Creditors in tussle over bankruptcy laws in Brazil A JBS beef processing plant in Rosario, Argentina. The company also has operations in Australia, US and North America When José Batista Sobrinho opened a butchers" shop in a town in Anápolis, Goiás state, Brazil's equivalent of the US Midwest, he could not have known that this tiny operation processing a couple of head of cattle a day would one day become the world's largest beef processor. Yet in the past eight years, under the management of his sons, the group has grown to become one of Brazil's foremost "national champions," with acquisitions of beef operations in Australia and the US, and expansion into the North American poultry market through the purchase of Pilgrim's Pride in 2009. As of early last year, there remained one frontier still unconquered by JBS - the Brazilian domestic poultry market. So when the company entered the sector in May 2012 by leasing the Brazilian assets of a French-owned company, Doux Frangosul, which had defaulted on its estimated R$1bn in debts starting in late 2011, it could hardly have asked for a better start. Although it has not disclosed the cost of the leases, a property registry of one of the company's two main plants, Passo Fundo, in Brazil's south, indicates JBS is paying R$500,000 ($223,000) a month for the plant. With capacity to process 430,000 birds daily and wholesale chicken fetching up to R$2.70 a kilogramme, the plant is capable of generating revenue that far outstrips the leasing costs. "We started up our chicken business in Brazil, the company was called Doux Frangosul, so now it's called JBS Frangosul," company executives said in a call with analysts last year. It's quite a substantial business, the third-largest chicken producer in Brazil, with capacity to process more than 1m birds per day. The deal may have pleased JBS's shareholders, which aside from the founding Batista family include powerful Brazilian state banks, BNDES and Caixa Econômica. But creditors of Doux Frangosul are fuming. They argue they are not seeing any of the proceeds of the leasing deal, which they allege is being done in violation of their rights over the company's assets, many of which were offered as collateral for its now unpaid debts. JBS denies any wrongdoing. "JBS leased/rented assets and it is not these assets that are the debtors but the companies who own them," JBS said. It added that it was willing to talk to creditors. Frangosul is just one of several alleged cases in Brazil of "de facto operators" - companies that run the assets of a business that is in default without payments to creditors, raising question marks over the effectiveness of Brazilian bankruptcy law. JBS has also clashed with creditors over its leases of the assets of Brazilian leather producers, Xinguleder and BMZ Couros. Separately, HSBC, Credit Suisse and ING are pursuing legal action against a Brazilian brewery, Cervejaria Petropolis, over its operation of the assets of a troubled oilseed processor, Imcopa, according to Debt Wire. Petropolis and Imcopa have denied any irregular business relationship. JBS leased/rented assets and it is not these assets that are the debtors but the companies who own them Oppenheimer Funds, one of the biggest lenders to Doux Frangosul, with unpaid debts of $60m, alleges the JBS lease agreement violates what is known in Portuguese as its alienação fiduciária over the Passo Fundo plant. This gives a creditor mortgage rights over an asset and prohibits its lease, sale, transfer or otherwise to a third party in the case of bankruptcy, Oppenheimer says. Bankruptcy experts say it is one of the strongest forms of collateral in Brazil. "This is our firm's first experience with the explicit violation of an alienação fiduciária," Oppenheimer said. The lease should not be legally recognized under Brazilian law. Oppenheimer is not the only one seeking to draw JBS into Frangosul's bankruptcy case. In a separate legal dispute in a US court with Doux Frangosul, Deutsche Bank said in court documents that JBS "is now using the plaintiff's [Doux Frangosul's] former operations in Brazil pursuant to a below market/deeply discounted lease agreement but has not assumed any of plaintiff's obligations to plaintiff's creditors." In addition, an agent for another creditor of Doux Frangosul, fund manager Ashmore, copied JBS on a letter to Doux Frangosul, seen by the Financial Times, which called for immediate payment of a $40m debt owed to the fund. Oppenheimer alleges that neither Doux Frangosul nor JBS has provided details of the lease arrangements, made any repayments or contacted it to discuss the matter. Frangosul's French parent, Groupe Doux, however, claims that restructuring talks are under way. So far more than R$150m was paid to creditors and Frangosul returned to full production. The existing debts are being negotiated directly with creditors," Doux said. JBS, for its part, rejects responsibility for the debts and argues that through the leases, which it says were fixed according to market value, it is maintaining the value of Doux Frangosul's assets, which would have been left idle otherwise. Lawyers say such cases highlight loopholes in Brazil's bankruptcy law, which is relatively new, having been reformed in 2006 to one more closely resembling the US Chapter 11 system. While the law can work relatively well in São Paulo and Rio de Janeiro, some debtors are able to drag out bankruptcy proceedings in the country's notoriously inefficient courts or obtain sympathetic rulings from smaller courts in their home cities in the country's interior. Creditors, for their part, are also often reluctant to force an outright liquidation of a company for fear of low recovery rates. In the case of Frangosul, the creditors" strategy will be to try to persuade JBS to take responsibility for the liabilities of Frangosul. JBS, however, will be keen to avoid this, especially after assuming another R$5.85bn in debt as part of a deal to take over the chicken and pork assets of another rival Marfrig. This will drive its leverage ratio up to more than 4 times earnings, before interest, taxation, depreciation and amortisation, says Fitch, the rating agency, which has put JBS's credit rating on review for downgrade.