A judge in Odebrecht Oil and Gas S.A.’s (“OOG”) Extrajudicial Recovery process—a process akin to the US prepackaged plan—just issued a ruling determining that a recovery process can impact a bank’s claim against a company stemming from debt arising from a drawn Letter of Credit issued to guarantee a company’s bond payment in case of default, even if such draw and reimbursement request occurred after the initiation of court oversight. Financial creditors Credit Agricole Corporate Investment Bank (“Credit Agricole”) and Citibank NA (“Citibank”) had objected to OOG’s reorganization plan in an attempt to exclude their claims – which arise from ‘letters of credit’ issued before OOG’s protection request but drawn upon by bondholders after the request – from the restructuring. Their argument was that the payments on those letters were made only after the filing of the process and an in-court reorganization process is only intended to restructure pre-filing claims. The court, however, determined that it is the issuance date of the letter that controls when the claim arises—bad news for bond insurers—as we explain below.
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After several out-of-court debt renegotiations with bondholders, which kicked off in September 2015 and resulted in agreed waivers and rescheduled payments, on 23 May 2017 OOG SA and 10 foreign affiliates from the Odebrecht conglomerate’s Oil and Gas arm filed a petition requesting an in-court process to restructure their financial debt. In an effort to redefine the payment conditions of the company’s secured notes due 2021 and 2022, as well as debt owed to financial unsecured creditors, the company filed three different plans and evidenced the minimum approval quorum (60%) for each, according to the chart below (approximate values):
On 25 May, the court granted the Extrajudicial Recovery request, holding that all the requirements provided for in the Brazilian Reorganization Law were evidenced in the initial petition. However, respectively on 19 and 21 July, financial creditors Citibank NA (“Citibank”) and Credit Agricole Corporate Investment Bank (“Credit Agricole”) objected the reorganization plan, requesting the court to exclude their claims from the Extrajudicial Recovery process.
In 2013, OOG SA hired Citibank to issue two letters of credit as guarantees to bondholders to ensure the fulfillment of certain obligations arising from Odebrecht Drilling Norbe VII / IX Ltd.’s bonds due 2021 and 2022. Those debt obligations were also guaranteed by two other companies of the group – Odebrecht Drilling Norbe VIII LLC and Odebrecht Drilling Norbe IX LLC. Similarly, Credit Agricole issued a letter of credit in 2014 to guarantee the company’s obligations on the bonds due 2022. ODN Tay IV GmbH – one of the companies of OOG’s group, owner of “ODN Tay IV” rig which is used to the same name’s oil exploration project – was required to maintain certain minimum amounts in two separate bank accounts: a debt service reserve account (in order to provide guarantees to pay the debt service) and an operating and maintenance service account (to pay the operation and the maintenance of the rig). Credit Agricole’s L/C was issued to comply with these deposit obligations. In either case, should the company fail to make necessary payments to bondholders and such bondholders request the banks to honor the letters of credit, Citibank and Credit Agricole would automatically have the right to be reimbursed by the company.
Following the initiation of OOG’s Extrajudicial Recovery process, bondholders drew on those letters of credit and the banks sought full reimbursement from OOG. OOG, however, sought to have those reimbursement claims impaired by its plan.
Time to pay up
First, the banks argued that the Corporate Court overseeing the Extrajudicial Recovery did not have competence to rule on the issues related to the foreign affiliates of OOG group on the basis that almost all of the debtors involved in the restructuring plan are not based in Brazil and that the plan proposed new bonds to be issued pursuant to the laws of New York, by English parties based in the Cayman Islands, guaranteed by companies based in Austria. In other words, the creditors argued that the Brazilian Court was not the appropriate venue to restructure the debt as the fulfillment of the plan would not occur in Brazil. In addition, the objectors argued that the court should not affirm the creditor vote that approved the plan as the plan allegedly contained illegal provisions including different payment conditions to creditors impaired by plans A, B and C, as well as abusive payment conditions. According to the objectors, the plan was a blank check written by the creditors on behalf of the company, or alternatively a debt forgiveness agreement, and not an actual restructuring plan.
But the key objection was to the impairment of the banks L/C reimbursement claims, grounded on Brazilian Reorganization Law Sections 49 and 163, § 1º which state that an extrajudicial plan shall include all claims constituted up to the date of the company’s court protection request. Therefore, although referenced claims arise from the letters of credit issued before OOG’s protection request (specifically to guarantee payment to bondholders, as mentioned above) actual payments on those letters had not been made until after the filing of the Extrajudicial Recovery process, so the banks’ rights to be reimbursed by the company – arising from the honoring of the guarantee – should not be impacted by a majority of other OOG creditors imposing a restructuring upon them. In US bankruptcy-speak, the banks argued that letters of credit drawn after the filing date are postpetition claims subject to payment in full, not prepetition claims which can be restructured, with the drawing date controlling the date the claim is crystallized.
A right in expectation, instead of an expectation of right
As to the first argument, the court held that while Brazilian Reorganization Law prohibits plans that propose different payment conditions to creditors in the same class, such prohibition does not extend to creditors belonging to different classes under different plans. Also, when it comes to complaints regarding claim impairment as a whole, the Court ruled that its interference on the process must be minimal—that it must only verify the existence of illegalities either in the payment proposals or in the approval of the plan. In other words, the Court is not allowed to interfere in the aspect of the economic viability of the reorganization plan, since such issue is exclusively for the creditors’ appreciation. In addition, according to Section 164 of Brazilian Reorganization Law, creditors’ objections may not challenge the economic terms of the plan, but rather only legal aspects like the non-attainment of minimum quorum approval or other legal requirements provided for either in the Brazilian Reorganization Law or in other applicable law.
Regarding the creditors’ allegations that their claims should not be affected by the Extrajudicial Recovery process, the court held that, as the letters of credit were issued at the same time of the bonds, the company’s obligation to reimburse banks if necessary was also constituted at that time, before the filing of the in-court restructuring process, although under a suspensive condition – payment would not be requested unless in the case of OOG’s default. In other words, the reimbursement claims were properly construed as contingent claims arising at bond issuance, not post-filing claims triggered upon a draw. By seeking reimbursement, the banks were not creating new claims but, rather, adopting the first step in collection. Citing a classic, prominent Brazilian jurist, the court held that in this case the banks have “a right in expectation, not an expectation of right.”
A bitter precedent for bond insurers
The issuance of letters of credit might be among a bank’s most profitable financial products, generating fees paid by the issuers regardless of whether or not disbursements ever become necessary. Further, where payments are required and the guarantee must be honored, additional fees, administrative taxes and interest are usually charged.
Those fees likely factor in both on the amount and the term of the letter of credit to be issued, in addition to the risk of default. After this ruling in OOG’s case, however, a new factor will need to be considered by the banks’ credit risk analysts either when granting or renewing a letter of credit: the possibility of a Judicial or Extrajudicial Recovery protection request by the company and the consequent impairment of the letter of credit claims by an in-court restructuring process.
The financial creditors are expected to appeal this decision to the State Court of Justice. An eventual appellate order ruling could set precedent that a bond insurer’s claim against the company can be slashed in a Brazilian reorganization process, regardless of when the guarantee is effectively honored. As companies continue to avail themselves to these relatively new processes more and more in Brazil, you can expect a commensurate impact on the bond insurance market should this legal determination hold.
 The company had been negotiating with an ad hoc group of holders of its 2022 bonds since Petrobras cancelled the charter and services contracts with OOG’s ODN Tay IV rig, in September 2015. Further, on 19 April 2016 OOG defaulted on the perpetual notes after the termination of a 30-day grace period that started 17 March, as reported.
 The request included 11 entities: Odebrecht Oleo e Gas SA, Odebrecht Oil & Gas GmbH, Obrebrecht Oil & Gas Finance, Odebrecht Oil Services, Odebrecht Drilling Norbe VIII/IX, Odebrecht Drilling Norbe Eight GmbH, Odebrecht Drilling Norbe Nine GmbH, Odebrecht Offshore Drilling Finance, ODN I GmbH, Odebrecht Drilling Six Nine GmbH, and ODN Tay IV GmbH.
 In 2006, Odebrecht group concentrated its investments in oil and gas in a new company named Odebrecht Oil & Gas.
 Citibank’s letters of credit were issued on 19 December 2013 and payment was made on 25 May 2017, while the Credit Agricole bonds’ guarantee letter of credit issuance took place on 24 February 2014 and corresponding payment occurred on 21 June, 2017. As mentioned above, OOG’s restructuring request was filed on 23 May 2017.
 Francisco Cavalcanti Pontes de Miranda (1892 – 1979).