Introduction

The 2nd Court of Bankruptcy and Judicial Recovery Cases of São Paulo recently found invalid a chattel mortgage securing an interchangeable chattel good (i.e. iron ore) offered to a foreign financial institution not authorized by the Brazilian Central Bank to operate in Brazil. According to the ruling, only Brazilian or foreign financial institutions authorized to operate in Brazil may receive a chattel mortgage offered to secure interchangeable goods.

The ruling is very important since, according to the Brazilian Central Bank, in January 2007 the balance of credit operations in Brazil held with financial institutions under foreign control was slightly less than R$ 400 billion, with many of these operations secured by chattel mortgages covering interchangeable goods.

Fiduciary ownership

In Brazil, there is a triple fiduciary ownership system, namely: (i) the Civil Code system, which regulates the fiduciary ownership of non-interchangeable chattel goods, when the fiduciary creditor is not a financial institution; (ii) Article 66-B of the Capital Market Law and Decree-Law 911 of 1969, which regulates the fiduciary ownership of interchangeable and non-interchangeable chattel goods, when the fiduciary creditor is a financial institution, and (iii) Law 9.514 of 1997, which regulates the fiduciary ownership of chattel goods, irrespective of whether the creditor is a financial institution or not.

Under fiduciary ownership, the debtor in the fiduciary operation transfers, as security, reversible ownership and indirect possession of the good to the fiduciary creditor. Upon fulfillment of the obligation, the fiduciary creditor returns ownership of the good to the fiduciary debtor. If, however, the obligation is not fulfilled, ownership is consolidated to the fiduciary creditor, who shall sell the good and, upon the price obtained, shall pay, passing on any residual balance, or, in some situations, even charge to the debtor any shortfall.

Because of its features, fiduciary ownership presents several advantages compared to other types of guarantees, and this ultimately influences, inclusively, the credit risk of an operation. Among the advantages, and in connection with what is of interest here, is the fact that the obligation secured by the fiduciary ownership is not subject to judicial recovery (or bankruptcy).

The matter involved in the ruling

The recent ruling involves the legal grounds that authorize the chattel mortgage. As previously stated, a triple fiduciary ownership system exists in Brazil; while the Civil Code authorizes the offering of this type of guarantee to secure non-interchangeable chattel goods, without any restriction as to who may be the creditor (an individual or legal entity, financial institution or not), the Capital Market Law specifies only the chattel mortgage as a security in the financial and capital market, authorizing the offering of this type of guarantee specifically to cover interchangeable and non-interchangeable chattel goods, provided that the creditor is a financial institution.

There is no doubt that typical financial and capital market operations are covered by the Capital Market Law. Therefore, a loan extended by a financial institution may be secured by a chattel mortgage involving interchangeable chattel goods.

However, the question in this situation is different: can a foreign financial institution, not authorized to operate in Brazil, extend a loan and receive a chattel mortgage offered as security regulated by the Capital Market Law?

The aforementioned ruling found that only a Brazilian financial institution or a foreign financial institution authorized to operate in Brazil may use the guarantee contemplated in the Capital Market Law (interchangeable, chattel). Consequently, and the ruling further found, given that the fiduciary creditor is a non-authorized foreign financial institution, the chattel mortgage agreement should have been entered into based on the Civil Code (not the Capital Market Law), not being allowed to establish a guarantee differing from a non-interchangeable chattel.

The mistake in the ruling

The ruling that found invalid the chattel mortgage securing an interchangeable chattel good, offered to a foreign financial institution, presents serious mistakes.

Initially, the ruling ignored the date on which the Capital Market Law was enacted, as well as what that law was aimed at.

The Capital Market Law was enacted in 1965 and it was intended to stimulate the extension of loans to enable Brazil to transition from an agrarian to an industrialized country. For this reason it foresaw a guarantee quite effective for the creditor in the event of breach on the part of the debtor.

There are no restrictions therein impeding its use by a foreign financial institution. Had that been the intention of the law, it would certainly have literally provided for this. As the Law does not do this, neither can the interpreter of the law.

In addition to the absence of any restriction, practically, the restriction on applying this Law only to national financial institutions represents a genuine countersense, as it limits the possibility of obtaining credit, thus making it difficult for companies established in Brazil to obtain loans.

Strictly speaking, the ruling ultimately requires that the foreign financial institution be authorized by the Central Bank to extend a loan to a debtor in Brazil and receive a chattel mortgage involving interchangeable chattel goods. In other words, every financial institution in the world must be authorized to operate in Brazil so that it may lend resources to Brazilian debtors and receive non-interchangeable chattel goods under a chattel mortgage.

Note that the requirement to register with the Central Bank is justified when the case is to capture resources in the Brazilian economy, where such authorization aims to protect national savings. However, when the resources involved in the loan are not captured in Brazil, such protection is unnecessary, hence the authorization is not necessary.

In addition to these points highlighting the mistakes of the ruling, it should be stressed that the ruling did not analyze the aspect of whether the good that was offered as a guarantee was interchangeable or non-interchangeable, it merely stated that the mortgage chattel should have been contracted based on the Civil Code.

Based on a reading of the documents that were presented, the good that was offered as a guarantee is a non-interchangeable chattel (it was converted into a non-interchangeable good at the parties’ free will). For being so, and even if it is found that the Capital Market Law applies only to a Brazilian financial institution or a foreign financial institution authorized to operate in Brazil, the fiduciary guarantee agreed would be valid, insofar as it covers a non-interchangeable chattel good (i.e. iron ore duly individualized).

Conclusion

As previously stated above, the ruling that found invalid the chattel mortgage as a guarantee offered to the foreign financial institution not authorized to operate in Brazil is wrong, either because the Capital Market Law cannot be interpreted in the sense that it applies only to Brazilian financial institutions or authorized foreign financial institutions or because the chattel mortgage covers a non-interchangeable chattel good.

Contributed by Luis Ambrósio and Gledson Campos, Global Restructuring and Insolvency partners of Trench, Rossi & Watanabe in cooperation with Baker McKenzie.