Reconfiguration of Labor Claims under the New Brazilian Bankruptc...

Since the new Brazilian "Bankruptcy Law" (Federal Law No. 11101) was enacted on Feb. 9, 2005, and became effective on June 9, 2005, scholars and practitioners have held wide-ranging discussions about the constitutionality of some of its provisions. The new legislation represents a paradigm shift from a legal framework dating back decades as new provisions were added to protect the rights of labor and tax claimants.

The former bankruptcy system coincided with a period of recognition and consolidation of labor rights, which influenced that system and its application by courts for 60 years. For instance, the old bankruptcy law afforded priority to labor and tax claims in an unlimited amount and often to the detriment of other secured and unsecured creditors.

The new bankruptcy law was introduced to permit the reorganization of viable enterprises as well as the efficient liquidation of those businesses that are not economically or financially viable.  The new law's general goals are to preserve jobs and creditors' rights. For some creditors, especially wage-earners, the privileges granted by the repealed law have been limited under the new legislation. These adjustments have resulted in certain lawsuits being filed with the Brazilian Federal Supreme Court questioning the constitutionality of certain provisions of the new law. The purpose of this article is to review some of the counterpoints that have been raised against the provisions of the new bankruptcy law that may conflict with the Brazilian Federal Constitution.

The New Priority Rule for the Treatment of Labor Claims
A big breakthrough in the bankruptcy law relates to the kinds of entitled claims and the order of priority in a liquidation proceeding,[2] in which the bankruptcy law grants first priority to the indispensable costs and expenses of the administration of the bankruptcy case. The new order of priority in payment is: (1) salary claims for services rendered up to three months before the liquidation decree;[3] (2) restitutions in cash (discussed hereinafter); (3) postpetition administrative claims; (4) other labor and occupational accident claims;[4] (5) secured claims; (6) general government claims listed as Public Collectible Debts; (7) special privileged claims; (8) general privileged claims; (9) general unsecured claims; (10) a penalty related to a claim arising under a contract, and fines for violation of criminal or administrative law, including tax-related fines; and (11) subordinated claims such as those provided by law or contract, as well as the credits of partners and officers without an employment bond.

Restitution in cash shall be made, first, if an asset that was held by the debtor-in-trust for a third party is transferred before the petition for restitution. In such a case, the claimant shall receive the appraised value of the asset or, if the asset has been sold, the realized value of the property. Second, under certain conditions, the amount delivered to the debtor, in local currency, has resulted from an advance on an export exchange contract. Lastly, restitution in cash shall be made if, the amounts delivered to the debtor are by a bona fide contracting party should the contract be revoked or declared null and void.

Sen. Ramez Tebet analyzed the draft bill within the scope of the Senate's Commission for Economic Affairs.[5] According to Sen. Tebet, the purpose of this labor claims cap is to avoid the frequent abuses by the management of bankrupt entities, who would file fraudulent multi-million dollar labor claims against the bankrupt estate to reclaim the assets of the estate, thereby harming legitimate labor creditors who should be protected. He added that the average amount paid to workers in labor claims was 12 minimum wages and the limit would not affect a significant number of employees, but rather a smaller group that does not need extra protection from the law to deal with such basic needs as food.

Although the preceding elements are reasonable, given the specific objective of the bankruptcy law-to protect those who need protection-at least two lawsuits have been filed with the Federal Supreme Court arguing that the 150-minimum-wage limit is unconstitutional.[6] These lawsuits basically state that the cap violates labor rights and social claims protected by the Brazilian Federal Constitution, as well as the constitutional principle of equality, because workers are treated differently. In the Direct Unconstitutionality Action No. 3424, for example, filed by the Confederação Nacional das Profissões Liberais, or the National Confederacy of Liberal Professions (CNPL), the claimant wage limit violates the constitutional principle of equality and prevents some creditors from receiving the full amount of the claims, while others to whom amounts under the established limit are owed can have their claim fully paid. 

An additional action asserting that the fourth paragraph of article 83,[7] which states that labor claims assigned to third parties shall be deemed unsecured claims for payment purposes, is being pursued before the Federal Supreme Court. This action is based on the argument that the aforesaid provision represents an insuperable restriction of property rights and an absolute violation of the principle of reasonableness.

The above-mentioned actions are pending before the Brazilian Federal Supreme Court. The authors believe that the Federal Supreme Court will uphold the constitutionality of the new provisions of the bankruptcy law discussed above. Rights created to protect workers are based on the common principle that certain statutory claims need to be protected because they are essential to the workers' livelihoods and prevent fraud by a debtor's management. The cap set by the bankruptcy law is intended to protect workers who depend on their salaries to feed their families, and makes it impossible for management to increase their salaries before the company files for bankruptcy so they can get a bigger piece of the pie after the bankruptcy is filed.

The Absence of Labor Liens for the Purchaser of Establishments in Bankruptcy
In line with the new bankruptcy law's objectives of providing distressed companies with the legal means to reorganize and maximize the value of their assets in liquidation, articles 60[8] and 141[9] set forth, in relation to corporate reorganization and liquidation, respectively, that a commercial establishment purchased through a bankruptcy sale is released from liens and encumbrances of all types, thus increasing the possibility of new money for either the reorganizing company or the bankruptcy estate. Courts and scholars have not agreed on the application of the aforesaid provision with respect to reorganization cases concerning liability for labor claims.

Direct Unconstitutionality Action No. 3934 argues that articles 60 and 141 offend the federal constitution because it provides a way to automatically extinguish legitimate workplaces, thereby disregarding constitutional provisions aimed at protecting labor rights and work itself. However, it is common sense among bankruptcy experts and practitioners that these provisions foster the creation and/or maintenance of workplaces because they maximize the likelihood that the commercial establishment is transferred to an entity with better conditions to manage it. This debate is considered one of the most sensitive points of the new bankruptcy law. Although the Superior Court of Justice has already signaled its understanding that labor courts must abide by the decision of the bankruptcy court in cases where the bankruptcy court authorizes the sale of a commercial establishment, free and clear of liens, the labor and bankruptcy courts still seem far from reaching consensus.[10]

Last December, the Public Attorney's Office presented its legal opinion to the Direct Unconstitutionality Action No. 3934, considering that the lawsuit should be judged groundless. Among other arguments, it states that the release-from-liability provision gives the business the chance to keep on operating, maintaining the employment contracts and generating profits, which would not be possible should the liabilities be transferred to the purchaser, since the investors would be easily intimidated and unmotivated to enter into a transaction to acquire assets from bankrupt or reorganizing companies.

Despite the issues raised in the preceding discussions and the much-anticipated decision of the Brazilian Federal Supreme Court concerning those issues, the general sentiment among bankruptcy experts and practitioners is that the new bankruptcy law marks a significant advance in the Brazilian bankruptcy system. It provides financially-distressed companies with a proper legal framework for reorganization, allowing debtors to present a reorganization plan based on its economic and financial capabilities rather than apply for a deferral and/or a reduction in repayment of unsecured debts. It helps reduce creditors' risks and tighten interest-rate spreads to the extent that it relates to the probability of the satisfaction of a creditor's claim that increases as a result of the preference that the law acknowledges. Most importantly, it helps create and preserve jobs and permits the reorganization of viable enterprises and the efficient liquidation of those that are not economically or financially viable.

1. Gilberto Deon Corrêa Junior is a partner at Veirano Advogados, Brazil, and the head of the credit and corporate recovery group. His co-author is Eduardo Guimarães Wanderley, an associate at Veirano Advogados.

2. The most significant change under the new bankruptcy law concerns the superior priority granted to secured claims over tax claims. However, a discussion of this change is beyond the scope of this article.

3. Salary claims are limited to five minimum wages per worker ("super-priority") (the minimum wage currently corresponds to R$465).

4. Labor claims continue to have priority over secured claims, but the legislation sets forth a 150-minimum-wage limit (including the amount paid strictly as salary claims, which are listed first). This means that the balance is considered equivalent to an unsecured claim (art. 83, I and VI, "c").  Note that there is no limit for claims arising out of occupational accidents.

5. Opinion No. 534, Senate's Commission for Economic Affairs, Federal Senate Official Gazette, June 10, 2004, beginning at page 17858.

6. Direct Unconstitutionality Actions No. 3424 and No. 3934, both pending judgment.

7. "Article 83. Credits in bankruptcy shall be rated in the following order:
Paragraph 4. Labor-related credits assigned to third parties shall be considered unsecured."

8. "Article 60. If the approved judicial recovery plan involves the judicial disposal of branches or separate production units of the debtor, the judge shall order that this be performed with due regard for the provisions of article 142 hereof.
Sole Paragraph. The object of the disposal shall be free of any encumbrance and the winning bidder shall not succeed the debtor's obligations, including tax-related obligations, with due regard for the provisions of article 141, paragraph 1, hereof."

9. Article 141. In the joint or separate alienation of assets, including the company or its branches, carried out in any of the modalities provided for in this article:
I - all creditors, in the order of preference established in article 83 hereof, subrogate to the proceeds of the asset realization;
II - the object of the disposal shall be free of any encumbrance and the winning bidder shall not succeed in the debtor's obligations, including tax- and labor-related obligations and occupational accident obligations.
Paragraph 1. The main section, II, of this article does not apply when the winning bidder is:
I - a partner in the bankrupt company or a company controlled by the bankrupt;
II - a direct or collateral relative within the fourth (4th) degree, by blood or affinity, of the bankrupt or of a partner in the bankrupt company; or
III - identified as an agent of the bankrupt for the purpose of defrauding succession.
Paragraph 2. Employees of the debtor contracted by the winning bidder shall be engaged under new employment contracts and the winning bidder shall not be liable for obligations arising from the previous contracts."

10. Conflito de Competência 61.272/RJ, Rel. Min. Ari Pargendler, j. 25.04.2007. This conflict of competence between bankruptcy and labor courts will now have to be decided by the Federal Supreme Court in the Recurso Extraordinário 583.922-9.