Debentures have become one of the main legal instruments for fundraising by Brazilian companies during the pandemic.
Restricted to corporations (Brazilian sociedades anônimas), there has been a large volume of private and public issuances of Debentures whose proceeds are being directed to working capital, debt re-profiling and capex.
In our experience, Debenture issuers and investors should pay attention, among others, to the following 5 key points:
1. Issuance Structure: Companies can issue Debentures through private offering (intended for single or multiple investors) or a public offering (for multiple investors). The stipulation of the terms and conditions of the issuance, such as the amount to be raised, interest rate, term, covenants and collateral will initially be determined by the issuer, but will be subject to the validation and requests of potential investors.
2. Destination of Funds: The use of funds is essential part in an issuance of Debentures. Investors in general, especially during the current pandemic, tend to decline to participate offerings that give a “blank check” to the issuer, that is, whose destination of the money is uncertain. The Debenture deed must clearly state where the proceeds will be used (eg. working capital, re-profiling, capex) and means for the Debenture holders to audit such use.
3. Covenants: Covenants section is a fundamental part of the issuance. It will provide for issuer’s obligations to debenture holders, such as providing periodic financial statements, material facts, financial ratios, free access to audits/verifications, restrictions on change of control, raising new debts above certain threshold, among others. Issuers and investors must carefully negotiate the Debentures covenants to avoid points of conflict in the future.
4. Events of Default: It is another fundamental section in the Debentures deeds and is usually not much discussed. The Events of Default should be evaluated carefully, and should respond questions such as, will the issuer be given grace period to satisfy defaulted obligations? If the company fails to pay debts to third parties, will this be an immediate cause for acceleration? These are some examples to be considered in default situations.
5. Debenture Holders’ Resolution Quorums: If the issuance of Debentures is subscribed by more than one investor, the deed must provide for how the debenture holders will live together, as the issuer’s creditors. Example: if there is a default by the issuer and only one of the debenture holders wishes to accelerate the debt. How to deal with other investors? Therefore, investors should pay attention to the provisions on deliberation quorums provided for in the deeds of issue.
The above points are not exhaustive and are intended to draw attention to the importance of negotiating, reviewing and understanding the terms of the debenture deeds, insofar as they are generally medium to long term funding, where the company and debenture holders will live with proximity until full repayment of the of the outstanding balance.