Collateral over assets in Brazil in international financing
The growing volume of financing for transnational business groups and leveraged buyout operations, in which corporate acquisitions are financed through debt, has increased the need to take collateral over assets in Brazil to secure loans made abroad in recent years. In this article, we will discuss some of the important precautions that these transactions require.
Governance Aspects in Business Groups – Brazilian law does not generally prohibit a Brazilian company from giving its assets as collateral for debt contracted by the controlling shareholder, or from guaranteeing this type of obligation. However, the transaction must be structured in such a way as not to harm the company itself or minority shareholders, which could lead to the controller being held liable for abuse of power. This risk can be avoided if the guarantor or security provider itself receives benefits, even if indirectly, in an amount compatible with that of the guarantees or security offered. In addition, the provision of guarantees or security must be preceded by the corporate authorizations required by the company’s organizational documents. Usually, the approval of the majority or totality of the guarantee or security provider’s shareholders is required.
Choice of Security – Superiority of Fiduciary Modalities – The choice of the type of security – such as pledge, mortgage or fiduciary transfer – depends on several factors, including the degree of protection desired, the nature of the assets, the type of creditor and costs.
Fiduciary security is typically more beneficial to the creditor than a pledge or mortgage. Because the fiduciary security temporarily transfers ownership of the collateral to the creditor, its foreclosure tends to be faster. Another very important advantage of the fiduciary security is that the fiduciary creditor may foreclose on the collateral even during the debtor’s recovery process (with a few exceptions), and the collateral does not form part of the debtor’s bankrupt estate. Creditors secured by pledge or mortgage, on the other hand, are subject to the debtor’s insolvency proceedings as secured creditors up to the limit of the value of the collateral, and as unsecured creditors for the portion of the credit that is in excess of such value.
The fiduciary transfer security was created by Law No. 4,728, of 1965. As this law is intended to regulate the Brazilian capital market, case law was formed in the sense that this type of security cannot be constituted in favor of a foreign creditor, who is not part of the local capital market. The same applies to the fiduciary assignment of credit rights, provided for in article 66-B of the same law.
This limitation, however, lost practical relevance after the Brazilian Civil Code of 2002 entered into force. The Code created a modality of property right called the fiduciary ownership, the effects of which are similar to those of the fiduciary transfer. Relevant case law has confirmed that the fiduciary ownership can benefit any creditor, either domestic or foreign. It is essential, therefore, that the contract constituting a fiduciary ownership in favor of a foreign creditor makes reference to the Civil Code and is drafted in a way that meets the requirements contained therein.
Objects of the Fiduciary Guarantee – The fiduciary ownership of the Civil Code can be created only over non-fungible movable goods – that is, those goods that cannot be replaced by others of the same type, quality and quantity. But the fungibility of a good depends largely on how it is described. If the asset is movable and can be described in the security agreement in such a way as to distinguish it from others of the same nature, it may be the object of fiduciary ownership.
The fiduciary transfer of real estate, in turn, is provided for in Law No. 9,514, of 1997. While this law regulates the Brazilian Real Estate Financial System (known as SFI), it was amended in the early 2000s to expressly provide that the fiduciary creditor does not need to be a member of the SFI. Thus, the fiduciary transfer of real property can also be constituted in favor of a foreign creditor, and it has the advantages mentioned above in relation to the mortgage.
Constitution and Registration of Guarantees – The constitution and registration of guarantees and security in Brazil may give rise to large fees, which in certain cases reach hundreds of thousands of reais. But, here too, the choice of the type of security is important. For example, the mortgage must be created by means of a public deed (with the exception of mortgage over very low value properties, which normally are not part of an international security package). But the fiduciary transfer of real property can be constituted by a private instrument, as there is a specific rule in this sense in Law No. 9,514, thus avoiding notary fees.
Another example is the security over machinery and equipment used in rural or industrial activities. The pledge on these assets must be registered at a real estate registry office, and if the assets are located in different cities, several registrations will be required. However, if the parties choose the fiduciary property instead of the pledge, it will suffice to register the security agreement in the registries of deeds and documents of the cities where the parties are located (or, as of January 1, 2024, solely in one location). Registration in these registries is typically less expensive and bureaucratic than registration in real estate registries.
Catch All Clauses – Brazilian law does not allow catch all clauses, in which the security provider charges all its assets as collateral for undetermined debts. In the Brazilian legal system, security binds specific assets to a certain debt. A consequence of this requirement is that both the debt and the assets must be perfectly described in the contract. Large international financings, however, tend to have a long term and be subject to periodic renegotiations. This may require amendments to the Brazilian security, with new formalization and registration fees being charged. Likewise, the acquisition of new assets of significant value by the debtor may require a contract amendment in order to charge them. This reality requires even greater care when drafting contracts. Secured obligation and collateral must be described in a specific way to meet the legal requirements for the validity of the security, but in such a way as to reduce as much as possible the need for future amendments.
The Collateral Agent – International transactions almost always rely on the figure of the collateral agent, who represents the creditors in the taking of security and its foreclosure. The agent may be one of the creditors or may be contracted solely to provide services, without being a creditor. However, under Brazilian law, security must be provided to the creditor. This does not prevent the creditors from being represented by an agent, but the documentation must provide the agent with the necessary powers to represent the creditors, as these – and not the agent – are the true holders of the security.
Contradictory security – The same asset can in principle be subject to security liens in more than one country, and such multiple security taking is relatively common in complex international financings. Care must be taken, however, so that the various security are not incompatible among them or nullify each other. An example would be the security provider that, after having constituted fiduciary ownership over an asset in Brazil, wants to pledge the same asset in another country. This would be legally impossible, since the security provider no longer has full ownership of the asset and thus lacks capacity to encumber it.
Complementation by personal guarantee – Under Brazilian law, the security provider is not responsible for the part of the debt that exceeds the amount obtained with the collateral sale. For this reason, it is common that in addition to providing security, the Brazilian subsidiary is asked to provide a personal guaranty (fiança). The guarantee may be included either in a specific clause of the credit agreement entered into abroad, or in a separate instrument (“letter of guarantee” or equivalent) signed in Brazil. In any case, it is essential that Brazilian conflict of law rules contained in Decree No. 4,657, of 1942, are observed so as to ensure the validity in Brazil of the choice of law governing the contract. Basically, the contract must be concluded by its final signature in the country whose law governs the agreement.
These and several other aspects must be carefully considered both by the Brazilian subsidiary and by creditors in international transactions when taking security over assets in Brazil.