CONTROL - THEORY AND PRACTICE
Vieira Cenevica Advogados Associados and J. Paul Groom


INTRODUCTION

There have been a number of changes in the ownership of companies operating B-band and A-band concessions. Indeed, there have been many changes in share holdings, where few changes were expected, due to restrictions in the regulations.

There was always a concern that the size of the telecommunications concessions would be too large for Brazilian private sector companies. For businesses with an entrance fee of hundreds of millions of Reais, and at times billions of Reais, there were only a handful of Brazilian companies able to participate. This was due to the government operating most businesses requiring substantial capital as monopolies, such as steel production, telecommunications, petroleum etc. Therefore, many of the Brazilian companies that entered the bidding for telecommunications concessions did so hoping for sizeable support from the debt markets, and recognizing that privatization happens once a lifetime. Thus, the circumstances under which these companies participated in the bids did not encompass debt not being available, while cash flows from other businesses of these groups have been affected by recession. ( It in noteworthy that Inepar, one of the principal Brazilian participants in telecommunications from the State of Paraná, has suffered from this situation, and has been forced to sell its 50% participation in the B-band operator for Region 8. )

The result was a large number of shareholder changes that clearly did not comply with extant rules, and a gap between theory and practice has opened.

In recognition of these " extra-Government rules ", the government was recently obliged to issue a resolution reiterating its policy, but allowing some of the shareholding changes that heretofore had occurred, even if they did not conform to existing regulations. This review of the rules is occasioned by the pressures on ownership that have become apparent since the devaluation of the Brazilian currency, and the expectation that these pressures could result in the need to change the regulations further.


CHANGES IN EQUITY

Some of the changes in the equity distribution that have occurred are as follows:


B - Band
  • At the time of concession award, Primav, qualified under bidding rules as the Brazilian controlling party, and 40% owner of Tess S.A . the winner of the authorization to operate mobile cellular service in the interior of the State of São Paulo. Primav is a company controlled by Cecilio Almeida, whose primary business is civil construction, based in the State of Paraná. The actual shareholder composition of Tess will be resolved by the Agência Ncional de Telecomunicações - Anatel later this year, but an ugly situation has developed that inter alia includes the payment of certain monies to Cecilio Almeida by Telia to relinquish his 40% voting shareholder rights in Tess. Telia, the Swedish telecommunications operator, is a minority shareholder in Tess. The issue is whether the control of Tess passed to Telia, or a third party, even if temporarily, with the assignment of Primav's rights, the passing of which Primav now disputes. Telia, being a foreign company, cannot own more than 49% of a B-band operator and the equity distribution could not be changed before the execution of the concession contract.
  • RBS, a media company from the State of Rio Grande do Sul, purchased 6% of both the São Paulo metropolitan area operator, BCP, and its sister company BSE, that operates in a six state region in the North-East of Brazil. After a year of participating in the investment RBS left both consortiums, with their shares being purchased by existing shareholders.
  • The concessionaire in the States of Rio de Janeiro and Espirito Santo, ATL Telecom, saw the exit of the Korean operator SK Telecom, after the license had been awarded. Williams, an American telecom investor entered as a shareholder. Since becoming a shareholder of ATL, Williams has increased its shareholding to the maximum voting shares permitted for foreigners under the law at present, 49%, with a further stake in preferred shares. More recently, the civil construction company, Queiroz Galvão chose to leave ATL.
  • Globo has made it clear that it wishes to concentrate its focus on broadcasting and content rather than the means of communications and is interested in selling is 19.9% stakes in two B-band properties in the states of Minas Gerais and Bahia/ Sergipe held through the União Globo Bradesco.



THE RULES

The " Minimum Law "

The B-band bids were authorized by what became known as the Minimum Law . This law was passed to expedite inter alia the B-band bids and contributed little in terms of specific regulations relating to ownership, leaving more specific regulations to the request for proposals ("Edital") and rules ("Normas") issued by the Ministry of Communications ("Minicom"). However, in Article 11 it was stated that "concessions for mobile cellular service ?..may only be granted to companies formed under Brazilian law with headquarters and administration in Brazil". In the accompanying Sole Paragraph the ground was laid for a Brazilian voting majority for B-band concessions. "In the three years from the publication of this law the Executive Power may adopt limits to the capital composition of concessionaire companies ?to ensure that at least 51% of voting capital belongs to Brazilians". In article 12, the basic principles of "diversity of control", and "stimulating competition" were enunciated.


Norma # 20

On November 4th 1996 Minicom issued a series of General Telecommunications Rules. Among the documents was Norma # 20, regulating, mobile cellular service. Norma # 20 takes a very broad view of mobile cellular service providing rules for interconnection, numbering, principles of competition, definition of service areas etc. However, there is not a significant amount of discussion of control and ownership other than the important definition of what constitutes "affiliation" between two entities.

Norma # 20 states "a company will be considered affiliated to another if one holds, directly or indirectly, at least 20% of the voting capital of the other or if 20% of the voting capital of both companies is held, directly or indirectly, by the same company or person. In the situation where ownership participation is held in a successive fashion by a number of companies, the final value of ownership will be calculated by multiplying the percentages in each company in the chain". There is no further comment concerning ownership.


Decreto # 2056

This decree stated that "the transfer of the concession or corporate control of the concessionaire may only be authorized after the period of 60 months has elapsed, starting with the beginning of commercial operation of the service ".

Transfer of the concession, or corporate control of the concessionaire without approval of the government, would imply forfeit of the concession .


Edital - Auction # 001/96

On January 9th 1997 Minicom issued the request for proposals relating to licenses to operate B-band mobile cellular service. The Edital defined the following issues:

  • 51% of voting capital must belong, directly or indirectly to Brazilians.
  • Before contract signature, the winning consortium must form a company.
  • A concession would not be granted to a company or consortium whose corporate articles have been altered, arising from the transfer of quotas or shares.
  • Any transfer of shares or quotas that affects the voting equity distribution is prohibited.



In order to qualify as a bidder in the B-band auction the proponent was obliged to prove its experience in managing mobile cellular business as follows:

  • Have a minimum number of mobile cellular terminals in existence (the number varies with the size of the Region being auctioned) .
  • The number of terminals per consortium member with more than 20% of voting capital can be included in this calculation .



Mobile Cellular Concession Contract

Chapter XIII of the concession contract deals with Transfer of the concession.

  • Transfer of the contract is allowed as foreseen in existing law and regulations, five years after the beginning of commercial service, approval of the regulatory authority, and the payment of taxes .
  • An indirect transfer can occur when control of the company changes due to a sale of existing shares, or arising from an increase in capital which requires prior approval of the regulatory authority .
  • All companies wishing to acquire control through a transfer authorized by the regulatory authority must comply with all of the qualification goals that exist in the Edital.
  • Consortia "are obliged to maintain, to the end of the bid proceedings, the initial composition of the consortium, that must equally by followed, including, among others, the percentages of corporate participation in the company constituted ?.".


SUMMARY

The above regulations, taken from a number of sources, provide regulations that may be summarized as follows:

  • In government auctions between July 19th 1996 and July 19th 1999, the government may rule that 51% of voting shares must belong to Brazilians.
  • The period in which B-band control may pass to non-Brazilians is not specifically dealt with in the rules. However, 60 months after commercial operation and conditioned upon government approval, will be the time when foreigners may assume corporate control of B-band mobile cellular operators which currently have Brazilian majority voting control.
  • The rules make it clear that a bidding consortium would have to maintain its initial percentage composition from the date of delivery of bidding documents, April 7th 1997, to the date that the corporate entity is formed, upon winning a concession.
  • However, the issue of "percentage" participation in a company moves to the concept of "control" when dealing with changes in transfer of the concession or corporate control of the concessionaire. Control is not a precisely defined term in any rule, and has allowed various interpretations:

    1. One definition of "control" could be that of the initial ownership of a company, at the moment of executing the concession contract, without respect to percentages of ownership. In other words, if a company owns even 1% of a company it could be said to "control" that percentage and therefore control rests with the initial voting shareholders.

    2. "Control" could be the concept of 51% Brazilian voting shareholders.

    3. "Control" could mean at least 51% of voting shareholders no matter what their origin, provided that the 51% Brazilian ownership rule continued to be observed.

    4. The definition of "Control" could go beyond calculation of voting percentages to include shareholder agreements and other means to assert control, disproportionate to voting percentages.

    As we shall see, the regulations issued by Anatel on February 4th 1999 went further than previous documents in defining ?control.


PRIVATIZED COMPANIES

Changes

On March 29th 1999 the União Globo-Bradesco executed an option with Telecom Itália to purchase its 50% holdings in two cellular holding companies, Tele Celular Sul and Tele Celular Nordeste. The exercise of the option was subject to approval by Anatel.

Although not part of the bidding consortium, BNDES took a 25 % holding in Tele Norte Leste (now called Telemar), and has been procuring a purchaser for their participation.

Telecom Itália has made it clear that it wishes to sell its 19.9 % participation in Tele Centro Sul and look for a larger participation in another fixed wire line company or mirror company. At least so far Anatel has taken the position that Telecom Italia, with its partners in Tele Centro Sul, Banco Opportunity and certain pension funds comprises an Economic Group and cannot sell its participation.


The General Telecommunications Law

On July 16th 1997 Brazil?s telecommunications bill was signed into law by President Fernando Henrique Cardoso and became known as the General Telecommunications Law . The Minimum Law, passed a year earlier had authorized the existing public sector concessionaires to prepare for privatization through the separation of fixed wire line and mobile cellular assets into separate entities. The General Law authorized the executive branch of Government to ?promote the restructure and privatization ? of twenty-nine fixed wire line operating companies and their mobile cellular subsidiaries.

The law stated that privatization would occur through the sale of shares , and referenced the issuance of an Edital that would contain most of the terms and conditions of sale.


PRIVATIZATION EDITAL

The privatization Edital placed no restriction on foreign capital.

The Edital introduced the idea of the "Economic Group ". "An Economic Group is constituted by affiliated companies, will be understood as a company affiliated to another company that is:

1. directly or indirectly controlled by another company,

2. controlled , directly or indirectly by another company including by means of shareholder agreement,

3. holds, directly or indirectly, whatever shareholder participation in another company equal, or superior to, 20% of the voting capital of the other company.

4. in the same way as a company, has 20% or more of its capital held, directly or indirectly by the same person or company.

It will be seen that this definition is broader than the definition used for the B-Band, and is designed to restrict informal associations of companies that may be associated through shareholder agreements only.


Resolution # 101

Anatel clearly recognized the gap between theory and practice relating to transfer of ownership. To close this gap Anatel passed Resolution # 101, which did the following:

1. Provided a new definition of Control

2. Provided a definition of the operation of a company .

3. Provides circumstances under which a control relationship could exist between companies ,

4. Transfers that have been made, and which were not in conformance with existing regulations are to be allowed provided they are supported by legal instruments formally executed prior to February 4th 1999 .


CONTROL

The new definition of "Control" is "the power to drive, directly or indirectly, internally or externally, in fact or by law, individually or by agreement, the corporate activities or the functioning of the company .


OPERATION

The operation of a company is understood as, corporate planning, definition of economic and financial policies, technology, engineering, the market and prices, or the discount and reduction of tariffs .


RELATIONSHIP

The following circumstances will be considered as indications of Control that are forbidden by regulations:

a) Financing relationship,
b) Provision of guarantees,
c) Transfer of goods on terms and conditions different from those practiced in the market,
d) Provision of telecom services upon favorable terms,
e) An operational agreement that stipulates favorable conditions,
f) Common use of material, technological or human resources,
g) Contracting together to buy goods or services,
h) Existence of a legal document with the purpose of transfer of shares between providers or assignment of rights of preference concerning the reciprocal transfer of shares.
i) Adoption of a trade mark or marketing or advertising strategy in common.


CONCLUSION

Resolution # 101 does the job of trying to plug loopholes in the existing law by which parties may have been able to subvert the purpose of developing and maintaining diversity of ownership of telecommunications service providers.

The key issue is whether Resolution 101 replaced existing legislation as defined in the documents previously mentioned, or whether it provides rules and regulations in addition to those existing. In fact, the Resolution makes reference to five articles of the General Telecommunications Law, of which three are applicable to mobile cellular service and provide for the goals of diversity of ownership , effective competition , and Anatel's approval of any changes in control . Therefore, it may be interpreted that the new specific rules of Resolution 101, within the context of the previously mentioned goals, are the regulations to which investors must conform today. Previous rules, such as the 51% Brazilian voting control that was necessary for B-band bids at the time of bid, have now been superceded.

Questions have been raised concerning the capacity of Resolution 101, vis a vis the General Telecommunications Law and Brazilian Corporate Law, but no law suit has been filed so far.


However, Brazil has a number of problems:

1. The telecommunications regulations do not take into account the economic circumstances of the country, and the B-band requirement of 51% Brazilian ownership at a time when Brazilian GDP is declining, and foreign debt has not been available is creating practical ownership difficulties.

2. The dearth of competitors and the values paid for mirror licenses indicate that foreign strategic parties are unenthusiastic about Brazil at present.

3. That the few Brazilian parties that do have significant resources, such as the pension funds, which could create the type of concentrations that Anatel is trying to avoid.

Under these circumstances further changes will be required, and Anatel may have to recognize ex poste facto approvals for these changes, or the changes will occur in side agreements that do not form part of the public record and which are dangerous for all concerned.
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