Brazil: Controlling Shareholders Of Mixed-Economy Companies* Are Punished For Violating The Brazilian Corporation Law

Last Updated: 9 June 2015
Article by Walter Stuber

On May 26, 2015 the Board of the Brazilian Securities and Exchange Commission (Comissão de Valores Mobiliários – CVM) judged, for irregularities involving breach of fiduciary duty and exercise of voting rights of the controlling shareholder, the following defendants:

1. State of São Paulo (Estado de São Paulo) - Punishment Administrative Process CVM nº RJ2012/1131; and

2. Union1 (União Federal) - Punishment Administrative Process CVM nº RJ2013/6635.

These two cases were established from the analysis by the Supervision of Relations with Companies (Superintendência de Relações com Empresas - SEP) of CVM and were reported by the Director Luciana Dias and their respective results are outlined herein.

The first case (Punishment Administrative Process CVM nº RJ2012/1131) involves complaints about transactions made between Empresa Metropolitana de Águas e Energia S.A. (EMAE) and Companhia de Saneamento do Estado de São Paulo (Sabesp), both mixed-economy companies controlled by the State of São Paulo.

In particular SEP analyzed the operations in which Sabesp withdraws water of two reservoirs owned by EMAE (Guarapiranga and Billings), free of charge and to the detriment of the hydroelectric generation capacity of EMAE, for public supply of the metropolitan region of São Paulo and for SEP these withdrawals would be non-commutative transactions between related parties.

According to the prosecution made by CVM's technical area, the State of São Paulo remained inert in this disadvantageous relationship resulting from the free catchment of waters of the reservoirs of EMAE by Sabesp. Consequently, the State of São Paulo have ceased to serve the interests of the other shareholders of EMAE and had therefore violated the provisions of the sole paragraph of article 116 of Law nº 6,404 of December 15, 1976 (the Brazilian Corporation Law – BCL). This was the conclusion of the prosecution.

A controlling shareholder is defined as an individual or a legal entity, or a group of individuals or legal entities by a voting agreement or under common control, which: (a) possesses rights which permanently assure it a majority of votes in resolutions of general meetings and the power to elect a majority of the company officers; and (b) in practice uses its power to direct the company activities and to guide the operations of the departments of the company2.

Pursuant to the sole paragraph of article 116 of the BCL, a controlling shareholder shall use its controlling power in order to make the company accomplish its purpose and perform its social role, and shall have duties and responsibilities towards the other shareholders of the company, those who work for the company and the community in which it operates, the rights and interests of which the controlling shareholder must loyally respect and heed.

The Reporting Director agreed with the prosecution and stated that the controlling shareholder has a duty to act proactively with all mechanisms that are at its disposal by guiding the company and the administrators to the attainment of the corporate purpose and by loyally guarding the rights and interests of the other shareholders of the company. Furthermore, the omission of the controlling shareholder in this function is reprehensible, in accordance with the sole paragraph of article 116 of the BCL, and the corporate legislation does not mitigate the role and responsibilities of the State of São Paulo as a controlling shareholder.

Following the vote of the Reporting Director, the Board of CVM unanimously decided to apply to the State of São Paulo the penalty of a fine in the amount of R$ 400,000.00 for breaking the sole paragraph of article 116 of the BCL.

As punished accused, the State of São Paulo could appeal with suspensive effect to the Appeals´ Council of the Brazilian Financial System (Conselho de Recursos do Sistema Financeiro Nacional).

The second case (Punishment Administrative Process CVM nº RJ2013/6635) involves complaints about the behavior of the Union as controlling shareholder of Centrais Elétricas Brasileiras S. A. – Eletrobras)3, in the context of Provisional Measure nº 579, of September 11, 2012 (MP 579/2912)4, which provided for a series of measures to reduce the cost of electric power in Brazil.

Pursuant to article 115 of the BCL, the shareholder shall exercise the right to vote in the corporation's interest; the right to vote shall be deemed abusive if it is exercised with the intent to cause damage to the corporation or to other shareholders, or of obtaining an advantage for the shareholder or for a third party to which neither is entitled, and which results or may result in damage to the corporation or to other shareholders.

Regarding conflict of interest, the first paragraph of article 115 of the BCL determines that a shareholder may not vote in a general meeting on a resolution which relates to the evaluation report on the property which he contributed to form the corporation's capital, to the approval of his accounts as a corporation officer, nor on any other resolution which may benefit him personally or in which he and the corporation may have conflicting interests.

According to the prosecution made by CVM's technical area, the Union would have infringed the first paragraph of article 115 of the BCL, by voting in a situation of conflict of interest at an extraordinary general meeting of Eletrobras held in December 3, 2012. In such meeting, the Union manifested itself in favor of the early renewal of concession contracts of generation and transmission of electricity between the subsidiaries of Eletrobras, as electricity concessionaires, and the Union, as granting power.

Following the vote of the Reporting Director, the Board of CVM unanimously decided to apply to the Union the penalty of a fine in the amount of R$ 500,000.00 for voting in the extraordinary general meeting in favor of the renewal of the concessions of generation and transmission of electricity of companies controlled by Eletrobras and breaking paragraph 1 of article 115 of the BCL.

As punished accused, the Union could appeal with suspensive effect to the Appeals´ Council of the Brazilian Financial System.

The values of the fines imposed by CVM were derisory compared to the damage caused to the two companies (EMAE and Eletrobras) and the minority shareholders, but are within the limits provided for in Law nº 6,385 of December 7, 1976 (the Brazilian Securities Law). More important than the financial burden in both cases is the sign given by CVM as the regulatory body of the Brazilian capital market that article 238 of the BCL is not a safe conduct for representatives of the government to commit any kind of barbarism or attack against state-owned companies with shares traded on the stock exchange, with negative consequences for their minority shareholders and the entire local market5.

Article 238 of the BCL establishes that a legal entity controlling a mixed-economy company has the duties and responsibilities of a controlling shareholder, but it may direct the activities of the company so as to satisfy the public interest in relation to its own functions.

The duties and responsibilities of the controlling shareholder are those contemplated in articles 116 and 117 of the BCL. As already mentioned above, a controlling shareholder has duties and responsibilities towards the other shareholders of the company, those who work for the company and the community in which it operates, using its controlling power in order to make the company accomplish its purpose and perform its social role; the controlling shareholder must loyally respect and heed the rights and interests of the minority shareholders, the workers and the community (sole paragraph of article 116 of the BCL). Furthermore, a controlling shareholder is liable for any damage caused by acts performed by the abuse of its power (article 117 of the BCL)6.

These decisions are relevant because they recognize that mixed-economy companies are also subject to the BCL. According to CVM, when acting as a shareholder the State must fully respect the rules of the securities market. This does not mean that the State cannot direct the activities of the company to satisfy the public interest, but that the quest for the public interest must obey the law.

The Reporting Director pointed out that CVM has already acknowledged that when it is a shareholder of a company the State does not necessarily need to opt for decisions that maximize profits. However the State action cannot lead to the subversion of the lucrative nature of the publicly-held corporations. It makes no sense to resort to this form of company if the intent of the public interest is to keep the company out of that purpose and with deficit.

Both decisions protect the Brazilian securities market, which would risk being undermined if the controlling shareholder of a mixed-economy company could act outside the law, simply claiming the existence of "public interest". These decisions also show that CVM is willing to fulfill its role of supervising and regulating the Brazilian securities market and that the law is applied to everybody, regardless as to whether the controlling shareholder is a public or private entity, without exceptions.


* Mixed-economy companies are enterprises with the majority of shares owned by the government, but that also have shares owned by the private sector and usually their shares are traded on the stock exchange.

1 The Union is the Federal Government.

2 This definition is contained in article 116 of the BCL.

3 Eletrobras is a mixed-economy company controlled by the Union.

4 MP 579/2012 was converted into Law No. 12,783, of January 11, 2013.

5 At Eletrobras losses are estimated at approximately $ 10 billion.

6 Pursuant to paragraph 1 of article 117 of the BCL, an abuse of power may take any of the following forms: (a) to guide a company towards an objective other than in accordance with its corporate purposes clause or harmful to national interest, or to induce it to favor another Brazilian or foreign company to the detriment of the shareholders' interest in the profits or assets of the company or of the Brazilian economy; (b) to provide for the liquidation of a viable company or for the transformation, merger or division of a company in order to obtain, for itself or for a third party, any undue advantage to the detriment of the other shareholders, of those working for the company or of investors in securities issued by the company; (c) to provide for a statutory amendment, an issue of securities or an adoption of policies or decisions which are not in the best interests of the company but are intended to cause damage to the minority shareholders, to those working for the company or to investors in securities issued by the company; (d) to elect a company officer or audit committee member known to be unfit for the position or unqualified; (e) to induce, or attempt to induce, any officer or audit committee member to take any unlawful action, or, contrary to their duties under the BCL and under the bylaws, and contrary to the interest of the company, to ratify any such action in a general meeting; (f) to sign contracts with the company directly, through a third party or through a business in which the controlling shareholder has an interest, incorporating unduly favorable or inequitable terms; (g) to approve, or cause to be approved, irregular accounts rendered by company officers as a personal favor, or to fail to verify a complaint which he knows, or should know, to be well founded, or which gives grounds for a reasonable suspicion of irregularity; (h) to subscribe shares with the contribution of property unrelated to the purpose of the company.

The content of this article is intended to provide a general guide to the subject matter. Specialist advice should be sought about your specific circumstances.

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Walter Stuber
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