Alternatives for restructuring of intercompany debts

The continued devaluation of the Real has increased the total indebtedness of Brazilian subsidiaries of foreign groups that incurred debts in foreign currency, particularly in relation to the U.S. dollar and the Euro, and these subsidiaries are now seeking ways of restructuring the debts to their parent companies. Such devaluation may cause very serious impacts, affecting financial results and possibly making the debts unpayable.

It is a fact that there has been a significant positive variation of the U.S. dollar in relation to the Real in the last few years. By way of example, the average annual dollar/real rate in 2015 was approximately R$ 3,34 and the average partial annual rate for 2020 calculated up to July 31, 2020 was R$ 4,98 , the rate today being more than R$ 5,60. In view of this scenario, the need has arisen to discover what action permissible under Brazilian law may be taken to restructure intercompany foreign currency debts, in order to reduce risks and negative impacts related to the exchange variation for the Brazilian subsidiaries.

For an analysis of such action, we have separated the debts, by their nature, into three groups: loans, importations and other types of debt.

As far as the first group is concerned, namely foreign currency loans, the principal amount and interest may be converted into a direct investment, whereby the total amount due will be converted into quotas or shares in the Brazilian debtor company, by establishment or increase of the creditor’s equity interest in the said company. However, in relation to this group it must be borne in mind that loans converted into direct investment in a period of less than 180 days from the date of entry of the funds will be subject to IOF (tax on financial operations) at the rate of 6%, plus penalty and interest from the date of entry of the funds into the country, whereas loans made and converted over longer periods will benefit from a zero rate for the same operation, pursuant to article 15-B, items XI and XII of Decree 6.306/07.

It is important to note that for any symbolic foreign exchange operation, whether of the type now referred to or any other described in the legislation such as those below, the rate of IOF on the exchange is also reduced to zero rather than the usual 0.38%, in accordance with article 15-B, item XVIII of Decree 6.306/07.

It must also be pointed out that the total amount of interest, if converted into capital, will be subject to the withholding income tax at the rate of 15%, since the conversion is regarded as being a form of payment of the obligation.

Also in relation to loans, if the conversion into capital is not a feasible alternative, but it is intended even so to avoid the risk of the foreign exchange variation, there is the possibility of switching to Reais the foreign currency applicable to the loan.

Another operation that merits attention for the purpose of restructuring debts in foreign currency involves importations, which may be converted into a loan, preferably with a change of currency into Reais, since the intention is to eliminate the risk of foreign exchange variation, or into direct investment.

For conversion of debts incurred on importation into a loan in local currency, it is necessary for the creditor formally to express its intention of doing so by means of a declaration, stating that the amount of the loan will be in Reais, to be calculated at the moment of the simultaneous exchange operations. Special attention should be paid to the incidence of IOF, the ideal solution being that the loan in question stipulate a repayment term of at least 181 days from the conversion, in which case a zero rate will be applied.

Conversion of the importation into direct investment may take place at any time by means of a declaration by the creditor and acceptance by the debtor, resulting in simultaneous symbolic foreign exchange operations.

As regards other foreign debts of an unspecified nature, these may be converted into a loan or direct investment, in the same way as importations, since any obligation that involves payment abroad may be converted, the only requirement being a formal statement by the creditor to that effect. However, it should be noted that some operations involving certain debts may give rise to the incidence of taxes as a result of their nature and must be considered specifically for the purpose of conversion. In this connection it must always be borne in mind that the exchange on sale of foreign currency on the conversion, the first leg of the symbolic operation, gives rise to the same effect as in the case of actual repayment.

It should be mentioned that the figures resulting from the conversions will be calculated in accordance with the exchange rates on the date of the symbolic operations for the conversion rather than the historic value of the debts in any of the cases above.

In relation to debts that are not capable of registration under the foreign exchange legislation, and cannot therefore be the subject-matter of a symbolic exchange operation for conversion, in accordance with Law no. 11.371/06, there is still the possibility of conversion into direct investment with the registration of so-called “contaminated” capital, which, although feasible, must be considered with great care.

Finally, before carrying out any restructuring of foreign currency debts, it is necessary to confirm that the information lodged with the Central Bank of Brazil is up to date, and also to consider from the group structural viewpoint the best option to be adopted.

Deborah Henriques Grasmann de Carvalho and Adolpho Smith de Vasconcellos Crippa

Associate lawyer and Partner in Company Law Area – São Paulo

[email protected] and [email protected]

Kirkland advises Travelodge and AllSaints on restructurings

Kirkland & Ellis is advising Travelodge, the UK’s largest independent hotel brand, on its company voluntary arrangement (CVA), which was approved by creditors on 19 June. The CVA involves Travelodge temporarily reducing rents and moving from quarterly to monthly payments on certain leases. Unlike most CVAs, there are no proposed hotel closures or permanent rent reductions.

The approval of Travelodge’s CVA follows the ground-breaking injunction to restrain a winding-up petition pending Travelodge’s restructuring and forthcoming legislation.

The successful vote will enable Travelodge to navigate the short-term challenges facing the business as a result of the COVID-19 pandemic. The process is now complete, subject to the usual challenge period.

Kirkland is also advising AllSaints, the global contemporary fashion brand, on the restructuring of its store portfolio through parallel CVAs of two English tenant companies. AllSaints successfully obtained recognition in the U.S. and Canada of one of the CVAs, which (if approved by creditors) will compromise the relevant company’s liabilities under leases in the U.S. and Canada. Recognition was obtained under Chapter 15 of the U.S. Bankruptcy Code and the Canadian equivalent (Part IV of the Companies’ Creditors Arrangement Act), on 17 June. If, and when, creditors approve the CVAs, follow-up recognition applications will be made to the U.S. and Canadian courts.

We believe AllSaints’ CVA represents a series of major firsts, including the first U.S. recognition of a landlord CVA, the first Canadian recognition of a CVA, and (if approved by creditors) the first compromise of U.S. and Canadian leases via a CVA.

The Kirkland team for Travelodge was led by restructuring partners Elaine Nolan and Kon Asimacopoulos and litigation partner Richard Boynton. Ian Wormleighton and Dan Butters, of Deloitte LLP, are the CVA supervisors. Tom Smith QC and Henry Phillips, barristers at 3-4 South Square, advised Travelodge on its CVA.

The Kirkland team for AllSaints was led by restructuring partners Elaine Nolan and Lisa Stevens in London, Joshua Sussberg and Neil Herman in New York, and David Seligman in Chicago. Richard Fleming and Mark Firmin, of Alvarez and Marsal, are the CVA nominees.