The Guaranteed Real Estate Bill (Letra Imobiliária Garantida - LIG) is a new credit instrument for long-term funding by financial institutions destined to real estate credit expansion, created by the Brazilian Federal Government by means of Provisional Measure (Medida Provisória) No. 656, of October 7, 2014 (MP 656/2014). This article analyses the relevant provisions of MP 656/2014 that regulate the issuance of the LIG.

I. Applicable Rules

This new credit instrument is governed by articles 18 to 49 of MP 656/2014 but it must still be regulated in detail by the Brazilian Monetary Council (Conselho Monetário Nacional – CMN). The provisions of the legislation on bills of exchange and promissory notes are also applied to the LIG to the extent that they do not contradict MP 656/20141.

The distribution and public offering of the LIG must follow the regulation of the Brazilian Securities and Exchange Commission (Comissão de Valores Mobiliários - CVM).

II. Legal Nature

The LIG is a registered, transferable and freely negotiable credit instrument, guaranteed by an Asset Portfolio subject to a fiduciary regime, to be issued by certain financial institutions. The issuing institution is responsible for the performance of all obligations under the LIG regardless of the sufficiency of the Asset Portfolio.

It is a promise of payment in cash and will be issued exclusively in the book form, upon registry in a central depository authorized by the Central Bank of Brazil (Banco Central do Brasil - Bacen).

III. Features

The relevant features of the LIG are the following: (i) the denomination "Letra Imobiliária Garantida" in Portuguese; (ii) the name of the issuing financial institution; (iii) the name of the holder; (iv) the order number, date and place of issuance; (v) the par value; (vi) the maturity date; (vii) the interest rate (fixed or floating). The capitalization of interest is admitted; (viii) other forms of remuneration, if any, including based on indexes or rates of public knowledge; (ix) the correction by the exchange variation clause, if any; (x) the form, periodicity and place of payment; (xi) the identification of the Asset Portfolio; (xii) the identification and value of credit loans and other assets that are part of the Asset Portfolio; (xiii) the imposition of the fiduciary regime on the Asset Portfolio, in accordance with MP 656/2014; (xiv) the identity of the trustee, stating its obligations, responsibilities and remuneration, as well as the assumptions, conditions and form of its dismissal or replacement and the other conditions of its performance; and (xv) the description of the real or personal guarantee, if any.

As an extrajudicial execution instrument the LIG can be enforced, regardless of protest, based on an entire certificate content issued by the central depository. The LIG can also generate a redemption value lower than the issuance value, based of the remuneration criteria, and it can still be updated monthly by a price index, provided that it is issued with a minimum term of 36 months.

If the LIG is issued with monthly update forecast for price index, the payment of appropriate monetary update figures since the issuance is forbidden, whenever the early redemption in whole or in part is scheduled to occur in a period of less than 36 months.

IV. Centralized Deposit

The LIG and the assets which form part of the Asset Portfolio must be deposited in an entity authorized by Bacen to exercise the centralized deposit activity, pursuant to Law No. 12,810, of May 15, 2013 (Law 12,810/2013). Should the assets do not qualify for the centralized deposit, then their records must be made at an entity authorized by Bacen or CVM, as the case may be, to engage in the activity of securities and financial assets registry in accordance with Law 12,810/20132.

The centralized deposit, which is performed by qualified entities as central depositories, comprises the centralized guard of financial assets and securities, fungible and no fungible, the control of their effective ownership and the treatment of their events. These entities are responsible for the integrity of the systems and records they kept relating to the financial assets and securities under centered custody.

For the purposes of centralized deposit, the financial assets and securities, in physical or electronic form, will be transferred in the fiduciary ownership regime to the central depository3. The effective ownership of the financial assets and securities object of the centralized deposit is presumed by the controls of ownership maintained by the central depository and the transfer occurs exclusively in accordance with the instructions given to the central depository.

V. Asset Portfolio

The Asset Portfolio of the LIG can be formed by the following assets: (i) real estate loans; (ii) Brazilian Treasury bonds; (iii) derivative instruments contracted through the central counterparty guarantor; and (iv) any other assets as may be authorized by CMN. The assets which form part of the Asset Portfolio cannot be subject to any kind of burden, except those related to the rights of the LIG holders. CMN establish the modalities of operation of credit accepted as real estate loans for the purposes of MP 656/2014.

The real estate loans can only integrate the Asset Portfolio if: (i) they are guaranteed by a mortgage or by fiduciary alienation of movable asset; or (ii) the real estate development that originates the credit operation is subject to the regime of affectation (regime de afetação) as referred to in article 31 of Law No. 4,591, of December 16, 1964, which provides for condominium buildings and real estate developments4.

The Asset Portfolio must meet the requirements of eligibility, composition, sufficiency, liquidity and term established by CMN. These requirements must contain at least the following: (i) the features of the assets of the Asset Portfolio with regard to guarantees and credit risk; (ii) the participation of the above-mentioned types of assets in the total value of the Asset Portfolio; (iii) the excess of the total value of the Asset Portfolio in relation to the total value of the LIG guaranteed by the Asset Portfolio, which may not be less than 5%; (iv) the weighted average maturity of the Asset Portfolio in relation to the weighted average term of the LIG guaranteed by the Asset Portfolio; and (v) the mitigation of currency risk, in the case of the LIG adjusted by the exchange variation clause.

VI. Fiduciary Regime

The issuing institution must establish the fiduciary regime on the Asset Portfolio. The trustee shall be a financial institution or an entity authorized for this purpose by Bacen and the beneficiaries will be the LIG holders guaranteed by Asset Portfolio.

The fiduciary regime will be established by registration in a qualified entity as a central depository of financial assets, which must contain: (i) the constitution of the fiduciary regime on the Asset Portfolio; (ii) the setting up of the patrimony of affectation, integrated by all of the assets of the Asset Portfolio subject to the fiduciary regime; (iii) the affectation of assets that integrate the Asset Portfolio as collateral of the LIG; and (iv) the appointment of the trustee, with the definition of its duties, responsibilities and remuneration, as well as the assumptions, conditions and form of its dismissal or replacement and the other conditions of its performance.

Financial resources from the assets of the Asset Portfolio are released from the fiduciary regime, provided that they met the eligibility requirements, composition, sufficiency, liquidity and term established by CMN and once the matured obligations of the LIG guaranteed by the Asset Portfolio are duly met.

The fiduciary will terminate with the payment in full of the principal, interest and other charges relating to the LIG guaranteed by the Asset Portfolio.

VII. Patrimony of Affectation

The assets which form part of the Asset Portfolio subject to the fiduciary regime constitute the patrimony of affectation. The patrimony of affectation is completely segregated and cannot be confused with the equity of the financial institution that issues the LIG.

These assets: (i) are not achieved by decreeing effects of any insolvency regime of the issuing institution (intervention, extrajudicial liquidation or bankruptcy) and, therefore, do not form part of the bankrupt estate (massa concursal); (ii) do not respond directly or indirectly by debts and obligations of the issuing institution, no matter how privileged they are, until full payment of the amounts due to the LIG holders; (iii) may not be subject to arrest, distraint, attachment, search and seizure or any other act of judicial constriction due to other obligations of the issuing institution; and (iv) may not be used to make or guarantee obligations assumed by the issuing institution, except those arising from the issuance of the LIG.

With regard to the LIG and to assets that integrate the Asset Portfolio, the patrimony of affectation prevails in respect of any debts of the issuing institution, including tax, social security or labor liabilities5.

VIII. The Issuing Institution Attributions

The issuing institution is responsible for administering the Asset Portfolio, maintaining accounting controls to enable their identification, as well as highlighting, in its financial statements, information regarding the Asset Portfolio.

Furthermore, the issuing institution has the following attributions:

  1. to promote the strengthening or replacement of assets that integrate the Asset Portfolio whenever there is insufficiency or inadequacy of the Asset Portfolio in relation to the requirements set out in MP 656/2014;
  2. in conjunction with the central depository, to ensure the trustee access to all information and necessary documents for the performance of the trustee´s duties;
  3. to respond for the origin and authenticity of the assets that comprise the Asset Portfolio;
  4. to respond for the losses caused to the LIG holders for breach of legal or regulatory provision, through negligence or reckless administration or by deviation from the purpose of the Asset Portfolio; and
  5. must designate the trustee, specifying, in the constitution of the fiduciary regime, the obligations, responsibilities and remuneration, as well as the assumptions, conditions and form of dismissal or replacement and the other performance conditions of the trustee.

IX. Trustee

As previously mentioned, the trustee must be a financial institution or other entity authorized for this purpose by Bacen. Entities linked to the issuing institution may not engage in this activity. The concept of "entity linked to the issuing institution" must still be established by CMN.

The trustee has general powers of representation of the communion of the LIG holders, in addition to the following attributions to be set by CMN: (i) to ensure the protection of the rights and interests of such investors, monitoring the performance of the institution that has issued the LIG in the management of the Asset Portfolio; (ii) to adopt the measures necessary for the judicial or extrajudicial defense of interests of such investors; (iii) to convene the General Assembly of Investors (the LIG holders); and (iv) to exercise, in the event of declaration of any insolvency regime of the issuing institution, the management of the Asset Portfolio, in compliance with the conditions laid down by CMN.

In the case of any violation to the provisions of MP 656/2014 and standards established by CMN and Bacen, the fiduciary agent, its managers and members of its contractual or statutory bodies are subject to the penalties provided for in the applicable legislation to financial institutions.

In the exercise of its powers of supervision, Bacen may require the trustee to present documents and bookkeeping, including access in real time to the information stored in its electronic systems. If the trustee refuses to meet those requirements, it shall be subject to the above-mentioned penalties.

X. General Assembly of Investors

The General Assembly of Investors must be convened with minimum antecedence of 20 days, by notice published in a newspaper of wide circulation in the place of issuance of the LIG. On first call, the General Assembly will be held with the presence of LIG holders representing at least two thirds of the total value of the LIG and, on second call, with any number. However, the presence of all the investors will supersede any lack of the requirements mentioned herein.

Any resolution taken by LIG holders representing more than half of the total value of the LIG present at the General Assembly is deemed to be valid, provided that such resolution formally does not require any other specific quorum.

XI. Insolvency of the Issuing Institution

In the event of declaration of any insolvency regime (intervention, extrajudicial liquidation or bankruptcy) of the issuing institution, the trustee is invested with a mandate to manage the Asset Portfolio, in compliance with the conditions laid down by CMN.

The trustee invested with mandate to manage the Asset Portfolio is empowered to assign, alienate, renegotiate, transfer or otherwise dispose of the assets, on behalf of the LIG holders, including powers to file or defend them in connection with lawsuits and administrative or arbitration proceedings related to the Asset Portfolio.

When any insolvency regime is declared: (i) the assets of the Asset Portfolio will be destined exclusively for the payment of principal, interest and other charges relating to the LIG guaranteed by the Asset Portfolio, and the payment of obligations arising from derivative contracts related to the Asset Portfolio, their costs of administration and tax obligations6; and (ii) the trustee shall convene the General Assembly of Investors7.

The General Assembly of Investors, convened as a result of the decreeing of any insolvency regime of the issuing institution, may adopt any measure pertaining to the management of the Asset Portfolio, provided that the conditions laid down by CMN are duly complied with.

The recognition by Bacen of insolvency of the issuing institution that, under current legislation, is not subject to intervention, extrajudicial liquidation or bankruptcy, produces the same effects discussed herein.

Once the rights of the LIG holders have been settled in full and the charges, costs and expenses related to the exercise of their rights have also been entirely satisfied, the surplus assets of the Asset Portfolio will be integrated into the bankrupt estate.

Should the Asset Portfolio be insufficient to pay all the LIG holders' rights, they will be entitled to sign up the balance of their respective credits in the bankrupt estate on equal terms with the unsecured creditors.

If the Asset Portfolio is solvent (as defined according to the criteria established by CMN), the accelerated maturity of the LIG guaranteed by the Asset Portfolio is prohibited, in case of insolvency of the issuing institution.

XII. Taxation

The income and capital gains produced by the LIG are exempt from tax on income, when the beneficiary is: (i) an individual resident in Brazil; or (ii) an individual or legal entity resident or domiciled abroad (except in the case of a favored taxation country), which carries out financial transactions in Brazil in accordance with the rules and conditions laid down by CMN.

In the case of any person (individual or legal entity) resident or domiciled in a favored taxation country, the Brazilian withholding income tax (Imposto de Renda Recolhido na Fonte - IRRF) will apply and be collected at source, at the rate of 15%.

Favored taxation country (país com tributação favorecida) means any country or dependency of a country:

(a) that does not impose tax on income or, when imposes, it is a low-tax country, in which the applicable income tax rate is equivalent to any percentage varying between zero and 17% (maximum)8; and

(b) whose legislation does not permit access to information concerning the corporate structure of the legal entities, their shareholders or partners or the identification of the effective beneficiary(ies) of the earnings allocated to non-residents. This situation happens: (i) whenever there is lack of information or confidentiality (opacity) in relation to the corporate structure of the foreign company, i.e. if the list of shareholders or partners is not disclosed; and/or (ii) if is not possible to identify the Ultimate Beneficial Owner (UWO), i.e. the person that holds the ownership of the shares of the foreign company9.

XIII. Aspects to be regulated

CMN will regulate the provisions of MP 656/2014 about the LIG, in particular the following aspects: (i) conditions for the issuance of the LIG; (ii) types of financial institutions authorized to issue the LIG, including specific requirements for the issuance; (iii) issue limits of the LIG, including those adjusted by the exchange variation clause. In the first year of application of MP 656/2014, the issue limit of the LIG with exchange variation clause cannot exceed, for each issuer, 505 of the total balance of the issued LIG; (iv) use of indexes, rates or remuneration methodologies of the LIG; (v) maturity of the LIG; (vi) weighted average period of the LIG, which cannot be less than 24 months; (vii) conditions of redemption and accelerated maturity of the LIG; (viii) form and conditions for registration and deposit of the LIG and the assets which form part of the Asset Portfolio; (ix) requirements of eligibility, composition, sufficiency, term and liquidity of the Asset Portfolio, including methodologies of calculation; (x) conditions of replacement and strengthening of assets that are part of the Asset Portfolio; (xi) requirements for acting as trustee and the events, conditions and manner of its dismissal or replacement; (xii) the trustee's attributions; (xiii) management conditions of the Asset Portfolio; and (xiv) conditions of use of derivative instruments.

XIV. Final Considerations

With the features of the Covered Bond, which is widely used in the international market, the LIG constitutes a debt instrument of the issuing institution, secured by a segregated Asset Portfolio (Carteira de Ativos) formed by real estate loans that serve as ballast warranty for these issues. Investors have dual guarantee: (i) the assets of the issuer; and (ii) the cash flow from the affected assets on the segregated Asset Portfolio.

This new and differentiated fundraising tool for financial institutions offers the buyer of the LIG a smaller credit risk and at the same time the possibility of reducing the final cost of real estate financing for consumers by attracting foreign investors. Additionally, the issuance of the LIG as a long-term investment approaches the funding deadline from the term of application of resources and diminishes the risks normally related to long-term financing.

1 In Brazil, this legislation is the Geneva Convention, i.e. the Convention Providing a Uniform Law for Bills of Exchange and Promissory Notes (Geneva, 1930) of The League of Nations, approved by Legislative Decree No. 54, of September 8, 1964 of the Brazilian Congress and enacted by the Executive Branch by means of Decree No. 57,663, of January 24, 1966. In addition, Decree No. 2,044, of December 31, 1908, that defines the bill of exchange and the promissory note and regulates the transactions with both credit instruments, it is also subsidiary applied to the matter.

2 Law 12,810/2013 states that it is incumbent upon Bacen and CVM, within the framework of their respective powers, to: (i) authorize and supervise the exercise of the activity of centralized deposit of financial assets and securities; and (ii) establish the conditions for the exercise of the activity referred to in item (i).

3 The constitution and extinction of the fiduciary ownership regime in favor of the central depository will be held exclusively with the inclusion and low of the financial assets and securities in ownership controls of the entity, including for advertising purposes and effectiveness vis-à-vis third parties. The records of the issuer or bookkeeper of the financial assets and securities must reflect faithfully the ownership controls of the central depository. The financial assets and securities transferred in the fiduciary ownership regime: (i) do not communicate with the general or special assets of the entities qualified as central depositories; (ii) must remain in the centralized deposit accounts on behalf of the effective owner or, when admitted by the relevant regulation, of his/her/its representative, until they are redeemed, withdrawn from circulation or returned to their effective holders; and (iii) are not liable to constitute a guarantee by entities qualified as central depositories and do not respond for their obligations. The central depository cannot dispose of the financial assets and securities received in the fiduciary ownership regime and it is obliged to return them to their effective holder or, when admitted by the relevant regulation, by his/her/its representative, with all rights and burden which they have been assigned while they are maintained in a centralized deposit.

4 Article 31of Law 4,591/1964 deals with the regime of affectation and was included by Law No. 10,931, of August 2, 2004, which contemplates the patrimony of affectation of real estate development, as discussed herein. Brazil is a civil law country. Under Brazilian law the patrimony of affectation is a patrimony, or legal estate, that can be divided for a fiduciary purpose, as being distinct from a person's general patrimony. It is similar in some respects to the way under common law property is held, managed, or invested in trust by a trustee for the benefit of third parties (beneficiaries). The affected property remains outside the grantor's patrimony; therefore, even if the grantor goes bankrupt, becomes insolvent, or incurs liabilities, the property remains untouchable and may continue to benefit the intended beneficiaries.

The real estate development can be subject to the regime of affectation, at the discretion of the developer. Pursuant to the regime of affectation, the land and the accessions object of the real estate development, as well as other assets and rights linked to it, will be kept segregated from the assets of the developer and constitute the patrimony of affectation, aimed at the completion of the real estate development and the delivery of the housing units to the acquirers. The patrimony of affectation does not communicate with the other assets, rights and obligations of the general patrimony of the developer or other patrimonies of affectation constituted by the developer and only responds by debts and obligations linked to its real estate development. The developer responds by damages caused to the patrimony of affectation. The property and rights belonging to the patrimony of affectation may only be given as collateral to guarantee a credit operation whose product is fully intended to complete the corresponding building and the delivery of the housing units to the acquirers. In the case of transfer (full or fiduciary) of receivables from the sale of units of the real estate development, the proceeds from the sale will also integrate the patrimony of affectation. Construction shares corresponding to the accessions linked to the fractional ideals are paid by the developer until the responsibility for the construction has been assumed by a third party. The financial resources of the patrimony of affectation will be used for payment or reimbursement of expenses related to the real estate development. The refund of the purchase price of the land can only be done when the sale of the autonomous units is made, in proportion to the respective fractions ideals, considering only the values effectively received as a result of the sale.

Excluded from the patrimony of affectation are the following: (i) the financial resources that exceed the necessary amount to the conclusion of the work, considering the receivables due until its completion, as well as the resources necessary for the full release of the construction financing, if any; and (ii) the value for the price of sale of the undivided interest of land of each unit sold, in the case of the real estate development in which the building is hired under contract work or administration.

In the case of sets of buildings, separate patrimonies of affectation may be constituted, taking into account: (i) the subsets of homes with the same completion date; and (ii) the buildings of two or more decks. The constitution of separate patrimonies of affectation must be declared at the memorial of incorporation. In financed real estate developments, the sale of units must have the consent of the financing institution or such institution will have to be duly notified, as per the provisions of the financing agreement. The hiring of financing and the granting of guarantees, including by means of transmission, to the lender, of the fiduciary ownership on the real estate units which are part of the real estate development, as well as the transfer (full or fiduciary) of receivables arising from the sale of these units, do not entail the transfer to the lender of any of the obligations or liabilities of the transferor of the property, the developer or the builder, that will remain as the only responsible for those obligations and duties allocated to them.

5 According to article 49 of MP 656/2014, the provisions of article 76 of Provisional Measure No. 2,158-35, of August 24, 2001, the content of which is transcribed below, do not apply to the LIG and to the assets that integrate the Asset Portfolio:

"Art. 76. the rules establishing the affectation or separation, at any title, of an individual or company equity do not produce effects in relation to tax, social security or labor debts, in particular with regard to the guarantees and privileges to which they are assigned.

Sole paragraph. For the purposes of the preamble of this article, all the goods and revenues of the person, his/her estate or bankrupt estate, including those that have been subject to separation or affectation, remain responding by the debts referred to therein."

6 In this hypothesis the general rule laid down in article 26 of the MP 656/2014 does not apply. According to the general rule, the financial resources originated from the assets that integrate the Asset Portfolio are released from the fiduciary regime, provided that they met the requirements of eligibility, composition, sufficiency, liquidity and term established by CMN and after all the matured obligations of the LIG guaranteed by the Asset Portfolio are duly settled.

7 To convene the General Assembly of Investors, the trustee will have to comply with the rules already discussed in item X of this article (General Assembly of Investors).

8 According to the provisions of the preamble of article 24 of Law No. 9,430, of December 27, 1996 (Law 9.430/1996).

9 This situation is provided for in paragraph 4 of article 24 of Law 9,430/1996.

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.