Theory and pragmatism of governance reform in business reorganization: a case study of Brazil

AutorGustavo Oliva Galizzi
Páginas130-146

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Introduction

The new Brazilian Bankruptcy Act (Act 11.101/2005), originally a bill that took ten years to be enacted by the National Congress, has introduced very important changes to the country's legal, economic and social arenas. Partially influenced by the American bankruptcy model, which has regulated business reorganizations since 1978, the new act represents, in the norma-tive scenario, the transition from the con-cept of bankruptcy as liquidation to that of bankruptcy as a reorganization means. Whereas formerly liquidation of the business was the norm, nowadays much more emphasis is placed on the role of reorganization for crisis-stricken companies, to the benefit not only of its shareholders but also of its employees, consumers, creditors and society as a whole.

The new act mostly seeks to ensure that only economiçally feasible companies, momentarily in the midst of some financial turmoil, be allowed to undergo some re-structuring while keeping their employees and meeting payments to creditors, rather than selling off company assets. By extin-guishing concordata1 while creating, in

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turn, the figure of judicial reorganization,2 the new act widens its scope and allows for the flexibility of corporate restructuring processes, by providing several mecha-nisms to tackle the debtor company's financial and economic difficulties.

The mechanisms prescribed by the new Brazilian Bankruptcy Act3 focus pri-marily on the financial and managerial re-form of the debtor company.4 As far as the mechanisms of managerial reform are con-cerned, especially noteworthy is the possi-bility of reorganizing the architecture of management, through either a court-ordered removal (Article 64 of the BB A) or the re-placement of corporate officers and direc-tors (Article 50, IV of the BBA). The theo-retical framework of such instruments is grounded on the principie of disassociation between the company and the owner thereof, regarded by most scholars to be one of the essential pillars of the new Brazilian bankruptcy law.

This paper argues that a belief in re-placing the company's management as an essential reorganization mechanism, even if accompanied by other steps,5 is un-founded. Several factors corroborate this claim. One is the high levei of concentra-tion between ownership and contrbl in Brazilian corporations, which hampers the re-placement of corporate officers by the

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board of directors (when existing).6 More-over, the reality carried o ver from other legal systems, especially the American one, shows that the court-ordered remo vai of the failing enterprise's management and the consequent appointment of a trustee are not always effective from an economic stand-point, and is therefore only granted under rare circumstances.

Management replacement is even more unusual in the reorganization processes of small and mid-sized companies, in which ownership and control are even more closely connected.

Taking that into account, the Paper also suggests that, alternatively to the re-placement/removal of management, the in-volvement of creditors in the governance structure of the debtor company can be a more effective and feasible instrument within the reach of them to provide a more successful management and consequently improve the economic performance of the company as it surfaces from bankruptcy.

During the pendency of the reorganization case, creditors replace shareholders as the focal point in the governance system of the failing enterprise. This shift in the governance system places the creditors in the role of the group entitled to hold the residual authority over business decisions. As the residual claimants of the firm during reorganization, creditors should take a more activist approach to governance issues by participating in the governance structure of the failing enterprise.

Part I of the Paper discusses the hy-potheses of management replacement as provided for and allowed by the Brazilian Bankruptcy Act and suggests that the em-phasis placed on them as an essential step towards recovery is overrated. The study comments on the experience of the American bankruptcy law, when applicable to the Brazilian reality.

In Part II, a case is made for the in-volvement of creditors in the governance structure of the debtor company as part of the overall effort to revitalize the enterprise. The Paper concludes restating that management replacement is a very exceptional re-structuring measure and that the involve-ment of creditors in the running of the failing enterprise may be a more viable instrument for them to influence the debtor 's business decisions during the reorganization case.

Part I - The Brazilian Model of Business Reorganization and the Belief in Management Replacement

The new Brazilian Bankruptcy Act fi-nally introduces into the national legal system the figure of judicial reorganization of economically feasible companies. As pre-viously mentioned, Brazilian legislators have sought to enable the economic re-emergence of the enterprise, ensuring pay-ment to the creditors, job stability and the conservation of the many interests that gravitate towards the business concern, as intended in Article 47 of the BB A.7 Some-what inspired by the US bankruptcy legis-lation, Chapter 3 of the Brazilian counter-part governs judicial reorganization, which can be equaled, by way of hermeneutics, to the well-known Chapter 11 of the United States Bankruptcy Code (Title 11, United States Code).8

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As regards its content, the Brazilian model of judicial reorganization is emi-nently focused on the managerial and financial restructuring of the firm. This Paper examines the mechanisrns of managerial restructuring only. More specifically, the study concentrates on the instruments of removal and replacement of management of the debt-ridden company, Such instruments can be summarized as folio ws: a) replacement of management by means of a unilateral proposal by the debtor (Articles 50, IV and 53 of the BB A); b) replacement of management through an initiative by the minority shareholders (Article 50, IV of the BBA); c) replacement of management as recommended in the creditors' alternative reorganization plan (Articles 50, IV and 55 of the BBA); d) removal of management through a court order, with a subsequent appointment of a trustee by the court (Articles and 65 of the BBA).

Such steps incorporate, in the norma-tive sphere, a common sense that had per-meated the academic scene since the Brazilian National Congress began to discuss the bill to reform the former bankruptcy act. It became commonplace for the books and articles on bankruptcy law to suggest that one of the cornerstones of the new act should be the possibility of disassociation between the company and the owners thereof.9 The rationale behind such claim is simple: in theory, disassociation promotes the removal of the company 's leading people without necessarily interrupting the economic activity, thus preventing bad management from bringing about the dis-solution of the business. Supporters believe that the reasons for the economic financial crisis stem from mismanagement. Replac-ing management, therefore, should be the very first step towards restructuring the company.10

Even though this assertion may appear to bear some theoretical logic or a legal meaning, in practice it does not. In the next four topics, this Paper analyzes each of the hypotheses of management replacement as suggested and allowed by the Brazilian law and demonstrates that the faith on them as an essential reorganization mechanism of the failing enterprise is unwarranted.

A - Management Replacement through theDebtor's Unilateral Proposal

In Brazil, management replacement through the debtor's unilateral proposal seems very unlikely. Under the BBA, the debtor, and not the creditors, is the incum-bent party to file the reorganization plan (Article 53 of the BBA) and as such it would appear to be highly unlikely that the debtor would come before a court of law and ad-mit that the reorganization of its business depends upon a management replacement. Not even the most optimistic creditors or minority shareholders dissatisfied with the present management composition would keenly expect the debtor to voluntarily put forward a unilateral replacement proposal.

Conversely, in the U.S. management replacement willingly brought on by the debtor is quite common. Lynn M. LoPucki and William C. Whitford conducted an

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empirical study of the forty-three largest publicly held companies to file and complete a bankruptcy reorganization case in the United States between 1979 and 1988.11 Management replacement by the board of directors often took place in the cases stud-ied.12 In fact, in the period starting eigh-teen months before filing and ending six months after confirmation of the plan, there was at least one replacement of CEO in thirty-nine out of forty-three cases (91% of the total number of cases). In thirty-one of these cases (72% of the total number of cases) there was at least one replacement of CEO pending a Chapter 11 case, or con-templated by the plan of reorganization.

Replacement of corporate officers is common in the US due to a greater separa-tion between control and ownership in US companies. That characteristic of the American capital market allows for less interaction among shareholders, board of directors and corporate officers, which fa-cilitates a replacement of the latter by the former. It is worth mentioning that while CEOs are commonly replaced, the same cannot be said of the board of directors. In fact, the board of directors is usually kept unaltered during the Chapter 11 reorganization case, as will be depicted in the next topic.

The replacement of corporate officers in Brazilian companies is not feasible, at least not as conducted in the US. Unlike the American reality, the capital market...

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