The separation of assets between a company and its related parties is a fundamental principle enshrined in both the Brazilian Civil Code and the Brazilian Insolvency Law (Federal Law No. 11,101/2005). However, according to article 50 of the Brazilian Civil Code, if there is an abuse of legal personality, demonstrated by misusing its purpose or mingling assets, the court (upon request from a party, or the Public Prosecutor’s Office when entitled to intervene) can disregard it. As a result, specific obligations can extend
to the personal assets of administrators or partners who directly or indirectly benefited from the abuse.
Currently, there is an ongoing and intense debate in Brazil regarding the limits for the bankruptcy court to disregard the legal personality of a company that filed for judicial reorganisation (a legal process equivalent to chapter 11, in the USA, and Administration, in the UK). This article explores this complex issue.
Separation of assets in Brazilian Law
The Brazilian legal framework has consistently emphasised the separation of assets between a company and its third parties. This principle ensures that the liabilities and obligations of a company remain distinct from those of its shareholders, directors, and other related parties. The objective is to protect the interests of company representatives.
One of the key challenges in cases in which the bankruptcy court considers disregarding legal personality lies in the burden of proof. Demonstrating the existence of misconduct or confusion between the company’s assets and those of its shareholders or directors can be a complex task. Courts must carefully analyse the evidence presented to ensure a fair and equitable decision.
The potential disregard of legal personality in judicial reorganisation and bankruptcy proceedings (the latter, a process equivalent to chapter 7, in the USA, and Compulsory Liquidation, in the UK) raises concerns regarding corporate governance. Company directors and shareholders may become apprehensive about the personal liability they could face if their corporate veil is pierced. This may lead to conservative decision-making and hinder entrepreneurship, as directors may become less willing to take risks due to the fear of potential personal repercussions.
The ongoing debate
In recent times, there has been a growing debate regarding the potential for the bankruptcy court to disregard the legal personality of a company in the context of judicial reorganisation proceedings.
The Brazilian Insolvency Law does not expressly provide for the bankruptcy court to disregard legal personality in such proceedings. Articles 82 and 82-A of Brazilian Insolvency Law contemplate the possibility of disregarding legal personality only in cases of bankruptcy. Therefore, the lack of a clear provision in the Brazilian Insolvency Law regarding the authority of the bankruptcy court to disregard legal personality may create an unpredictable environment for companies, investors, and creditors.
In a significant ruling (Interlocutory Appeal No. 2043438-91.2013.8.26.0000), the São Paulo Court of Justice (known for its extensive experience in relevant judicial recovery and bankruptcy matters) confirmed a lower court’s decision to disregard the legal personality of a company under judicial recovery. The decision was based on the court’s finding of confusion and mingling of assets, leading to the conclusion that the company’s corporate veil needed to be pierced.
In ruling on the mentioned Interlocutory Appeal, the São Paulo Court of Justice did not determine the inclusion of third parties as active participants in the judicial recovery process nor did it establish procedural or substantial consolidation. The ruling merely acknowledged the possibility of recognising that certain assets, diverted from the company undergoing judicial reorganisation, could be declared as its property due to asset confusion.
In summary, this ruling did not change the nature of the judicial reorganisation process, considering that the Brazilian Insolvency Law does not allow individuals (natural persons) to seek the restructuring of their personal debts through a judicial reorganisation process.
Notable case in bankruptcy
In a bankruptcy matter (Interlocutory Appeal No. 2190828-50.2022.8.26.0000), the São Paulo Court of Justice upheld a lower court’s decision to disregard the legal personality of Rakuten USA Inc’s subsidiary companies. This decision allowed the assets of the directors to be used to pay off the bankruptcy creditors.
Those assets have been seized due to a suspicion of fraud perpetrated by the bankrupt companies against their creditors. According to the trial court, articles 153, 154, 155, and 158 of the Companies Act should be applied, considering that the conduct indicates the appearance of multiple violations of the administrators’ duties, such as the duty of diligence, prudence, and loyalty. Additionally, as stated by the trial court, there are strong indications that the parties involved acted with negligence and breached the law.
The ruling rendered in the Interlocutory Appeal No. 2190828-50.2022.8.26.0000 is still subject to revision by the Superior Court of Justice. Meanwhile, the assets of the representatives will remain under seizure, unless the involved parties present new evidence, and the trial court decides to reverse the order. Ultimately, if the judgment of São Paulo Court of Justice is not overturned, the assets of the representatives may be expropriated, and the proceeds from the sale used as payment to the aggrieved creditors.
In comparing the rulings of Interlocutory Appeal No. 2043438-91.2013.8.26.0000 and Interlocutory Appeal No. 2190828-50.2022.8.26.0000, it becomes evident that the piercing of the corporate veil in the latter case is significantly broader. It encompasses all assets of the involved parties. In contrast, in Interlocutory Appeal No. 2043438-91.2013.8.26.0000, the piercing was limited to assets linked to the fraud, which were then returned to the debtor’s estate.
The debate surrounding the possibility of disregarding legal personality in judicial reorganisation and bankruptcy proceedings continues to be a highly contentious issue in Brazil. As the debate persists, it is crucial for legal practitioners, policymakers, and stakeholders to engage in constructive dialogue to strike a balance between protecting the interests of creditors, promoting corporate governance, and fostering a business-friendly environment. Ensuring legal certainty and predictability will be critical in shaping the future approach to this complex and multifaceted issue in Brazilian law.