The Shareholder Rights and Activism Review: Brazil
i General perception
It is a common perception that shareholder activism2 is still incipient in the Brazilian business environment. Activist campaigns are rare because, among the possible explanations (putting aside the implausible one that Brazilian companies are flawlessly managed and shareholders are completely satisfied with them), the typical capital structure of Brazilian companies makes activism ineffective; or the Brazilian regulatory framework on the subject offers few instruments to make activism worth its while. In this chapter, the potential causes will be analysed, without seeking to conclude whether corporate activism is a net positive or negative, and the above reasons (or a combination of them) will be considered to understand whether any of them justify the relative lack of activist campaigns in Brazil.
ii Are there too few targets for activist campaigns?
Currently, there is only one stock exchange in Brazil: the B3 (Brasil, Bolsa, Balcão). There are 455 companies listed on the B3, with 56 initial public offerings from the beginning of 2020 until the time of writing in 2021.3 Although that number is average among OECD countries, the general perception is that the Brazilian capital markets remain underdeveloped (the total market capitalisation in 2020 represented 65 per cent per cent of GDP4). This is perhaps due to the high interest rates historically paid by the Brazilian government, contributing to most investors preferring fixed income government debt,5 which (on a much smaller scale) was recently amplified by the flight of essentially Brazilian businesses to foreign stock exchanges due to the adoption of shareholder models that allow multiple voting (such as XP Inc, StoneCo Ltd and Pag Seguro Digital Ltd).
Another relevant factor is the capital structure of Brazilian companies. Historically, most Brazilian companies were controlled by families or small groups of shareholders linked by a shareholders' agreement. True corporations were less than a handful. This is changing and the proportion of pulverized control companies in the Novo Mercado listing segment of the B3 rose from 19 per cent in 2009 to 54 per cent in 2021,6 although (according to the Corporate Governance Yearbook of the Public Companies 2020–2021) from a sample of 150 Brazilian companies, only 6 per cent of the company's capital is dispersed (i.e., no shareholders hold more than 10 per cent of the shares).
Thus, despite the relative historical scarcity of opportunities for activism, Brazil's business environment may be moving towards a phase in which the equity structure of publicly traded companies allows for greater opportunities for shareholder activism. The following Section examines whether the law and regulations in force foster – or, conversely, discourage – activist campaigns.
Legal and regulatory framework
Brazilian Corporate Law (Law 6,404 of 15 December 1976, as amended) (BCL) and the regulations issued by the Brazilian Securities Commission (CVM) contain legal provisions available on the activist toolkit, such as relating to the supervision right, a very broad pre-emptive right that applies in any situation except, practically, stock option plans and public offerings,7 and the right to withdraw from the company in certain circumstances (such as mergers, changes in the business or changes to mandatory dividends).8
These broad principles give rise to a number of specific rights:
i Toolkit on shareholders' meeting
BCL sets forth that generally it is the board of directors that may call a shareholders' meeting. However, it also allows the shareholders and the fiscal council to call the shareholders' general meeting in certain cases. General meetings serve to dismiss and elect board and fiscal council members,9 make changes to the company's by-laws, determine guidelines for management, and initiate investigations, among other matters. In all such cases, shareholders must always exercise their voting rights in accordance with the company's interests and not their own.10
The fiscal council can call the shareholders general meeting (1) in case of delay of more than one month to call the annual general meeting by management, and (2) whenever the fiscal council identifies any serious or urgent reasons.11
Shareholders may also call general meetings if management does not call in 60 days or by shareholders representing at least 5 per cent12 of the share capital when (1) management fails to attend a call request made by shareholders within eight days, or (2) when a general meeting call requested by the fiscal council is not carried out by the management.
Even if minority shareholders are able to call meetings to discuss issues that may affect the company, there is no guarantee they will be able to form a majority capable of approving such resolutions, especially in companies with large shareholder groups that are friendly to management.
The BCL also allows shareholders to request the CVM to extend or interrupt the general meeting calling period. The extension is for up to 30 days from the date of disclosure of documents relating to such general meeting. The interruption is for up to 15 days to allow the CVM to review the proposals of the meeting and evaluate if they violate legal or regulatory provisions. Both tools are often requested to be used by minorities dissatisfied with proposals put forth by management or by controlling shareholders, and can serve as an effective pressure point if granted by the CVM, which is somewhat common but by no means guaranteed.13
ii Supervision and control
The shareholders also have the essential right of supervision, pursuant to Item III of Article 109 of the BCL. To this end, BCL created the fiscal council, a corporate body dedicated to the supervision of management and financial statements (shareholders can supervise management directly in some limited forms, such as reviewing corporate books).
The fiscal council can be composed of three to five members. Minority shareholders representing 10 per cent of the voting share capital (or shareholders holding non-voting capital, regardless of percentage) may elect one member each. The actual functioning of the fiscal council is optional, but shareholders may request it (provided they represent 10 per cent of the voting shares or 5 per cent of the non-voting shares).14
Although the fiscal council is a collegiate, members can act individually in supervising, denouncing, and requesting clarification to management.15 In practical terms, the fiscal council is an important instrument in improving transparency and oversight, especially in companies with controlling shareholders.16
iii Liability of the controlling shareholders and directors
An avenue often used by activists in Brazil is the threat of liability of the controlling shareholder or management for damages caused to the company or its shareholders, or both.
A controlling shareholder (Section 116 of the BCL) is one that holds the majority of votes at shareholders' meeting, and that has the power to appoint the company's directors and effectively uses such powers to direct the company's social activities.
The BCL sets extensive fiduciary duties to the controlling shareholder. The breach of such fiduciary duties constitutes an abuse of power and can give rise to liability of the controlling shareholder for losses and damages caused.
Claims for liability of controlling shareholder are somewhat rare in the activist scenario as the incentives are, mostly, skewed: claims will often generate little or no compensation to the shareholder that filed the suit and had to support its costs.
A currently more fashionable tool is found in Section 246 of the BCL, which sets forth the possibility of imposing liability to controlling companies. Shareholders representing 5 per cent or more of the share capital17 can start the suit (also even shareholders holding any number of shares, as long as they offer security for the costs and attorney's fees due in the event the action is dismissed18).
For this type of suit the BCL creates an economic incentive: a 5 per cent prize to the shareholder that starts the suit and 20 per cent for its lawyers, calculated on the compensation paid to the company. This claim is therefore more attractive to shareholders and has been used recently, for example, by the minority shareholders of Braskem SA, whose parent company (Odebrecht SA) admitted corruption. Certain shareholders of Braskem claimed that the corruption acts were a true abuse of control power held by Odebrecht and that Braskem was used as a means of obtaining undue benefits for Odebrecht managers, seeking compensation of 3.65 billion reais.
In addition to the civil liability of the controlling shareholder, the BCL provides for a specific suit for the liability of directors for breach of fiduciary duties. Such suit, provided for in Section 159 of the BCL, must be proposed by the company after a decision of the general meeting.19 If the company does not take any action after three months from the approval by the shareholders, then any shareholder may propose it. Shareholders representing 5 per cent20 of the share capital can file such suit if it has been rejected by the shareholders' meeting.21
iv Appointment of directors
Shareholders can and often do interfere in the management of companies by appointing members of the board of directors. Generally, directors are chosen by majority vote, but the BCL has two procedures for minority representation in the board.
The first of these is multiple voting (Section 141 of BCL). In such a procedure, the voting is done individually, not by slate, and the number of voting shares is multiplied by the number of candidates to the board. This enables shareholders to concentrate their votes on one or few candidates. Such voting must be requested by the voting shareholders that represent at least a certain percentage of the share capital (depending on the amount of capital stock of the company; in most Brazilian listed companies, the percentage is 5 per cent).
The second procedure is separate voting, which is intended for companies with a controlling shareholder. If a separate voting is requested, up to two additional directors may be appointed. One by voting shareholders representing at least 15 per cent of the capital stock (in Novo Mercado companies that have only voting common shares the CVM interpreted this provision of law to reduce the threshold from 15 per cent to 10 per cent) and the other by non-voting shareholders representing 10 per cent of the capital stock. If the shareholders with and without voting rights do not reach such levels, then they may unite and elect one director, provided that they represent, in aggregate, 10 per cent of the capital stock. This procedure is only available for shareholders that prove they held their shares for at least three months.
In any event, the controlling shareholder (if applicable) is granted the right to elect the same number of directors as the minorities plus one.
v Approval of management report and remuneration
An important procedure for mitigating the agency conflict between directors and shareholders is set forth in Section 152 of the BCL and determines that the management's compensation must be approved by the shareholders' meeting. This model established by the BCL since 1976 was a milestone at the time and is still advanced today.
The directors shall also submit to the approval of shareholders the management report and the financial statements. If the management report and financial statements are approved without reservations, then the management can no longer be held liable for past actions (except error, fraud, wilful misconduct or sham).22
For this reason, the members of management who are also shareholders cannot vote for the approval of the management report and financial statements.23 The CVM has recently interpreted such restriction to apply to entities controlled by a member of management.24
vi Conflict of interest
Section 115 of the BCL prohibits shareholders from voting in certain circumstances. In addition to voting for approval of their accounts if they are members of management, a shareholder cannot vote in any situations in which they may 'benefit particularly' or if they have conflicting interests with those of the company.
The 'particular benefit' is a lawful benefit but one that serves the interests of one or a group of shareholders and no one else. An example of what the CVM considered a 'particular benefit' was a proposed different exchange ratio (for the controlling shareholder) on a merger.25
The 'conflicting interest doctrine' is a contentious issue at the CVM. Historically, most decisions established that the shareholder is not prohibited from voting, but an analysis should be made of whether any vote cast was detrimental of the company after the event. CVM's recent position on the nature of the prohibition in this case is that there exists an absolute and previous prohibition on the exercise of votes by shareholders that have conflicting interests with those of the company.26
Thus, shareholders can use administrative and judicial methods to prevent votes that conflict with social interests from being cast. In cases where the controlling shareholder is in a position of conflict, the minority shareholders are able to decide on the specific resolution in which the controlling shareholder is prevented from voting.
Key trends in shareholder activism
The studies available27 show that shareholder activism, although reduced, has been growing in Brazil. Despite the improvement in the governance of the listed companies, which tends to reduce the activism from the shareholders,28 especially institutional shareholders have conducted activist campaigns against Brazilian companies. As expected, the activism, when related to the management of the companies, tends to target less efficient Brazilian companies,29 whose returns are only observed two to four years after the activism event. However, there is consistent activism from those investors when related to M&A transactions, such as the examples described in Section IV. In these cases, the main source of activism is the shareholders of the M&A target company, who strive for short-term aims (i.e., to ensure the enforcement of legal protections for shareholders during such transactions, as well as to get the highest possible price). In any case, there are a number of tools available to the shareholders, such as: (1) requesting extension or interruption of the general meeting calling, which is especially used with M&A transactions; (2) seeking claims against managers or controlling shareholders, or both; (3) requesting fiscal council and electing a member; (4) requesting cumulative voting to increase the chances of managers appointment by minority shareholders; and (5) pursuing a court order for corporate books disclosure. In a brief, these tools are usually used in two main strategies: (1) organising shareholders to voice concerns; and (2) threatening or taking legal action before CVM or Brazilian courts.
Recent shareholder activism campaigns
To illustrate recent activism campaigns, two cases are presented that occurred in 2020–2021 and that exemplify the types of issues that shareholders face in Brazilian public companies. These are by no means exhaustive of what an activist may find in the Brazilian market.
On 11 August 2020, Linx SA (Linx) released a material fact communicating the market of the execution of an association agreement with STNE Participações SA, a company controlled by STONECO LTD (StoneCo), then the latest Brazilian company listed on Nasdaq. The association agreement consisted of the integration of the activities of STNE and Linx by means of a merger of all shares issued by Linx into StoneCo's corporate structure.
However, the transaction was questioned by Linx's minority shareholders due to non-compete agreements executed by Linx's founders and managers (who held approximately 14 per cent of the company) and the offer to the founder and Linx's CEO Alberto Menache to continue working as CEO of the company. According to Linx's investors, the non-compete agreements and work offer represented a disguised control premium of approximately 30 per cent for the founders and, in the case of Alberto Menache, approximately 60 per cent.
In addition, the breakup fees applicable to Linx (initially set in the association agreement at 605 million reais and 151 million reais in the event of (1) breach of exclusivity and contracting of a competing transaction; and (2) total or partial non-approval in a way that made the transaction unviable by Linx's shareholders) were also questioned by minority shareholders, Totvs, which entered the dispute for the acquisition of Linx, claiming that these fines were illegal. Subsequently, the largest fine was reduced to about 454 million reais, and the fine for failure to approve the shareholders' meeting was waived by StoneCo, after B3 decided that the decision to leave the Novo Mercado could not result in a fine for Linx.
As a result of the proposal made to Alberto Menache and the non-compete agreements entered into, the founders of Linx asked for a position from the CVM on whether there was a conflict of interest and, consequently, whether they would be prevented from exercising their votes at the meeting that would resolve on the transaction. The initial response from the CVM was that there would be a conflict of interest and the founders would be impeded from voting at the meeting. However, in an appeal filed by the founders, the CVM board understood, by majority vote, that there was no conflict of interest and, therefore, they would be qualified to participate in the meeting. In addition, the CVM rejected requests for postponement and interruption of the shareholders' meeting deadline.
Despite achieving important victories during the course of the negotiations, StoneCo still pulled out the final stops a few minutes before the scheduled time for Linx's shareholders' meeting to be held. StoneCo confirmed the additional payment of 268.6 million reais in cash, bringing the offer to approximately 6.8 billion reais and ending the conflict with Linx's minority shareholders.
ii Gol/ Smiles
On 7 December 2020, Smiles Fidelidade SA (Smiles), management company of frequent flyer programmes, responded to the proposal made by GOL Linhas Aéreas Inteligentes SA (Gol), an airline company and its controlling shareholder, announcing the merger of their shares. The transaction, if implemented, would result in the migration of Smiles shareholders who so elect to the combined shareholder base of GOL and Smiles, and the cash redemption of those who choose not to migrate.
However, Gol's proposal for the merger of Smiles ended up causing disagreement among some of Smiles' minority shareholders and Gol. Minority shareholders stated that was an undervaluation of Smiles, criticising the value presented by the airline company, and the purposes of the transactions, with Smiles once holding a good financial position and Gol facing the covid-19 aviation crisis. In addition, due to the controlling relation between Gol and Smiles, the transaction should have had the approval of a majority of Smiles' free-float shareholders, which allowed minority shareholders to increase their pressures on Gol.
In return, and intermediated by the minority shareholder Esh Capital, Gol carried out a relevant improvement of the offer during the shareholders' meeting that decided on the transaction. In addition, in the merger protocol there was a loophole for Gol to improve the value of the proposal without the need to add to the document. In practice, this created space for Gol to improve the offer hours before or during the shareholders' meeting, being the same mechanism that allowed StoneCo to increase the proposal to acquire Linx, hours before the shareholders' meeting.
On 4 June 2021, the transaction completed.
In 2020, CVM has issued Instruction 627/2020 to facilitate activism by reducing the minimum percentages for the exercise of certain rights. According to CVM's study,30 the new rule would encompass 77 per cent of publicly held companies in Brazil and more than 64 per cent of Brazilian companies would have a reduction of at least 1 per cent on the percentage required for the exercising of rights. However, it's important to highlight that CVM has also started proceedings against short activists (in the IRB/Squadra matter). Activists eagerly wait for a resolution of such a matter to get guidance on potential limits to their actions.
Besides that, the president of the republic issued a provisional measure, which was amended and approved as a bill by the House of Representatives, with changes that may have a relevant impact on corporate activism in Brazil. The bill provides for changes in the BCL, such as: (1) the creation of dual-class shares (which means the attribution of different voting numbers between classes of shares) for unlisted companies; (2) the approval of substantial sales of assets and transactions between related parties that represent more than 50 per cent of the company's assets to be submitted to the approval of the shareholders; (3) prohibiting publicly held companies from accumulating the position of chair of the board of directors and the position of CEO or main executive of the company; and (4) increasing the period for convening shareholders' meetings from 15 to 21 days. Currently, the bill awaits approval by the federal Senate and, if approved as is, may increase the shareholder activism in Brazil since, on the one hand, it increases the powers of the general shareholders' meeting and allows for a longer mobilisation period, and on the other hand, it may generate a greater concentration of shareholder power through the creation of the dual-class shares system.
There seems to be no empirical evidence to suggest (one way or another) that the levels of activism in Brazil are low due to the excellent management of the companies. However, despite the increase in the number of companies without a majority controlling shareholder, true corporations are still rare in Brazil. Thus, the capital structure is still a relevant obstacle to the emergence of activist campaigns.
The activist toolkit certainly looks robust in terms of legal instruments available, but the reality is that the measures to convene meetings and to hold directors and controlling shareholders accountable will rarely make sense from a cost-benefit perspective. This is because they will depend on a long and exhaustive judicial processes (in which management can access the funds of the company itself), while the fruits of these campaigns are, in the most part, destined for the company or divided among the other shareholders, which generates a strong disincentive to activism.31
Conversely, the mechanisms for minority shareholders to contribute to the composition of the board of directors through multiple voting and separate elections are an effective way of allowing shareholder participation. Furthermore, Brazilian law has a powerful alignment incentive in relation to the definition of management remuneration, which may prevent the extraction of private benefits and reduce agency conflicts, particularly in true corporations.
1 Lior Pinsky, Levi Santos and Victor Meneguelli are partner, junior associate and legal assistant at Veirano Advogados, respectively. The authors would like to acknowledge Robson Barreto's valuable input to this chapter.
2 For the purposes of this chapter, we consider shareholder activism from three main angles: (1) shareholders' intervention in the management of the company, especially by defining the composition of the board of directors; (2) supervision of the acts of the directors; and (3) liability of the controlling shareholders and directors who cause damage to the company and its shareholders.
3 According to B3 data available at: <http://www.b3.com.br/pt_br/produtos-e-servicos/negociacao/renda-variavel/empresas-listadas.htm>.
4 OECD. Corporate Governance Factbook 2021, p. 28, available at <https://www.oecd.org/corporate/Corporate-Governance-Factbook.pdf>. In countries where there is more than one stock exchange, only the one with the largest number of listed companies was considered.
5 Since November 2016, the base interest rate in Brazil was progressively lowered (currently at 4.25 per cent per year), which prompted a mass migration of investors to the stock markets (the number of investors holding shares in Brazilian companies has risen from 500,000 in 2016 to 3.2 million on December 2020).
6 According to a series of studies conducted since 2005 by KMPG with about two hundred Brazilian companies available at the following links <http://www.kpmg.com.br/publicacoes/estudo_gc_2010_final.pdf> and <https://assets.kpmg/content/dam/kpmg/br/pdf/2021/03/governanca-corporativa-mercado-capitais.pdf>.
7 Even a non-registered public offering (similar to a 144A offering in the U.S.) pursuant to I-CVM 476, the pre-emptive right can only be waived if the existing shareholders are granted priority rights in the offer (Section 9-A).
8 The withdrawal right has been reduced by (1) a legal reform (since 2001, it is no longer available for shares that have liquidity (i.e., form part of the IBOVESPA or IBRX index) and dispersion (i.e., the controlling shareholder holds less than 50 per cent of such shares); or (2) by interpretation by the CVM (since the shareholder may, at the limit, sell his position in the stock exchange). For example, CVM has decided that 'minor' changes in the business purpose of companies do not give rise to the right to withdraw (RJ2015/3074, SEI Case 19957.000175/2018-83), but only to substantially modify the business purpose.
9 Section 122 of the BCL.
10 BCL, Article 115.
11 Section 123 of BCL.
12 According to CVM Instruction 617, this percentage can be reduced to (1) 4 per cent if the company's share capital is between 100 million reais and 1 billion reais; (2) 3 per cent if the company's share capital is between 1 billion reais and 5 billion reais; (3) 2 per cent if company's share capital is between 5 billion reais and 10 billion reais; and (4) 1 per cent if the company's share capital is higher than 10 billion reais.
13 The CVM will often grant an extension in cases where it found an omission of relevant information necessary for the meeting (Proceedings SEI 19957.011269/2017-05; RJ2012/3718 and RJ2012/3718) and will authorise the interruption when there is clear evidence of illegality (the CVM has recently denied this in a number of situations, such as in cases RJ 2007/14245, RJ2009/2905, RJ2003/5352, RJ2009/3455, RJ2015/12295, RJ2015/12383, RJ2013/5608, 19957.000716/2019-54, RJ2014/3059, SEI 19957.007756/2018-46 and SEI 19957.007885/2018-34).
14 Instruction 324/2000 of the CVM.
15 See art. 163, item I. Lazzareschi (2012, p. 541) and Eizirik (2016, Vol III, p. 200).
16 EIZIRIK (2015, Vol. III, 198) highlights that the fiscal committee constitutes the internal, organic and institutionalised instrument for the exercise of supervision by the shareholders.
17 This percentage can be reduced according to the company's share capital, as mentioned above in footnote 13.
18 Some of the ongoing claims based on Section 246 of the BCL argue that the requirement to post security is illegal as it disincentivises smaller minorities to exercise their rights. The law on this is not yet settled.
19 LUCENA, José Waldecy. Das Sociedades Anônimas – Comentários à Lei. Rio de Janeiro: Renovar, 2012, p. 601.
20 This percentage can be reduced according to the companies' share capital, as mentioned above in footnote 13.
21 Section 159, § 4º of the BCL and Section 2 of CVM Instruction 627/2020.
22 The Sadia case illustrates this well. Sadia – the largest food processing company at the time in Brazil - famously lost 3.8 billion reais in 2008 with leveraged exchange rate financial derivatives. The company tried to sue its former CFO based on Section 159 of BCL, but the suit was ultimately rejected by the courts (including the STJ) because the shareholders had approved the management report of the year into which the derivatives had been entered.
23 Sections 115,134, § 1 and 156.
24 Specifically, the CVM barred entrepreneur Eike Batista to act in public companies for five years for violation of Section 115, § 1 of the BCL. Eike was chairman of the board of directors of Óleo e Gás Participações SA and also a shareholder through two companies (Centennial Asset Mining Fund LLC and Centennial Asset Brazilian Equity Fund LLC). Such companies voted favourably to approve the management report of the company, something that was common at the time. The bar was later reduced to a fine of 500,000 reais after Eike appealed to the Appeal Council of the National Financial System (CRSFN).
25 The landmark case is Duratex/Satipel. The ratio that was proposed to Duratex common and preferred shares held by minority shareholders was lower than that proposed to the shares held by the controlling shareholder of Duratex. The CVM decided that the proposal was legal, but that Duratex's controlling shareholders were prohibited from voting in the merger, and Duratex would have to call a special meeting of preferred shareholders to resolve on the transaction.
26 According the CVM position in Administrative Proceeding RJ2209/13179.
27 See the studies 'Recent activism initiatives in Brazil' (2018), 'Shareholder Activism Impact on Efficiency in Brazil' (2019), 'The Role of Institutional Investors in Promoting Good Corporate Governance Practices in Latin America: The Case of Brazil' (2008), and 'Governança Corporativa: Fator Preponderante no Ativismo de Acionistas no Brasil' (2020).
28 See 'Governança Corporativa: Fator Preponderante no Ativismo de Acionistas no Brasil' (2020), available at: <https://www.scielo.br/j/rac/a/3cSCzt5HjgG8gBFqGBDhdRt/abstract/?lang=pt>.
29 See 'Shareholder Activism Impact on Efficiency in Brazil' (2019), available at: <https://www.amecbrasil.org.br/wp-content/uploads/2018/04/Recent_activism_initiatives_in_Brazil.pdf>.
30 The study is named 'Conditions for Shareholders' Attendance in Meetings of Public Companies' and is available at: <http://www.cvm.gov.br/export/sites/cvm/menu/acesso_informacao/serieshistoricas/estudos/anexos/Criterios_para_a_participacao_de_acionistas_em_assembleias_de_companhias_de_capital_aberto.pdf>.
31 Also, on 22 June 2020, Petrobras disclosed that an arbitral panel determined that Petrobras will reimburse certain shareholders for the depreciation of their shares due to Petrobras' managers acts of corruption. Petrobras continues to fight this decision and did not provide more details about the case (arbitration claims are generally confidential in Brazil), but this shows that shareholders are starting to get more creative in terms of going after their rights.