(Somente em Inglês) What is the value of a guaranty? The enforcement of guarantors during debtor’s judicial reorganization under Brazilian law

It is common in Brazil for an individual or an entity to undertake responsibility for the performance of financial obligations of a debtor. If the debt is not paid on the due date, or in any subsequent date with accrued interest and monetary adjustment, the lender can take action to enforce its rights under the agreement, against the assets of both the debtor and the guarantors. Although law provides that personal guaranties are subsidiary in principle, nearly all loan and financing agreements contain provisions in the sense that guarantors waive such prerogatives and are jointly and severally liable for the debt as principal obligors. As a result, the lender is usually not required to proceed against the debtors before taking action to collect its claim from the guarantors.

If a debtor company files for reorganization under Brazilian law – a proceeding which resembles a U.S. Chapter 11 case –, the court orders a stay of proceedings, for a period of 180 days, against its assets, which cannot be attached by the creditors for the purpose of satisfying their claims. In a reorganization, the debtor is not allowed to pay pre-filing debt, otherwise as set forth in a plan approved by the required majorities of creditors, and duly confirmed by the court. The plan of reorganization may take an estimated six months or more to be approved by the creditors and confirmed by the court, and contains provisions that impair claims, imposing a haircut, modifications in the interest rates, or grace periods. Given that actions are suspended, that the debt is not expected to be paid within at least the end of the stay, and the likelihood of an impairment provided for in the plan, lenders may feel compelled to enforce their guaranties, seeking to promptly receive full payment of their claims.

When the guarantor is a parent company or otherwise related to the principal obligor, it may well be the case that they both jointly file for reorganization. It is common for several companies which are under the same corporate control to file a joint reorganization petition, on the grounds that they belong to the same economic group. In corporate groups in which there are plenty of cross-guaranties, a joint filing is usually expected to assure that the debt will be fully restructured and that there will be no loose ends. In this case, both the principal obligor and the guarantor are debtors under the same reorganization proceeding, and both will benefit from the court protection during the stay period.

In a reorganization, the court may allow substantive consolidation of the debtors, in which case all creditors will be treated as if they held claims against the group as a whole, and not against each separate entity. Should this happen – and substantive consolidation is quite frequent in Brazil –, then it is likely that the creditor will have only one claim against the group under the reorganization plan, and not a claim against each individual debtor. The fact that one of the entities guaranteed full payment of the claim will be of little value in this case, as it will probably not result in any additional amount to be received. If there is no substantive consolidation, however, the separateness of legal entities is respected, and the creditor holding a claim against the principal obligor and the guarantor will be entitled to receive from both entities, according to the relevant provisions of the reorganization plan.

A guarantor who is not a debtor under the reorganization is, in principle, not protected by the stay of proceedings and does not benefit from the provisions of the plan. There are several reasons why a guarantor would not file for reorganization together with the principal obligor: because, for instance, it is an individual shareholder not willing to try any aggressive judicial measure which may backfire, or a parent company which controls other branches of a larger and financially healthier corporate group. This means that the lender would, at least in principle, be free to enforce the guaranty against such persons, to seek full satisfaction of its claim. The guarantor who pays the debt will subrogate in the rights of the respective lender, and will become a creditor under the plan, entitled to be reimbursed only pursuant to the terms of such plan – i.e., with the applicable haircut, grace period, and interest rates, regardless of having disbursed the necessary amount to pay the claim in full to the original creditor. This may be particularly disquieting for individuals, who are usually shareholders of the debtor that agreed to guarantee the debt. After all, in addition to watching a massive loss of value in a struggling company, shareholders may have their personal assets – except for some exemptions such as their homes – taken away.

It is no surprise that several guarantors – especially individuals – try to shield their assets, requesting that the stay of proceedings and the releases under the plan of reorganization be extended to them as well. Several plans of reorganization contain a clause specifically discharging all the guarantors from the debt, something over which creditors – especially those holding the guaranties – have heavily litigated against in the last decade, claiming this provision to be null. The reasoning for this would be that the reorganization plan cannot create releases in favor of third parties. The guarantor would only be part of the restructuring with the specific agreement of the relevant creditor. Although the majority of court precedents support the reasoning of the creditors, debtors and their guarantors still fight for the validity of the release of guaranties. According to their viewpoint, the debt is undividable and therefore would be restructured as a whole, thus not being possible for a creditor to collect the claim in full against the guarantor, while the obligor is discharged. Another way of saying it is that the guaranty, due to its accessory nature, cannot be kept intact while the main obligation is modified. The provision discharging both debtors and guarantors would be thus valid and binding on all the creditors, including the ones holding the guaranties, regardless of them agreeing or not with the plan. Although the possibility of a discharge of guarantors under the plan has been endorsed even by a one-off decision of the Superior Court of Justice – the highest court for non-constitutional matters – in 2016, it has been supported by a diminishing number of courts. However, the ongoing discussion seems to be nowhere near the end.

So, a guaranty issued by a third party can be a valuable instrument to help creditors collect their claims under Brazilian law, even when the principal obligor files for judicial reorganization. In these cases, the enforcement of claims against those third parties may be subject to hiccups, but, given the court precedents of the last decade, creditors holding guaranties can expect either a favorable outcome in litigation, or at least a strong bargaining position in a negotiation. Even in the cases when both the debtor and the guarantor files jointly for reorganization, not all is lost, as there is a chance that the guaranty leads to the negotiation of a better recovery.

 

For more information, please contact Paulo Campana, at pcampana@cascione.com.br, João Paulo Servera, at jpservera@cascione.com.br and Renato Moraes at rmoraes@cascione.com.br.