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André Luiz Marcassa Filho
Pinheiro Neto Advogados, São Paulo
amarcassa@pn.com.br

Thiago Del Pozzo Zanelato
Pinheiro Neto Advogados, São Paulo
tzanelato@pn.com.br

Guilherme Fonseca Schaffer
Pinheiro Neto Advogados, São Paulo
gschaffer@pn.com.br

 

Introduction

The State of Brazil has always had strong involvement in society. This can be easily demonstrated by heavy investment in social security,^[1] and by the state’s support of third-sector projects.^[2] Wherever you look, the chances are there’s public money involved.

The same applies for Brazil’s economy. The country has a long standing practice of creating wholly or partly-owned state-controlled companies in multiple sectors of the economy.^[3] However, this apparent prevalence of state-controlled entities in certain sectors of industry and services may soon be about to shift.

The current administration has been pushing the privatisation agenda hard. It has also been increasing the number of concessions and public-private partnerships.^[4] Such projects, although presenting good investment opportunities, demand attention when analysing target companies.

In particular, investors should be aware of mismanagement, especially in relation to corruption or fraud. With regards this issue, it is worth clarifying that in Brazil ‘corruption’ only officially exists when related to public officials.^[5] This is despite a relevant bill proposal in Brazil’s Congress which aims to criminalise commercial bribery.^[6]

Moreover, as widely reported, Brazil has a systemic issue with corruption and fraud, as shown by the repercussions of the Lava Jato, or ‘Operation Car Wash’.^[7] From an international perspective the country is still perceived as struggling with political integrity and combating corruption.^[8]

In addition, the social, economic and financial implications of corruption are vast and affect society as a whole.^[9] Practical impacts are demonstrated by cases such as that of Eike Batista, once Brazil’s wealthiest person, who is now in prison guilty of market manipulation,^[10] and Odebrecht, who filed the largest in-court restructuring proceedings in Latin America history, amounting to BRL98.5bn (approximately US$19.7bn).^[11]

Nevertheless, as the majority shareholders suffered greatly from the financial (and criminal) fallout of corrupt and fraudulent acts, so did minority investors. While the Enron scandal^[12] is probably still one of the better known examples around the world, Brazil has been adding some experience to the list.^[13]

As such, if someone is looking to invest or has invested in a Brazilian company, especially state-controlled companies, and gets suspicious of corruption, fraud or mismanagement by directors, precaution needs to be taken. In particular, due to Brazil's and the US' differences on the statute of limitations regime, whenever the investor or minority shareholder becomes wary of directors’ and/or officers’ fraudulent acts, they should act promptly to minimise the risk of having civil action for damages time-limited. Some of the differences between Brazil's and the US' statute of limitations, as well as the respective actions for damages are analysed below.

Directors’ and officers’ liability in Brazil

In Brazil, directors and officers are liable if proven that:

• they have breached the duties set out in the applicable legislation^[14] or company by-laws;

• they have caused damage to the company; and

• a link is established between their conduct and the damage caused.^[15]

While in Brazil, a Federal Law governs the matter, in the US each State has its specific statute underlying the causes of action for recovery of damages. However, despite the numerous legislation, most States provide for actions based on fraud, defined as a conscious misrepresentation or omission of a fact with the intention to induce someone with justifiable reliance in that information to act or refrain from acting in a certain manner, causing damages to this person.^[16]

The rules in the State of New York, one of the most traditional jurisdictions in the US, are similar. According to said law, in order to hold directors liable for losses caused to the company (and to its shareholders), a plaintiff must prove a breach of fiduciary standards of conduct and to their duty to undertake any corporate action in good faith.

The statute of limitations applied in Brazil and certain US jurisdictions differ however, regarding the initial term used for calculating the limitation period for filing actions on fraud, corruption or mismanagement. According to New York and Delaware state laws, for example, the limitation period starts from the accruing of the cause of action.^[17] New York state law also provides for an alternative limitation period, starting from the time the plaintiff or the person under whom the plaintiff claims discovered the fraud, or could with reasonable diligence have discovered it.^[18] In Brazil, however, the approval of the accounts by the shareholders discharges the directors and officers from liability before the corporation and shareholders.^[19] As such, an investor or the corporation itself seeking damages against directors and/or officers must – if they unqualifiedly approved the financial statements and accounts – first file an action to annul general shareholders’ meeting that approved such accounts in which the director or officer was discharged.^[20] Later, or in conjunction with the annulment action, the plaintiff may file the civil action to recover damages, based on the director’s or officer’s mismanagement, in the three years following the general shareholders’ meeting that approved the accounts.^[21]

The most practical consideration arising from this comparison is how to deal with suspicions of fraud, corruption or mismanagement in a timely manner. While US practice would probably advise on initiating an investigation and, only after the delivery of the final report, filing an action; doing so in a dispute against a director or an officer that caused damage to the corporation due to fraud, corruption or mismanagement, under Brazil’s substantive law, would likely cause the civil action to run out of time.

In order to work around such problems, a new category of action for the recovery of damages has been used in Brazil. While the practice has usually been for the company or its shareholders to file a suit against directors or officers, as a consequence of corruption allegations on bond values, minority investors have been filing lawsuits and arbitral proceedings against companies and their controlling shareholders.

In particular, the importance of arbitration has been increasing in such scenarios because of a provision set in the ‘new market’ rules,^[22] a special segment of Brazil’s Stock Exchange (B3) with stricter compliance stipulations.^[23] All companies must have arbitral clauses in their by-laws providing for all disputes between their shareholders, officers, directors and members of the fiscal board to be resolved by arbitration, administered by the Câmara de Arbitragem do Mercado or Arbitral Chamber of the Market,^[24] an arbitral institution which was created solely for this purpose.

Most importantly, the use of a less restrictive dispute resolution method from a procedural standpoint has allowed for the development of a new category of a civil action to recover damages, inspired in the US class actions, in which the minority shareholders may file the civil action against the companies and/or its controlling shareholder.

Given the economic magnitude of these cases, having the companies and/or its controlling shareholders as defendants increases the chances of payment of the minority shareholders, if successful. It also serves as a means of avoiding the need to annul a previous shareholders’ meeting that approved the accounts.

Despite being fairly new, Brazil’s experience has already quite a few to showcase, of which Petrobras is probably the most prominent case. This state-controlled corporation, was created in 1953 as part of the President Vargas ‘the oil is ours’ campaign. It suffered a serious impact in its share value due to revelations that its directors and officials were heavily involved in corruption. The announcement of this news, together with the release of fake financial reports, caused a number of investors and minority shareholders to file notices of arbitration against Petrobras, seeking damages due to devaluation of their shares.

It is reported that five arbitral proceedings have been initiated against the company, amounting to billion dollar sums.^[25] Moreover, holders of American depositary receipts (ADRs) filed a class action before the US courts. Petrobras argued the existence of a valid and binding arbitration clause, but the US Court of Appeals for the Second Circuit maintained the jurisdiction of the Southern District of New York over the case.^[26] The class action was later settled.^[27] Another class action was filed before Brazil’s courts, but considering the cases have different legal regimes,^[28] it was dismissed without prejudice due to the existence of an arbitration clause.^[29]

In another case, JBS has also had arbitral proceedings initiated by an association of minority shareholders.^[30] The company suffered a massive undertaking in its shares as the result of a leak of a recording by JBS’s controlling shareholders, Joesley and Wesley Batista, in which the former President allegedly authorised a bribe to secure the silence of former Speaker of the House, Eduardo Cunha in investigations.^[31]

The event represented the worst day for Brazil’s stock exchange index in nine years and was immortalised as ‘Joesley Day’.^[32] Despite of the damage to shareholders, the 2018 Report indicated the company was no longer responding to the two proceedings for the recovery of damages.^[33]

Also recently, Vale, who operated a tailings (earth-fill embankment) dam which collapsed in Brumadinho, a city in the State of Minas Gerais, suffered severe losses to its market value and is having to incur massive costs to restore the environment and compensate victims. In light of this, investors initiated proceedings against the company alleging the lack of information on the risk of the dam collapsing.^[34]

Use of arbitration involving state-controlled entities

Extra caution should be taken regarding the binding effect of arbitration clauses to such parties if the controlling shareholder is a state-controlled entity. Such entities would include the federal government, state government or the federal district, which comprise the ‘direct administration’, or a state-controlled company or bank, which form part of the ‘indirect administration’.

From an historical perspective, the public administration’s participation in arbitral proceedings was first accepted by the Federal Supreme Court (STF) in the Lage case, in 1973.^[35] However, considering that at the time, Brazil had yet to enact arbitration legislation, which only took place 23 years later, on 23 September 1996, with Federal Law No 9,307 (BAA)^[36] and was caught afterwards in a discussion on the constitutionality of the BAA, which was only resolved by the Federal Supreme Court in 2001,^[37] the debate was long postponed.

After establishing a legal framework and the constitutionality of arbitration, the possibility of its use by state-controlled entities was once again ascertained in the Copel case.^[38] The Federal Government’s Tribunal of Accounts (TCU), however, considered that the absence of legal authorisation impeded public officials to include arbitral clauses in contracts. For this reason, in 2015, the BAA was amended by Federal Law No 13,129/15 specifically to mention that the public administration may use arbitration to resolve disputes concerning economic and disposable matters.^[39] The legal provisions authorising arbitration by the public administration were further expanded by decrees enacted by the Federal Government and some states which specified some aspects of arbitral clauses and proceedings in greater detail, such as the seat of arbitration, applicable law, advancement of costs, publicity of proceedings, inter alia, which are expected to facilitate and encourage public officials to choose arbitration.^[40]

The tendency towards permitting (and incentivising) the use of arbitration by state-controlled entities has, however, had a recent shift in a case concerning the binding effect of the arbitral clause contained in Petrobras’s by-laws to the Federal Government.^[41] On analysing the case, Reporting Justice Nancy Andrighi of the Superior Court of Justice (STJ) was outvoted by the remaining justices of the Second Session, who are responsible for judging cases of private law. They declared the Federal Government was not bound by the arbitral clause. Justice Luis Felipe Salomão, who cast the clinching vote, argued that the jurisdiction of the federal courts to trial the case was the result of a prima facie lack of subjective and objective arbitrability.

On the subjective point, Justice Salomão recognised the possibility of the public administration using arbitration as a method of dispute resolution. He did, however, caution its use to the existence of a specific legal provision:

‘With effect, the legal authorisation extracted from Law No 13,129/15 refers to the consecration, in the legislative sphere, of the well-established case law of the STF and STJ in regard to the adoption of arbitration by the public administration, but only before legal or regulatory specific provisions.’ (emphasis in original) (free translation).

Justice Salomão explained that, at the general meeting in which the arbitration clause was inserted into the by-laws, the Federal Government was solely represented by the Attorney General acting on behalf of the Federal Government (AGU), who did not have powers of representation to agree to an arbitration clause. He did not, however, indicate who would possess such capacity, concluding that the Federal Government has never agreed to arbitrate.

On the objective arbitrability point, a debate as to the subject-matter of the arbitral proceedings arose because the arbitral clause has a particular provision which obstructed the Federal Government’s votes in general meetings from being challenged in arbitration, for declaring it as non-disposable right.

The issue focused on whether the arbitration was discussing the votes of the Federal Government. Based on a decision by the arbitral tribunal, Justice Andrighi, understood that the object of the dispute related to the devaluation of Petrobras’s bonds, and that the existence, validity or efficacy of the Federal Government’s deliberations had no link to the cause of the action.

In opposition, however, Justice Salomão opined that it concerned the election of the directors responsible for the acts of corruption, fraud and mismanagement that led to the bonds’ devaluation, which would be outside of the scope of the arbitral clause.

He did, however, agree with Justice Andrighi’s view in the objective of the arbitration several times. This is only one of the decision’s contradictions both in itself and to the courts case law. Moreover, the absence of Justice Andrighi in the session in which Justices Salomão and Bellizze cast their votes is certainly attention worthy. This is further emphasised by the mention to a BRL58bn (approximately US$11.6bn) fiscal risk and that the case represented the ‘largest lawsuit in the world’.^[42]

Put differently, the decision had serious political and economic implications. Also, an idiosyncrasy in Petrobras’ arbitration clause gave rise to some discussions, which may not have occurred otherwise. In spite of that, and considering this is still an isolated ruling, the implications should be treated with caution.

Conclusion

Brazil still faces serious issues involving corruption. This affects not only politics and public finance, but also has a massive impact on the economy, the financial markets and investors.

Idiosyncrasies in Brazil’s substantive law ought to be observed by the practitioners. Otherwise, there is a risk of statute of limitation expiring in Brazil on actions for damages due to fraud and corruption filed against directors and officers. Moreover, parties should be aware of new possible civil remedies being taken against the company and its controlling shareholder to recover damages resulting from omissions in the disclosure of relevant facts to the market. Finally, even more care should be taken if a state-controlled entity is one of the defendants in arbitration proceedings instituted by minority shareholders. This is because of specific singularities in the recent decision by the STJs, its applications in other disputes involving shareholders and state-controlled entities remain uncertain. It is still to be seen what effects this recent STJ’s decision will have and if this decision will have any impact on how arbitration will be used in Brazil in the future, as an efficient and secure method of dispute resolution for matters involving fraud and corruption.

 

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