Presentation made at the 50th Congress of the Union Internationale des Avocats, on the 2nd November 2006, in Salvador, Bahia, Brazil.
In recent years, Joint Ventures as a strategic model for coordinating business interests have become an ideal vehicle to expand business, penetrate foreign markets and develop and commercialize new products as well as to permit companies to concentrate on their core activities.
There are numerous aspects that must be carefully considered before entering into Joint Ventures, including the nature of the relationship (contractual or non contractual Joint Venture); the common objectives of the parties; the contribution of each party to the Joint Venture; corporate governance issues; the expected return and the criteria for the distribution of profits; joint marketing strategies; and the related agreements that will be also executed (Shareholders’ Agreements, Trade License Agreements, Confidentiality and Non-Competition Agreement, etc).
Recent studies show that an important percentage of international joint ventures fail within the first three years, mainly through deficiencies in the initial process of establishing the terms and conditions of the partnership.
Therefore, the model through which the Joint Venture will be established is subject to many factors that must be taken into consideration by the partners prior to implementing the same such as the internal laws and the cultural aspects of the countries where the company will be head-offices; where the products or services resulting from such Joint Venture will be commercialized; the form in which the Joint Venture will be administrated, and by whom, as well as the respective participations of each party in the business.
In this paper, we will discuss some of the main points that must be considered by the parties when deciding on entering into a Joint Venture in Brazil. For ease of reference we have divided the paper into “dos” and “don’ts”:
2.1 DEFINE THE FRAMEWORK AND OBJECTIVES OF THE JOINT VENTURE, WITHOUT SIGNING ANY BINDING DOCUMENT
Obviously, the first point that must be carefully analyzed and defined by the parties is the objective of the Joint Venture and the steps necessary for its achievement. The parties shall record their intentions by means of a term sheet or a Memorandum of Intention, which must be cautiously drafted by experienced lawyers in order not to create a binding obligation between the parties and/or to trigger the legal timeframe within which it may be necessary to submit the prospective transaction to the Brazilian Antitrust Authorities. In this regard, it is important to expressly state that the terms and conditions indicated in the term sheet are subject to no material adverse findings in further legal, financial, environmental and tax due diligence investigation.
The term sheet or the Memorandum of Intention shall contain the principal terms and conditions of the proposed transaction and the steps to be taken by each party to consummate the same.
2.2 EXECUTE A CONFIDENTIALITY AGREEMENT
Considering that during the negotiations for the creation of the Joint Venture the parties will certainly exchange information of a confidential nature, together with the execution of the Term Sheet or the Memorandum of Intention, the parties should also celebrate a Confidentiality Agreement, in order to protect and keep secret information exchanged and to establish the reciprocal rights and obligations regulating the access and use of any such confidential information.
2.3 SEEK A SUITABLE CORPORATE VEHICLE TO ACCOMMODATE THE INTERESTS OF THE PARTIES INVOLVED IN THE TRANSACTION
To become effective a Joint Venture should be governed by a written contract that sets out the specific terms regulating the relationship between the parties. Although it is possible to enter into a non-corporate Joint Venture, in which the participants contract rights and obligations individually for their common benefit, generally the incorporation of a specific purpose company proves to be a better solution for establishing the duties and rights of the parties involved in the transaction, since, in this case, the law grants corporate status to such companies as legal entities separate from their participants.
In Brazil, the most frequently used corporate structures for Joint Ventures are the “Sociedade Anônima” (S.A.) and the “Sociedade Limitada” (LTDA). In both cases all participants have limited liability.
An S.A. is essentially a commercial legal entity whose capital stock is represented by shares. Under this corporate type, the liability of the shareholders is limited to the amount of the issued share capital subscribed to or acquired by them.
In its turn, the liability of the partners in a LTDA is limited to the total of the company’s capital. Until the capital is fully paid-up, each quotaholder is liable for the entire amount of the capital and not only for its quotas. From then on the quotaholders will have, prima facie, no further liability to the company or to third parties.
The capital of an S.A. is divided into shares representing parts or fractions of the share capital. The shares may be common, preferred or fruition shares, depending on the rights they confer to their holders. Common shares entitle the holder to common or essential shareholder rights. Preferred shares have special rights of a financial or policy nature. Fruition shares result from amortisation of the common or preferred shares.
All shares must be registered. The ownership of shares is formalised by the register of the name of the shareholder in the Nominal Share Register. Brazilian law does not permit bearer shares.
The LTDA is established by contract and it has only a single class of partners, the limited liability quotaholders. The quotas are registered in the articles of association and are not represented by securities or certificates. Because the ownership and the number of quotas are written into the articles of association, any transfer of title will result in an amendment to the articles under signature of all of the quotaholders or, at least, of the quotaholders who represent ¾ (three quarters) of the capital.
Below please see a chart containing the essential differences between the two types of companies:
Limited to the sum of the corporate capital.
Limited to the shares subscribed.
By one or more individuals who must have permanent residence status in Brazil.
By two officers, at least, shareholders or not, and who must have permanent residence status in Brazil. In addition, the by-laws can provide for a Board of directors, whose members must own shares in the company, but do not need to be resident in Brazil.
Election of Managers
By the totality of the quotaholders, while the corporate capital is not yet entirely paid-up. From thereon, quotaholders representing 2/3 of the corporate capital, in the case the indication is not inserted in the Articles of Association or ¾ if it is.
By majority of votes, if not otherwise established in the by-laws or in the shareholders agreement.
Approval of quotaholders representing at least ¾ (three quarters) of the total company capital, except when the law establishes otherwise.
The majority of votes of those present at the general meeting, except when the law establishes otherwise.
Transfer of Quotas/shares
The right of first refusal is possible and foreseen in the respective law. Regarding Tag-along, although not expressly foreseen in the applicable law, it is possible to include such a statement in the company’s articles of association.
The law expressly provide for the right of first refusal and the tag-along. Normally such provisions are included in the Shareholders Agreement.
As a consequence of the new Brazilian Civil Code which is been in force since 2003, the LTDA has become more bureaucratic and to some extent hinders the establishment of Joint-Ventures by overly restricting the rights of the contracting parties, imposing deliberative quorums, as well as excessive formalities.
In addition, the costs of constituting and maintaining LTDA companies was also affected by the new rules, since the new civil law determines the need for the publication of the notice convening General Meetings.
Finally, it is important to point out that apart from the specific points mentioned above, Brazilian corporate law, governing the SA, permits the execution of Shareholders’ Agreements regarding voting, controlling and purchase of shares, granting the right of specific performance of such agreements.
The law that governs the LTDA does not specifically address the issue of Quotaholders’ Agreements. Therefore, the validity of a Quotaholders’ Agreement could be subject to discussion in the courts. In case the parties decide to proceed with the incorporation of a LTDA., it is important that the partners adopt very detailed Articles of Association which would cover, as much as possible, all the future relations of the parties, including the decisions over the management of the company.
2.4 CHECK IF THE TRANSACTION IS SUBJECT TO THE PRIOR APPROVAL OF THE BRAZILIAN ANTITRUST AUTHORITIES
Brazilian Competition Law (Law 8.884 of 13 June 1994, as amended by Laws 9.069 of 19 June 1995 and 10.149 of 2 December 2000) establishes antitrust measures in keeping with the constitutional principles of free enterprise and competition and restraint of abuses of economic power. Accordingly, it contains provisions detailing violations of the economic order such as abusively exercising a dominant position or acts such as collusive behaviour or unfair business practices.
Certain acts and agreements considered potentially anticompetitive must be submitted to the Brazilian Antitrust Authorities (CADE – Conselho Administrativo de Defesa Econômica) for review and approval. Furthermore, certain acts such as mergers, acquisitions or joint ventures must also be submitted to CADE for approval if, as a result of the transaction, the parties involved achieve a share of 20% or more of the relevant market and/or if their individual or collective gross sales in Brazil, as reflected, in their latest financial statements have exceeded R$ 400 million.
Acts must be submitted to CADE no later than 15 business days following the execution of the first binding document between the parties. Failure to abide by the deadline will subject violators to fines between approximately US$ 40,000 and approximately US$ 4,000,000.
2.5 ESTABLISH RIGHTS OF FIRST REFUSAL, TAG ALONG AND/OR DRAG ALONG
Such provisions will permit the parties to sell their interest in the Company to external parties, provided that such shares are first offered to the other shareholders of Company upon the same terms and conditions.
In addition, through the Tag Along provision the Joint Venture partners may establish that the controlling shareholder can only negotiate its shares with a third party if such third party is willing to extend the offer, upon the same terms and conditions, to the other shareholders. From the economic perspective, Tag Along provisions represents the ideal mechanism to divide the “controlling premium” normally paid to the majority shareholder in case of a sale of shares, equalizing, therefore, the prices paid for each share. From the legal perspective, Tag Along provisions are a unilateral promise of purchase. Tag along rights also stimulate increased liquidity of the shares.
On the other hand, Drag Along rights are normally granted to the controlling shareholder to permit such shareholder to negotiate its shares with a third party and force the others shareholders to sell upon the same terms and conditions.
Essentially the objective of such clause is to increase the number of prospective buyers of the shares, so as to include prospective buyers that are not willing to own a company with minority shareholders.
From the legal perspective, the Drag Along provision is understood as an unilateral promise of sale.
3.1 DO NOT ENTER INTO A NON-CORPORATE JOINT VENTURE FOR AN UNDETERMINED PERIOD OF TIME
Brazilian laws establish that contracts without a determined period of time can be, generally, rescinded with prior notice. Notwithstanding the above, the Brazilian Civil Code determines that whenever a large investment has been made by one of the parties the other will only be able to rescind the same after a reasonable period of time sufficient for the investor to pay back his investment. In any circumstance the matter would be subject to a court decision.
In the case of corporate joint Ventures, without prejudice to the Right of First Refusal, to permit sufficient time for the parties to pay back the investment and achieve the minimum expected return, it is strongly recommended to establish restrictions on the transfer of shares or quotas for a specified period of time.
3.2 DO NOT ENTER INTO A JOINT VENTURE WITHOUT ESTABLISHING THE MECHANISMS FOR THE MANAGEMENT OF THE COMPANY AND CORPORATE GOVERNANCE
When a partner of the Joint Venture is a foreign company it is recommended that a Board of Directors be created in order to permit the appointment of foreign individuals. The number of the members of the Board must be also established and their rights and obligations must be well defined.
The management of the company must be structured to permit the partners to have access, through their representatives, to the relevant information of the company’s business operations, providing transparency, security and confidence to the shareholder.
In this regard, it is important to establish a mechanism by which the partners are kept regularly informed and consulted with respect to the developments of the company’s important business matters, transactions and contractual commitments.
The corporate governance policies for providing transparency to the management of the company must include the obligation to provide the parties with at least the following regular information:
• monthly financial and operational information, as provided to the management;
• unaudited quarterly financial statements;
• audited annual financial statements;
• relevant agreements entered by the company; and
• any reasonable request for information.
3.3 DO NOT ENTER INTO A JOINT VENTURE WITHOUT ESTABLISHING THE QUORUM FOR STRATEGIC DECISIONS It is vital that critical decisions shall only be taken with the consent of the partners. In general the main decisions requiring the consent of the partners are the following:
• any material changes in the company’s by-laws;
• the authorization or issuance of any class or series of equity securities;
• any acquisition, merger, sale of assets or other reorganization involving the Company, in one or more related transactions where the cumulative value exceeds an amount pre-determined by the parties;
• dividend policy, the declaration and/or payment of dividends;
• any change on matters related to the functioning of the Board of Directors; and
• appointment of the Company’s independent auditors, and change in accounting principles.
3.4 DO NOT ENTER INTO A JOINT VENTURE WITHOUT KNOWING YOUR PROSPECTIVE PARTNER
Due to the fact that a Joint Venture with a Brazilian Company can result in the successive liability of both the Joint Venture vehicle and the foreign partner, a Join Venture agreement shall be subject a full legal due diligence investigation on the prospective partner. If the Joint Venture is, for whatever reason, to be implemented using an existing corporate vehicle, full legal, accounting, tax and environmental due diligence investigations must be performed.
3.5 DO NOT ENTER INTO JOINT VENTURES WITHOUT LEGAL AND TAX ADVICE Naturally no one should consider entering into any form of Joint Venture arrangement without taking appropriate professional advice, specifically legal and tax advice.