The Ecuadorian Business Optimization and Corporate Governance Act: A Milestone in Latin American Company Law

Since 2020, Ecuador has been implementing the most ambitious corporate law reforms Latin America has observed in the past decades. Recently, the Ecuadorian National Assembly enacted the Business Optimization and Corporate Governance Act 2023 (the Act), which reformed the Ecuadorian Companies Act to eliminate transaction costs for the benefit of entrepreneurs and businesspeople and modernise the corporate governance framework in the country.

Among those ambitious reforms, the Act allows the incorporation of companies with a single shareholder and provides the alternative to file the instruments of incorporation through private documents, eliminating the obligation to certify those documents before a notary public. Furthermore, the recent regulation, following the model of the Directive 2017/1132 of the European Union, has also restricted the absolute effects of the ultra vires principle, by determining that any act executed by the company shall be binding upon it, even if those acts do not fall within the objects of the company. These reforms were implemented to remove barriers to forming legitimate businesses, eliminate restrictions on the company's contractual capacity, and protect third parties that, bona fide, executed contracts with companies.

From a corporate governance standpoint, the Act has implemented several reforms to promote a more efficient corporate direction and control system. For example, following Martin Gelter’s recommendations, Ecuador redefined its regulation of derivative actions. As a result, the Act eliminated the provision that required a qualified minority of shareholders to file a claim on behalf of the company. Therefore, under the current regulation, any shareholder of the company, regardless of his shareholding, is allowed to file a claim on behalf of the company when the company’s representatives did not pursue those actions after a month of the corporate decisions (or either directly, without requiring approval of the filing from the shareholders’ general meeting, when the claim is based on a breach of the duty of loyalty). Besides, the Act also allows the filing of a derivative claim not only against the company’s directors but also against controlling shareholders when they acted in breach of their corporate obligations (for example, when they abused their voting rights or when they engaged in a related-party transaction, without the approval of a majority of the minority shareholders of the company).

The Act also empowered minority shareholders. First, concerning related-party transactions, the Act gave minority shareholders significant decision rights by imposing the majority of the minority system to approve certain transactions between the company and its controlling shareholders. Also, when a related-party transaction claim is filed, the burden of proof is imposed on the defendant controlling shareholder, who will have to demonstrate that the operation was conducted in normal conditions and without an unjustified privilege. Furthermore, from the perspective of a trusteeship strategy (instituting a neutral decision-maker to reduce conflicts of interests of corporate insiders), the Act determines that minority shareholders can appoint at least one independent director. Also, minority shareholders are allowed to request the Superintendence of Companies (the Ecuadorian public agency that controls, inter alia, the incorporation, operation, and liquidation proceedings of Ecuadorian companies) to convene a general meeting if the company’s directors do not call it, under the petition of the minority shareholders. These provisions seek to mitigate the agency problems arising between controlling and non-controlling shareholders in Ecuador, due to private benefits of control obtained by controlling shareholders at the expense of their non-controlling counterparts.

Fourth, Ecuador abolished the ‘capitalize or liquidate’ rule, which had been applied since 1964. As mentioned in an earlier post, under article 198 of the previous Ecuadorian Companies Act, corporate directors, under their general duty of diligence, had an obligation to call a shareholder's general meeting in the event that qualified losses rose to at least 50% of the company’s legal capital. Failure to comply with this procedure could result in the company's liquidation ordered by the Superintendence of Companies. This requirement was detrimental to companies dealing with financial difficulties but still having an economically viable business since Ecuador's minimum capital requirements are nominal (including the so-called sociedades anónimas, which only require $800 as their minimum legal capital and, as a result, have to comply with this procedure when they register $400 or more of operational losses). Besides, some authors have argued that the ‘capitalize or liquidate’ rule a) is incompatible with the limited liability principle, b) is inefficient because it penalizes risk-taking and c) is based on an unreliable balance sheet measurement, which may significantly differ from the company's actual economic value.

Fifth, the Act provides a modern regulation of corporate groups. To begin with, the Act determines that a corporate group’s existence depends on the subsidiary company's subordination (based on proprietary, contractual or factual control exercised by its parent company) and on the unity of purpose and direction. According to the Act, a corporate group may not result solely from corporate control. It also needs to have a single purpose guiding all the companies forming the group. That purpose, established by the parent company and assumed by the subsidiary companies, has to promote the interest of the group as a whole instead of those of single companies. The Act has established several regulations to be observed once a corporate group is formally recognized by the Superintendence of Companies (either ex-officio or upon the parent company’s request). For example, a subsidiary company will be banned from acquiring ordinary shares issued by its parent company. Also, while subsidiary companies are deemed to be independent legal persons, their parent companies may face secondary responsibility for the subsidiaries’ unpaid obligations if the insolvency of the subsidiary company arose from an irresponsible financial interference of the parent company. These provisions protect corporate creditors from opportunistic behaviour through corporate groups.

The Ecuadorian corporate reforms, which began in 2020, have constituted a milestone in Latin American company law. These reforms will create several benefits in Ecuador because they will mitigate agency problems in Ecuadorian firms more expediently and remove obstacles to establishing and operating corporations in Ecuador. Besides, from a policy standpoint, the reforms will promote entrepreneurship, innovation and economic growth through efficient regulations allowing Ecuadorians to conduct their businesses under a more precise framework, implemented to safeguard shareholders’ investments and to promote business formalization.  We expect that these reforms will encourage other Latin American legislators to modernize their corporate law frameworks, since efficient corporate law can be a powerful mechanism to promote the region’s progress.

Paúl Noboa-Velasco is a Lecturer in Corporate Law at San Francisco de Quito University, a Partner at Equity Abogados and the Academic Coordinator of the Ibero-American Institute for Law and Finance.