Alberto Faro, Renata Oliveira and Felipe Baracat

The recently published Law No. 14,112/20, which amends the Judicial Recovery Law, brought innovations on the institute of substantial consolidation, generating some concern for sponsors and funders of infrastructure projects in the modality Project finance.

The consolidation of assets arises in American jurisprudence as a measure of unification of assets and liabilities of companies of the same economic group that are going through an economic and financial crisis, so that all recoverers are responsible for all creditors of the economic group, and that all creditors take the risks of the entire group, and not only their direct debtors.

The U.S. courts then define two determining tests for substantial consolidation, applied in this order, (i) the fact that creditors have negotiated with different companies believing that it is a single economic one; and (ii) the fact that the businesses developed by debtors are characterized by such equity confusion that substantial consolidation would be a beneficial measure for all creditors. The requirements of American jurisprudence are also:

  • the presence of consolidated financial statements;
  • identity in market performance and corporate composition;
  • the existence of cross-guarantees; And
  • the existence of a single integrated capital control system.

In any case, substantial consolidation in the form currently configured in the United States represents an exceptional measure and is based on clear legal certainty.

The concern for Project finance in Brazil arises characteristics inherent in this financing model. There are traces such as centralized ownership structure and segregation of projects in several SPEs (specific purpose companies), in addition to the identity of market action between the various companies of the same business group. There are also real guarantees of the projects, and it is common to grant personal guarantees by the parent companies. Cross-guarantees are often also observed.

The concept of substantial consolidation arose with the edition of Law No. 14,112/20, but was already applied by jurisprudence. A not-so-recent decision of the 1st Bankruptcy and Judicial Recovery Court of São Paulo,[1] regarding the judicial recovery process of the Urbplan group, it was the first to establish objective criteria applicable to companies of the same economic group, highlighting: interconnection of companies of the economic group; existence of cross-guarantees; wealth confusion; joint market action; coincidence of directors and corporate composition; relationship of control and/or dependence; and asset diversion.[2] In any case, before the new law, substantial consolidation had already been applied with some degree of legal certainty.

Law No. 14,112/20 innovates by pointing out the institute as an exceptional measure, defining objective requirements for its application. First, and necessarily, when there is "interconnection and confusion between debtors' assets or liabilities" and then cumulatively with at least two other of the following four requirements:

  • existence of cross-guarantees;
  • relationship of control or dependence;
  • full or partial identity of the corporate framework; And
  • joint market action among the postulants.

The market concern is related to these requirements, as the structures of the Project finance may have some similarities with such elements.

In any case, the first filter would be impaired: there should not, as a rule, be equity confusion in structured financing operations. This is because each SPE is, in general, the embodiment of an independent enterprise. Creditors are also not expected to negotiate with the same economic group. On the contrary, creditors understand that the contracting of debts with the SPs represents, above all, a protection of their credit, since they assume a risk, previously quantified, specific to the project financed, even if they often have reliable guarantees from shareholders or with the conclusion of an ESA (Equity Support Agreement).

The main difference from more traditional business financing is that the Project finance adopts this structure exactly to allocate risks efficiently and protect creditors within a resource leverage scenario – the creditors of these projects do their risk and credit analysis based on this structure and, consciously, adopt the risks of a given project without the intention of assuming the risk of the business group. The new law also seems to bring greater predictability to the application of the institute in this context, by positively the conditions and requirements for its application and also considering that the jurisprudence has well understood the contractual, corporate and capital structure inherent in this type of financing.

Another important and sensitive innovation for the Project finance substantial consolidation will result in the immediate termination of trust sums and claims held by one debtor in the face of another. This will not, however, impact any lender's real guarantee. That is, if, on the one hand, there are impacts on the credit risk of projects with the potential extinction of the fidejussory guarantees, on the other hand, the law would rule out the possibility of ineffectiveness of real guarantees.

[1] TJ/SP. Case No. 1041383-05.2018.8.26.0100. Processing in the 1st Bankruptcy and Judicial Recoveries Court of the Capital.

[2] Such requirements are not adopted in a unique manner by case law. This is the decision of Judge Daniel Carnio Costa, holder of the 1st Court of Bankruptcies and Judicial Recoveries of São Paulo, a court specialized in the matter of the TJ / SP - today the court of greater relevance in matters of commercial law and whose theses are usually replicated by other courts.