Speech given at Canning House, London, England, November 28, 1997.
1.1.- Brazil’s privatisation initiatives gained momentum during the current administration of President Cardoso and have evolved with dynamism in both the federal and state levels, as we have seen in this seminar. These policies, long required, have been very well received both internally, where they enjoy a trenchant popular support, and abroad, where they have contributed to the growing favourable foreign investment climate on an institutional level, as well as in terms of concrete business opportunities.
1.2.- In order for this to be possible, a major legislative effort had to be made on the part of both executive and legislative branches of government to give the adequate legal structure necessary for this endeavour, which included constitutional reforms, always difficult to come by. This effort is far from finished and some anachronisms remain in our legislation, a good part of which have, however, already been addressed by means of bills currently before Congress. In spite of these problems, the privatisation initiatives have not been hindered (3) and have, from the perspective of the private sector, both nationally and internationally, benefited from a quite efficient legislative infra-structure for business law.
1.3.- I have divided today’s presentation as follows:
i) This introduction;
ii) The constitutional background for privatisation;
iii) General legal considerations about joint-ventures;
iv) The “consortium”;
v) The “S.A.” and shareholders’ agreements;
vi) The “Ltda.” as a risk for joint ventures; and
2.- THE CONSTITUTIONAL BACKGROUND FOR PRIVATISATION.
2.1.- Brazil’s federal constitution of 1989 has enshrined the principle of equality in contracts with the public administration, which include those dealing with privatisation. (4) However noble the principles and the intentions of the drafters of the Constitution, such equality originally excluded foreign capital, as article 171 made a distinction between Brazilian companies controlled by Brazilians and those controlled by foreigners. In addition, preference was given to national capital in detriment to foreign capital for the acquisition of assets and services with respect to contracts with the public administration. This preference was removed by the 6th Constitutional amendment of 15th August 1995, which assured equal legal treatment to all companies incorporated under Brazilian law, irrespective of the origin of their capital. (5) Accordingly, the new privatisation law (6) allows foreign individual or entities to acquire up to one hundred percent of assets being privatised, unless a lower percentage is established for specific cases.
2.2.- The 8th Constitutional amendment of 15th August 1995 allowed the government to grant concessions of telecommunications services to the private sector, the so called “Band B” mobile telephone services, which started in April of 1997. In this particular case, the invitation to bid presented by the Brazilian government required bidding parties to have at least 51 percent of their voting capital held by Brazilians.(7) Preparations are now underway for the privatisation of the Telebras subsidiaries including the “Band A” mobile telephone services, and new laws and norms have been enacted in the recent past to regulate this initiative. (8) It has already been determined that for the “Band A”, the same type of format adopted for “Band B” in terms of Brazilian majority control will be maintained. This restriction shall be valid for both until 20th July 1999. (9)
2.3.- With respect to oil and gas, the 9th Constitutional amendment of 9th November 1995 allowed the state to hire private sector companies for the drilling, refining, international marketing and transportation of oil, oil based derivatives and natural gas. In August of this year (10), the 44 year old state monopoly of the oil sector was terminated and a new agency (11) created to act as regulator of the sector.
3.- GENERAL LEGAL CONSIDERATIONS ABOUT JOINT VENTURES.
3.1.- Whilst the Brazilian Commercial Code (12), enacted into law in 1850 modelled after French and Italian laws, has the precise corresponding legal institutes to general partnership (sociedade em nome coletivo) (13) and limited partnership (sociedade em comandita) (14), these are now rarely used and have thus fallen into disuse. The basic reason why business normally eschews these institutes is the unlimited and several responsibility of the partners. Thus, the usual company types preferred by business and widely utilised in Brazil are limited liability ones: the company by shares (S.A.) (15) and the company by quotas (LTDA.) (16). Accordingly, joint ventures are structured around these types in the way we shall see later during the course of this presentation.
3.2.- On the other hand, the so called “memoranda of understandings” or “heads of agreement” are best used with extreme caution and great parsimony, in view of the fact that, under Brazilian law, an obligation to contract and even a business proposal is binding (17), unless some legally defined circumstances prevent the transaction from being implemented (18), and a default under a memorandum of understandings will be subject to damages and lost profits, to which one should add Court fees and legal costs. Therefore, it is best to execute a final agreement or else to have a final agreement with a suspensive condition for implementation at a later date.
3.3.- For joint-ventures pertaining to privatisation, it has been common to see the usage of “consortia”, a type of contract regulated by the S.A. law, which consequently do not have legal personality, and to incorporate only after the objective of the “consortium” has been secured. At the beginning of the privatisation process, some direct and/or indirect agents of the public administration suggested to the interested parties the execution of “contracts of association” as an alternative for non-incorporation, alongside “consortia” (19). Very quickly, the legal establishment advised clients against such path based on the position that “associations”, rather than being contracts, are legal entities (20) without profitable ends, duly defined and regulated by the Brazilian Civil Code and must be duly incorporated. Unlimited and several responsibility of the partners derive from “associations” (21). The legal treatment of “consortia” under Brazilian law will follow in the course of this presentation.
4.- THE “CONSORTIUM”.
4.1.- “Consortia” are contracts regulated by the S.A. law (22) with the purpose of implementing a given project. Therefore, the “Consortium” is not a legal entity and the parties to the respective contract are individually responsible and exclusively liable (23) to the amount of their corresponding participation in the transaction at hand. Bankruptcy of one “consortium” member is not extensible to the others; amounts eventually due to a bankrupt member will be paid in accordance with the terms of the agreement.
4.2.- The formation of a “consortium” requires a written agreement, which may indicate a name to designate the venture. The object of the enterprise must be defined, as well as its duration and headquarters. The obligations of each of its members should be clearly indicated, as well as any contributions and share of common expenses. In addition, the contract should regulate how the revenue is to be received and how results are going to be shared. Of course, the administration of the “consortium” has to be dealt with in the agreement, as well as the accounting of the same. It is important to define a system for voting and to establish the necessary quorum for deliberations, which may vary depending on the nature of the matter. The “consortium” agreement and its eventual amendments must be filed at the Board of Trade (24) of the state where it has its headquarters.
4.3.- A typical “consortium” contract for privatisation ends would establish as its objective the purposes of bidding for the specific company or rights, in accordance with a given bidding notice. Mechanics and quorum for the determination of the bidding price should be established. Choice of counsel for representation before the bidding commission (and eventually in Court) should also be made. Contemplated action in case of a victorious bid would include the incorporation of a company and the basic operational and financial agreements applicable thereto. It is not unusual to have appendixes in great detail governing these aspects. Choice of laws and courts should be made bearing in mind that the company to be eventually incorporated as a result of a successful bid may be established in a different state from the “consortium”.
5.- THE “S.A.” AND THE SHAREHOLDERS’ AGREEMENTS.
5.1.- The S.A. is a company by shares and the most efficient company type in Brazil for joint-ventures in general, irrespective of the magnitude of the business, in spite of its relatively higher maintenance cost deriving from the transparency requirements established by law. Shares can be common or preferred. Common shares entitle the holder to common shareholders’ rights in addition to voting rights. The latter can be regulated by shareholders’ agreements, as we shall see briefly. Preferred shares confer upon the shareholder rights of an economic or financial nature, such as a higher dividend, the priority in the distribution of dividends and/or in the refund of capital. Preferred shares are usually deprived of voting rights by the By-laws. The S.A. is legally allowed to structure its capital with a balance of up to two thirds of preferred shares to one third of common shares. This can be very convenient when structuring a joint-venture between national and international parties, whenever there is a quantitative restriction to international participation, such as in the telecommunications area.
5.2.- Depending on its By-laws or on its nature (25), a S.A. may be managed by a board of directors (26), its executive body, or by a board of directors and by an administrative council (27), the latter in charge of giving the general guidelines and of electing the board of directors. The administrative council must have at least three members, whereas the board of directors two, all of which without exception must be resident in the country. The S.A. must hold an annual shareholders’ meeting and publish its respective minutes and its annual financial statements in the local press. The S.A. law provides detailed protection of minority interests (28) as well as preferred shareholders.(29)
5.3.- The S.A. law contemplates the institution of shareholders’ agreements (30) which has greatly contributed to making the S.A. the ideal joint venture company form in Brazil. This is so because the S.A. law allows for the specific performance of obligations, in a country where traditionally, the default of obligations is resolved by the determination of losses and lost profits, a slow procedure in the Courts, in view of the nature of the proof required and also an inadequate one for most company law situations.(31) Shareholders’ agreements should be in writing, filed with the company’s management and have a fixed final term rather than an indeterminate one.
6.- THE “LTDA.” AS A RISK FOR JOINT VENTURES.
6.1.- The LTDA. is the simplest and cheapest company type in Brazil and is ideally suitable for sole enterprises that forego a diversity of partner interests. The LTDA. is created by a contract (32) and its capital is represented by quotas, rather than shares. This distinction is significant because quotas are not represented by independent certificates; they are simply referred to in the contract. Because of this characteristic, a transfer of quotas requires an amendment to be signed by all the quotaholders or, at least those representing the majority of the capital. (33) Management of the LTDA. is incumbent on the quotaholders and may be delegated to officers, which happens always when the partner resides abroad.
6.2.- Several attempts in legal doctrine have been made to transform the LTDA. from a limited liability partnership of personal nature into a limited liability capital partnership. These attempts have included the structuring of the LTDA. with a board of directors, with preferred quotas and with quotaholder meetings, often with more success with the Board of Trade than with the Judiciary. Brazilian courts have consistently seen the LTDAS. as personal partnerships and will grant the dissolution of the company upon the application of any disgruntled or dissenting quotaholder.
7.1.- Given the limited time allocated for today’s presentation, this has been largely a topical exercise and, accordingly, I have endeavoured to outline only some of the most important aspects of the subject matter. I have also produced a written text with extensive footnotes attempting at examining in greater depth or clarifying what has been said today. This paper will be available from the Canning House. Lastly, a word about financial matters. Brazil still maintains exchange controls, in spite of significant liberalisation in the recent past. Exchange legislation and regulation from the Central Bank of Brazil is in place and should be carefully considered whenever a venture in Brazil is considered.