185-13.2013.8.24.0020

CDM Foods

1 10.17.13 1.13.14 6.3.1422

6.17.1423

7.14.1424 Approximatel

y 4 million

dollars

Approximately

60

Y

e

s

Y

e

s

16 Assembly was not installed because there were not enough creditors present 17 Plan was confirmed by Creditors assembly. 18 Angelgres ceramics actually complied with all plan obligations and its reorganization was terminated on March 2nd, 2016. 19 Plan was confirmed by Creditors assembly. 20 Assembly was not installed because there were not enough creditors present 21 Plan was confirmed by Creditors assembly. 22 Assembly was not installed because there were not enough creditors present 23 Plan was confirmed by Creditors assembly. 24 CDM actually complied with all plan obligations and its reorganization was terminated on April 25th, 2017.

4

Bankruptcy case #

/ Debtor’s name

Number

of

debtors

Date

initial

petition

was filed

Date plan

was

presented

Creditors’

assembly

Court decision

confirming/rejecting

the plan

Debt25 Number of

Creditors

Did

creditors

approve

Plan?

Did

Bankruptc

y judge

confirm

plan?

001633395.2012.8

24.0023

Ponte aérea Travel

Agency

1 03.16.12 May

2012

(day not

specified

)

10.20.1526

None to

date

No decision to date Approximatel

y a million

dollars

Approximately

50

N

/

A

N

/

A

008.12.023674-2

Teka textile group

5 10.26.12 1.11.13 06.26.13

08.27.13

10.02.13

10.30.13 Approximatel

y 400 million

dollars27

Approximately

2000

Y

e

s

y

e

s

25 Does not include tax debt, which is not subject to plan participation. 26 A new plan was presented 27 In a recent decision, the judge affirmed that ‘chances for reorganization’ seem to be more and more remote.

1

Appendix B - National relevant cases

Bankruptcy case # /

Debtor’s name

Number

of

debtors

Date

initial

petition

was filed

Date

plan

was

present

ed

Creditors’

assembly

Court decision

confirming/rej

ecting the plan

Debt1 Number of

Creditors

Did

creditors

approve

Plan?

Did

Bankruptcy

judge confirm

plan?

0377620-

56.2013.8.19.0001

OGX group

4 10.30.13 2.18.14 6.3.14 6.13.142 Approximately 4

billion dollars

Approximate

ly 300

YES YES

0015595-

79.2013.8.26.0100

LBR dairies

10 02.15.13 7.12.13 9.30.13

10.9.13

11.4.133 Approximately

300 million

dollars

Approximate

ly 2000

YES YES

0067341-

20.2012.8.26.0100

Rede Energy

5 11.26.12 5.29.13 06.05.13

07.03.13

09.17.134 Approximately

1,3 billion dollars

Unknown/un

disclosed

YES YES

2005.001.072887-7

Varig S/A Airlines

3 6.17.05 9.12.05 9.24.05

12.19.05

12.28.055 Approximately 3

billion dollars

Approximate

ly 20.000

YES YES

583.00.2005.070715-0

Vasp Airlines

1 6.10.2005 8.24.06 8.26.066 Approximately a

billion dollars

Unknown/un

disclosed

YES YES

1 Does not include tax debt, which is not subject to plan participation. 2 The reorganization is still active. 3 The reorganization is still active. 4 The reorganization was concluded on 08.29.2016. 5 In this case, considered to be the first reorganization of the country, the companies came out of their reorganization on 09.02.09, but later had their liquidation ordered on

August 20th, 2010. 6 The reorganization was converted to liquidation on August 29th, 2008.

2

1

Appendix C - Santa Catarina State Cases.

Bankruptcy case # / Debtor’s

name

Number of

days between

initial petition

filing and plan

presentation1

Number of

days between

plan

presentation

and first

creditors’

meeting

Number of days

between initial

petition filing and

(first2) court decision

confirming/rejecting

plan.

Outcome (to date)

1 Ongoing reorganization

2 Debtor has come out of

reorganization.

3 Reorganization was

converted to liquidation

4 Non-applicable.

Case classification (as

proposed in the research

methodology).

1- Very successful

2- Successful

3- Failure.

0046851-57.2011.8.24.0038

(BUSSCAR group)

60 144 332 3 3

0307449-64.2014.8.24.0045

(First S/A Group)

153 106 523 1 2

0012301-85.2014.8.24.0020

Manchester Chemistry

group

97 186 737 1 2

0004041-62.2014.8.23.0038

Metalúrgica Duque

85 204 532 1 2

1 First time the plan is presented. 2 In some cases the first decision by the Bankruptcy judge has been appealed and reversed by the appeals Court.

2

Bankruptcy case # / Debtor’s

name

Number of

days between

plan

presentation

and first

creditors’

meeting

Number of days

between initial

petition filing and

(first3) court decision

confirming/rejecting

plan.

Outcome (to date)

1 Ongoing reorganization

2 Debtor has come out of

reorganization.

3 Reorganization was

converted to liquidation

4 Non applicable

Case classification (as

proposed in the research

methodology).

1- Very successful

2- Successful

3- Failure.

0006965-22.2012.8.24.0004

Angelgres ceramics

91 157 312 2 1

0002767-

83.2013.824.0075Airela

Pharmaceutical

60 152 241 1 2

028.11.002856-0 COPOSUL

Plastics

77 196 367 1 2

0023185-13.2013.8.24.0020

CDM Foods 88 141 270 2 1

001633395.2012.824.0023

Ponte aérea Travel Agency

60

Not applicable

(plan was not

presented)

1902 (no court

decision to date;

Considering May

31st 2017)

4 3

008.12.023674-2

Teka textile group

77 166 369 1 24

3 In some cases the first decision by the Bankruptcy judge has been appealed and reversed by the appeals Court. 4 But see footnote on appendix A. It is very likely that reorganization will be converted to liquidation shortly.

1

Appendix D - National relevant cases

Bankruptcy case # /

Debtor’s name

Number of

days between

initial petition

filing and plan

presentation

Number of days

between plan

presentation and

first creditors’

meeting

Number of days

between initial

petition filing and

(first1) court

decision

confirming/rejectin

g plan.

Outcome (to date)

1 -Ongoing reorganization

1 2 Debtor has come out of

reorganization.

2 3 Reorganization was

converted to liquidation

3 4 Non applicable

Case classification (as

proposed in the research

methodology).

1- Very successful

2- Successful

3- Failure.

0377620-

56.2013.8.19.0001

OGX group

111 105 226 1 2

0015595-

79.2013.8.26.0100

LBR dairies

147 80 262 1 2

0067341-

20.2012.8.26.0100

Rede Energy

184 07 295 2 1

2005.001.072887-7

Varig S/A Airlines

87 12 194 22 1

583.00.2005.070715-0

Vasp Airlines

? Plan presentation

date not available

442 3 3

1 In some cases the first decision by the Bankruptcy judge has been appealed and reversed by the appeals Court. 2 But see comments about VARIG in the essay. Hardly a success.