Exit financing is a type of financing granted to companies under an in-court reorganization or out-of-court reorganization proceeding, with the specific purpose of paying off the credits restructured by the reorganization plan and financing the debtor's operations after the process is over.
This type of financing is different from DIP financing (Debtor in Possession Financing) structures, which are usually granted throughout the reorganization proceeding and are intended to finance the debtor until a reorganization plan is approved or even during the implementation of such plan.
Exit financing is generally granted after the plan has been approved to enable payment of the competition creditors, closing of the proceeding, and reinsertion of the company in the market under normal competitive conditions.
Although DIP financing structures are already widespread in judicial reorganization proceedings in Brazil, exit financing is still little used. Both were inspired by US practice related to Chapter 11 of the US Bankruptcy Code.
The use of this instrument in judicial reorganization proceedings in Brazil is interesting inasmuch as the Company Reorganization and Bankruptcy Law (LRF) provides that, even after approval of the reorganization plan, the debtor should be kept under judicial reorganization until all the obligations set forth in the plan due up to two years after the granting of judicial reorganization have been fulfilled.
During this period, the company shall be kept under judicial reorganization, under the supervision of the trustee and the judge himself, and must comply with all the formalities provided for in the LRF, in addition to suffering all the limitations and difficulties intrinsic to a company whose name says "under judicial reorganization".
It is no news that companies under judicial reorganization find it more difficult to obtain credit in the financial market and to negotiate contracts with customers and suppliers, who are often unwilling to take the risk of contracting with companies in such a situation.
Thus, obtaining exit financing for the payment of the claims restructured by the plan allows for a faster and more efficient end to the judicial reorganization proceeding and reinsert the company in the market under normal competitive conditions, which facilitates access to credit lines and financing under better conditions.
The recent changes made to the LRF by Law 14,112/20 with respect to debtor financing during judicial reorganization, which includes a whole new section dedicated to the topic,[1] certainly contribute to providing greater legal certainty to the lender and, therefore, to an increase in the use of different financing modalities in judicial reorganization proceedings.
One of the main changes that help reinforce the legal security of the investor is the new article 69-B. It expressly states that, even if an appeal is filed against the decision that authorized contracting of the financing and the decision is reversed, it is not possible to change the extra-business nature or the guarantees granted by the debtor to the lender in good faith, if the funds have already been released.
Thus, once the granting of financing and the granting of the guarantees have been authorized, it is not necessary to await the final and unappealable decision in order to disburse the funds, since there is legal protection against ineffectiveness of the priority and the guarantees granted.
In the same vein, article 69-D states that in the case of bankruptcy of the debtor before the funds are fully released, the contract is automatically terminated and the lender will not be obliged to disburse the remaining amount. The sole paragraph of the same article reinforces the preservation of the preferences and guarantees granted up to the limit of the amounts delivered to the debtor before the date of the decision that converts the judicial reorganization into bankruptcy.
Also in the case of a bankruptcy, the reform of the law gave more priority to the payment of the amounts disbursed by the lender in the judicial reorganization. It is second only to the expenses indispensable for administration of the bankruptcy and to labor claims of a strictly salary nature due within the three months preceding the bankruptcy decree, up to the limit of five minimum wages per worker.[2]
Article 69-C also introduced the possibility for the judge to authorize the creation of a subordinated guarantee of one or more assets of the debtor in favor of the lender, dispensing with the consent of the holder of the original guarantee
This provision does not apply, however, to guarantees of fiduciary sale and fiduciary assignment. Thus, even the creation of a guarantee under a condition precedent on the same assets already encumbered must observe the restrictions and any need to obtain the consent of the original creditors provided in the respective debt and guarantee instruments.
Challenges for the application of exit financing
Although the LRF reform has brought about some advantages that make greater use of exit financing feasible in judicial reorganization proceedings in Brazil, we believe that some challenges still have to be faced in the cases to come. Since exit financing is granted at the end of the reorganization proceeding (or as a measure to terminate it), most likely the debtor's obligation to repay the financing will occur after the reorganization is terminated.
In the event of default, the creditor will have the legal and contractual remedies provided, which usually include the possibility of executing of the guarantees and filing for bankruptcy. It is not clear from the legal provisions whether the priority of financing granted in the context of a judicial reorganization already terminated would extend in the event of a new petition for judicial reorganization or a supervening decree of bankruptcy.
That is, would exit financing, in a new judicial reorganization or bankruptcy, maintain its bankruptcy-exempt nature or, since it is a previously existing claim, would it be considered an unsecured claim?
The answer to this question is not clear and, in our opinion, will still depend on the evolution of this concept and on court decisions that address the issue. In our view, the purpose of the law in giving preference to the DIP lender to receive its claim is precisely to stimulate the credit market for companies under judicial reorganization, ensuring greater legal security as to the non-concurrence of credit and priority of receipt in any event.
However, article 69-D deals specifically with cases of converting judicial reorganizations into bankruptcy, and is silent as to the decree of bankruptcy after termination of the judicial reorganization.
Likewise, there is no legal provision regarding the debtor entering into a new judicial reorganization process without the financing granted during the reorganization having been fully paid off. It is also unclear whether such claims would have an bankruptcy-exempt nature simply because they were granted under the prior judicial reorganization.
In practice, investors and lenders of companies under judicial reorganization will probably continue to demand the granting of fiduciary sale and assignment guarantees over the debtor's assets as collateral for their financing, in order to reinforce the bankruptcy-exempt nature of their claims in any bankruptcy or new reorganization process.[3]
In our view, the greater legal security afforded to the good faith lender, especially against the declaration of ineffectiveness and nullity of the constituted guarantees, will tend to foster the credit market for companies under judicial reorganization in Brazil.
[1] Section IV-A - Debtor and Debtor Group Financing during Judicial Reorganization
[2] As per the new wording of article 84 of the LRF.
[3] According to article 49, paragraph 3, of the LRF, claims secured by fiduciary sale and fiduciary assignment of real or personal property are not subject to the effects of judicial reorganization. In bankruptcy, on the other hand, article 85 of the LRF grants the fiduciary creditor the right to request restitution of the asset sold or fiduciarily assigned, and restitution in cash is also applicable, should the asset no longer exist at the time of restitution, in which case such amounts will have a bankruptcy-exempt nature, pursuant to article 84, I-C, of the LRF.
