Tenders Take Center Stage

On November 1, 2001, the Brazilian Congress published Law No. 10,303/01, amending and introducing substantial changes in Brazil’s corporation and securities commission laws. This reform aims at increasing investors’ reliability on the emerging Brazilian securities market, securing some important political rights of minority shareholders in Brazilian corporations and strengthening the administrative independence of the Brazilian Securities Commission (Comissão de Valores Mobiliários – CVM).

The new law represents another leap forward in the government’s modernization program, designed to make Brazil a reliable partner in the global economy. The following key issues are worthy of note concerning mergers and acquisitions deals and strategic financing operations.

In terms of preferred shares, the law limits the issuance of non-voting preferred shares to 50% of the total capital stock. This cap applies to new corporations and to initial public offerings of non-listed corporations. Existing corporations may keep their 2/3 share ratio between preferred and common shares, even in a future share issuance.

Preferred shares must have one of the following minimum preferences to qualify for market trading: priority in receipt of dividends corresponding to at least 3% of the book value per share, and, after this priority condition is met, preferred shares will be treated as common shares; or dividends at least 10% higher than those paid to common shares; or a tag-along right exercisable at a minimum of 80% of the price paid to the controlling shareholder in transfer of control, plus the right to dividends at least equal to those paid to common shares.

The law also introduces changes for preferred shareholders with regard to redemption of shares, distribution of mandatory dividends and voting rights in privatized companies. Share redemptions now must be approved by shareholders representing at least 50% of the relevant class of shares, but the by-laws may provide otherwise. Preferred shareholders may acquire voting rights if the corporation fails to distribute the mandatory dividends, which, in principle, cannot be lower than 25% of adjusted net profits. The creation of preferred “golden” shares is allowed to ensure the government’s veto rights in privatized corporations.

Brazilian corporations may now give debenture holders an option to receive payment of the principal and ancillary charges in cash or in assets, and monetary adjustment may also be provided at any index adopted for restatement of government bonds, at currency exchange variation,or at any other index not expressly prohibited in Brazil. The by-laws of corporations may provide that disputes between shareholders and the corporation will be referred to arbitration without the need for court enforcement.

Under the new law, the chairman of either a board of directors meeting or a shareholders’ meeting has the right to disregard any vote in disagreement with a binding shareholders’ agreement. Absences or abstentions at general meetings or board meetings will entitle an aggrieved shareholder to vote the shares held by the absent or abstaining shareholder, or in lieu of the board member who infringes a shareholders’ agreement. Powers of attorney granted for the purposes of a shareholders’ agreement to cast a vote for or against certain resolutions in a general meeting may now exceed one year. The binding effects of a shareholders’ agreement are also warranted by the appointment of a representative to interface directly with the corporation.

Currently, the approval of certain matters by the general meeting (e.g., creation of preferred shares or increase in an existing class of preferred shares; changes in the privileges attaching to preferred shares; reduction of the mandatory dividends; amalgamation or merger of the corporation into another entity; participation in a group of companies; the change of corporate purpose; or spin-off operations) may give the dissenting shareholder the right to withdraw from the corporation against redemption of its shares.

Withdrawal Restrictions
Under the new law, the right to withdraw does not apply if there is liquidity and dispersal of the relevant type or class of shares in the market. Liquidity is defined as the participation of the relevant class or type of shares in a stock index in Brazil or abroad, and dispersal stands for the holding, by the controlling shareholder or its related entities, of less than 50% of the relevant type or class of shares. Spin-offs will now trigger the right to withdraw whenever there is a change in the corporate purpose, except for contributions of assets and liabilities to a companies that engage in essentially the same activities; this right also applies whenever there is a reduction in the mandatory dividends, or a resulting participation in a group of companies.

The new law lifts all restrictions for non-resident and foreign individuals, and provides for the election of board members under two circumstances: (a) the election of two board members by non-controlling shareholders, in a separate voting (excluding the controlling shareholder), since such shareholders represent at least (i) 15% of the voting shares; and (ii) 10% of the total capital stock, combining non-voting or restricted voting shares; or (b) the election of one board member by all non-controlling shareholders, irrespective of their voting rights, representing at least 10% of the total capital stock. During a transition period of four years, the board members elected by minority shareholders as per items (a.ii) and (b) above must be chosen out of a three-nominee list prepared by the controlling shareholder.

As a result of political debates over the privatization program, the by-laws may now provide for the participation of employees’ representatives in the board, to be elected directly by employees. All board members elected by minority shareholders have veto rights in the appointment of independent auditors. Independent auditors must keep their working papers available for inspection or investigation for a period of at least five years.

As for the preemptive rights of minority shareholders, the by-laws of listed corporations already containing an automatic authorization for capital increases may now provide for the issuance of securities without preemptive rights to existing shareholders, or with an exercise period shorter than that previously established by the general meeting or in the by-laws, provided that such securities are placed in exchange for shares in a public offer for acquisition of the corporation.

Another important change relates to mandatory tender offers, tag-along rights, restraining of liquidity, and delisting issues. Under the new law, the direct or indirect disposal of control in a listed corporation is subject to the condition that the purchaser of the controlling stock undertakes to make a public tender offer for acquisition of the voting shares held by minority shareholders at a price not lower than 80% of the price per share paid to the controlling shareholder. Alternatively, the purchaser may give minority voting shareholders an option to maintain their ownership interests against payment of a premium corresponding to the difference between the market value of the shares and the amount paid to the former controlling shareholder. Tag-along rights do not apply to minority shareholders of privatizing corporations, provided that the binding public notice is published before the new law comes into force.

Delisting at CVM is only possible if the issuing corporation, or its controlling shareholder, completes a public tender offer to acquire all outstanding shares at a fair price, which must be at least equal to the corporation’s equity value appraised as per any of the following criteria: net book value, fair market value of the net equity, discounted cash flow, comparison by multiples, share quotation on the securities market, or any other criterion acceptable to CVM. Minority shareholders representing at least 10% of the outstanding capital may call a special general meeting of all holders of outstanding shares to decide on reappraisal of the corporation. If less than 5% of all shares issued by the corporation are outstanding after the end of the tender offer, the general shareholders’ meeting redeem such remaining shares at the price established for the tender offer itself. In addition, if the controlling shareholder increases its ownership interest in a listed corporation by a percentage which hinders the market liquidity of the remaining shares, it must make a public tender offer for all outstanding shares at a price determined by the same criteria used for going-private public tender offers.

Gaining Independence
The new law also restructures CVM as an independent regulatory agency reporting to the Ministry of Finance. CVM will be directed by one chairman and four commissioners appointed by the President of the Republic for a term of office of five years, without reelection. One-fifth of the CVM board must be renewed every year, and all candidates must be approved by the Senate.

Congress also included three crimes in the securities laws reform: market manipulation, punishable by imprisonment from one to eight years and a fine; use of insider information, punishable by imprisonment from one to five years and a fine; and irregular exercise of an office, profession, activity or function, punishable by imprisonment from six months to two years, and a fine. Several provisions were devised to curb the use of privileged information for insider trading. Fines will be commensurate with the offender’s damage or undue advantage.

The new law is effective on February 28, 2002, but is immediately applied to corporations organized after November 1, 2001. Mandatory amendments to corporate by-laws must be made within one year. Any change in the rights conferred upon existing shares as a result of these amendments, if made until December 31, 2002, will not trigger withdrawal rights of dissenting shareholders.

Hélio Nicoletti is senior partner and Leandro Ramozzi Chiarottino is an associate lawyer in the corporate and M&A group at Pinheiro Neto Advogados in São Paulo.