Gabriel Rios Corrêa and Juliana Carvalho de Azevedo *

On June 28, 2013, the Brazilian securities and exchange commission (Comissão de Valores Mobiliários - CVM) enacted Instrução 535, amending Instrução 391, which regulates the organization of Fundos de Investimento em Participação - FIPs, also known as Brazilian private equity funds.

The FIP is a fund dedicated to investments in shares, debentures, warrants and other securities convertible into or exchangeable for shares issued by publicly held and closely held companies. It differs from other investment funds on a crucial aspect: the FIP may only invest in companies in which it holds decision-making powers.

The new Instrução 535 changed certain rules of Instrução 391 related to the operation of FIPs. The most important change was made in item III of Section 35 of Instrução 391. This item previously provided that FIPs were prohibited from granting guarantees to obligations undertaken by third parties, even if the third party was a company controlled by the FIP. According to the change introduced by Instrução 535, a FIP may now grant guarantees if permitted under its by-laws and the specific guarantee is approved by 2/3 of the FIP’s units. In addition, the FIP administrator must adopt mechanisms to give notice of granted guarantees to potential investors of the FIP. For such purpose, the FIP administrator must at least publish a note in newspapers with information on the granted guarantees and post this information on its website.

Although the FIP came to be one of the most used vehicles for PE&VC investments in Brazil (specially for its favorable tax treatment), the FIPs’ activities and their use as vehicles in private equity transactions were restrained by the prohibition set forth in the original wording of item III of Section 35 of Instrução 391. In 2012, three FIPs administered by Votorantim Asset Management DTVM Ltda. had to face the potential constraints of the revoked rule. The three FIPs presented an irrevocable offer for the acquisition of a 60% stake in a company named Eólica Faísa S.A., which is developing five wind power plants in the State of Ceará, Brazil, known as Complexo Eólico Faísa. According to the CVM’s website, the project for construction and operation of the wind power plants would be financed by development banks. As customary in financial transactions, these banks required the FIPs to guarantee Eólica Faísa’s obligations under the loan agreements. The guarantee package would include an aval (a personal guarantee), the fiduciary assignment of financial investments and the pledge of the company’s shares held by the FIPs.

Despite the prohibition, Votorantim called a meeting of investors of the three funds and the investors approved the guarantee package by unanimous vote. Subsequently, Votorantim, acting on behalf of the FIPs, filed with the CVM a request for exemption of compliance with item III of Section 35 of Instrução 391.

The three FIPs administered by Votorantim were not the only ones that had to tackle this problem. During the past years, many FIP administrators submitted to the CVM exemption requests to obtain a waiver of the same rule. Given the impacts of this restrictive rule, on many occasions (including when deciding Votorantim’s request), CVM waived the applicable legal restriction when proven that 100% of the FIP’s investors approved the guarantees and the administrator adopted mechanisms to give notice of the existence of such guarantees to future potential investors of the FIP.

In view of the great number of exemption requests, in December of 2012 the CVM called a public hearing to discuss the amendment of Instrução 391 with market participants. According to CVM’s original proposal, the FIP administrator would be allowed to provide guarantees on behalf of the FIP if previously authorized by all of the fund’s investors. Additionally, following CVM’s prior decisions on the matter, the proposal established that the administrator would have to inform future potential investors of the existing guarantees given by the FIP.

During the public hearing, many investors, lawyers and advocacy groups such as ABVCAP (Associação Brasileira de Private Equity & Venture Capital) and ANBIMA (Associação Brasileira das Entidades dos Mercados Financeiro e de Capitais) submitted to the CVM counterproposals, a significant number opposing the unanimous vote requirement for the approval of the granting of guarantees. The CVM took these counterproposals into account and modified its original proposal upon the enactment of Instrução 535, allowing guarantees to be granted by FIPs with the approval of investors holding at least 2/3 – instead of all – of the FIPs’ units.

Fund managers, investors and market agents generally agree that the amendment of Instrução 391 is highly important for the development of the private equity market in Brazil. It is expected that this change will make it faster and easier for FIPs to grant guarantees, since the exemption request to CVM will not be required and the administrator does not have to obtain approval of all the investors. The supermajority vote requirement of 2/3 of the investors, however, is still high and will require FIP managers and administrators to be proactive when trying to approve the granting of a guarantee that is necessary to secure a deal for the fund.

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* Gabriel Rios Corrêa and Juliana Carvalho de Azevedo are respectively partner and associate of Lobo & Ibeas Advogados.