This article is intended to provide the international lawyer with an outline of the Venezuelan legal requirements for international loans granted to the Bolivarian Republic of Venezuela (the "Republic") and issues of debt securities by the Republic. The focus is on international and not domestic debt transactions. We will focus on transactions by the Republic and not by other public sector instrumentalities such as states, municipalities and government-owned companies (i.e., Petróleos de Venezuela, S.A. (PDVSA)).
1. Principles of Venezuelan Public Finance
Venezuelan public finance is governed by the Constitution, the Organic Law on Financial Administration of the Public Sector (Ley Orgánica de Administración Financiera del Sector Público, the "Public Finance Law"), regulations thereunder issued by the President of the Republic, and the annual indebtedness laws also known as "umbrella laws". There are some provisions of other laws, such as the Venezuelan Central Bank Law that also touch aspects of public finance.
The Ministry of Finance (the "Ministry") is the body of the Republic in charge of public finance matters and is vested with the power to negotiate and incur financial obligations on behalf of the Republic.
A. What is a public finance transaction?
Public finance transactions or public credit transactions (operaciones de crédito público) are defined as transactions by which the Republic incurs any form of indebtedness. The Public Finance Law (art. 76) lists the following as public credit transactions: (i) issue and placement of debt securities, including treasury bills (letras del tesoro), (ii) credits of any kind, (iii) public works contracts or acquisitions which involve payments by the Republic to be made in fiscal years beyond the fiscal year in which they are contracted, (iv) creation of security interests and guarantees, and (iv) restructuring or refinancing of previously existing public debt.
Public credit transactions must be approved by the National Assembly which is the federal legislative body. Currently, this approval is twofold, one is the approval set forth in the annual indebtedness law and the other concerns each specific transaction.
A. Annual Indebtedness Law
Public credit transactions have to be approved in the annual indebtedness law, which sets forth the maximum indebtedness amount —in Venezuelan bolivars and in U.S. dollars— that may be incurred by the Republic during a fiscal year. The annual indebtedness law also indicates the use of the proceeds to be raised by the Republic through public credit transactions.
The Republic is therefore bound by the annual maximum amount of indebtedness as well as the use of proceeds specified in the annual indebtedness law. Annual indebtedness laws only refer to maximum amounts and use of proceeds. They do not regulate the terms and conditions of public finance transactions.
B. Approval of each Specific Transaction
In addition to being approved in the annual indebtedness law, each specific public credit transaction (e.g., loan or notes issue) must be presented for approval by the Permanent Finance Commission of the National Assembly, which has a ten business day term to approve or disapprove the transaction. If the commission does not render its decision on the transaction within the aforesaid ten-day term, the transaction is deemed as approved (art. 79, Public Finance Law).
The Public Finance Law requires that the request for approval of each public credit transaction be filed together with the non-binding opinion of the Venezuelan Central Bank (the "Central Bank"), this is dealt with below under Section 3.
In our opinion, which is consistent with the Republic's past practice, it is sufficient for the Republic to file a description of the material terms and conditions of the transaction submitted for approval, similar to a term sheet describing terms and conditions such as: principal amount, interest rate, amortization schedule, governing law, name of the underwriter or financial institution and fees. We believe it is not necessary for the Republic to file with the aforesaid commission the actual drafts of the transaction documents such as credit agreements, offering circulars, subscription agreements, form of notes and related documents.
From late 2000 until early 2003 it was not necessary for the Republic to obtain approval from the National Assembly for each specific transaction. However, a decision by the Constitutional Chamber of the Supreme Tribunal rendered on September 24, 2002, states that public credit transactions are "public interest" contracts and therefore have to be approved by the National Assembly when entered into with entities not domiciled in Venezuela, contrary to the original Public Finance Law which expressly stated that the Annual Indebtedness law amounted to legislative approval. In light of this decision —which rewrote an article of the 2000 Public Finance Law— the Public Finance Law was later amended in January 2003 by the National Assembly to include the provision that now requires each transaction be approved by the Permanent Finance Commission of the National Assembly.
The decision stated that public finance transactions are "public interest" contracts and therefore have to be approved by the National Assembly if they are to be entered into with foreign governments, institutions or entities not domiciled in Venezuela. However, the decision also states that the prior authorization from the National Assembly is not required for (i) the issue of debt securities by the Republic, or (ii) financing obtained from entities domiciled in Venezuela.
As mentioned above, on January 9 2003, the National Assembly amended the Public Finance Law to include the provision that requires all public credit transactions to be submitted for approval by the Permanent Finance Commission of the National Assembly. This amendment did not carve out any exceptions to the approval by the Permanent Finance Commission of the National Assembly. It may be anticipated that the Public Finance Law will be amended again to create exceptions from approval, such as the ones set forth in the Supreme Tribunal decision of September 2002.
What happens if the Permanent Finance Commission of the National Assembly disapproves a public credit transaction after the elapse of the ten business day term it has to render the decision? We believe that any such late disapproval would be invalid because the transaction would have been legally deemed as approved. Nevertheless, the political ¾ albeit not legal¾ implications of such a situation should not be overlooked, specially in light of the effects it may have on the reputation of the international bank or underwriter.
C. Exemption From Authorization
The Public Finance Law exempts the following transactions from approval by annual indebtedness law (art. 87 and 88): (i) issue and placement of letras del tesoro (treasury bills); however, the Ministry must indicate the maximum amount of letras del tesoro in the annual budget prepared by the Ministry for approval by the National Assembly; (ii) treasury transactions (operaciones de tesorería) which mature in the same fiscal year on which they are incurred, and (iii) payment of the Republic's obligations arising from its membership in international financial institutions (e.g., Corporación Andina de Fomento and the IMF).
In addition, debt restructuring and refinancings that reduce interest payments, extend maturities, swap external debt for internal debt, reduce the Republic's outbound cash flows, generate NPV savings or otherwise benefit the Republic, are not subject to approval in annual indebtedness laws. The issue here is whether or not the foregoing transactions, which are clearly exempted from one form of legislative approval (i.e., approval in the annual indebtedness law) are also exempted from approval by the Permanent Finance Commission of the National Assembly, which is required for each specific transaction. We believe that the foregoing types of transactions do not require approval by the Permanent Finance Commission of the National Assembly. In effect, Chapter III of the Public Finance Law (which contains articles 87 and 88) refers to "transactions that do not require legislative approval". In addition, the intent of the Public Finance law is to give the Ministry more flexibility to enter into these types of transactions, which generally have short windows of opportunity —liability management transactions— -or are required by the Republic to cover temporary cash shortfalls (transactions maturing in less than one year). However, the matter is not entirely clear and to the best of our knowledge there are no precedents clarifying this issue.
The Republic may not grant security interests over its assets or revenue to guarantee its obligations under public finance transactions (art. 93, Public Finance Law). It is not clear if the Republic may grant security interests over assets located outside Venezuela pursuant to a foreign law. To our knowledge the Republic has never granted any such security interest in recent history. Moreover, we believe that any such security interest granted outside Venezuela would not be enforceable in Venezuela. The funds raised in public finance transactions may nevertheless be deposited in interest bearing offshore trusts or bank accounts, which may be used to pay the Republic's obligations under public finance transactions.
The Republic may not guarantee the obligations of third parties, unless such guarantee is authorized under the special regime for public works concessions or public services (art. 92, Public Finance Law).
Under the Public Finance law, the Republic's short term debt (e.g., debt maturing in less than 365 days) must be repaid in full upon maturity and may not be refinanced. This provision does not seem to bar the issue of new debt to repay maturing short term debt.
3. Central Bank Opinion
Under the Public Finance Law, the Republic must obtain a non-binding opinion from the Central Bank on every public credit transaction (art. 86, Public Finance Law). More specifically, the Ministry must request a non-binding opinion from the Central Bank on the "monetary impact" and "financial conditions" of each public credit transaction. The Central Bank has a five business day term to render its opinion, after the expiration of which the Ministry may go forward with the transaction even if the Central Bank did not render its opinion.
The issue of what happens if the Central Bank renders an adverse opinion seems moot because the opinion is legally non-binding. Again, here the political implications of an adverse Central Bank opinion should be pondered by the conservative banker or underwriter. It has been the case that the Central Bank renders opinions stating that the coupons of a specific issue of debt securities is higher than the spread over U.S. treasuries at which Venezuelan securities trade or that other terms are inconvenient to the Republic.
As mentioned above, the request for approval that the Ministry must submit to the Permanent Finance Commission of the National Assembly must enclose the Central Bank opinion. From a political standpoint, an adverse Central Bank opinion may not be helpful for legislative approval. We think that the Ministry can file its request for approval by the Permanent Finance Commission of the National Assembly without an opinion from the Central Bank is the aforesaid five business day term elapsed without the Central Bank having rendered its non-binding opinion. However, the matter is not entirely clear. In effect, Article 79 of the Public Finance Law states that the request for approval must be filed together with the Central Bank opinion "pursuant to the terms of article 86" which in turn states that after the five business day term has elapsed, the Ministry can go forward with the transaction. Therefore, we believe that if the five-day term has elapsed and the Central Bank has not rendered its non-binding opinion, then the request for approval with the commission may be submitted without the Central Bank opinion.
4. Foreign Currency Obligations. Exchange Controls
In general, the Republic is obligated to sell to the Central Bank at the applicable exchange rate all the foreign currency it raises from public credit transactions. This obligation is traditionally set forth in the annual indebtedness law. However, the Republic may instruct its lenders or the underwriters of its securities to use the proceeds from the financing to pay obligations of the Republic outside Venezuela pursuant to the annual indebtedness law. For example, the Republic may order a lender to use all or part of the funds being lent to the Republic to pay a foreign supplier of machinery and equipment to be purchased by the Republic in connection with an infrastructure project. The obligation to sell the foreign currency proceeds to the Central Bank exists even when there is an open market foreign exchange regime in Venezuela, as was the case until February 5, 2003.
5. Setoff and Netting
Under Venezuelan law, setoff (e.g., the settlement of reciprocal, liquid and matured debts to the extent of the smaller debt) operates automatically as a matter of law (art. 1332, Civil Code). There are several types of setoff, one of them being contractual setoff which like legal setoff consists of discharging reciprocal debts but by way of a contract. For example, two parties that have cross-claims against one another may agree to setoff both cross-claims even if one of the cross-claims is for example unmatured (compensación convencional).
Under the Venezuelan Public Treasury Law (Ley Orgánica de la Hacienda Pública Nacional) the Republic has immunity from setoff (art. 9). However, we believe that the scope of this immunity does not extend to the Republic's assets located outside Venezuela. Consequently, it may be interpreted that only the assets of the Republic located in Venezuela are immune from set off. In addition, we believe that the Republic's immunity from setoff as set forth in the Venezuelan Public Treasury Law, does not prohibit contractual setoff. Consequently, the Republic may validly agree to setoff cross-claims with other private or public entities by way of a contract. This is important for transactions entered into under the ISDA Master Agreement.
The Republic is not subject to Venezuelan insolvency law. The phrase "governments don't go broke" applies in Venezuela from a legal standpoint. In effect, Venezuelan insolvency law contained in the Commercial Code sets forth two sets of rules on insolvency: bankruptcy (quiebra) and moratorium (atraso), neither of which are applicable to the Republic.
7. Governing Law; Jurisdiction and Process Agents
Venezuelan courts will recognize the choice of a foreign law to govern the transaction documents of a public finance transaction with the Republic. Likewise, the choice of a foreign jurisdiction by the Republic in connection with a public finance transaction is enforceable in Venezuela. Nevertheless, this matter requires some explanation.
Article 104 of the Public Finance Law states that the Venezuelan Supreme Tribunal has jurisdiction over controversies arising from public finance transactions. However, Article 104 also states that the foregoing provision does not affect whatever agreements the Republic has executed in connection with choice of law and choice of jurisdiction, subject to article 151 of the Venezuelan Constitution.
Article 151 of the Venezuelan Constitution sets forth the famous "Calvo Clause", under which "public interest" contracts shall be governed by Venezuelan law and shall be subject to Venezuelan jurisdiction even if the contract is silent on choice of law and jurisdiction. However, article 151 also states that this "clause" shall be deemed as included in public interest contracts unless it is "contrary to the nature of the contract".
The Attorney General of the Republic (Procurador General de la República) has rendered administrative precedents for several decades stating that the execution, delivery and performance by the Republic of the documents involved in public finance transactions constitute acts of jure gestionis and, accordingly, the execution, delivery and performance of such documents constitute private and commercial acts as opposed to public or governmental acts (jure imperii).
Consequently, it was historically accepted that public finance contracts were not "public interest" contracts. However, a recent decision by the Venezuelan Supreme Tribunal (see Section 2(B) above) states that in general, public finance transactions are "public interest" contracts. Nevertheless, international financial transactions —specially with an emerging market borrower— need to be subject to the law and jurisdiction of an international financial center such as New York or London. From this viewpoint, the choice of Venezuelan law and jurisdiction would clearly be contrary to the nature of international financial contracts.
Therefore, based on the foregoing, we believe that the choice of a foreign law, foreign jurisdiction and the waivers of sovereign immunity by the Republic normally contained in the documents involved in public finance transactions (e.g., credit agreements, subscription agreements, dealer manager agreements, warrant agreements, fiscal agency agreements, calculation agent agreements, offering circulars, appointments of the process agents outside Venezuela, among other) are binding on the Republic and enforceable in Venezuela.
It is customary that the appointment of the Republic's process agents (e.g., London or New York) be made through a power of attorney granted by the Attorney General to the process agent and notarized in Venezuela (normally the Venezuelan consul general (New York) or the Ambassador (London) as the case may be). We understand that for the validity of the choice of New York law in New York, the appointment of the New York process agent has to be irrevocable. We are of the opinion that the irrevocable appointment of process agents can be made via a simple letter which does not have to be notarized. However, the practice has been to grant a formal notarized power of attorney.
8. Taxation of Lenders and Noteholders
Annual indebtedness laws traditionally include a provision that exempts from federal Venezuelan taxes all interest, capital gains and commissions arising from public credit transactions. Therefore, the holders of notes issued by the Republic and the Republic's lenders are not subject to Venezuelan income tax on the interest income they receive from the Republic. Any capital gains realized from the disposition of the Republic's debt would not be subject to Venezuelan income tax. Likewise, underwriters and investment banks are not subject to Venezuelan income tax on the commissions or fees they are paid in connection with public credit transactions.
The provision set forth in annual indebtedness laws is normally very broad because it exempts the Republic's creditors from all federal Venezuelan taxes (tributos nacionales), and there are no state or local taxes applicable to public credit transactions in Venezuela.
In addition, under the Venezuelan income tax law, interest paid on the Republic's debt securities and capital gains arising from their disposition are exempt from Venezuelan Income Tax (article 14(13), Venezuelan Income Tax Law). It is important to keep this article in mind in case the tax exemption normally included in annual indebtedness laws is not included in a given year. However, the exemption set forth in the Venezuelan Income Tax Law only exempts income arising only from the Republic's debt securities and not from other types of financings such as direct loans.
From time to time, the policy issue arises in the National Assembly of why should interest and capital gains arising from public credit transactions by exempted from Venezuelan income taxation. In the unlikely event that the foregoing exemptions are ever repealed, the standard tax gross-up and indemnity provisions of credit agreements and other financial documents are fully enforceable in Venezuela.
9. Persons Authorized to Execute Public Finance Contracts
The Minister of Finance is authorized under the Public Finance Law to execute the agreements involved in public finance transactions (art. 98). Venezuelan counsel should always confirm the designation of the Ministry by the President of the Republic in the Official Gazette and should not limit their review to the certificates of incumbency normally issued by the Ministry in public finance contracts. The Minister of Finance has the authority to delegate the power to execute public finance contracts on other officers of the Ministry. Venezuelan counsel should also confirm that the delegation by the Minister of the power to execute public finance contracts has been published in the Official Gazette, although it may be argued that an internal resolution of the Minister may suffice to delegate such powers.
Additionally, the President of the Republic has the power to designate persons other than the Minister of Finance to execute public finance contracts.
Copyright © 2004
Carlos Omaña A.
Caracas, June 2004
The content of this article does not constitute legal advice and should not be relied on in that way. Specific advice should be sought about your specific circumstances.