Corporate Law Comes of Age

After 26 years of extensive Congressional and academic debates over the reform of the Brazilian body of civil laws, the Brazilian Congress enacted, and President Fernando Henrique Cardoso sanctioned Federal Law No. 10406, published in the Official Gazette of the Federal Executive on January 10, 2002, instituting the new Brazilian Civil Code (the “New Code”). The New Code is a major step forward in Brazilian civil law issues, and as such, has conceivably raised some criticism and doubts concerning its interpretation. But these dissenting voices come as no surprise, in light of the imminent revocation of an 85-year-old civil code that has stood out for its juridical excellence, and whose interpretation has long been consolidated in legal writings and past court rulings.Professor Miguel Reale, a renowned jurist and lawyer who chaired the committee of notables that drafted the proposed bill reforming the erstwhile civil code, notes that civil law is “the constitution of the ordinary man,” in that it lays down the rules of conduct to be followed by every citizen; for this reason, civil law must be in tune with the times. In fact, the New Code is rather up-to-date.

Under the chairmanship of Reale, who is renowned worldwide for his theory of tridimensional law, this committee of notables devised a basic framework for the New Code, comprising a general part and five special parts (law of obligations, corporate law, in rem law, family law and estate law). This article focuses on the major aspects of the New Code regarding corporate law, notably the provisions applying to corporate establishments and types of company organization.

In addition to the matters attaching to civil law only, the New Code (unlike its 1916 predecessor) touches on commercial law issues, partially replacing the somewhat outdated Brazilian commercial code (promulgated in 1850), and fully replacing Decree No. 3708 of January 10, 1919, which regulated Brazilian limited liability companies.

Modernizing Corporate Law

The New Code chapter on corporate law, containing nearly 230 articles, introduces a slew of rules and a few unprecedented concepts that are instrumental in modern corporate relations. An innovative approach is given by the New Code to the concept of enterprise and of establishment, scarcely addressed in Brazilian law until now. These novel concepts may eventually facilitate the performance of increasingly sophisticated corporate deals, such as asset transfer in capital contribution deals, known as dropdown of businesses, mergers, spin-offs and acquisitions of companies. According to the New Code, establishment stands for a commingling of assets organized by an entrepreneur or enterprise for the development of certain corporate activities. As a result, the establishment may be viewed as a separate, independent entity around which variegated legal rights and businesses gravitate, provided that they are consistent with the nature of such an entity.

An agreement for disposal,right of enjoinment or lease of an establishment will not be enforceable on third parties until it is filed by the establishment owner with official registries and published in the press. If the seller does not have enough assets to settle its liabilities, the validity of an establishment sale will be conditional on full payment to all creditors, or on their express or implicit consent to the sale within 30 days.

The establishment buyer will be held accountable for payment of debts preceding the establishment transfer, provided that these obligations have been properly accounted for. The seller will remain jointly and severally liable for a one-year period after transfer of the establishment. Unless otherwise expressly authorized, the establishment seller cannot compete with the buyer during a five-year period after the transfer. The New Code has thus put an end to disputes over the constitutionality of non-compete clauses usually found in international contracts and M&A deals.The New Code chapter on corporate law provides that, unless there is an express provision to the contrary, the buyer is subrogated to all contracts that are binding on a transferred establishment. For this reason, a close look at existing obligations is of the essence before the establishment is acquired.

Streamlining for Sales

On corporate terms, the New Code also innovates by regulating the existence of a de facto company (that is, a company not organized on formal terms) and introducing the simplified company concept. The simplified company was devised to streamline the administration of small and medium-sized businesses, for which complex corporate structures are improper. This new type of corporate organization is unlikely to stir the interest of small and medium-scale foreign investors in the short run, because of the sheer lack of court precedents over this issue. The New Code maintained the two company formation vehicles that account for over 95% of the legal entities currently organized in Brazil: joint-stock companies (sociedades anônimas) and limited liability companies (sociedades limitadas). The sociedades limitadas, which are by far the most common type of corporate organization in Brazil, were extensively affected by the New Code and its legislative changes. As in past rules, the New Code prescribes that the liability of partners in a sociedades limitada is limited to their respective ownership interests (known as “quotas”), but all of them are held jointly and severally liable for payment of the company’s capital.

Under the New Code, the articles of association of a sociedades limitada may be governed by (i) the New Code only, with subsidiary application of the rules on simplified companies; or (ii) the Corporation Law (Federal Law No. 6404 of December 15, 1976), to the extent applicable. Unless there is any express provision to the contrary in the articles of association, the partner in a sociedades limitada may assign all or any portion of his ownership interest (quotas) to another partner (irrespective of the other partners’ consent) or to third parties (unless the holders of quotas representing more than one-fourth of the company’s capital are contrary to this assignment).

The New Code expressly provides for the instatement of an annual Audit Committee (Conselho Fiscal) in sociedades limitadas, as it already happens with sociedades anônimas. The Audit Committee members must be resident in Brazil. The minority partners representing at least one-fifth of the company’s capital are entitled to elect, separately, one Audit Committee member and his deputy. The sociedades limitadas are now required to hold general meetings of partners at least once a year (within four months after the end of each fiscal year), for approval of corporate accounts and election of senior managers (if necessary).

Capital Increases

In addition, the New Code states that an increase in the quota capital of sociedades limitadas may only occur after all quotas have been fully paid up and that the partners may exercise their preemptive rights in 30 days. Any capital increase must be reflected in an amendment to the articles of association. But the quota capital of a sociedades limitada may be reduced only if (i) the company has sustained irrecoverable losses, or (ii) the company is overcapitalized vis-à-vis its corporate object. Under the new rules for sociedades limitadas, any capital reduction must be preceded by resolution of the partners in this respect; publication of the minutes of the meeting in which the capital reduction was approved; and expiration of a 90-day period counted from publication of the corporate document providing for this capital reduction. These measures are intended to allow any aggrieved creditor to contest this capital reduction within the 90-day holding period.

Unfortunately, the New Code will translate into a substantial increase in the operating costs of sociedades limitadas, as senior management is now faced with a number of new expenditures, such as publication of corporate documents in the press, and maintenance of special corporate books (books of minutes of meetings, and the like). No change was made by the New Code in the operation and management of sociedades anônimas, which are still governed by the provisions of the Corporation Law, as currently amended.

Although it has taken 26 years for the New Code to be enacted, the successive updates and amendments (around 1,200 proposals) to the bill originally submitted to Brazilian Congress have brought the New Code in line with modern trends and expectations. Notwithstanding such updates and amendments, the Brazilian Congress is now examining bill No. 6960/2002, which was presented in order to change relevant provisions of the New Code, particularly in corporate law matters. The New Code provisions will take effect on January 11, 2003.

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