Brazil On Bankruptcy: Destroying Pandemic-Hit Companies For Profit – OpEd
By Viorel G. Morari*
With 475,000 deaths from COVID-19 in Brazil and 17 million recorded cases (at the time of writing), the immediate need is for critical aid and sound counsel—to save lives. In the mid-term—if Brazil is to have any chance of “recovering”—the international community must permanently eradicate Brazil’s “other virus”: the corruption which has blighted local commerce, the judiciary and domestic politics, and which is just as infectious as COVID.
The international community should take heed—if not for altruism, then for self interest. The confusion, disruption and panic brought by COVID-19 are creating optimum conditions for Brazil to serve as both incubator, and exporter, of transnational crime. Corrupt practices mutate, just like the coronavirus. As The Economist remarked on July 5 in regard to a number of investigations—present and past, which show little progress— “Brazilian corruption has roots in a promiscuous relationship between the state and private firms.”
As a jurist, who currently serves the Republic of Moldova as the government’s anti-corruption prosecutor, I have witnessed many gradations of this statement, in Central and Eastern Europe, and abroad. However, in my own research, it has become clear that Brazil’s legal system has particular flaws, which could enable particularly complex forms of white-collar transnational crime.
Like Moldova, Brazil has been saying the right things to its international partners for several decades. The country signed a bilateral investment treaty (BIT) with the United States in 2011. Meanwhile, pressure from allies led Brazil’s judiciary to recognize tax havens—first by list, and then by intergovernmental agreement. By 2014, Brasilia’s had even assumed Model 1 IGA status under the Foreign Accounts Transparency Act (FATCA). Such agreements gave Brazil better standing with international banks, provided greater credence to judicial decisions made in the country’s courts (in the event of international arbitrage), and improved perceptions on rule of law.
As the pandemic has shown, laws which confer joint and several reporting statuses upon partners are only as good as each partner’s integrity. Despite the veneer of credibility, the pandemic has exposed serious cracks in Brazilian commercial law.
This is best exemplified by an explosion of bankruptcy proceedings. Corruption, which has certainly worsened during the pandemic, is leading actors with close ties to the country’s judiciary to utilize Brazil’s amended bankruptcy law as a means to pursue foreign investors for huge sums of historic debt, usually in international legal cases—even if in reality, the funds have been considered irretrievable debts for decades.
While Western jurists, international compliance monitors, and corporate transparency watchdogs have previously lauded Brazil’s new approach to bankruptcy, likening the new 2005 law (to which I refer) to Chapter 7 of Title 11 in the U.S. bankruptcy code—where instead of attempting to resuscitate a failing business, its assets are simply sold to repay debtors—insufficient attention is being paid to the law’s many problems. It is logical that many judges ruling in international litigation brought to U.S or British courts would feel sympathy for Brazilian entities or government bodies who allege historical corruption by American or English nationals. As the countries share a bilateral investment treaty, exchange key account information under FATCA, and are committed by treaty to fighting transnational crime, it is difficult to conceive that a Brazilian court may not have acted with integrity—even if, on paper, its judiciary has followed the law to the letter.
There is the law in Brazil; then, as with bankruptcy under COVID-19, there is the reality.
Drafting equivalents to U.S law may well work in a pluralist democracy, with fair courts, observation of process, and impartial attorneys. But in Brazil, as in many other countries in the developing world, the law simply serves to incentivize the expedited bankruptcy of operable companies—to the profit of the corrupt, and the powerful. The greatest flaw in Brazil’s Bankruptcy Law is the key decisions made on a company’s behalf, by a judge, and judicial trustee (who is appointed by a judge). As we know from “Operation Car Wash”—which is perhaps the biggest corruption scandal the world has seen in decades—Brazilian judges do not have a high trust score. In the view of Transparency International, a considerable number of them are corrupt, or subject to political pressure when ruling.
Brazil’s bankruptcy loophole is less complex than it may sound, but in order to comprehend the blindingly dangerous capacity for corruption and conflict of interest during cases which have taken place in the country since the pandemic began, it’s important to lay down the precepts of the amended 2005 Brazilian Bankruptcy Law, or “BBL” (Nova Lei de Falências e Recuperação de Empresas, Law N° 11,101). Brazil’s Bankruptcy Law, enacted in 1945, provided for the liquidation of insolvent companies—but proved cumbersome and problematic as the country ditched military dictatorship for a market economy. Instead of giving a company the means to overcome its financial difficulties, the 1945 law prohibited the struggling business from presenting a plan for recovery, or restructuring—even when it could prove technically feasible. As such, assets had to be sold separately through auctions that often took place many years after the beginning of the bankruptcy procedure.
Market liberalization in the 1980s led to large-scale privatization, inflows of foreign direct investment, and casino capitalism—with Brazil’s government jettisoning vast publicly owned entities to the private sector, often for cents on the dollar. But at the time, Brazil needed those cents. As privatizations failed, investors pondered the risks involved, as they watched the investments of other market entrants go awry, or fail—to the detriment of creditors, employees, and the government itself. With no legal means to allow creditors and debtors to keep a viable businesses afloat, debts could not be renegotiated.
Debate on amendments to the 1945 law began in 1993, and eventually Congress approved the new law in December 2004. Effective from-mid June 2005, the law applies to all new requests for recovery or bankruptcy, and effectively provides companies with the opportunity to present stakeholders with a restructuring plan. This makes “judicial re-organization” (recuperação judicial) Brazil’s principal form of insolvency procedure. With a court-approved agreement between debtor and creditors in place to resolve outstanding tax and labor liabilities, a failing company can be granted a stay period of 180 days for all claims and enforcement proceedings, and can delay judicial recovery.
This might sound appealing, but in practice it’s akin to commingling bankruptcy proceedings with a very corrupt strain of speed-dating. If a struggling company has assets to strip, accounts to freeze, no friends in politics, and no presence in the country, the entity is a very appealing prospect to a judicially appointed judicial trustee—themselves a lawyer—who can quickly wind up the company and pocket a large slice of the profit.
Proponents of the law often argue that it provides the state with greater likelihood of recovering tax debts, and employees stand a better chance of receiving unpaid wages. However, to those familiar with the operating realities of business in an emerging market, where politics and business are indivisible, it is blindingly obvious that the law has many cracks in its drafting. These cracks allow judges—who are, in many cases, political appointees—to profit, by determining another judge—who is now in private practice as a lawyer—to be the best judicial trustee to pursue a debt. Remunerating employees who have been exploited comes second to paying that trustee, who on occasion receives a percentage of asset arrests, and in this regard acts like a judicially-approved bounty hunter (or vulture).
Of funds recovered, the first party’s fees to be paid are those owed to the judicial trustee and his assistants. While labor-related claims and occupational accident claims related to services rendered after the bankruptcy decree by employees must be settled, remuneration is limited to 150 minimum wages per creditor. Within the first six creditors of priority, the next set of costs to be paid from asset recovery are those incurred during the bankruptcy proceeding—meaning costs accrued in the collection, administration, and sale of the bankruptcy estate assets, distribution of the proceeds, and court costs. Within the highest-ranking debts to satisfy falls those fees which arise from “juridical acts performed during judicial re-organization proceedings, or after the bankruptcy decree [and to] expenses and taxes related to the period after the bankruptcy decree.”
Turning a profit from bankruptcy in Brazil requires simple components that depend on prolonged involvement from the justice system, particularly as courts stall amid COVID-19. When conducting an expedited bankruptcy under the 2005 law, the judicial trustee appointed to negotiate the bankruptcy is appointed by a judge. The same judge may then approve the “judicial re-organization” process—placing fees owed to the judicial trustee as principal priority, before even reimbursing employees. As lawyers and judges frequently move between private practice, bankruptcy practitioners are very happy to employ them, thereby creating conflicts of interest which have disenfranchised thousands of businesses during the pandemic. As gatekeepers to corporate transparency, Brazil’s judiciary and attorneys are meant to keep businesses afloat. Instead, they’re actively conducting “judicial re-organizations” which are designed to fail in 180 days, sometimes even pushing individual clients into bankruptcy too, as under the 2005 law the judicial trustee is entirely responsible for distributing what a client owes.
I don’t wish to undermine, or pour scorn, on all rulings made by Brazil’s judiciary. However, I would encourage judges evaluating decisions raised in London, Stockholm, and within the United States, to consider the Republic of Moldova’s experience. Moldova also became a signatory to FATCA in 2014 under IGA Model 2 terms, just two months after Brazil ratified the treaty in September. And like Brazil, Moldova was making all of the right noises to the European Union and its allies—through NATO membership, involvement in the Eastern Partnership Program, and repeated, impassioned cries for root and branch reform of our judiciary. Shortly thereafter, it became clear that Moldova’s judiciary—via decisions granted against foreign companies, which could subsequently be enforced abroad—had facilitated the theft of at least $1 billion USD from savings accounts held by its countries poorest people. The figure was equivalent to 12% of our national GDP. This seems piteously small change, in light of the expose that was to follow. In one of the largest money laundering cases ever reported, and dubbed “the Troika Laundromat” it transpired that corrupt judgments, enacted in Chisinau for fake debts, had been enforced abroad against fictive foreign companies. The process allowed the Russian mafia to launder at least $19.7 billion. Some estimate the sum to be worth closer to $80 billion. Today, despite many bilateral treaties, foreign investors in Moldova remain locked in arbitration. Our legal system is only, seven years later, beginning to regain its dignity.
Making a dime on misery is a pandemic reality. There will always be corrupt judges and public officials, in every society. However, COVID-19 has made many people in all societies desperate. It has made others greedy. The obvious gaps for influence peddling and corruption in Brazilian bankruptcy law should cast into doubt the sudden race to collect old, foreign debt—which will not only damage short-term relationships with investors, but cripple many more companies during the pandemic in the mid-term. It will also slow Brazil’s recovery, which, after years of division, should be the priority going forward.
*Viorel G. Morari is a Senior Jurist & Anti-corruption advocate, who has served as Anti-Corruption Prosecutor to the Republic of Moldova. With almost 20 years practicing experience as a state prosecutor and anti-corruption advocate and campaigner, Morari have has worked closely with the European Union to develop Moldova’s legal framework and harmonize legislation with the country’s European neighbors, particularly in the fields of humanitarian and criminal law.
The views expressed in this article are those of the authors alone and do not necessarily reflect those of Geopoliticalmonitor.com.
