At the end of the first quarter of 2023, Brazil still has one of the highest real and nominal basic interest rates in the world. Adding to this the turbulence that the international economy is going through in a post-pandemic and war scenario, with high inflation and rising interest rates even in the most developed countries, infrastructure financing in Brazil is experiencing an especially challenging moment.
Credit is essential for all sectors of the economy, including households. However, without credit, especially in the form of project finance, infrastructure projects entrusted to the private sector will not be viable. And investment in infrastructure plays a relevant role in economic growth, since the availability and quality of transportation, energy, and telecommunications infrastructure, among others, are requirements for the growth and competitiveness of other sectors of the economy.
Not by chance, reduction of interest rates is one of the biggest concerns of the new government.
Several factors explain the high value of the Selic (the basic interest rate in Brazil), with emphasis on the country's fiscal situation and how it is viewed, with greater or lesser distrust, by the market.
On the other hand, one of the main factors responsible for the even higher interest rates on credit transactions carried out in the financial market is the high risk of default, which is directly related to the availability and efficiency of collateral.
On June 1, 2022, the Chamber of Deputies approved Bill 4,188/21, which seeks to improve the collateral system in Brazil. Initiated by the Executive Branch, the bill had contributions from associations representing various market segments and is awaiting consideration by the Federal Senate, where it should have priority.
Guarantees can contribute to greater availability of credit and to cheapening it, as well as to performance of contracts and legal certainty in general. Improvements, therefore, are more than welcome, especially in Brazil, where the reaction of the Legislative Branch to correct inefficiencies or legal gaps is usually slow, and consolidation of case law to overcome interpretative doubts is equally slow.
The bill intends, for example, to eliminate inefficiencies and uncertainties of the real estate fiduciary sale system that have persisted for more than 25 years, since the advent of Law 9,514, of 1997!
Among them is the discussion of whether the rule in paragraph 5 of article 27 of the law would imply automatic extinguishment of the secured debt, in the event of a second auction of the property sold in which there was no bid equal to or greater than the value of the debt, even if the fiduciary sale agreement expressly excludes this extinguishment.
Some judicial precedents already point to lawfulness of the removal of the extinguishing effect, when expressly agreed upon in relations between companies, and not between individuals. However, these precedents are still far from being settled case law.
And what are the other improvements proposed by Bill 4,188/21?
The main new features are:
- discipline of the specialized collateral management service, in charge of collateral management institutions - GGI;
- discipline of the collateral agent;
- recognition of the legal possibility and the more detailed discipline of successive fiduciary sales or assignments over the same asset;
- broader improvement of the process of extrajudicial enforcement of the fiduciary sale of real property; and
- recognition of the legal possibility and discipline of extrajudicial foreclosure of mortgages.
The specialized collateral management service and collateral management institutions - IGGs
This is undoubtedly the biggest innovation of the bill, which creates the concept of an IGG, a legal entity under private law responsible for specialized management of collateral, which should be regulated in more detail by the National Monetary Council (CMN).
Although it does not qualify as a financial institution and is prohibited from conducting activities that are exclusive to such institutions, an IGG will be subject to regulation, authorization, and supervision by the Central Bank.
An IGG will act on its own behalf when establishing, registering, managing, valuing, and enforcing collateral, but for the benefit of creditor financial institutions. It will also assume fiduciary duties not only vis-à-vis these institutions, but also vis-à-vis the borrowers in the secured transactions and the provider of the collateral. Breach of these duties will result in personal liability for the IGG.
With such a high level of regulation and responsibilities, it is questionable whether we will have companies willing to take on this role.
The IGG differs from a mere collateral agent. The latter is a well-known figure in the market, especially abroad (collateral agent). In Brazil, although not so widespread and reserved for more complex transactions, the collateral agent is equivalent to a simple agent of creditors holding collateral, acting in their exclusive interest and with a scope of action, rights, and obligations defined in a contract signed with them.
The IGG was designed to play a different role. In contrast to the collateral agent, the initiative to contract the IGG would, as a rule, not be taken by the creditor agent, but by the individual or legal entity interested in holding an asset, usually indivisible, linked to multiple potential credit transactions.
As one potential use of this service, imagine an individual who has only one property to pledge as collateral. In theory, it could even be a family asset, since the bill, among its general provisions, also amends the legal framework for family assets, to remove exemption from foreclosure whenever the asset is voluntarily offered as collateral by its holder, regardless of the nature of the secured obligation.
Suppose, then, that this individual, at first, sees the need to take out financing that represents only 10% of the value of the property. Instead of tying 100% of their single, undivided property to the loan, which would represent an undesirable overcollateralization and could create a barrier to any future loan transactions, the individual will hire a IGG to manage the security interest on the property.
The security interest on the property will then be registered in the name of the IGG, and it will be permitted in the respective contracting instrument of the IGG to link multiple credit transactions to this collateral within the maximum term of the contract and up to the maximum total amount equivalent to the value of the property, as independently assessed by the IGG.
Once a financial institution agrees to grant credit to the individual in question, it would link its credit to the collateral under the management of the IGG, consuming at that time, in relation to the total collateral, only the maximum amount of credit granted and apparently without the need for any addition to the security interest already registered in the name of the IGG in the competent public register.
The individual would be free to contract new credit transactions in the future, until the total value of the security interest, as assessed by the IGG, is exhausted. In addition, as the originally linked transactions are amortized, this would open up more space for new credit transactions.
The collateral managed by the IGG, as a mere service provider, and registered in its name would not be confused with its own assets. Therefore, they would not be liable for any obligations of the IGG, but would constitute separate assets.
Risks and benefits of the proposal
The market will need time to assimilate this novelty, but the figure of the IGG has merit and could optimize the use of assets pledged as collateral, enabling a greater number of credit transactions at a lower cost.
However, the change is not immune to risks, in particular the risk of a supervening decrease in the original appraised value of the asset, after that original value has been backed by credit transactions that have fully consumed it. In this case, any supervening reduction in the value of the asset pledged as collateral, or even the original overestimated valuation, will mean a shortfall in collateral, to be shared proportionally among all creditors, unless an order of priority is stipulated among them.
Perhaps because it anticipated this possible scenario, the bill authorized the IGG to provide personal guarantees, which would secure the credit precisely when the collateral it manages is insufficient. Likewise, the bill establishes that the CMN may regulate the possibility for the IGG to acquire existing credit rights, including those linked to the collateral.
While these authorizations may, on the one hand, mitigate the risk of insufficient collateral under management, on the other hand, they may create the risk of conflict of interest that the project is concerned with avoiding by preventing the IGG from engaging in activities that are exclusive to a financial institution.
In any case, having understood the purpose of the IGG, it does not seem that it can be of much use in the context of infrastructure financing. It is of the essence in project finance transactions, typical of the infrastructure sector, that financial agents have the leading role in structuring security interests. For this context, the provisions regarding collateral agents will have greater application.
The IGG seems to have been designed for simpler and more standardized credit transactions, so much so that it is limited to transactions in the national financial system. Credit transactions in the capital market or with foreign lenders were excluded from its application from the outset.
As the explanatory memorandum of the bill shows, IGGs have the potential to facilitate the operations of cooperatives, fintechs, and small financial institutions, institutions that do not necessarily require collateral that is individualized or that they structured.
The concept of the collateral agent is not new, but express regulations regarding it will be very welcome.
In project finance transactions, where there is often a need for different senior or subordinated financing agents to share collateral, the appointment of the collateral agent by these agents was already common, even in Brazil.
With caveats applicable to certain assets, not being a regulated activity (unlike with IGGs), any legal entity can act as a collateral agent. Among the exceptions, it is worth mentioning the receipt and custody of financial funds on deposit, which is an activity exclusive to financial institutions, as well as administration or management of investment funds, which requires authorization from the CVM.
In public-private partnerships, it is also common to appoint collateral agents to hold securities, receivables, or assets as collateral for the public consideration due to the private partner. In this case, the appointment of the collateral agent must meet the requirements set out in the PPP notice or in the draft concession agreement and its exhibits.
Due to these frequent uses, we already contended for, in 2018, the convenience of a legal system for collateral agents.
In fact, in any of these contexts, until an express framework is approved, the collateral agent will not be free from undesirable questions. Even if all are defensible, the mere existence of doubts and questions contradicts the ultimate purpose of collateral, which is to provide certainty and predictability.
Strictly speaking, if its role is justified on the sole basis of a power of attorney, the collateral agent should act on behalf of the principal, and not on its own behalf. But this is not the practice: the collateral agent usually receives and registers collateral in its name, without the necessary indication of all beneficiaries of the collateral.
In this respect, the commission would be the most appropriate typical contract for the collateral agent to act on its own behalf but in the interest of the principal. However, the typical commission contract, as provided for by articles 693 et seq. of the Civil Code, seems to limit its use to the context of the acquisition or sale of goods, which does not exactly fit with the receipt, management, and enforcement of collateral.
But even if the concept of collateral agent is based on an atypical engagement, which would not be prohibited, the absence of a clear regulations may raise doubts in a scenario of execution of the security interest or for the agent's liability regime. The proposed regulations is therefore very timely to give more certainty to the role of the collateral agent, including in the context of project finance.
Successive sales and fiduciary assignments of the same asset
Bill 4,188/21 came in good time to confirm the possibility of successive fiduciary sales, as already admitted without further doubt for mortgages.
With some interpretative effort, it was already possible to defend the legality and validity of "second or third degree" fiduciary sales.
In a perfectly feasible line of reasoning, it was contended that the fiduciary could dispose of its residual rights over the asset already disposed of in a fiduciary capacity at an earlier time, including the right to regain full ownership of the asset, after discharge of the secured debt.
The bill uses another basis, but with equivalent effect: that it is lawful for anyone to dispose of future property. Even if, in this case, the fiduciary ownership in favor of the fiduciary creditor is only perfected with subsequent acquisition of the asset by the fiduciary debtor, the effectiveness of the sale will be retroactive to the date of registration of the security interest (article 1361, paragraph 3, of the Civil Code).
Although the bill has brought this express confirmation only in the context of the fiduciary sale of real estate, its reasoning seems perfectly applicable to the fiduciary sale or assignment of any other asset or right.
The proposal has good potential for application even in infrastructure financing, as it is not uncommon in this market to require collateral with different degrees of priority in favor of subordinated creditors. Although it was already possible to defend the legal viability of second-degree fiduciary sale, the risk of disputes could not be ignored.
Improvements to enforcement of the fiduciary sale of real property
Another novelty to be highlighted in the bill is the objective provision that, in a second auction, the property fiduciarily sold may be sold for up to 50% of the value assigned to it in the fiduciary sale agreement. This removes the subjectivism from the concept of an arm’s length price.
And, as already referenced above, if the sale is made for a price lower than the debt, the debtor will remain liable for the difference, ruling out automatic discharge.
It is also interesting to introduce a provision to deal specifically - and with less room for doubt - with execution of a claim secured by more than one real property fiduciarily sold.
Extrajudicial execution of mortgages
The bill also proposes to amend Law 9,514/97 to extend the alternative of extrajudicial execution to mortgages, which is not currently allowed under the Civil Code.
This possibility could be useful in various segments, including infrastructure financing. Extrajudicial execution tends to offer greater speed and efficiency to the process of forced execution of the asset, removing the slowness and litigiousness of the judicial route.
The bill also brings in other more specific changes. It now expressly admits the creation of a security interest on mining rights other than the mining concession, such as on the right to a research authorization permit, licensing right, and mining permit.
It also aims to abolish Caixa Econômica Federal's monopoly on civil pledges.
Among other matters foreign to the central topic of security interests and with a special chance of review in the Senate or presidential veto, we highlight the proposal to reduce to zero the withholding income tax, with respect to income paid or credited to a beneficiary resident or domiciled abroad, produced by any debt securities publicly distributed by a legal entity governed by private law other than financial institutions, by FIDCs, or even by financial notes, without further requirements or conditions.
Bill 4,188/21 is far from offering a comprehensive solution to all the inefficiencies and challenges existing in our collateral system, in its various modalities and market segments, but it certainly demonstrates concern and commendable progress. It is hoped that it will be approved with the urgency that the issue deserves.
ENEI, José Virgílio Lopes. Guarantees of Performance of the Public Administration to Contractors in Public-Private Partnerships. São Paulo: Almedina, 2018.