Exercise of Shareholder Control Over a State Owned Enterprise - Comments on Comissão de Valores Mobiliários’s decision in the Eletrobras case

The Comissão de Valores Mobiliários (CVM), the Brazilian equivalent of the SEC, has recently imposed sanctions on the Federal Government for actions taken as the controlling shareholder of the public company Eletrobras. More precisely, the sanctions were imposed on the Federal Government for voting in a general meeting to grant approval of an Elecrobras significant transaction. CVM considered that the Federal Government had a conflict of interest and should have abstained from voting in a shareholders’ meeting called to approve the renewal of the concession contract held by Eletrobras and its subsidiaries for electrical power generation.

 In Brazil, the Federal Government is also the public authority responsible for regulating the electrical sector. According to CVM, the renewal of the concession contract for electrical power generation was a related party transaction that could bring indirect economic benefits to the Federal Government.

My paper criticizes CVM’s approach, arguing that the contract renewal was a legitimate public policy decision in the context of the electrical sector as a whole.

 The general corporate law in Brazil (Law 6.404/76) encompasses state owned enterprises (SOEs), albeit making some exceptions in Chapter XX. Article 238 sets out the main difference in legal treatment concerning SOEs as compared to privately owned ones. It acknowledges the presence of a peculiar public interest in each SOE, namely the public interest that justified its creation as a legal entity.

The public interest mentioned in article 238, by itself, should have been enough to sustain the managerial decision taken by Eletrobras. In other words, there was no need to call a general meeting. Eletrobras’ board of directors could have decided by itself to renew the contract without invoking any financial advantages to the company.

 The assessment of the public interest in each situation follows the same business judgment rule rationale. The main issue is not the merit of the decision, but its adherence to some procedural requirements. The directors should balance the SOE’s various priorities and come to an informed decision,  in good faith and without a conflict of interest.

 In making a business decision, the board of directors is not bound to seek profit maximization, although it cannot ignore a decision’s financial consequences for the SOE’s general performance. It is crucial that the implementation of a public policy by an SOE does not jeopardize its financial sustainability in the long run. To ensure that this requirement is met, the total business return rate should cover at least the company’s WACC (Weighted Average Capital Cost).

 Since the SOE’s purpose encompasses the public interest (in the specific sense explained above), the director’s fiduciary duties also have a broader meaning. The directors do not need to receive explicit guidance from the State, as controlling shareholder, to be able to act in favor of the public interest, provided their actions adhere to the SOE’s institutional objectives.

 Even in  the current case,  where the board of directors  decided to submit the subject to the general meeting, the Federal Government should not have been barred from voting. Otherwise, the general meeting of Eletrobras would have been unable to grant the approval of the contract renewal and consequently to ensure the implementation of the desired public policy. In the SOE operational context, it does not make sense to transplant the same rules of conflict of interest applied to the controlling shareholders in privately owned enterprises.

To become a real conflict of interest for the State, as controlling shareholder, to vote in the SOE shareholders’ meeting, the existence of a potential economic benefit is not enough. The economic benefit for the State will appear in almost any public policy enterprise decision, since it usually transfers costs from the public budget to the SOE budget.

In fact, to establish the existence of a conflict of interest in these cases, the economic benefit for the State must be autonomous and not merely ancillary to a specific public policy. Additionally, the deliberation must bring to the State a peculiar advantage as a shareholder as compared to the treatment given by the company to other shareholders.

Mario Engler Pinto Junior is a Professor and Assistant Dean for Professional Master Program at FGV Law School – São Paulo.