More than ten (10) years after the enactment of Brazilian Bankruptcy Law, a uniform understanding by the Brazilian courts of several matters remains unresolved, being the application of substantive consolidation one of the most troubling.

Consolidation (procedural and material)

In this respect, Brazilian Bankruptcy Law is silent on the possibility of judicial recoveries being filed by and/or involving more than one company of a same corporate group. In this respect, Brazilian Bankruptcy Law makes reference to “debtor” in the singular form and does not expressly provide for the possibility of a judicial recovery being requested by more than one company or being consolidated.

Notwithstanding the above, Brazilian procedural law recognizes that multiple claimants or multiple respondents may co-exist in a judicial proceeding, since the Code of Civil Procedural Law (CPC) establishes the possibility of co-claimants or co-respondents in a given case, provided that, inter alia, their rights or obligations are common.[1] Nevertheless, the possibility of a judicial recovery claim being filed by more than one claimant (procedural consolidation) is not to be mistaken with the unification of assets of different legal entities (material consolidation).[2]

Procedural consolidation solely consists in the existence of more than one company on the claimant’s side of the judicial recovery, thereby mitigating costs and expediting the proceeding. This type of consolidation does not, however, entail the unification of assets or liabilities. Accordingly, it is possible to process the judicial recovery of more than one company, in a same proceeding, while still recognizing the separation of their respective assets.

On the other hand, material consolidation entails the unification of assets and liabilities of two separate legal entities. This unification may result in the assets of one company being sold to pay the obligations undertaken by the other company. There is no doubt that material consolidation poses greater difficulties than procedural consolidation. The general application of material consolidation may undermine the principle of segregation of assets of companies, affecting, therefore, the prevailing principle that a creditor of a given company or companies (in case of guarantees) would look solely to the respective assets of such company or companies to satisfy the claim. The application of material consolidation may have severe impact on credit risk analysis undertaken by creditors and the required due diligence exercise.

The reasons that justify the substantive consolidation will vary on a base by case basis. However, the analysis of the substantive consolidation`s requests filed before Brazilian courts reveals that, in the majority of the cases, such requests are based on: (i) the companies being part of the same economic group; (ii) the existence of a common management of the companies; and (iii) the existence of cross guarantees among the requesting companies.

Differently from other countries in which material consolidation is allowed, such as the United States, Spain or Portugal, material consolidation in Brazil has been applied in a broader way, i.e. without justification in a situation of non-equalness among the creditors. (For instance, Portuguese corporate law establishes the joint responsibility of a controlling company with respect to a loan granted to its controlled company when such loan is made under the order of the controlling company. In such situations, Portuguese corporate law further establishes that a case of material consolidation between the controlled and the controlling company will apply if the controlled company is declared insolvent).

Under other law systems material consolidation will only apply in very few cases, mostly when there is comingling of assets and liabilities of the debtors in way that it becomes almost impossible to segregate such assets and liabilities (i.e. the material consolidation will apply to the same two cases in which the lift of corporate veil applies) or in situations in which creditors reasonably believed that they were dealing with a single corporate entity. This is the guidance described in the guidebook prepared by the Commission of the United Nations for International Commercial Law (UNCITRAL).

According to the UNCITRAL guidebook, for a material consolidation to be authorized, the existence of the following is required: (i) a common account covering all of the members of the corporate group; (ii) several inter-company loans; (iii) transfer of funds without observing the required formalities; and (iv) the same place of business in regard to all of the companies that comprise the corporate group.

In Brazil, either due to the absence of specific provisions or guidance in the Bankruptcy Law, Civil Code and the Brazilian Corporation’s Law, material consolidation has been authorized by courts without a common criteria and without observing the existing requirements for lifting the corporate veil. Court decisions are mostly solely based on the primary request made by the very company that is filing for its judicial recovery.

In conclusion, it is urgently necessary to amend Brazilian Bankruptcy law or unify the understandings of the courts to establish the objective criteria that must be complied with in order for procedural and material consolidations to be authorized, preventing that creditors have their credit risks increased and recovery efforts undermined based on interpretations that where non existent at the time of the granting of the credit.