The effect of Brazil’s anti-corruption probe on M&A transactions
November 2016 | EXPERT BRIEFING | MERGERS & ACQUISITIONS
As it has been widely reported, Brazil is in the midst of an extensive corruption probe that has already involved several politicians and executives. This probe – named Operação Lava Jato (literally, Operation Carwash) – initiated in 2009 through federal police investigations into money laundering and bribery at Petrobras, Brazil’s huge majority-state-controlled oil company. Since 2014, Operation Carwash has also revealed a number of bribery cases related to illegal behaviour in other spheres of the government in its relationships with private and public companies.
The enactment of the Brazilian Clean Company Act (BCCA) in August 2013 can explain in part the increase of anti-corruption investigations in Brazil. BBCA came as an answer after protests related to the hike of bus fares that led to larger protests against corruption, bringing thousands of Brazilians on to the streets.
The BBCA, later regulated by Brazilian Federal Decree No. 8,420/2015, provided investigators, prosecutors and judges with the necessary tools to carry out more in depth investigations within Operation Carwash. This included leniency agreements, among other legal measures.
The BBCA was an innovative development within the Brazilian legal system; it was a key factor in helping to combat corruption in Brazil and helped to press Operation Carwash forward. Since it was enacted, Brazilian law has expressly stated that legal entities should be held liable for ‘harmful acts’ performed for their benefit against national or foreign public administration. Prior to the enactment of the BCCA, Brazil was a signatory of international conventions against corruption and bribery, but the only law that provided penalties for corrupt acts was the Brazilian Criminal Code, which only held individuals liable.
Liability under the BCCA is strict or objective (responsabilidade objetiva), meaning that there is no need to evidence that the legal entity had the intention or even knowledge of the illegal acts. According to the BBCA, legal entities are liable for any harmful acts against the public administration performed by its representatives, employees or any third parties the legal entity has entered into agreements with, if the illegal acts were performed, to the relevant company’s benefit, after 29 January 2014, the date on which the BCCA became effective.
Moreover, the liability of the legal entity exists regardless of any statutory changes, amalgamation, merger, spin-off, or other change in control, and any affiliated companies are jointly and severally liable for the payment of any fines imposed as a consequence of harmful acts against the national or foreign public administration and for the compensation of related damages.
Penalties imposed by the BBCA range, firstly, from 0.1 percent to 20 percent of the company’s gross revenue in the year preceding the year in which the administrative proceeding is initiated, excluding taxes, and extraordinary publication of the decision which convicts the legal entity; or secondly, if it is not possible to assess the amount of the total gross revenue of the legal entity, the fine ranges from BRL 6000 to BRL 60m, provided that the fines cannot be lower than the advantage obtained.
Such broad scope of the liability of legal entities provided under the BBCA generates two common questions to the acquiring entities in M&A transactions involving Brazilian targets. Firstly, how far up and down the corporate ladder does such liability go? And secondly, whether ‘economic group’ is to be considered jointly or separately liable, the one existing at the time of the alleged misconduct, or the economic group in place after the merger or acquisition has taken place?
The BCCA is unclear in its response to such queries, and to date there has been no precedent regarding the scope of the liability of companies under the BBCA.
According to the Brazilian Civil Code and Brazilian Corporation Law, a company controls another when it has, directly or indirectly, the majority of votes in stockholders’ meetings and the power to elect most of its directors and officers, effectively using its power to direct the company’s activities. The Brazilian Civil Code also establishes that companies are considered as affiliated (coligadas) when a company holds 10 percent or more equity participation in the capital stock of the other, not being its controller, while Brazilian Corporation Law establishes that an affiliate is characterised when a company has considerable influence over the other (and significant influence is presumed when an investor holds more than 20 percent of an entity).
As for the question on the liability of the economic group, from a purely technical analysis of the BCCA, all entities belonging to the economic group of the company (at the time of the imposition of the penalty) can be held jointly and severally liable for the payment of fines and damages arising from the illegal act.
Effects of Operation Carwash and the BBCA in M&A transactions
In this context, M&A transactions involving Brazilian targets, cross-border or not, started to considerably emphasise thoroughly anti-bribery and anti-corruption due diligence (ABC due diligence) prior to signing or as a condition precedent to closing. ABC due diligence aims to verify whether a target is compliant with applicable anti-corruption legislation. It involves interviews with its representatives, officers, key employees and third parties, if applicable, and review of conduct performed for the company’s benefit. The goal is also to identify if there are any specific issues of concern to address in the relevant transaction documents and negotiations.
Even though there is a lack of precedents due to the recent regulation of the BBCA through the Brazilian Federal Decree No. 8,420/2015, in principle, pre-acquisition violations of the BCCA may result in the payment of fines and damages by the new controlling shareholder of the target company due to successor liability provided under such law.
Hence, upon the identification of possible anti-bribery and anti-corruption issues or concerns during the ABC due diligence phase and, in case the acquirer decides to go forth with the acquisition, transaction documents should be carefully drafted and negotiated, especially when it comes to indemnification provisions.
In this sense, a number of provisions can be included in the transaction documents in order to mitigate bribery and corruption issues risks, such as, a broad and robust ABC representation and warranty in connection with compliance with anti-corruption laws and the maintenance of anti-corruption policies and procedures reasonably designed to ensure compliance with applicable anti-corruption laws. Standard indemnification protections should be included. For example, the negotiation of a specific guarantee, uncapped indemnification to cover any and all losses incurred due to corrupt practices related to the target company, including establishing a higher survival period for such indemnification obligation. Finally, in case the signing of the transaction documents and effective closing thereto are segregated, establish that conducting thorough ABC due diligence of the target company and confirming that the target company complies with anti-corruption laws and policies is a condition precedent to closing.
With the impeachment of Dilma Rousseff, Brazil’s former president, a rebound in business confidence is starting to reappear, signalling a possible economic recovery. Such political factors and a possible future of cleaner politics thanks to the BCCA and anticorruption probes will likely benefit Brazil as a whole, attracting foreign investment once again. Nonetheless, foreign investors should be on the lookout for possible past corrupt practices of Brazilian targets, employing efficient mechanisms to navigate through these turbulent waters in M&A transactions.
Paula Surerus is a partner and Ana Carolina Zattar is an associate at Veirano Advogados. Ms Surerus can be contacted on +55 21 3824 1376 or by email: email@example.com. Ms Zattar can be contacted on +55 21 3824 1378 or by email: firstname.lastname@example.org.
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Paula Surerus and Ana Carolina Zattar