In the end, how many companies filed for bankruptcy protection in 2020?

Brazil, like basically the rest of the world, experienced a severe recession in 2020, with a GDP drop exceeding 4%. As a consequence, some experts predicted that the number of bankruptcies and judicial reorganizations would explode: some professionals estimated that five thousand requests for judicial reorganization would be filed in 2020. A study by the Secretariat of Economic Policy (SPE) of the Ministry of Economy indicated that, if the Covid-19 crisis had moderate effects, a number close to 1,900 judicial reorganizations was expected in 2020, and if the crisis was severe, more than 3,500.

Serasa, the agency responsible for collecting this data in Brazil, recently consolidated the latest information from last year, and the results fell far short of the estimates above: only 1,179 requests for judicial reorganization were made in 2020, a number 17.64% lower than in 2019. This is the lowest level of requests since 2014.

So the question arises: how could the experts have estimated numbers so far from reality?

To humbly suggest ways to answer the question above, the authors of this article published, at the end of 2019, the book "Business Recovery: (in)utility of financial metrics and legal strategies". Chapter two of the work dealt precisely with models (and difficulties) in predicting, based on macroeconomic variables, the number of companies that will experience solvency problems.

There, even before the pandemic, it was already indicated that the relationship between GDP and the number of companies in difficulty did not present as clear an effect as one might suppose. Effectively, GDP " was the most important component of all models" (p. 73). However, the effect of this variable was "in the opposite direction to that expected in all models" (p. 74), and this would indicate that "the mechanisms of GDP propagation in the creation and destruction of businesses still need to be understood more deeply, including the timeframes that relate economic cycles" (p. 75) , probably exceeding one year between a crisis and its effect on business solvency. In other words, no evidence was found that a fall in GDP generates an immediate (and increasing) effect on the number of companies seeking the protection of bankruptcy institutions.

Using the models developed in the book, with data updated until 2019 and recursively estimating how many companies would file for bankruptcy protection in 2020, the estimate of new bankruptcy protection requests was obtained in a range between 1,297 and 1,313 — a quantity much more aligned with the value actually observed (1,179) than the estimate of the experts previously indicated (from 1,900 to 5,000).

Despite warnings prior to the pandemic and the greater accuracy of the indicated models' predictions, it is important to emphasize that these authors also estimated a higher number of judicial reorganizations than actually observed. In other words, there seems to be something unusual about the demand for this legal mechanism in 2020 that would warrant the formulation (and testing) of hypotheses. Such explanations could involve:

1) The fact that small businesses don't even consider the possibility of filing for bankruptcy protection, opting instead to close their doors directly;

2) The expectation that the government would assist companies, which led them not to immediately implement recovery measures; or, alternatively,

3) The debate regarding the modifications to Law No. 11.101/2005 raised expectations that it would improve the environment for companies in crisis.

It is necessary to open a parenthesis here: if any company has relied on the non-distribution of its judicial reorganization in either of the last two scenarios outlined above, it has been tremendously disappointed, as government aid to companies has been timid and the reform of bankruptcy legislation, after the presidential vetoes, has served mainly to create a super-creditor in the tax authorities, without providing returns equivalent to the struggling businesses.

In other words, it is believed that the pandemic has laid bare and amplified pre-existing doubts about the (lack of) understanding of the relationships between macroeconomic variables and corporate solvency. In this sense, 2021, with the risk of overwhelming the judiciary with issues related to companies in crisis, will be a year of challenges and learning for scholars of credit risk and companies in crisis. Let's stay alert and evolve in our discussions!

By Eduardo da Silva Mattos and José Marcelo Martins Proença.

Source: Legal Consultant