Precatorios: Brazil faces public funds default

Local governments under pressure to service judicial payments debt; Lawyers concerned about possible technical default

Brazil is heading towards an official default and unilateral restructuring of government judicial securities. The securities, commonly referred to as precatorios, are orders issued by local courts for government institutions to pay damages, contractual differences, expropriations and other monetary awards.

Lawyers suggest there is up to $100 billion in outstanding precatorios. “No reserves and no provisions appear in the public balance sheets for precatorios,” says Flavio Brando, a member of the Brazilian Bar association and partner at law firm Machado Meyer. “The federal treasury department in Brasilia has failed to book and publicize the existing and potential precatorios debt throughout the country, because it would put a stain on their otherwise excellent track record, and, much worse, it would compromise the politicians’ statements that Brazil enjoys a remarkable surplus in its public accounts.”

The government began to tackle the potential problem in 2006, starting work on a law known as PEC 12. This constitutional amendment is a sophisticated form of technical default whereby the mayors and governors of each owing state or region will have to allocate 0.6% to 2% of net revenue funds to pay court-ordered awards. No deadline is set for full payment. This means that in the state of Sao Paulo payments would take a minimum of 15 years, in the city of Sao Paulo 26 years, and in the state of Goias 90 years. The state of Espirito Santo would still owe money in more than 100 years’ time.

A second caveat of PEC 12 states that interest rates on precatorios will be reduced to reflect the reference rate, as with saving accounts. There will be no adjustments made in line with inflation.

In April, the senate voted unanimously in favour of this change. The House of Representatives is due to vote in the coming months. “If approved, PEC 12 will effectively legalize a default on the payment of these credits,” says Brando.

Brando spoke in New York to international investors, lawyers and rating agencies about the issue in May. “All the people were amazed to hear of this situation,” he tells Euromoney.

Luiz Dias de Souza, another Bar member, said in a recent report: “[If these changes are] incorporated into the constitution, [they] constitute an assault on rights of creditors, and moreover, a step back for Brazil.” Souza and Brando claim that if the House of Representatives passes PEC 12, this policy of constitutional default will scare off potential investors.

But the Brazilian treasury is dismissive of these claims. Paulo Fontoura Valle, treasurer at Brazil’s ministry of finance, says the adoption of sound economic policies and the management of the federal public debt helped Brazil gain investment grade last year.

Despite Valle’s confidence, on May 13 the Speaker of the House agreed to a public hearing before members cast their votes.

Author(s): Chloe Hayward
Source: Euromoney. (June 2009)

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