Brazil Revenue Based Finance - Debt - Impact Terms Platform

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This analysis was provided by TozziniFreire Advogados

Table of Contents

Executive Summary

This research paper summarizes the main structures identified for revenue-based financings available in Brazil.

While Brazilian laws does not provide for concepts that are designed specifically for revenue-based financing , companies and investors may structure transactions by adjusting existing types of funding mechanisms available under existing regulations. For the purposes herein, we will suggest three types of structures, under equity, debt and receivables discount models:

Equity: investment by acquiring equity interest is one of the most common types of investment in Brazil. The acquisition of equity interest may occur by means of (i) execution of a share/quota purchase agreement, (ii) execution of a convertible loan, (iii) increasing the corporate capital by means of execution of an investment agreement, and (iv) incorporating a Brazilian subsidiary. Brazilian law provides for several types of legal entities, of which the Sociedade Limitada (limited liability company) and the Sociedade Anônima (corporation) are the most commonly used. Other company types are seldom used in practice, because most of them provide for unlimited liability of their partners. For limited liability companies and corporations, the partners liability is limited to their paid stake in the corporate capital and there are generally no minimum capital requirements. Moreover, dividends are currently tax exempt in Brazil, regardless of the status of the beneficiary. In this type of investment, it is possible to ensure a minimum return by means of (i) defining the interest in the convertible loan agreement; (ii) a put option, granted in an agreement between the partners and the company; or (iii) using redeemable shares.

Debt: issuance of debentures. A debenture is a security issued by a corporation (sociedade anônima), with mechanics that are similar to bonds governed by New York laws. The terms and conditions of the issuance of the debentures are regulated in an indenture executed by the issuing company. The debentures are essentially fixed-income debt instruments where the debenture holders are entitled to receive the repayment of the principal amount plus an accrued interest (fixed or floating). However, Brazilian laws allow the issuing company to stipulate that debenture holders may have the right to receive a share in the company’s profits or even an additional premium fee, which is based on income or profit variations of the company. The investors are usually represented by a fiduciary agent (similar in nature to a trustee). Debentures are one of the most relevant debt instruments used by companies in the Brazilian capital markets.

Receivables discount (securitization): funding granted by receivables investment funds (Fundos de Investimento em Direitos Creditórios – “FIDC”), which is a form of condominium regulated by the Brazilian Securities Commission (Comissão de Valores Mobiliários – “CVM”). The FIDC is a fund whose main purpose is to purchase receivables from Brazilian entities, and it benefits from technical and specialized services of administration, portfolio management and custody of the investments, provided by regulated entities. The FIDC is funded by investors, which in turn receives quotas issued by the FIDC. Although the FIDC (and investment funds in general) operate similarly to companies, it does not have a legal personality. Earnings from investments are distributed to FIDC’s quotaholders. On the other hand, the FIDC’s quotaholders also bear losses and other expenses that compose its liabilities. The FIDC is a viable way of ensuring that companies obtain cash by anticipating their receivables (revenues) without incurring in additional debt.

Members of TozziniFreire Advogados are qualified to practice law in the Federative Republic of Brazil. We do not express herein any answer concerning any law other than the law of the Federative Republic of Brazil.

Investment Structure Summary

Transactions in Brazil usually do not provide for preferential rights to receive distributions based on an agreed portion of gross revenues, free cash flow or net income. Nonetheless, there is no explicit prohibition in this regard under Brazilian law, hence, initially, it is possible that a debt instrument provides for preferential rights regarding the company’s profits if agreed between the parties.

One common example of debt structure that may provide for this type of preferential rights in Brazil is the issuance of debentures. Debentures are securities regulated by Law No. 6404 of December 15, 1976, which provides that corporations (sociedades anônimas) may issue debentures entitling its holders to credit rights according to the conditions set forth in the indenture. Debentures are debt instruments that may or may not be convertible into shares against the issuing company. The debentures are essentially fixed-income debt instruments where the debenture holders are entitled to receive the repayment of the principal amount plus an accrued interest (fixed or floating). However, Brazilian laws allow the issuing company to stipulate that debenture holders may have the right to receive a share in the company’s profits or even an additional premium fee, which is based on income or profit variations of the company. This permission to estipulate premium or variable coupon based on company’s income or profit variations allows Brazilian players to structure debt financing that follows a rationale that is similar to a revenue-based financing, given that the investors will have the right to receive additional payments deriving from company’s profits (as premium or variable coupon) and, generally speaking, Brazilian bankruptcy laws determine that creditors of the company have preference in payments compared to its shareholders.

Debentures may be subject to private placements or public offerings. If public offered to investors, it must observe the rules of the CVM concerning public offerings of securities.

Two types of ESG related debentures have been issued in the past few years, (a) green, social and sustainable bonds, and (b) sustainability-linked bonds (“SLB”).

The green, social and sustainable bonds aim to attract capital to projects that have a positive social and environmental impact. On the other hand, through SLB, companies are required to achieve agreed ESG goals and following key ESG performance indicators (KPIs).

Category for tax purposes

Debentures’ income is categorized for tax purposes as fixed income investment (see Critical Tax Considerations below).

Governance Rights

The debentures’ indenture may provide for clauses determining the need of prior consent of the investors for the approval of specific matters in shareholders’ meetings. This is not mandatory and commercially negotiable. Debentures used in venture debt or private equity deals tend to be more restrict in terms of what companies may or may not do in terms of governance.

Investor Qualification Requirements

Investor qualification requirements could apply depending on the public offering regime adopted, in accordance with CVM regulations. The issuance of convertible debentures from companies in the preoperational stage (A-Category) can only be acquired by professional or qualified investors. Moreover, the issuance of convertible debentures from operational companies (A-Category) in the automatic registration regime, without prior review by a self-regulatory authority, after January 2, 2023, should also only be acquired by professional and qualified investors. Common debentures (i.e., not convertible) issued following the automatic registration regime, without prior review by a self-regulatory authority, may be acquired by qualified or professional investors, and by retail investors only in certain specific situations, such as the case of standardized debentures.

For reference, qualified investors are:

professional investors.
individuals or legal entities that have financial investments worth over R$ 1,000,000.00 (one million reais). Statement of their status as qualified investors also needs to be provided.
individuals that have been approved in technical qualification exams or have certifications approved by the CVM as requirements for registration as autonomous investment agents, securities portfolio managers, securities analysts, and securities consultants, in relation to their own resources.
investment clubs, provided they have a portfolio managed by one or more quota holders that are qualified investors.

And professional investors are:

financial institutions and other institutions authorized to operate by the Central Bank of Brazil.
insurance companies and capitalization companies.
open and closed complementary pension fund entities.
individuals or legal entities that have financial investments worth more than R$ 10,000,000.00 (ten million reais). Statement of their status as professional investors also needs to be provided.
investment funds.
autonomous investment agents, securities portfolio administrators, securities analysts, and securities consultants authorized by the CVM, in relation to their own resources.
non-resident investors.

Investors of debentures may be either local or foreign. Any investment by foreign investor in debentures that are subject to public offerings and registered in organized markets must be made in accordance with Resolution No. 4,373. Resolution No. 4,373 provides that financial instruments and securities acquired by non-resident investors (including registered debentures) must be: (i) registered and deposited in an institution authorized by the Central Bank of Brazil or the CVM; or (ii) registered in a clearing and settlement system authorized by the Central Bank of Brazil or the CVM to render this service.

Before making the investment, the non-resident investor must (i) appoint a legal representative in Brazil, which must be a financial institution authorized by the CVM or the Central Bank of Brazil; (ii) obtain a registration as a foreign investor with the CVM; and (iii) appoint a custodian of securities authorized by the CVM (which may be the same entity as the legal representative).

Additionally, the assets owned by the foreign investor (i.e., the registered debentures) must be deposited in the non-resident investor’s account or in a collective account in a financial institution authorized by the CVM or Central Bank of Brazil to provide these services. The foreign investor must also be registered at a local brokerage firm.

Currency Considerations

The debentures must be denominated in Brazilian reais, except in case of obligations in which Brazilian laws authorizes payments in foreign currencies. Exceptions include situations of foreign investors. Accordingly, debentures issued abroad may be denominated in foreign currency.

For local debentures, Brazilian law authorized the issuance in Brazilian reais and indexed to foreign currencies.

Collateral

Security interest and guarantees may be granted by the issuer if required by investors. The following types are usually requested in the financial and capital markets, cumulatively or alternatively:

Fiduciary transfers;
Pledges;
Mortgages; and
Personal guarantees.

In a fiduciary transfer structure, a certain asset is transferred to the debenture holders on a fiduciary basis and by way of security to ensure payment of a given obligation. Upon fulfillment of the secured obligation, the debtor reacquires full title to the asset, thereby extinguishing the fiduciary ownership held until then by the debenture holders. In the event of default by the debtor, however, the debenture holders obtain full title to the asset, which must then be sold to satisfy the unpaid debt.

In the pledge structure, if the debtor fails to pay the relevant obligation, the creditor will have the right to sell the pledged asset through a judicial sale or through a private sale, if authorized by the pledge agreement or by a special power of attorney granted by the pledgee. The proceeds will be applied to the unpaid debt. As a matter of Brazilian law, pledge agreements cannot provide that creditors are entitled to keep pledged assets if debtors fail to pay. However, in case of credit rights the creditor will use the relevant amounts to be reimbursed on the value of its credit. Structures involving liens over bank accounts where the credit rights are deposited are common in Brazil.

A mortgage is a security interest created over real estate or other certain asset specified by law. Under a mortgage structure, if the debtor fails to pay the relevant obligation, the creditor will have the right to sell the mortgaged asset through a judicial sale and use the proceeds to satisfy the unpaid debt. As a matter of Brazilian law, mortgage agreements cannot provide that creditors are entitled to keep mortgaged assets if debtors fail to pay.

A security interest may be created over a variety of assets: real estate, fungible movable assets, non-fungible movable assets, rights and credit rights. Depending on the asset to which the security refers, the agreement must be registered with either a Real Estate Registry Office, a Registry of Deeds and Documents or another type of registry (such as corporate books in case of shares).

Priority Payment Rights

Preferential rights are not necessarily linked to equity rights, but to an obligation of the company to pay to investors a certain premium or variable coupons of the debentures based on financial factors of the company. Under local bankruptcy laws, the investors of the debentures will have priority of payments compared to existing shareholders.

For example, it is possible to establish that the issuing company will have to pay an additional premium to investors calculated over a percentage of payments received from certain commercial contracts executed with clients (i.e., if those receivables are not paid, then the company will not have an obligation to pay the premium). Another example is to provide in the indenture that the company will have to pay a variable coupon calculated over an agreed formula that takes into consideration certain its financial conditions (for example: monthly income x EBITDA x fixed percentage).

Distribution and Redemption Limitations

The indenture may provide for negative covenants in which the issuer is not allowed to distribute dividends and profits to its shareholders above the minimum legal amount, without prior consent of the investors.

Legal limitations to pricing or total return

Decree No. 22.626/1933 (Usury Law), prohibits and establishes penalties if there is stipulation in any contracts of interest rates higher than twice the legal rate. Thus, the Usury Law functions as an interest control mechanism for loans offered to the private productive sector. It is also worth mentioning that usurious stipulations that establish interest rates higher than legally permitted in civil loan contracts are null and void, in which case the judge must, if requested, adjust them to the legal measure or, if they have already been complied with, order the refund in double of the amount overpaid, with legal interest from the date of the undue payment, as provided by Provisional Measure No. 2,172-32, dated August 23, 2001.

It is worth noting that the Brazilian Superior Court of Justice (“STJ”) has a settled understanding that financial institutions are governed by a specific law and, therefore, the above-mentioned interest limitation does not apply to them. In addition, in a decision by STJ (SPECIAL APPEAL No. 1.634.958 – SP (2016/0277295-7)) on the applicability of the legal rate limits to investment funds, the STJ held that investment funds have similar roles as financial institutions, given that their activities involve attracting popular savings through the issue and subscription of securities for the granting of credit, and therefore they also do not need to observe usury rules.

Thus, for the reasons given by the STJ, our understanding is that the legal rate limit is not applicable to financial and capital markets transactions. However, interest limitations may apply to debentures and other securities subject to private placements that do not involve financial institutions and that are not registered in organized markets and, therefore, follow the same rationale as loan transactions (as opposed to debentures subject to public offerings, which are considered investments in the capital markets).

For reference, although there are certain discussions about what is the “legal rate” for the purposes of interest limitation, our understanding is that interest should be limited to the Special System for Settlement and Custody (“SELIC”) rate. Any interest due above the SELIC rate may be considered by Brazilian courts null.

Status in Insolvency Proceedings

Status in insolvency proceedings will depend on whether the credit rights are collateralized. The debentures may also be subordinated, which means that the credit of the debenture holder would have preference only over the shareholders of the issuer, in the event of bankruptcy.

Brazilian insolvency law provides for the following priority of payment in bankruptcy scenario of a debtor: (i) claims arising from labor legislation, limited to one hundred and fifty (150) minimum wages per creditor, and without limit for those resulting from an occupational accident; (ii) credits encumbered with security interest up to the limit of the value of the burdened asset; (iii) tax claims, regardless of their nature and the time when tax event occurred (an exception to non-concurrent claims and tax fines); (iv) unsecured claims; (v) contractual fines and pecuniary penalties for breach of criminal or administrative law, including tax fines; (vi) subordinated credits; (vii) interest accrued after the decree of bankruptcy.

Furthermore, bankruptcy and judicial reorganization proceedings bind all the existing credits against the relevant debtor at the time of the request (pre-petition claims), even those undetermined or not yet matured or disputed, contingent, or unsettled at the time of the filing except for (i) tax and social security-related credits; (ii) credits related to forward foreign exchange agreements; and (iii) claims (a) arising from financial leases, (b) secured by a fiduciary lien (“alienação fiduciária”), (c) of owners or committed sellers of real estate which respective agreements include an irrevocable and or irreversible provision, and (d) purchase agreements containing a title retention provision.

Limitation of Liability

Investors’ liability towards the issuer is limited to its funded or committed investment.

Transfer Restrictions

The debentures may be subject to transfer restrictions of up to eighteen (18) months depending on the public offerings regime, the situation of the company (if operational or preoperational) and the types of investors involved

Critical Tax Considerations

Debentures’ interest is taxed as follows:

Foreign investor duly registered with the Brazilian Central Bank as portfolio investor (Resolution 4.373) and not located in a tax haven: 15% withholding tax;
Foreign investor not registered with the Brazilian Central Bank as portfolio investor (Resolution 4.373) and located in a tax haven: 25% withholding tax;
Local investor – Individual: 15% to 22.5% regressive withholding tax rates (according to the maturity of the investment);
Local investor – Legal entity: same rates described above, but the final tax cost will vary according to the legal entity’s tax regime.

Brazil Revenue Based Finance – Debt

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