Fraud can assume many faces. One of the biggest challenges for legal professionals is to seek, identify and nullify transactions made by debtors in financial troubles (particularly businesses and their owners or controlling shareholders) who aim to hide assets from their creditors.
Generally, before a loan is granted, the lender demands information from the borrower to analyse his or her capacity to perform the loan. In this, it is paramount that a full scenario of the financial situation of the debtor be provided, so that the lender can assess the assets available, be aware of the outstanding liabilities and measure the risk involved, which can be compensated by a collateral or a higher interest rate.
Furthermore, given that the capital structure of Brazilian firms is generally centred on the figure of a controlling shareholder (who is normally the manager of the company), it is customary for lenders to demand that this person be jointly liable with the main debtor, so that his or her assets can be reached in the event of default.
The problem arises when creditors try to enforce their rights and find only an empty shell, namely a company without assets that is a compromised operation; or a debtor under a formal insolvency procedure for the 'bad' company, while safe harbour has been granted to the 'good' company, which is led by a straw man through another company with a different name but that is, in fact, the same business.
Brazilian law provides a framework for creditors and other victims of dishonest practices to obtain the annulment of transactions involving transference of assets, and to obtain seizure of the assets. However, a preliminary step consists of finding evidence about the debtor and suspect transactions involving his or her assets, as well as how and when to use the evidence. This task demands the use of specific tools, deep knowledge and multiple skills in several areas of law, so that assets can be traced and recovered.
Whenever there are strong elements of proof concerning diversion of assets and fraudulent transactions, Brazilian courts tend to be responsive to their claims, so that the due process of law can be granted.
II LEGAL RIGHTS AND REMEDIES
Brazilian rules against fraud and diversion of assets are spread through a set of civil, commercial, procedural and criminal laws. Certain rules are applicable depending on the specific situation.
i Civil and criminal remedies
The Brazilian Civil Code (BCC) has a specific chapter regarding defects of contracts, including the regulation of fraud against creditors.2 In this context, free transference of assets or releasing of debts, if carried out by an insolvent debtor, or by a debtor whose insolvency resulted from the transactions, can be annulled by pre-existing unsecured creditors as harmful to their rights. Secured creditors whose collateral became insufficient have the same right.
Fraud can only be alleged by a person who already held a credit against the debtor at the time of the fraudulent transference, as the law assumes that when the credit came into existence (either through a loan or by means of another legal relationship), the creditor should know the economic and financial situation of the debtor.
Onerous contracts of the insolvent debtor shall also be void when insolvency is notorious, or there are reasons that are known to the other party.
In all situations mentioned above, the creditor can file a defeasance action against the debtor who committed the fraud, the person who received the asset or third parties who received them in bad faith.
A different situation provided for in Brazilian law is fraud against creditors in execution action. It consists of an institute with procedural nature, set forth in Article 792 of the Brazilian Code of Civil Procedure (BCCP) of 2015, which assumes that there is an execution procedure in course, regardless of the insolvency of the debtor. From the perspective of the creditor who filed the execution action, the transference is not void but ineffective, which implies that a defeasance action is not necessary and the asset can be seized during the execution procedure.
The BCC, in its Article 167, also punishes parties involved in sham transactions, which are considered null and void when:
- they appear to confer or transmit rights to people different from those to which they are actually conferred or transmitted;
- they contain untrue statements, confessions, conditions or clauses; or
- the instruments are backdated or postdated.
A sham transaction is a matter of public policy and can be declared by the judge on his or her own initiative and authority at any time and level of jurisdiction in a pending litigation, regardless of the bringing of a defeasance action.
Furthermore, the BCCP also provides for urgent measures (i.e., seizures) that can be taken in the beginning of a lawsuit, without the defendant's knowledge. The BCCP also brings up the brand-new early evidence procedure, which can be requested before the commencement of the appropriate lawsuit, whenever:
- there is a grounded fear that it will become impossible or very difficult to verify certain facts pending the action;
- the evidence to be produced is likely to lead to plea negotiation or a suitable method of dispute resolution; or
- previous knowledge of the facts can justify or avoid the filing of a claim.
For companies that have formally ceased their activities, Article 1,146 of the BCC allows recognition of business succession in the case of establishment transference. Apart from formal establishment purchases and sales, this possibility arises when there is evidence that another company is carrying out the same line of business at the same address of the debtor, but the managers and shareholders are different. Generally, in these cases, the managers of the debtor are acting by means of an intermediary and it is possible to reach the assets of the new company.
A similar and common approach is to disregard the legal entity, provided for in Article 50 of the BCC, the regulation of which is implemented by Articles 133–137 of the BCCP. According to Brazilian law, the doctrine on disregarding the legal entity is applicable in two situations: deviation from purpose or equity confusion. While the former implies the use of the company by their managers or shareholders for purposes different from those aimed by the law and the corporate by-laws, the latter represents a messy overlap between the company's assets and liabilities and its shareholders' or managers' assets and liabilities, so that money flows from one side to the other without legal justification. As a consequence, the court can declare that certain obligations of the company be extended to the particular assets of its managers or shareholders. The reverse of this doctrine is also permitted by law.
In an insolvency context, pursuant to Articles 129 and 130 of the Brazilian Bankruptcy Law (BBL), certain transactions executed during a period before the opening of a liquidation procedure and set forth in law can be considered ineffective before the estate regardless of the fraudulent intention. On the other hand, all transactions carried out with the intention of harming creditors can be revoked, whenever it is proven that there is a fraudulent collusion between the debtor and third parties and the effective loss is supported by the estate.
Moving to the criminal sphere, the Brazilian Criminal Code devotes one chapter to fraud, including fraudulent larceny. This crime, as provided for in Article 171, is when an individual obtains, for himself, herself or third parties, an illicit advantage to the detriment of another person by inducing that person to make, or be sustained in, an error, by means of trickery or any other fraudulent means. The punishment for this crime is one to five years in prison, and a fine.
It is important to emphasise that this crime has four prerequisites:
- obtaining an advantage;
- causing injury to someone;
- for this purpose, there must be an element of deceit; and
- as a consequence, someone was led to make a mistake.
Another crime that merits attention is pledge defrauding, which involves the sale of pledged collateral by the debtor in possession of the collateral to third parties, without the consent of the creditor, regardless of whether the debtor obtained an economic advantage in the sale. This crime is provided for in Article 171, Paragraph 2, Subsection III, of the Brazilian Criminal Code, and the punishment is the same as that for fraudulent larceny.
Article 172 of the Brazilian Criminal Code specifies the crime of simulating trade bills, which consists of issuing invoices, trade bills or sales notes that do not correspond to the goods sold or services rendered. This crime directly affects the credit market, as the invoices or trade bills are normally discounted in a bank against immediate cash. The punishment is two to four years in prison, and a fine.
Further, the crime of receiving stolen goods is specified in Article 180 and consists of acquiring, receiving, transporting or hiding an object while knowing of its illegal origin. It is also required that the person has the purpose of obtaining benefit for himself, herself or a third party; the punishment for this offence is one to four years in prison, and a fine.
Brazilian law also criminally punishes money laundering conduct that is verified when someone hides or disguises the nature, origin, location, disposition, movement or ownership of goods, rights or amounts coming directly or indirectly from previous crimes. Here, the main goal is to give a legal appearance to assets that are criminally obtained. Punishment involves three to 10 years in prison, and a fine.
The likelihood of success in each case will depend on the level and nature of the evidence of fraud brought before the judge, as well as the court in which the claim is proposed. The low volume of claims and the high qualification of the clerks can contribute to faster and favourable results.
At the end of 2016, Brazilian courts had almost 80 million pending legal processes, of which 51.1 per cent referred to execution actions, including tax executions (which represented 38 per cent of the total pending cases).3 Besides this, in the pre-judgment phase, ordinary proceedings (e.g., defeasance actions) before state courts took an average of one year and four months for the law court decision to be made, while an execution action took four years and six months.4 This difference can be explained because the execution action only ends when the debt is fully paid. However, after a final court decision in a legal process, the plaintiff has to enforce it, and another period starts to run, which makes the procedure longer.
Furthermore, according to the 2017 World Bank's Doing Business Report, a claim in São Paulo Civil District Court takes about 731 days to be resolved, from the moment the plaintiff files the lawsuit in court until payment.5 Within this period, it takes 480 days until trial and judgment, while enforcement of the judgment requires 210 days. This process can be shortened if the plaintiff has an execution instrument, and enforcement procedures can start immediately.
It is important to highlight that these time frames can change drastically depending on the court before which the claim is filed. For example, an execution action in the state of Pernambuco takes about seven years to be resolved, while in the state of Minas Gerais such an action takes less than four years.6
The choice of venue must observe the rules of the BCCP, but will be governed basically by the general rule (the domicile of the defendant) or the jurisdiction chosen in the contract by the parties. Arbitration clauses are allowed for claims related to transferable property rights and are recommended for complex matters, but enforcement procedures must be initiated before the regular courts.
As a rule, initiating a court procedure in Brazil entails the payment of court costs, which vary according to the state and are based on the value of the matter in controversy. In 2017, the cost of starting a civil claim in São Paulo was one per cent of the value of the matter in dispute, limited to 75,210 reais. In addition, to bring a claim to court, the plaintiff must pay attorneys' fees, which can be negotiated on a case-by-case basis. Other costs can arise, depending on the claim; for example, in relation to court clerks, registrars, seizures and appeals.
The 2017 World Bank's Doing Business Report found that the cost of a claim in São Paulo Civil District Court, considering the cost for court fees and attorney fees, is 20.7 per cent of the value of the matter in controversy.7
For plaintiffs who live abroad, the BCCP states that they must post bond for court costs and fees if they do not have real estate in Brazil to assure payment of these. The bond is not required in enforcement procedures (such as execution actions), counterclaims or in the case of express waiver in international treaty or agreements to which Brazil is a signatory.
Filing an execution action, which is the fastest way to recover assets and values, demands an execution instrument, as listed in Article 784 of the BCCP and basically involves documents representing an unquestionable and payable right. The most common are promissory notes, checks, debentures, banking credit certificates and any particular document signed by the debtor and two witnesses in which the debtor recognises his or her obligation.
Execution instruments arising from other countries do not depend on any ratification by Brazilian courts, although their effectiveness is subject to the formation requirements of the law of the place of execution, and Brazil must be indicated as the place of performance of the obligation.
If the claimant does not hold an execution instrument, he or she must file an ordinary proceeding and get a judicial execution instrument, which can be further enforced.
In any context, if a fraudulent transference is identified, the first and most important step for claimants is to gather as much evidence as possible to show the judge that the debtor is surely dilapidating or hiding his or her assets from creditors. Each specific situation must be carefully analysed so that the strategy to be followed can be defined, either in the civil or the criminal field.
ii Defences to fraud claims
Defences vary from case to case. The Brazilian Constitution grants defendants a due process of law that comprehends the possibility of a full defence, following an adversary system in which one party must be granted the opportunity to challenge the arguments brought by the other party.
In fact, by their nature, executory actions are less likely to be challenged and defendants can manage a motion to stay collection, claiming the unenforceability of the execution instrument, incorrect seizure or erroneous appraisal, amounts that are higher than those due, improper accumulation of executions and any subject matter that could be claimed in an ordinary procedure.
In actions involving fraud, before they are declared, the judge must notify the third party that acquired the asset to file a third-party defence within 15 days.
On the other hand, in an ordinary procedure, the defendant will have the opportunity to defend himself or herself in a broad manner, including evidence-finding represented by witnesses, documents, statement of the other party and expert proof.
The defendant may claim at any time during the court action or procedure that credit has lapsed or is statute-barred, in which case, a credit cannot be enforced, or a transaction subject to annulment can be revalidated. For example, the limitation period within which a defeasance action must be brought is four years, counted from the day the fraudulent transference was executed, while the collection of unquestionable debts must be made within five years and the payment of an instrument of credit can be demanded in three years.
III SEIZURE AND EVIDENCE
i Securing assets and proceeds
According to Article 300 et seq. of the BCCP, on the commencement of a lawsuit, as a preliminary injunction ex parte, the creditor may file for an urgent protection request whenever there is evidence of the probability of the right and of danger of damage or risk to the useful result of the process. The request can be justified when there is evidence of fraud involving the transference of assets, aiming to hide them from creditors. Urgent protection may be effected by seizure, registration of protest against disposal of property and any other suitable measure to assure the right. On the other hand, the request will be denied whenever there is danger of irreversibility of the effects of the decision.
In addition, the claimant is responsible for losses caused by the effectiveness of the urgency request if:
- the court's final decision is unfavourable;
- the claimant does not provide the necessary means for summoning the defendant within five days;
- the urgency request ceases to be effective; and
- the judge recognises the loss of the procedural right or the occurrence of prescription.
A similar effect can be achieved through execution actions. According to Article 799, Section VIII of the BCCP, the claimant may request urgent measures in the initial complaint whenever there is strong evidence of asset diversion or a deep economic or financial crisis – as proven by the recent growth of lawsuits against debtors, the amounts involved, recurring losses in financial statements (when publicly available) or discontinuance of activities.
Through such a request, it is possible, without the previous knowledge of the debtor, to seize bank accounts and investments in real time by means of the Bacenjud system. This is a system that interconnects the courts to the Central Bank of Brazil and the banking institutions, to expedite requests for information and the transmission of judicial orders to the national financial system, via the internet.
For vehicles, a similar approach is possible via Renajud, an online system of judicial restraint of vehicles created by the National Justice Council, which links the courts to the national traffic department (Denatran) and allows research and real-time dispatch of judicial orders for vehicle restrictions, including attachment records, to the database of the national registry of motor vehicles (Renavam).
The seizure of real estate is also possible in São Paulo through the online system ARISP (Sao Paulo Real Estate Registers Association, for real estate located in São Paulo). For other states, seizure must be carried out by way of an official letter (generally in a physical form) from the court.
These effects can also be achieved under Article 828 of the BCCP, which allows the claimant to obtain a preliminary certificate from the court and record it with the real estate registry or other registries of debtor's assets subject to seizure, attachment or freezing. The certificate indicates the court authority for the execution action, the parties and the amount involved. Any sale of, or burden imposed on, the relevant asset will be presumed to be in breach of the execution action.
Quotas of limited liability companies can also be seized in accordance with a court order to this effect. This will be recorded in the company's summary card, in the commercial registry, preventing any change in the articles of association of the company, including the sale of the equity interest. For joint-stock companies, the seizure must be recorded in the registered share register.
Seizure of trademarks is also possible, and this must be registered with the National Institute of Industrial Property. The BCCP also expressly allows the seizure of credits in the name of the debtor, parts of the revenues of the debtor (in the case of companies, as long as it does not make the business impracticable) and rent that the debtor receives.
A similar approach can be taken through the brand-new procedure of early evidence production, allowed in cases where there is a justified fear that the verification of certain facts during a forthcoming lawsuit will be impossible or very difficult. In theory, this procedure is applicable in cases where an asset dilapidation has been identified that will not be possible to prove in the future. However, the most advisable strategy would be to seize the assets through an urgent protection request.
Pending the outcome of a foreign or domestic claim (except execution action), if fraudulent transferences are identified, an independent lawsuit for fraud may be filed against creditors, including an urgent protection request to freeze the assets on the verge of being transferred. However, strong evidence must be shown to convince the court of the risk of damage and the probability of the right over the assets.
ii Obtaining evidence
Obtaining evidence of fraud is considered a challenge, as the financial statements of the vast majority of Brazilian companies are not publicly available. Therefore, information from the market is a starting point, as is confirmation of a relevant decrease in the business of the debtor.
In the event of default, when there is no more dialogue with the debtor, a diagnosis of the debtor's assets is paramount to guide the strategy that will be followed. This task involves several out-of-court procedures and investigations.
First of all, it is necessary to know what collateral was offered, its current situation and who possesses it. If the collateral was sold by the debtor, there can be civil and criminal consequences, as mentioned above.
Second, the apparent situation of the debtor must be identified, gathering all available information about its activities, assets and debts. This task involves several steps that begin with research on courts' websites to find claims against the debtor. If he or she is not found at his or her known address or addresses, this represents a strong sign that his or her activities were shut down.
Likewise, high quantities of civil, fiscal and labour claims involving relevant amounts indicate the existence of deep financial or economic crisis that precedes the asset concealment. Lawsuits can also reveal what assets other creditors are pursuing.
Furthermore, online research on the federal revenue website can show whether the debtor is regular or inactive, as well as if he or she provided an email address or phone number.
An additional approach consists of accessing the debtor's website and trying to find out where he or she carries out his or her activities, who the debtor's clients are and what line of business the debtor has developed. On Google Street View, it is also possible to identify the debtor's headquarters or plants and check whether there is another company operating there, indicating the continuation of business through a new company.
Also, research in the commercial registry in the name of the company debtor and its partners can reveal the incorporation of new companies with the intention of receiving assets or assuming the activities of the debtor, while the creditors litigate against an empty shell. Changes in the debtor's capital stock or in his or her capital ownership may also draw researchers' attention, as the old partners joint liability to the company can be changed by fake partners, to protect their personal assets.
Research of trademarks in the National Institute of Industrial Property may reveal whether valuable and famous marks have been transferred at no cost or for low amounts, which may also indicate an attempt to hide assets from creditors.
Moreover, research on real estate registries can track transference of real estate in an insolvency situation. In São Paulo, research can be conducted online through the ARISP website at a low cost. Similar research is available for vehicles, aircraft and boats.
Finding debtors and their managers through social networks such as Facebook or LinkedIn can reveal what they are doing and where, and indicate whether they have assets that nobody was aware of. However, news reports can also tell us if a company is in a troubled situation, has ceased activities or has filed for judicial recovery.
IV FRAUD IN SPECIFIC CONTEXTS
Bmart Brinquedos is an important player in the toys retail market in Brazil. In 2016, it filed for the Brazilian reorganisation procedure (judicial recovery) in substantive consolidation, declaring a total debt of 120 million reais, distributed among banks, suppliers and workers.
Its CEO, founder and controlling quota holder was guarantor for and jointly liable with Bmart for several loans with Brazilian banks. In 2015, aware of the fact that judicial recovery under the BBL is applicable only to companies, and that credits can be enforced against a guarantor who is a natural person, the CEO and his family began the concealment of several valuable personal assets, particularly real estate. Furthermore, with a view to surviving the reorganisation procedure, he also tried to hide valuable company assets, including the profits from Christmas sales and trademarks.
A few months before filing for judicial recovery, the CEO incorporated an individual limited liability company (EIRELI). He then changed the articles of association of the other 25 companies of the group to remove all his relatives from the partnership, leaving only himself as partner of the companies alongside his EIRELI. In other words, he became his own partner in 25 limited liability companies, which is questionable from the perspective of Brazilian law.
Besides this, he incorporated two other companies: one a business managing trademarks, and the other a family holding company investing in real estate. While Bmart's trademarks were transferred for the small amount of 100 reais to the first company, the CEO increased the capital stock of the second company by transferring to it all real estate in his name, and weeks later sold all his quotas to his sons against a payment of 16 instalments, the first of which would become due five years later. Considering that the group and its CEO had borrowed a large amount of money from the banking market, the fraud was manifest.
In parallel, another EIRELI was incorporated by the brother of the CEO in the same place, the main distribution centre of Bmart's stores, to work as the new main supplier of the group. Actually, the new company worked as a brass plate company, as it was not subject to the judicial recovery and could buy goods from the real suppliers under better conditions, as well as hiding the profits of the stores and not being monitored by the insolvency practitioner or the judge.
Finally, the billings of the insolvent companies were being transferred directly to the CEO's EIRELI and could not be reached by the creditors, as that company was also outside the judicial recovery process. This practice can also be considered a tax crime. Additionally, it was proved that the reorganised companies were paying the personal debts of the CEO.
After intense research and reconstruction of all steps adopted by the CEO and the group, one creditor filed a request for urgent protection against the CEO and all parties involved, in secret, aiming to seize all assets that had been transferred fraudulently. The order was granted and, furthermore, the creditor filed a defeasance action and an execution action.
The matter was brought before the insolvency judge, who called a hearing in which the CEO recognised the diversion of assets. As a consequence, the prosecutor requested the commencement of a criminal procedure and a trustee was nominated by the judge to supervise the day-to-day operations and authorise all cash movements. In the end, the creditor and the CEO reached a settlement and the actions proposed by the creditor were shelved.
V INTERNATIONAL ASPECTS
International legal cooperation can be understood as a formal way of requesting from another country some judicial measure, investigation or administrative action in relation to a concrete case in progress. The effectiveness of justice in the context of intensified relations between nations, whether in respect of commercial, migration or information matters, increasingly requires a state to adopt a proactive and collaborative approach.
A concrete example of the importance of international legal cooperation is Lava Jato, or Operation Car Wash, the largest investigation of a scheme of systemic corruption, bribery and money laundering in Brazil, involving large companies and politicians.
In three years, the operation conducted 183 requests for cooperation with 43 different countries. Of these countries 14 provided information through active requests and also requested information for cooperation.
According to the Operation Car Wash task force:
The amount of international cooperation celebrated within this operation demonstrates a scenario that should become more common in the next years and in the development of future research. The exchange of information between authorities in different countries with the aim of combating transnational crimes and unraveling a series of illicit crimes committed, beyond the country itself is a reality that only tends to grow. And in three years, the investigation of the country's biggest corruption scandal reinforces that this is a path without a return and of fundamental importance for the progress of the work carried out both in Brazil and in other countries.8
Until March 2017, the exchange of information between the authorities of the countries allowed the recovery of almost 756 billion reais abroad, of which 594 billion reais have already been repatriated.
Furthermore, in 2015, the BCCP reinforced international cooperation between jurisdictions, according to international treaties ratified by Brazil. This cooperation may involve:
- summonses, subpoenas and judicial and extrajudicial notifications;
- gathering evidence and obtaining information;
- ratification and enforcement of decisions;
- granting of urgent remedies;
- international legal assistance; and
- any other judicial or extrajudicial measures not prohibited by Brazilian law.
Nonetheless, the Brazilian Constitution still determines that foreign decisions depend on ratification by the Superior Court of Justice to be enforced in Brazil and, unless an international treaty says differently, this procedure has to be followed.
VI CURRENT DEVELOPMENTS
Brazilian law has evolved in the past years in terms of enforcement procedures and the punishment of acts related to fraud, in both the civil and the criminal spheres. A great number of legal procedures are now electronic, which makes them faster, and makes decisions more effective. Furthermore, online seizure procedures such as the Bacenjud and Renajud systems have greatly facilitated the recovery of assets.
However, certain practices should be improved, such as registry services, as most of these are expensive, slow and are not provided as online services, impeding deeper research into assets and the prompt implementation of seizure or freezing orders.
Apart from this, a draft bill of law to reform the BBL is being prepared by the Ministry of Finance, involving specific rules about fraudulent practices in preparation for judicial recovery, to make the recognition and prevention of such practices easier.
1 Leonardo Adriano Ribeiro Dias is an associate and Aitan Canuto Cosenza Portela is a partner at ASBZ Advogados.
2 Articles 158–165, BCC.
3 National Justice Council. Justiça em números 2017: ano-base 2016/Conselho Nacional de Justiça – Brasília: CNJ, 2017, p. 107. Available at: www.cnj.jus.br/files/conteudo/arquivo/2017/09/904f097f215cf19a2838166729516b79.pdf. Accessed on 11 September 2017.
4 National Justice Council op cit, p. 131.
5 Available at: www.doingbusiness.org/data/exploreeconomies/brazil#enforcing-contracts. Accessed on 24 July 2017.
6 National Justice Council op cit, p. 135.
7 Available at: www.doingbusiness.org/data/exploreeconomies/brazil#enforcing-contracts. Accessed on 24 July 2017.
8 Available at: http://politica.estadao.com.br/blogs/fausto-macedo/em-tres-anos-lava-jato-teve-mais-de-180-pedidos-de-cooperacao-internacional. Accessed on 24 July 2017.