217 Million Reasons for Brazilian Companies to Structure Their Foreign Investments
Yesterday, Ecuador announced a 217 million USD settlement with Petrobras for payment of assets nationalized in 2010. This is the kind of news that all Brazilian investors should remember when investing abroad–there’s value to structuring the investment properly.
As many readers know, Brazil has not ratified any bilateral investment treaties, and it is not a member of the Washington Convention, which established the International Centre for Settlement of Investment Disputes and handles many claims between investors and states. The only way to bring an investment arbitration claim against a state is through valid consent by both the investor and the state to arbitration. Usually, this consent comes through an investment treaty, and unless the investor is a national of a country with any investment treaty, the investor cannot bring an investment arbitration claim against a state. So if Brazil is not a party to a bilateral investment treaty, how did Petrobras file a notice of dispute with Ecuador and proceed on the path to investment arbitration? And why does it matter?
According to news reports, Petrobras started the process for bringing an investment claim by filing a notice of dispute under the Ecuador-Argentina bilateral investment treaty (or “BIT”). This means that Petrobras likely initiated its investment through its Argentine subsidiary, which is a national of Argentina and can benefit from the protection of the BITs Argentina has ratified. This is likely how Petrobras put itself in the position to be able to start an investment arbitration. In negotiations with a state, this can matter, sometimes quite a lot.
Like many negotiations, the final outcome is often a result of the bargaining power of the parties. While there are many moving pieces, one of the key elements is the ability to seek redress for nationalization of assets. Without an investment treaty providing for arbitration, this means a lawsuit in the courts, usually the courts of the country where the investment is located. Because of the difficulties inherent when bringing a large claim against a country in its own courts, the investor can find itself at a disadvantage when negotiating with a state relative to nationalization of assets. One of the ways to tip the scale a little bit in the favor of the investor is to have the possibility of starting an investment arbitration claim. From news reports, it appears Petrobras used the possibility of an investment arbitration to help in its negotiations. If the news reports are true, Ecuador moved its inital offer of $168 million to a final settlement at $217 million, a sizable amount.
The mechanics behind the settlement are likely far more complicated, and one can only guess at the details. There are many factual distinctions that can determine the strength of Petrobras’ potential claim, including its ability to use the Ecuador-Argentina. But it appears that Petrobras pursued a clever path in this instance, which other Brazilian companies should study for their investments.
Updates from the Brazilian Legislative Scene: International Disputes Focused
The Brazilian Congress has been busy considering a couple of important legislative changes to key features of international dispute resolution: applicable law and the validity of arbitration awards. Both of the bills under consideration merit attention from international observers, especially those who do business in and with Brazil.
Projeto de Lei 2.937 (the number of the legislative proposal, called Proposal 2937 for this article) seeks to dramatically alter the Brazilian Arbitration Law. Currently, arbitration has flourished in Brazil, attracting many large disputes on both the domestic and international scenes. Arbitration clauses are a common feature of many commercial relationships, from shareholder agreements to public-private partnerships. But Proposal 2937 would likely provoke serious changes in the current system. Proposal 2937 would allow the losing party to seek the review of the judiciary of the merits of the arbitration award, allowing a losing party to reopen the case on the very issues the arbitral tribunal decided. Although greater review may sound appealing, it would undermine the arbitration process, giving the losing party the option to drag the case on for years, repeatedly challenging the decision of the tribunal. The Brazilian Committe on Arbitration has mobilized against the issue and is actively working in the Brazilian Congress to stall it. An article from the Brazilian business journal Brasil Econômico highlights the opposition, quoting some of the most renowned practitioners in the area. Right now, the bill is in committee and is not scheduled for a hearing or vote, but the Brazilian arbitration community is taking a strong stance, actively working with the Brazilian Congress on the issue.
The other piece of legislation at issue is far closer to becoming law and goes the opposition direction of Proposal 2937. Projeto de Decreto Legislativo 222 de 2011 (another method for identifying bills in the Brazilian Congress, called Legislative Proposal 222 for this article) seeks to adopt the Convention on the International Sale of Goods as the law of Brazil. Otherwise known as the CISG, this international treaty has wide acceptance in many countries, including the U.S., China, and Germany. The CISG provides a set of laws that govern international contracts for the sale of goods, normally providing a leveler, more trusted playing field for companies in different countries. The Brazilian “House of Representatives” (using a U.S. method to describe part of the bicameral legislature) has approved Legislative Proposal 222, and it now heads to the Brazilian Senate, where it has a strong chance of passage. Legislative Proposal 222 has been in the legislative process for quite sometime, including this article describing the legislation and its path as of May 2011.
While Proposal 2937 would seriously hinder the use of arbitration, Legislative Proposal 222 would substantially even the playing field in many of the international arbitration cases that involve Brazilian companies. International practitioners and scholars should closely follow both pieces of legislation because both can influence present and future international transactions.
A Continuing Trend in Arbitration Grows Stronger
Although arbitration has increasing acceptance for commercial matters in Brazil, there is significant opposition in other areas of the law. One of the strongest sources of disapproval has historically been labor law. But a recent decision from the labor courts of São Paulo marks a continuing trend in favor of arbitration.
Labor law in Brazil normally falls into a completely different set of rules and decisions. The substantive law tilts in favor of the employee, and the labor courts exercise their jurisdiction jealously. The labor courts have high case loads, and there is little in the form of binding precedent, as the common law system recognizes. Further, it is not uncommon for two nearly identical cases to have completely contrary results. And for years, these courts have refused to recognize arbitration clauses, even in contracts with high-level executives. It appears that trend is changing.
Valor Economico is reporting that the one of the labor courts in São Paulo recently refused to enforce an arbitration clause between a high-level executive and his former employer, BTG Pactual, a highly renowned Brazilian investment bank. Labor courts routinely seek to protect workers from arbitration using the theory that the labor contract is a contract of adhesion. In other words, the employer foists the contract on the employee, so the court should not enforce a one-sided negotiation. In Valor article, the labor court rejected the application of this reasoning because the executive had sufficient bargaining power to allow the court to enforce the arbitration clause.
Although this decision is not binding on other courts, it shows a continuing trend in the Brazilian judiciary. Where contracts with high-level employees call for arbitration, courts increasingly enforce the arbitration clause.
International Trade and Brazil: An Ever-Evolving Picture
It seems like Brazil is in the news constantly these days, and for good reason–its economy is growing, unemployment is dropping, and apparently there are 19 new millionaires per day. But the picture of international trade is increasingly complex. No longer is growth based solely on foreign direct investment from the United States and Europe. Instead, Brazilian investment abroad is increasing, trade ties are expanding in different directions, and the Brazilian government is embarking on new ventures all over the world. A few articles sum up these changes.
Recently, the magazine Florida Trend named Brazil the “Floridian of the Year.” For those living in Florida, especially South Florida, this should come as little surprise. The full article is worth reading, including some points:
“Indeed, 2011 became the year that cemented Brazil’s importance to Florida. For the first time, Brazil surpassed the United Kingdom as the top source for overseas tourists. Brazilians played a key role in soaking up Miami’s distressed real estate to the point that developers began new condo projects . . . Brazil, as it has been since 1998, was again Florida’s top trade partner. Florida captures 22% of all U.S.-Brazil trade and runs a surplus, exporting $13.8 billion to Brazil while importing just $2.2 billion.”
The article also noted the investments by Brazilian companies in Florida, including a new plant by Embraer and the international expansion of the restraurant franchisor, Giraffas. For Florida, international trade with Brazil defies the common notion of a one way street going south.
Another development has been the growth and reliance on ties with China. The Economist has followed this story closely, noting an estimated 19 billion USD in investment slated for 2012. But the relationship is increasingly complex, with the Brazilian government moving to protect its industry from Chinese competition:
“The prominence of the location is appropriate: imported Chinese cars have suddenly become a visible presence on Brazil’s roads. This has alarmed Brazil’s car industry and President Dilma Rousseff’s government. Last month a 30-percentage-point tax increase on cars with less than 65% local content took effect, taking the tax on some imported models to a punitive 55%—on top of import tariffs.”
Again, this change in the trade dynamic is putting pressure on other areas long thought moribund. In the same article, former minister Sergio Amaral calls on Brazil to galvanize the internal market in South America to meet the challenge of competing with the Chinese.
Finally, Brazilian investment lead by the government has reached to all corners of the world. This week, President Dilma Rousseff visited Cuba on the occasion of releasing the last piece of a multi-million dollar loan to redevelop the Puerto de Mariel, near Havana. The national Brazilian development bank, BNDES, financed the project, which includes a large development zone near the port for the export of Cuban goods. BNDES loaned over 600 million dollars to help develop the port, and Brazilian company Odebrecht had lead the construction efforts. In addition to investments in Africa and other parts of South America, it is apparent international trade with Brazil will increasingly include all areas around the globe.
The FCPA, Brazil, and Arbitration
In an article recently published in Valor Economico (registration required), Mauricio Gomm and I looked at the Foreign Corrupt Practices Act (FCPA) and its effect on Brazilian companies. More and more, Brazilian companies find themselves potentially liable under the FCPA, especially as Brazilian companies increasingly grow and expand. As Brazilian companies increasingly worry about the FCPA, how will that change their business practices and the features of doing business in Brazil? A round up of news articles provides an interesting overview.
As confirmed in theory and practice, the FCPA can impact the compliance programs that companies implement. In an article from the online journal sponsored by BOVESPA, a recent interview confirms both the application of the FCPA and the concern of Brazilian companies to adapt their compliance programs:
Mas esta legislação pode se aplicar a empresas de origem brasileira?
- Sim, um exemplo são as grandes multinacionais brasileiras listadas na bolsa americana. Elas estão sujeitas ao FCPA, mas ainda não há registro de nenhum caso de violação e sanção. Há, no entanto, uma percepção de que é uma questão de tempo para que isso ocorra. Isso porque as autoridades americanas têm focado nos países emergentes e em suas empresas para verificar o cumprimento desta legislação. Há interesse de que haja uma situação envolvendo uma empresa com este perfil, para o estabelecimento de um caso importante que sirva de exemplo. O monitoramento por parte das autoridades americanas é percebido como cada vez mais intenso.
For those not versed in Portuguese, the speaker being interviewed, Mr. Bruno Maeda, states affirmatively that Brazilian companies are subject to the FCPA and that Brazilian companies are following more closely the activities of the US authorities. This article follows on the heels of a recent announcement by Brazilian airline company Embraer of an investigation launched by the US government regarding potential violations of the FCPA.
When it comes to disputes, the FCPA can also play a role. Although the FCPA does not provide a private right of action, the criminal conduct that forms the basis of an FCPA violation can help build a case for damages. We have seen this occur in a number of circumstances, including potentially criminal conduct by one shareholder in a closely held company. In the event of a dispute, the potential for an FCPA investigation can influence settlement discussions and create liability for the other shareholders who did not participate in the allegedly illegal activity. This is something we mentioned in the context of a potential arbitration:
“Para o advogado contencioso, existem alguns riscos e oportunidades. Ainda que o FCPA, dentro de seu texto, não confira direito a uma ação cível, o escopo criminal do referido diploma legal pode servir de base para um contencioso cível judicial ou arbitral. A guisa de exemplo, a falta de conhecimento sobre o alcance do FCPA, ou a ausência de controle e política interna, pode gerar perdas substanciais. Considerando que tais perdas surgem de uma falha da empresa, nasce para os respectivos acionistas um direito de processar a diretoria ou aqueles que por ação ou omissão contribuíram para a prática do ato corrupto.”
The concern for both criminal and civil liability is pushing Brazilian lawmakers to act. The Brazilian Congress is currently considering its own anti-bribery statute. If enacted, it would be interesting to see the interaction between the US and Brazilian laws. Where Brazilian companies now worry about the FCPA, it would be quite interesting to see US companies worry about Brazilian ant-bribery and corruption legislation in the future.
Manifest Disregard and Other Standards of Review
As mentioned in prior posts, SILC has a particular soft spot for international arbitration. Not only is the procedure fascinating, it is increasingly becoming the primary way to resolve international disputes. As part of our interest in the area, we frequently publish articles on the topic, and the journal Lima Arbitration recently published an article from the office on a topic of general interest to the international arbitration community–extra-statutory standards of review.
As described in the article, extra-statutory standards of review are all of those grounds for review of an arbitration award that fall outside the terms of the applicable statute. In the United States, these grounds of review appear almost exclusively in the interpretation of chapter one of the Federal Arbitration Act, which applies largely in cases of domestic arbitration. The extra-statutory standards of review focus largely on “manifest disregard of the law,” a phrase deriving from an opinion of the Supreme Court in the 1950′s and growing to mean that a court can vacate an arbitral award when the arbitrator knew of the applicable law and chose not to apply it. Different circuits have approached extra-statutory standard of review in many ways, using terms such as “arbitrary and capricious,” “completely irrational,” and “fundamentally irrational.” But after the Supreme Court’s in Hall Street Assoc. v. Mattel in 2008, many courts have started questioning extra-statutory standards of review. Our article reviews the history of these standards of review, looks at the current state of the law, and puts forward an approach for courts to look at challenges to arbitration awards.
Top Ten Tips for Brazilian Negotiations
There’s something about top ten lists that engages the reader but still provides helpful information. As part of the Association of Corporate Counsel’s ongoing “top ten” series, Mauricio and I teamed up with Christiana Abbade do Couto, General Counsel for Iron Mountain do Brasil, to create our own list of Top Ten Tips when Negotiating Contracts in Brazil.
Our top ten list contains a range of helpful nuggests, with something for the novice as well as seasoned investor. One of the most interesting topics from recent news events is the influence of FCPA and SOX. From the article, our guide was the following:
“If you have to comply with FCPA and SOX and will contract with Brazilian company, it is best to research and learn about the company quite deeply before contracting with it. Not all Brazilian companies are in compliance with this legislation, and most of Brazilian companies have not heard about these laws. It is important to train your Brazilian counterparty and audit prior contracting.”
This is just the tip of the iceberg, but there is much more lurking underneath. In the coming days, we are going to look a bit more deeply at this issue, including how it can impact both the dispute resolution and transactional spheres of lawyering. What would you include in a top ten list that we failed to mention? Did we miss something?
What We’ve Been Up To Recently
It has been awhile since posted on this space, but we have not been taking a vacation. In addition to our normal work activities, Mauricio and I were working as guest editors for a special edition of the International Law Quarterly, a publication of the International Law Section of the Florida Bar. The results of the project are a guide for both transactions and litigation practice in Brazil. The topics are wide ranging and include viewpoints from all sectors of the Brazilian economy, including government officials, professors, and prominent practitioners. We definitely cannot take credit for the content of the articles–the authors donated their time, the Florida Bar gave editorial support, and Al Lindsay of Hogan Lovells tied it all together. But the result is something we commend to all readers, even if their interest in Brazil is only passing. So feel free to download and enjoy, and be sure to let us know your thoughts.
Direct and Indirect Investment in Brazil: Remittance, Repatriation, and Reinvestment
1. Indirect/Market Investments
Foreign investments in Brazil can be divided in two types: direct and indirect (also known as market investments). We will not discuss this second type of investment in this essay, except to note it is not welcome under the current system. Indirect or market investment (investimento indireto ou de mercado) is the so-called (and criticized) speculative capital (capital especulativo). It is known for entering and leaving the country fast, normally by a mere matter of rumors on the particularities of the given country. Some call “hot money” or “smart money,” and government authorities perceive, especially given the recent prominence of the country, as something to be tolerated, but never fully accepted. Its existence can come in many forms as it is defined by the National Monetary Council (Conselho Monetário Nacional – CMN)’s Resolution nº 2.689/2000, which defines indirect investments among others as companies’ debentures, shares, bonuses and stocks owned by foreigners not residing in Brazil and obtained by operations in the financial and/or stock market.
2. Direct investments
a) Remittance of Profits
Until 1996, profits gained in Brazil and remitted abroad were subject to withholding taxation of 15% (the same rate that applies to corporations, in general). Currently, the profits or dividends calculated using as basis the results generated starting in January, 1996, paid or credited by legal entities taxed under the real, presumed or arbitrated profit, are not subject any longer to the withholding of income tax and are not part of the basis of calculation of the beneficiary’s income tax, residing in the country or abroad (Lei nº 9.249/95, art. 10).
As mentioned before, companies established with foreigner capital or foreigners residing in Brazil are subject to the same taxes as anyone else. If a company wants to remit money abroad, it may do so, at the end of its fiscal year, after paying the proper contributions and taxes to the government.
Nevertheless, those remittances can be made beforehand, along with the anticipated distribution of profits and dividends, as long as authorized in the company’s statute or by-laws (which can happen by end of a trimester, quarter, semester, etc.).
Remittances in currency do not depend on any previous authorization by governmental authorities (both in and out of the country). All the investor has to do is remit its investment through a banking establishment and operate using the official rate.
b) Reinvestment of Profits
Reinvestments of profits are the profits generated by national companies that are reinvested in the same company that generated them or in other sector of the economy (Art. 7º, Lei 4.131/1962). To reinvest profits, the foreigner investor must register those profits as foreign capital. In other words, it must act in the same way when it performed the initial investment, increasing the company’s basis of calculation for tax purposes (including for future repatriations).
c) Repatriation of foreign capital
According to Article 690, II, of the 1999 Income Tax Regulation Rules (Regulamento do Imposto de Renda de 1999 – RIR/99), the repatriation of foreign capital can be made at any time back to the country of origin, however it has to be duly registered before the Brazilian Central Bank (Banco Central do Brasil – Bacen). If the capital to be repatriated is larger than the capital initially registered, such difference shall be considered capital gain, being subject to the 15% withholding income rate.
d) Particularities of Sending Money Abroad
Regarding remittance of profits, given the double taxation rule, profits remitted abroad are not taxed, since they had been taxed before, when there is a distribution of profits and dividends. They have to be, however, declared in the legal entity’s annual income tax declaration. Also given recent rules by the Central Bank, all companies retaining foreign capital must declare the exact amount before that institution, until November 1, 2011 (Circular 3,559 of 19 September 2011).
Finally, it is worth mentioning that the remittance of foreign currency abroad for the purposes of investments by Brazilian entities is totally tax free (Articles 8, 9 and 10, Resolution nº 3.568/2008, part of the International Exchange and Capital Market Regulation – Regulamento do Mercado de Câmbio e Capitais Internacionais - RMCCI). Under the previous rules, transactions above US$ 5,000,000.00 (five million US dollars) required previous approval by the Bacen.
After this article, we will look at the particularities of dealing with investments inside the country.
Defining and Registering Foreign Capital for Investing in Brazil
- Ed. Note: Continuing series from Olavo Bernardes.
In 2010 Brazil received 48.4 billion US dollars in direct foreign direct investment, placing the country in fifth place in terms of direct foreign investment, after the United States, China, Hong Kong and Belgium. That was a growth of 84.6% compared to the previous year, accordingly to a study by the United Nations Conference on Trade and Development(“UNCTAD”).
A number of factors have contributed to this massive amount of investment. Some of those factors include the economic stability achieved, growth of the middle class, rating of Brazilian government bonds as “investment grade,” planning and construction of large infrastructure projects (largely due to the upcoming World Cup and Olympics). Also, the volume of remittances has never been higher, reaching US$ 18.768 billion according to statistics from the Brazilian Central Bank.
But what does “foreign capital” mean in the eyes of the Brazilian legal and regulatory regime? And how should foreign investors register their capital when investing in Brazil? Both of these questions are crucial to foreign investment in Brazil.
a) Definition of Foreign Capital
Law 4.131, from September 3, 1962, and its regulatory decree, Decree 55.762, from February 17, 1965, define as foreign capital, “the goods, machinery and equipment entering in the country, without an initial relocation of assets, destined to the production of assets and services, as well as financial or monetary resources entered to be applied to such activities, belonging to individuals or legal entities, residing or headquartered abroad.” These laws pre-date the 1988 Brazilian Constitution, which accepted the above definition.
As mentioned in a previous post, Article 172 of the Brazilian Federal Constitution states that “[t]he law shall regulate, based on national interests, foreign capital investments, shall encourage reinvestments and shall regulate the remittance of profits.” Article 5 of the Constitution further applies to foreign capital by guaranteeing particular rights. Article 5 established the principle of equality, providing equal protection and equal rights to all citizens and foreigners residing inside Brazilian territory; there is no discrimination between foreign and national capital, treating both equally.
b) Registration of Foreign Capital
All foreign capital in the form of foreign direct investment (investimento estrangeiro direto) must be registered before the Brazilian Central Bank. In order to regulate the capital that enters the country, Law 4.131 of 1962 attributed such function to the Credit and Currency Bureau (Superintendência da Moeda e do Crédito or “SUMOC”) until March 31, 1965, when the then recently created Brazilian Central Bank (Banco Central do Brasil or “BACEN”) took over such role. The BACEN issues a certificate of registration, reflecting the amount invested in foreign currency and its equivalent in national currency. Such certificate is necessary and obligatory for future remittances of profit abroad, repatriation of capital invested and registration of reinvestment of profits, as we shall see in future works.
Registration includes the following: a) foreign capital that enters the country under the form of direct investment or loans, whether in regular currency, or assets; b) remittance made abroad as capital gain, profits, dividends, interests, as well as royalties for the payment of technical assistance, or of any other title that implies transfer of profits abroad; c) reinvestment of foreign capital profits; e) changes in capital of monetary gain of companies proceeding of agreement with the legislation at stake; and the foreign capital and respective reinvestment of profits already existing in the country on September 27, 1962.
Registration is a simple procedure that can be done electronically using a BACEN registration program (Registro Declaratório Eletrônico or RDE). Given the nature of the registration, the person registering is legally responsible for any incorrect or incomplete information.Non-residents can register through representatives, which is normally the company receiving the foreign investment.
c) Exchange rates and Additional Information
