Trade Alert - October 2016, Issue 34
Brazil is the seventh largest economy in the world in terms of GDP and the fifth largest country by population after China, India, the United States and Indonesia.
Legal System: Brazilian law derives from Portuguese, French, Italian and German Civil law. It is based on statutes and recent constitutional reform (Amendment to the Constitution 45, 2004) which introduced a mechanism similar to the stare decisis, called Súmula Vinculante. However, under article 103-A of the Brazilian Constitution, only the Supreme Court is allowed to publish binding rules. Inferior judges and courts, and the public administration, are therefore obliged to obey the interpretations of the Supreme Court. The Federal Constitution, in force since 21 October 1988, is the supreme law of the country and organizes the country as a Federative Republic. The 26 federate states have powers to adopt their own Constitutions and laws. Their autonomy, however, is limited by the principles established in the Federal Constitution.
Politics: On 1 September 2016, Dilma Rouseff was removed from office following impeachment proceedings. This brings an end to 13 years in power for the left-wing Workers’ Party. Michel Temer of the centre-right PMDB party, who had been serving as president during the impeachment proceedings, was sworn in as President until the end of Rouseff’s term on 1 January 2019. Faced with the country’s deepest recession since the 1930’s, Temer is now seeking to encourage foreign investment into the country.
Reuters recently reported that his centre-right government plans to auction off licences to operate oil and gas, electricity and infrastructure projects in an attempt to boost private investment. Between the 1950’s and 1997, Brazil’s oil and gas industry was dominated by the state-owned Petroleo Brasileiro SA (Petrobras) until the Petroleum Law (Federal Law No.9,478/1997) was enacted in 1997 which enabled future contractual agreements with private or state-owned companies.
Since that time, Brazil has become a key player in the global investment environment and now provides opportunities for foreign investors to explore the emerging market in industries such as oil and gas, shipping, infrastructure, agriculture and telecommunications.
In this month’s Trade Alert, we highlight some of the key considerations for loan investors in Brazil.
Foreign investors are not required to hold a banking licence to acquire the debt of a Brazilian borrower (whether fully funded or revolving).
However, there are a number of rules and regulations which foreign investors must adhere to when investing in Brazil.
Foreign investments in the Brazilian capital markets must follow the rules set out in Resolution No. 4,373 issued by the Brazilian National Monetary Council ("Resolution 4,373"). Resolution 4,373 provides that an investor which is not a resident of Brazil may freely invest in any financial instrument or security available to an investor which is a resident of Brazil, provided that the foreign investor:
- appoints a Brazilian financial institution as its representative in Brazil;
- is registered as a foreign investor before the Brazilian Securities and Exchange Commission (Comissão de Valores Mobiliários, the "CVM");
- executes a custody agreement with an entity authorised by CVM to provide custody services;
- registers the funds entering Brazil for the purposes of investing in the Brazilian capital markets pursuant to Resolution 4,373 with the Central Bank of Brazil through an electronic declaratory registration process (Registro Declaratório Eletrônico); and
- ensures that assets purchased must be registered and kept in custody or deposited with an institution or entity authorised by the Central Bank of Brazil or by the CVM to provide such services. Such transactions must also be registered with authorised clearing systems.
Cross border loans (and other cross border investments made outside the Brazilian capital markets) are not subject to Resolution 4,373, but any such investment must be registered with the Central Bank of Brazil to ensure repatriation of interest and principal.
Registration of debt: when purchasing cross border loans, the assignee should confirm that the debt is properly registered with the Registry of Financial Transactions (Registro de Operações Financeiras) through the Central Bank of Brazil to ensure remittance abroad of any proceeds from such debt (see Regulatory Requirements above).
Interest rate restrictions: Brazil has usury rules that restrict the amount of interest that an investor who is not a licenced entity (such as a bank) may charge from the debtor under a Brazilian law governed loan agreement. The rate is restricted to the Selic Rate (the Brazilian official interbank interest rate), which is currently around 14% per year. On at least one occasion, these laws have been applied to restrict the interest rate applicable to a bank note assigned to a non-financial institution.
METHODS OF LOAN TRANSFER
Assignment is the preferred method of loan transfer and Brazilian law states that the assignment of debt includes all of its accessories. Unless expressly prohibited in the loan agreement, assignments are enforceable against the debtor provided that the debtor is notified of the assignment.
An assignment of a loan does not affect the security or any guarantee. Any amendments to the terms and conditions of the debt may, however, affect the guarantee if the guarantor had not consented to such amendment.
Transfer by novation would create a new obligation, whereby a new creditor replaces the original creditor, therefore it is not the recommended form of transfer in Brazil. Local law does not deploy trust structures for holding security and transfer by novation may trigger negative tax consequences.
Participation agreements are not commonly used in Brazil.
SECURITY AGENTS AND TRUSTS
Brazil does not have domestic trust regulations.
However, a trust created under the law of a foreign jurisdiction will be recognised (provided that it is not deemed to be contrary to Brazilian law), except in relation to judicial reorganisation as there are precedents which prevent a trustee from voting on behalf of bondholders in relation to a restructuring.
In Brazil, it is common for creditors under a syndicated loan to appoint an attorney-in-fact to represent the creditors in relation to the execution and performance of the security documents. In this case, the new lender would benefit from the existing security upon becoming a party to the original credit agreement.
In case of an insolvency of a security agent, the security held on behalf of the creditors would not fall into the insolvent estate, as the security agent acts as attorney-in-fact on behalf of the creditors and is not deemed to be the holder of record of the security.
However, in respect of certain local debt instruments (debentures), Brazilian law does recognise the concept of an agent (agente fiduciário) that would represent the holders of the debentures in their dealings with the issuer.
Except as indicated above, agents and security trustees are able to enforce their rights in the Brazilian courts provided that they can present sufficient evidence that they have the requisite power and authority to do so.
TAX AND STAMP DUTY
Withholding Tax: pursuant to Brazilian tax law:
- interest payable by a Brazilian debtor to a foreign lender is generally subject to a 15% withholding tax (unless the rate is reduced under a double tax treaty) or 25% if the creditor is located in a Low or Nil Tax Jurisdiction, as listed in the Brazilian Tax Authorities Ordinance No. 1,037, as amended.
- no withholding tax is payable on dividend distributions to a non-resident. As from 2015, dividends will be determined based on IFRS.
Exceptions: Withholding tax will not apply, however, if the proceeds of the foreign-sourced loan are used to finance the borrower's exports and such loan (principal amount) is repaid with receivables from exports from Brazil made by the borrower or by entities that make up part of the borrower's economic group. This is typically the case with export prepayment transactions, a form of financing broadly used by Brazilian exporters.
Transfer Tax: there is no transfer tax payable that lenders should be aware of.
However, if the transfer results in a new foreign-sourced loan with a final maturity of 180 days or less from the date the new proceeds entered Brazil, then a 6% IOF/Exchange tax on the proceeds of the loan will apply. However, any such tax would be borne by the Brazilian borrower.
Stamp duty: there is no stamp duty payable either (i) on the transfer of a loan; or (ii) on the transfer of real estate security.
As a general rule, in order to be effective against third parties the assignment of a loan:
- must be implemented by means of a public deed; or
- be filed with the public registrar of titles and deeds.
For purposes of enforceability and admissibility into evidence before the public agencies and courts in Brazil of foreign documents, the signature of the parties signing outside Brazil must be notarized by a notary public licensed to act as such under the laws of the place of signing, and the signature of such notary public must be authenticated by a consular official of Brazil or, if the place of signing is a contracting state to the Convention Abolishing the Requirement of Legalisation for Foreign Public Documents dated 5 October 1961, apostilled.
Furthermore, in order to be presented to Brazilian judicial authorities for enforcement in Brazil such security documents must be translated into the Portuguese language by a sworn translator.
Registry of Deeds and Documents: The creation of a mortgage and the perfection of most security interests require registration with the appropriate public registry. The registration fee for registering a financing document is based upon a state fee table and involves a percentage of the amount being secured, limited to a cap. Currently, in the State of São Paulo the fees range from USD 25.60 for a financing agreement worth up to BRL 1,413 (USD 453.00), to a fee of BRL 15,459.11 (USD 4,945.00) for a financing agreement worth BRL 71,871,810.01 (USD 19.6m) and above.
For the registration of a mortgage before the registry of real estate in Sãu Paulo, the fees range from USD 49.70 for a financing agreement worth up to BRL 1,413 (USD 453.00), to a fee of BRL 139,353.65 (USD 44,664.00) for a financing agreement worth BRL 87,135,000.00 (USD 28m) and above.
KEY POINTS FOR TRADERS
Interest rate restrictions may apply to a non-regulated financial institution, where the loan agreement is governed by Brazilian law. Loan acquisitions should be completed by assignment to avoid release of security and negative tax consequences. 15% withholding tax may apply to payments of interest, and registration in the Public Register is required to complete a transfer.
Special thanks to Laura Massetto Meyer and Eduardo Augusto Mattar from Pinheiro Guimaraes who assisted with this Trade Alert.
LEHMAN BROTHERS INTERNATIONAL (EUROPE) – WATERFALL IIC JUDGMENT
The Honourable Mr Justice Hildyard’s Waterfall IIC judgment  EWHC 2417(Ch) concerning the application of statutory interest on provable debts in the administration of Lehman Brothers International (Europe) (“LBIE”) was handed down by the English High Court of Justice on 5 October 2016.
Of particular note for current holders of LBIE claims is that Hildyard J found that the cost of funding should be limited to the actual cost of borrowing by the original counterparty to the ISDA Master Agreement and that the cost of raising equity was, in his view, not part of the cost of funding. The judgment is subject to appeal.
Following the judgment, traders of UK insolvency claims should require full details of claims calculations from original holders to verify amounts due. Please click here for a Cadwalader memo regarding the judgment.
Income tax due by Claim holders on interest? On 11 October 2016 Her Majesty’s Revenue and Customs (“HMRC”) lost a legal battle with the LBIE administrators after the High Court ruled that creditors owed money by LBIE are not required to pay income tax on the interest they earn whilst their money is tied up in the failed bank.
The High Court criticised HMRC’s inconsistent statements about what tax would be due from creditors and ultimately sided with LBIE’s administrators, PWC. The decision means that creditors will avoid a potential tax bill of more than GBP 1bn on the surplus from the estate. However, HMRC has been given leave by the court to appeal, meaning the matter is not yet fully settled.
Please click here for the judgment of the case between (1) Anthony Victor Lomas, Steven Anthony Pearson, Paul David Copley, Russell Downs, Julian Guy Parr (Applicants) –and- Her Majesty’s Revenue and Customs (Respondent)  EWHC 2492 (Ch) dated 11 October 2016 by The Honourable Mr Justice Hildyard.
UPDATE TO THE INSOLVENCY RULES
The Insolvency (England and Wales) Rules 2016 (the “Rules”) were laid before Parliament this month and will come into force and effect from 6 April 2017, replacing the Insolvency Rules 1986. The Rules are intended to:
- consolidate existing rules and amendments into a single piece of legislation;
- modernise and simplify the language used in the rules;
- incorporate various other changes to existing legislation, such as replacing creditors’ and contributories’ meetings with decision making procedures and enabling electronic communication with creditors; and
- be far reaching and apply to all cases administered by Insolvency Practitioners, not just those commenced following the implementation date.
Please click here to view an Explanatory Note to the Insolvency Rules 2016, published by the Government.
SECTION 110 SPECIAL PURPOSE VEHICLE TAX CHANGES IN IRELAND
The Irish Department of Finance in its recently published Finance Bill 2016 (“FB 2016”) sought to address the use of Section 110 TCA 1997 special purpose vehicles (“S110 SPV”) by overseas investors to minimise tax liabilities relating to Irish property transactions. The FB 2016 proposes to restrict the amount of deductible interest for S110 SPVs where the interest is: (i) profit dependent; or (ii) exceeds a reasonable commercial return, in each case where profits from which the interest is funded arises from loans (and derivatives relating to such loans) that derive the greater part of their value from Irish land and are secured on Irish land. The proposed changes do not affect anything other than S110 SPVs that own such loans or derivatives. The legislation is very clear that other types of transactions entered into by S110 SPVs are not affected. Furthermore, profits accrued prior to 6 September 2016 will not be affected, and so there should be no retroactive effect in that regard.
Securitisation transactions (including Collateralised Loan Obligation, Residential Mortgage Backed Security/Commercial Mortgage Backed Security and Loan Origination transactions) have been expressly excluded from the scope of the proposals. Other exemptions exist where debt due by a S110 SPV is held by Irish taxable holders, pension funds and their EU equivalents. There is also the possibility that other vehicles could be used for Irish real estate loan investment, but specific advice should always be taken in this regard.
FB 2016 will go through a number of stages of review, discussion and improvement before being passed as legislation before the end of the year.
- Oi S.A
Oi SA has been in bankruptcy since June 2016. It presented a restructuring plan in September 2016 which included steep haircuts and long grace periods on principal and interest payments. A statement released by the Steering Committee (“Steering Committee”) of the Ad Hoc Group of Oi Bondholders objected to the terms of the plan.
Following this, Bloomberg reported that Oi is now looking to replace PJT Partners with an alternative financial adviser that has more experience in Brazilian law. Chief Executive Officer Marco Schroeder has commented that as the company is now in a judicial recovery process “it is natural that we look for a financial adviser that understands very well the legal issues”.
According to Reorg Research Oi is expected to present a business plan by month-end that will detail the change in advisors. The company’s third-quarter earnings results are expected to be published on 10 November 2016, and will host a conference call with analysts and investors to discuss the results at 8:30 a.m. EDT on 10 November 2016 to discuss the same.
Following the rejection, the company’s creditors are able to demand immediate repayment of its EUR 1.164bn debt.
The Commercial Court of Nanterre had previously dismissed the company’s shareholder group Regroupment PPLOCAL’s request to defer the AGM to give the company more time to collate information for shareholders.
Despite more than two-thirds of Solocal’s creditors approving its restructuring plan to reduce its debt to EUR 400m, without shareholder approval the company will not be able to submit the restructuring plan to the Commercial Court of Nanterre for its sanction. It is now in the hands of the Commercial Court as to how to proceed with the company’s financial safeguard plan, put in place in 2014.
- GENERAL HEALTHCARE GROUP
Reorg has recently reported that BMI Healthcare, the U.K. private hospital group controlled by GHG is seeking to syndicate its seven year GBP 285m term loan. The deal would allow the company to reduce rent expenses and pay GBP 180m towards its propco. It is said that lenders must commit to the new debt by 4 November 2016.
GHG had a revenue of GBP 879m in 2015 with an EBITDA of GBP 59m. The company underwent a large restructuring of over GBP 1.5bn of debt earlier this year in order to continue operating and not fall into winding up proceedings, such as in the case of Southern Cross, the country’s biggest care home operator, in 2011.
The President of Iceland issued a decree on 20 September 2016 in which he dissolved the Parliament (Althingi) and announced that new elections will take place on 29 October 2016. At the time of writing, the populist Pirate Party are polled as a key contender to be the newly elected party.
According to Bloomberg, the Pirate Party’s stance is difficult to assess, as they believe that their policy should be shaped by its members via an online voting procedure. A spokesperson for the party wanted to reassure investors that there would not be any surprises in relation to their monetary policy.
Despite the recent economic boom in Iceland, populist parties such as the Pirate Party have been challenging the established order and support a variety of new policies such as a revised constitution promoting transparency and a fairer re-distribution of the dividends from Iceland’s natural resources, meaning higher taxes on fishing and mining corporations.
In order to enter the Althingi, each party must overcome a 5 per cent threshold. Gudni Th. Johannesson, the recently elected President, is to decide who should be the next Prime Minister. The decision is not automatic and is based on who is likely to have the best chance of forming a viable majority government.
- GLITNIR HOLDCO EHF
On 27 October 2016, Glitnir redeemed the Notes in part by way of an optional redemption payment in cash pursuant to Condition 6.3 of the Terms and Conditions of the Notes. The final amount used to redeem the Notes was EUR 64,861,181.
The aggregate principal amount of the Notes is EUR 429,462,724 immediately following the payment on 27 October. Transfers are once again being processed following the temporary halt on transfers implemented for the redemption.
Glitnir is required by Clause 12.1(c) the Terms and Conditions of the Notes to provide a summary asset monetisation plan within 120 days of the end of each of its financial half-years. Glitnir has published this plan and is available on the secure website for review by investors.
- LBI EHF
Pursuant to 9.1(c) of the Conditions and further to the Unscheduled Payment Notice issued on 3 October 2016, Bondholders were notified that the final amount of cash paid on 12 October 2016 was EUR 418,713,810.
Following the payment, the aggregate principal amount of the Convertible Notes is EUR 1,562,612,653.
Payments were made to the euro account of the Bondholder noted on the Register at the time of payment.
Queries regarding payments can be directed to US Bank, as the Registrar, at:CDOAgencyServices.LBIhf@usbank.com