On 20 September 2019, the Brazilian federal government, lead by the president Jair Messias Bolsonaro, enacted Law No 13,874/2019 (the Brazilian Economic Freedom Act), which was passed with the aim of (i) reducing day-to-day bureaucracy for Brazilian investors, (ii) establishing free market guarantees and (iii) providing greater legal certainty for Brazil’s business environment. As a result, the Brazilian Economic Freedom Act has promoted relevant changes in several Brazilian laws, such as the Brazilian Civil Code, the Corporation Law, the Public Record Law and the Brazilian Labor Code.
Within this context, the Brazilian Economic Freedom Act is guided by the following four main principles: (i) guaranteed freedom in the exercise of economic activities; (ii) good faith before public authorities; (iii) subsidiary and exceptional intervention of the state in the exercise of private economic activities; and (iv) recognition of private entities or individuals’ vulnerability when compared to the state.
Before analysing those changes, it is important to point out that the new rules set forth in the Brazilian Economic Freedom Act were initially introduced in Brazil through Provisional Measure No 881, published on 30 April 2019, which was promulgated with the main purpose of helping the Brazilian economic recovery, reducing the unemployment rate and attracting foreign investment to Brazil.
The Brazilian Economic Freedom Act was preceded by intense debates between the Brazilian federal government, Congress and the business community in Brazil, in which our firm had the opportunity to closely participate, and its innovations were well received by our legal system.
Among the innovations brought by the Brazilian Economic Freedom Act, it is important to highlight the following changes made in the Brazilian Civil Code.
One of the changes made by The Brazilian Economic Freedom Act in the Brazilian Civil Code was to establish guidance principles on the interpretation of contracts regulated by that code. According to the changes, the interpretation of contracts must: (i) be based on the behaviour of each party after the conclusion of the deal; (ii) be done in accordance with the market usages, customs and practices related to the type of business; (iii) be based on good faith; (iv) be done in favour of the party who did not draft the contract, if applicable; and (v) correspond to what would be the reasonable negotiation between the parties on the issues brought to the table.
Furthermore, the new rules set forth in the Brazilian Civil Code (brought by the Economic Freedom Act) authorise parties to freely negotiate the rules regarding interpretation of their contracts, filling the gaps and integrating legal transactions other than those regulated by the code.
The social role of contracts
Judicial interference has been one of the main causes of uncertainty in M&A transactions in Brazil. In order to reduce this, the Brazilian Economic Freedom Act has created new rules regarding the social role of contracts regulated by the Brazilian Civil Code, which establish principles of minimum interventions and exceptionality of contractual revision by local court houses in private negotiations (without public authorities).
Contract review or termination parameters
The Brazilian Economic Freedom Act has introduced a new article in the Brazilian Civil Code (Article 421-A), which establishes that civil and business instruments are assumed to be equal and symmetrical, except in the scenarios where: (i) one of such documents contains elements that justify the non-application of such rule; or (ii) contracts are regulated by special laws (different from the Brazilian Civil Code).
In order to guarantee equal and symmetrical treatment, parties to civil or business contracts must establish objective parameters regarding the interpretation of contractual clauses, as well as, review and/or termination rules.
In addition, the new provisions of the Brazilian Civil Code also guarantee to the parties: (i) the ability to define previous risk allocation, which must be completely respected and observed; and (ii) that contract review will only occur in limited and exceptional situations.
The impact of the new provisions on mergers and acquisitions
Due to the abovementioned changes in the legal system and framework, especially the reduction of judicial interference in private transactions and the capacity of parties to freely stipulate objective interpretative rules regarding their contractual relationship, the Brazilian legal community believes that those improvements will bring more certainty to private transactions in Brazil and, consequently, the volume of cross-border merger and acquisitions involving Brazilian assets or companies will increase even more in the next few years.
Before the Brazilian Economic Freedom Act was enacted, private Brazilian M&As and American or British M&As used to have some relevant differences in their structure. However, due to the new rules, those differences may be reduced, mainly because the Brazilian federal authorities have reinforced contractual freedom in negotiations between private parties, giving preference to the parties’ contractual terms over the statutory provisions set forth in Brazilian Law.
For instance, indemnification clauses in Brazilian law and New York law transaction documents may seem similar, but their effects were quite different. Under Brazilian law, a breach of contractual provisions normally is compensated to the extent a non-breaching party suffers direct losses or damages, which may include both actual and direct damages and loss of profits. Indirect losses and punitive damages were usually not recognised on the grounds that the Brazilian law meant to restore the non-breaching party to the position it would have been in if the breaching party had complied with the rules set forth in the contract, and not to punish the breaching party for its conduct.
On the other hand, under New York law, indirect damages may be indemnified and investors normally include indirect damages (such as diminution in value and consequential damages) within the scope of losses.
Nevertheless, based on the freedom in the exercise of economic activities granted by the Brazilian Economic Freedom Act, there is strong evidence that Brazilian private transactions would be able to include indirect damages in the definition of indemnifiable losses, provided that the parties establish objective parameters regarding the interpretation of contractual clauses regarding indirect and/or punitive damages. In this scenario, there are strong arguments that provisions like the one stated above would not be subject to judicial interference, as long as those parameters are clear, objective and impartial.
Another good example of how the rules set forth in the Brazilian Economic Freedom Act may be used by Brazilian lawyers in private transactions, can be found in the negotiation of force majeure clauses. Due to the coronavirus pandemic in 2020, private parties in M&A transactions had to rebuild force majeure provisions, in order to establish special rules regarding the impacts of the pandemic. This is also good evidence that the Economic Freedom Act can, indeed, guarantee preference to parties’ contractual terms over statutory provisions.
In this sense, there are solid indications that M&A lawyers in Brazil would be able to reduce interference by Brazilian judges in private transactions (not just regarding discussion on indemnification and/or force majeure clauses, but all SPA provisions), which normally tend to replace terms mutually agreed by both parties involved, with other ones they understand, from their perspectives, to be better and/or fairer to the parties.
Therefore, even though the Brazilian economy is still healing from all the losses caused by the coronavirus pandemic in 2020, the changes in the Brazilian Economic Freedom Act, with some political events in the last few years (such as the approval of pension reform and the adoption of pro-market policies), may pave the way for more investment in Brazil. It may also encourage foreign investors, including the ones from Anglo-Saxon countries, to feel even more comfortable and attracted to invest in Brazil, due to the fact that, from now on, parties on private deals governed by Brazilian law are free to negotiate the rules of their transaction documents in their best interest. This will be likely to bring more certainty to private transactions in Brazil, as they tend to be drafted in a way that makes both parties feel more comfortable and protected.
Only for illustrative purposes, in the second semester of 2020 our firm had a good indication that this was correct. During this period, there was a very aggressive increase in the number of deals we were involved in (we broke our M&A transaction biannual record) and in the market in general. Our firm has strong evidence to believe that such increase has been driven by two factors: (i) the significant devaluation of the Brazilian Real against US Dollar and Euro; and (ii) all transactions documents we have drafted/negotiated already contain adjustments in order to reflect the rules brought by the Brazilian Economic Freedom Act.