By Rodrigo Takano and Murilo Caldeira

Although the Brazilian economic scenario has considerably improved over the last 12 months (especially if compared with the difficult years of 2015 and 2016, when the political and economic crisis that still affects the Brazilian market was at its peak), the number of new companies facing insolvency and judicial recovery proceedings in Brazil continues to grow.

Between January and June 2018, the number of new requests for judicial recovery increased 9.9 per cent compared to the same period in 2017, increasing from 685 to 753. Only in the last 12 months, 1,488 new requests for judicial reorganisation were filed by companies in Brazil, 4.78 per cent higher than in the year 2017, when 1,420 new requests were presented.

This crisis, that has been consistently affecting the Brazilian economy since the end of 2014, together with the sharp appreciation of the US dollar, which has risen from R$2.20 to R$4, and the recovery of the European and North American economies, has generated investment opportunities in distressed companies in Brazil. As a result, the number of M&A transactions involving companies undergoing judicial reorganisation has substantially grown since 2015.

Distressed M&A transactions usually involve substantial challenges that must be addressed before getting the deal through. This is so because the transaction itself must not only accommodate the purchaser’s interests but also be an instrument for the distressed company to recover its financial health. In many cases, the sale is essential for the company to be able to restructure its capital structure and business in order to comply with its reorganisation plan and financially recover itself.

Within those M&A transactions, the distressed company’s existing labour and employment liabilities (which may be pre-petition or post-petition) and current employees play an important role and, therefore, the ability to properly address such liabilities is essential for a successful transaction.

One of the most effective mechanisms to address the distressed company’s existing labour and employment liabilities is by the acquisition of assets, when sold as isolated productive units. This is so because, according to the sole paragraph of Article 60 of the Brazilian Bankruptcy and Judicial Recovery Law, the sale of ‘isolated productive units’ made in the context of a judicial recovery and reorganisation plan, in accordance with the recovery proceeding, will be clear and free of any liens and succession of the buyer and exempt from debtor’s obligations.

Specifically, Brazilian major doctrine and case law understands that there would be no labour succession in cases involving the acquisition of isolated productive units by third-parties in the context of judicial recovery proceeding because the application of labour succession rules in these type of transactions could hinder acquisitions of isolated productive units, which are vital for enabling the payment of the obligations established in judicial recovery plans.

While these types of acquisitions are already widely known in Brazil, another very effective and efficient mechanism, recently introduced by the Brazilian Labour Reform, that may be used to address the distressed company’s existing labour and employment liabilities and to support the implementation of mass dismissals and business reorganisations, is still not well known. This new mechanism allows the ratification of out-of-court settlement and release agreements, executed between companies and employees, by Brazilian labour courts. After the ratification of the out-of-court settlement and release agreement, employees cannot file labour lawsuits against the employer and released parties.

Although this mechanism was initially intended to address individual disputes, certain distressed companies have been successfully able to use it to address not only their existing but also their potential future labour and employment liabilities on a collective basis through the execution of collective agreements with labour unions representing their employees.These collective agreements are especially relevant in these cases because, according to case law, the absorption of relevant employees by the purchaser within transactions involving the acquisition of isolated productive units shall not be carried out through the transfer of the relevant employees from the seller to the purchaser (as the law determines within regular M&A transactions), but rather through their termination and subsequent re-hiring by the purchaser, which usually triggers the filling of several new labour lawsuits against the seller. Now, with the possibility of entering into a collective agreement with the labour union representing its employees, the distressed company could negotiate a collective out-of-court settlement and release agreement that would avoid those potential new labour lawsuits, substantially increasing the chances of having a successful reorganisation process.

This type of agreement may also be very efficient when, after the asset deal, the distressed company intends to implement a mass dismissal due to a change in its business, which could also trigger a significant number of new labour lawsuits that could hinder its reorganisation. As an example, the 3rd Labour Court of the City of Goiania, State of Goiás, recently ratified a collective out-of-court settlement and release agreement, executed between a shipping company and the labour union that represents its employees. In this specific case, the controlling shareholder of the shipping company decided to terminate its shipping operations and dismiss 120 workers. The collective agreement established the payment of additional voluntary severance payments by the shipping company based on years of service in exchange of a release of claims. The rationale behind the collective agreement was to avoid the filing of labour lawsuits by the former workers against the shipping company that could substantially affect the timing and costs initially estimated for the closing of the business.

In other cases, the execution of an out-of-court settlement and release agreement with the labour union representing the distressed company’s employees could be used as a mechanism to implement a reduction of the labour and employment debts and to adjust the company’s business, preparing it for a future sale within the judicial reorganisation. This is especially relevant if the company intends to close a specific business to focus on another. Without such negotiation, a reduction of the labour and employment debts could be questionable.

It can be seen, therefore, if the collective negotiation is properly implemented by the interested parties, this new mechanism introduced by the Brazilian Labour Reform can bring a great level of certainty and substantially reduce the risks involved in distressed M&A transactions, which, depending on the circumstances, may be essential to getting the deal through or not.

This article first appeared on the website of the Employment and Industrial Relations Law Committee of the Legal Practice Division of the International Bar Association, and is reproduced by kind permission of the International Bar Association, London, UK. © 2018 International Bar Association.