Brazil: Conflicts Of Interest In Corporate Reorganizations

Last Updated: 13 February 2008
Article by Monique Mavignier

One of the most delicate issues in commercial law is the regulation of corporate reorganization transactions, in which there are not two distinct parties, with opposing interests, but instead a single interest, or a single controlling shareholder, present in the various companies involved in the reorganization. In this respect, two solutions are theoretically possible: either to restrict voting rights and, in many cases, make the transaction impracticable for lack of quorum or to create an alternative system to protect minority shareholders. Article 264 of Law no. 6,404/76 (the Brazilian Corporations Law) was created with this last purpose in mind.

Article 264 requires that, in consolidations, spin-offs or mergers involving controlled companies or companies under common control, the shareholders of the controlled company must receive – in addition to information on the exchange ratio effectively offered – a statement demonstrating how the exchange ratios for the shares belonging to the non-controlling shareholders are calculated, based on the net equity value of the shares issued by the companies involved, valued according to the same criteria and on the same date, at market prices or based on another criteria accepted by the Brazilian Securities Commission ("CVM").

The rule contained in article 264 seeks to provide to minority shareholders additional information on the reasonableness of the share exchange ratio negotiated by management and, consequently, to prevent abusive actions by the controlling shareholder. In other words, the controlling shareholder is able to exercise its voting rights in a situation where there is a potential conflict of interests, because minority shareholders are able to compare the exchange ratio effectively offered with an independent valuation and, if they decide to exercise their appraisal rights, are entitled to the higher of book value or the valuation performed pursuant to article 264.

In recent years, discussion on the application of article 264 to corporate reorganization transactions has intensified, mainly in transactions subject to the jurisdiction of the CVM, by virtue of the large number of this type of transaction involving publicly held companies. The position adopted by the CVM on this question therefore merits a brief examination.

The issue which frequently comes up in corporate reorganization transactions to which article 264 applies concerns the real usefulness of the valuations required by law, in light of the time and cost of preparing valuations in certain transactions, such as transactions approved by 100% of the shareholders involved or transactions involving a merger of a wholly-owned subsidiary, where the merged company's shares, at the time of the merger, are held exclusively by the absorbing company.

In both the above described situations, the CVM's position seems to be that (i) either there is no interest to be protected by the commission, which then no longer requires submission of a valuation under article 264 by the publicly held companies involved, although the CVM recognizes that it does not have the power to exempt companies from complying with the provisions of article 264, or (ii) the CVM is justified in authorizing the adoption of a simpler criteria, such as a comparison of the book value of the companies involved, to meet the ends sought by article 264.

The CVM's reasoning appears to be that in such cases, there is no potentially dissenting minority that could possibly exercise its appraisal rights to withdraw or, even if the absorbing company has minority shareholders, there is no change to its net equity and, therefore, no issuance of new shares (which is why it is not necessary to establish any exchange ratio), given that the value of the merged company is already fully reflected in the absorbing company's net equity, due to the equity method of accounting.

Anumber of decisions by the CVM illustrate the issues raised above. In cases involving Unibanco, Suzano Petroquímica, Gafisa and Dixie Toga, for example, the Commission acknowledged the need to take the relative costs and benefits into account, and simplified the merger process of wholly-owned subsidiaries or closely-held companies controlled by publicly-held companies, in which third-party shareholdings was completely irrelevant.

It is appropriate, lastly, to mention the CVM's opinion on the method to be applied for purposes of complying with the provisions of article 264 in the cases which do not fall under the situations described above. In a recent decision (in a proceeding to investigate the merger of Banco Santander Noroeste S.A. into its controlling shareholder, Banco Santander S.A., in 1999), the CVM held that "this is 'a method of individual valuation of assets and liabilities, tangible and intangible, at their probable market value' – the so-called "liquidation balance sheet". At the same time, nothing prevents the CVM from authorizing the use of a different method in certain transactions, such as discounted cash flow, the purpose of which is to obtain economic value and reflect future prospects, and indeed the CVM has already granted such authorization on application by the interested party. It is also obvious, nonetheless, that however appropriate another method appears to be, its use must be authorized by the Commission.

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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