Law and Business Review of the Americas

VOLUME 21 WINTER 2015 NUMBER 1

TABLE OF CONTENTS

PERSPECTIVE An Ethical Analysis of the 2014 FIFA World Cup in Brazil Arjyo Mitra...... 3

ARTICLES Pre-Merger Analysis in Brazil: First Round (2012-2014) Carlos Emmanuel Joppert Ragazzo and M´ario Sergio ´ Rocha Gordilho Jr...... 23

Puerto Rico: America’s Tax Haven or Vacation Paradise Jason Sampas ...... 49

CASE NOTE Past Due: An Introduction to Sovereign Debt, the Ongoing Dispute Between NML Capital and Argentina, and Possible Ramifications of the Dispute’s Outcome Jamison Joiner ...... 85

UPDATES Best Business Practices: The Next Weapon of Terror in Argentina Tony Godfrey ...... 101

Trans-Pacific Partnership–Is it Really “NAFTA on Steroids?” Natalie Sears ...... 107

Succession to the Throne and the Canadian Charter of Rights and Freedoms Christopher Cornell ...... 115 Editorial and Submission Policies: should ensure that the significance of a con- tribution would be apparent to readers This journal is a quarterly, professional outside the specific expertise. Special terms peer-reviewed publication produced by the and abbreviations should be clearly defined Southern Methodist University Dedman in the text or notes. School of Law’s International Law Review Accepted manuscripts will be edited, if Association (and its Law Institute of the necessary, to improve the journal’s effec- Americas), as well as the Section of Interna- tiveness of communication. If editing tional Law and Practice of the American should be extensive, with a consequential Bar Association). The journal relies on the danger of altering the meaning, the manu- ongoing cooperation of the SMU School of script will be returned to the author for ap- Business, the SMU Departments of Eco- proval before type is set. Alternatively, the nomics and Political Science, and the manuscript may be returned to the author London Forum of International Economic to address the deficiencies. In all events, the and Financial Law at the Centre for Com- editors reserve the right, after discussion mercial Law Studies at Queen Mary Col- with the author, to change its acceptance de- lege, University of London. cision, or to move a publication from one is- Aims and Publication Policy: sue to a later or earlier issue. The editors will not accept unsolicited student-written This journal addresses the legal, business, submissions, nor will they consider articles economic, political and social dimensions of or reports that have been, or are to be, pub- Western Hemispheric integration efforts lished elsewhere, or materials prepared for (e.g., NAFTA, FTAA, MERCOSUR, etc), one’s clients or business promotion. their implementation, their future evolve- Manuscripts submitted for publication ment and expansion, and their overall im- should be submitted in duplicate with a pact on doing business in the Americas. cover letter summarizing the contents to: The journal will combine practical and policy implications of these integration Editor-in-Chief processes. As such, it will cover not only LAW AND BUSINESS REVIEW OF THE AMERICAS matters of immediate concern and interest, Southern Methodist University but also matters respecting reform of legal, Dedman School of Law business, economic, political and social P.O. Box 750116 structures (including human rights, gender, Dallas, Texas 75275-0116 labor, and environmental issues) within the [email protected]. various countries in the Western Hemi- At the time the manuscript is submitted, sphere. Subject matter concerning other re- written assurance must be given that the ar- gional integration efforts in the world and ticle has not been published, submitted, or various other comparative topics in the in- accepted elsewhere. The author normally ternational trade and investment areas will will be notified of acceptance, rejection or also be addressed, from time to time. need for revision within 8-12 weeks. However, topics of particular concern to Manuscripts may range from 6,000 to the journal will include: (1) free trade, direct 10,000 words (approximately 20-30 pages in investment, licensing, finance, taxation, la- length). However, longer articles are ac- bor, environmental, litigation and dispute cepted based upon topic, quality, and space resolution, and organizational aspects of availability. The title of the article should NAFTA and other specific integration ef- begin with a word useful in indexing and in- forts and their specific implementation. For formation retrieval. Text and endnotes practical reasons, English is used as the lan- should be double-spaced. All endnotes guage of communication; (2) subject matter should be numbered in sequential order, as involving economic, legal, political and so- cited in the text. Unless for good reason ac- cial integration, and reform effects in Latin ceptable to the editors, endnotes for legal and Central America and in the Caribbean articles should conform to The Bluebook, Basin; and (3) FTAA implications. Uniform System of Citation (18th ed, 2005; Article Submission: online version 2008). For non-legal articles, the citations should be internally consistent The editors will consider for publication within the given article. Authors should manuscripts by contributors from any coun- submit short biographical data, including his try. Articles will be subjected to a profes- or her affiliation; an abstract summarizing sional peer-review procedure. Authors the manuscript (not to exceed 150 words). ISSN 1571-9537 THE INTERNATIONAL LAW REVIEW ASSOCIATION An Association of The International Lawyer and Law and Business Review of the Americas SOUTHERN METHODIST UNIVERSITY DEDMAN SCHOOL OF LAW 2014-2015 STUDENT EDITORIAL BOARD

IAN PHILLIPS President

THE INTERNATIONAL LAWYER LAW AND BUSINESS REVIEW OF THE AMERICAS MAI TRAN BENJAMIN STEPHENS LESLIE ROUSSEV ANN MARTIN Editor-in-Chief Managing Editor Editor-in-Chief Managing Editor

Associate Managing Editors ALEX ALLEN JAMIE BROOKS KATHLEEN CRUZ ROXANNE HAJIKHANI CLAYTON SMITH ANGEL TORRES JIBRAEEL ZAIDI

Senior Note & Comment Case Note & Comment Canada NAFTA Editor Editors Reporter Reporter LAUREN CROUCH COURTNEY FLOYD CHRISTOPHER CORNELL NATALIE SEARS MIMI GHASSEMI JACOB JOHNSON BARABRA MACKOWIECKI JOHN SMITHEE JEFFREY VETETO JORDAN WYNN Latin America Reporter Citations Editors Administrative Managing Editor ANTHONY GODFREY JERI D’AURELIO KRISTEN JACKSON GREG FIJOLEK NEERAJ GILANI ANDREW HATCH

Articles Editors JACOB CRUMRINE JANET LANDRY DANIEL LUNSFORD JASMINE CULPEPPER SAMER LAWAND AUSTIN MERCER JODY LYNN HOLM JUSTIN LEE ANNABEL PEDRAZA BRYNNA KROUGH TYLER LIVINGSTON SAMUEL PONDROM DIVYESH LALLOOBHAI LEV PRICHARD

Staff Editors ALYSON ALFORD-GARCIA ZAINAB KHAN SYDNIE SHIMKUS CLIFTON BEECH WILLIAM KYLE RYAN SNOW ADAM BELL MARIO A. LAMAR MICHAEL STEVE WALTER CARDWELL IV ELISE LEGROS MATTHEW STRINGER JULIA DANESHFAR AMY MAHER CHRIS VALENTINE JERI LANE D’AURELIO AUSTEN MASSEY DAVID VILLARREAL KATHERINE DEVLIN JENNIFER MCCOY KAMRAN VORA CORY EDEN DIANA MINEVSKI CAMILLE WALKER NATALY ELBERG KATHERINE MITCHELL TAYLOR WILLIS VIENNA FLORES CHARLES NORTH PHILIP WORAM JUSTIN HANNA ABBY PARMELLY WALKER YOUNG BRITTNEY HERSON FORREST ROBERTS WARREN YOUNG CORTLAND HOGE BRANDT ROESSLER LIANG YUE JAMISON JOINER BEN SCHWARTZ LEPING ZHANG KRIS KEARNEY RYAN SEAY MEI ZHANG NADIA KHALID TALIBRA FERGUSON Administrative Assistant —Editorial Base— Southern Methodist University Dedman School of Law Dallas Law and Business Review of the Americas

Honorable Editor-in-Chief PROFESSOR ROBERTO MACLEAN President, SMU – LIA

Co-Editors-in-Chief JOSEPH J. NORTON DIEGO C. BUNGE SMU-Dallas UBA-Buenos Aires

Associate Editors-in-Chief MAURICIO BAQUERO-HERRERA MARTIN L. CAMP MARCOS AURELIO´ P. VALADAO˜ Colombia SMU-Dallas Brasil

—BOARD OF SENIOR PROFESSIONAL EDITORS—

RODRIGO OLIVARES-CAMINAL OMAR GARCIA-BOLIVAR JORGE A. GONZALEZ London Washington D.C.-Caracas Dallas

ROSARIO SEGOVIA-HEPPE GABRIEL GARI ANTONIO PENA˜ LAWRENCE B. PASCAL SMU-Dallas London-Montevideo Miami SMU-Dallas

CHRISTOPHER MALCOLM VIRGINIA TORRIE GERARDO VASQUEZ´ COMEZ´ West Indies Toronto Mexico City

NARA PORTO CLAUDIA CARBALLAL-BENAGLIO Dallas-Brasil Mexico-Dallas

—SMU FACULTY ADVISORY BOARD—

Chair LUIGI MANZETTI (POLI.SCI.)

GAIL M. DALY (LAW) GEORGE MARTINEZ (LAW) THOMAS OSANG (ECON.) CHRISTOPHER H. HANNA (LAW) MICHAEL LUSTIG (POL.SCI.) MARC I. STEINBERG (LAW) JOHN S. LOWE (LAW) DANIEL J. SLOTTJIE (ECON.) PETER WINSHIP (LAW) —ADVISORY BOARD—

—ABA Representatives—

Chair GLENN P. HENDRIX

Canadian International Investment & International Trade Committee Development Committee Committee JOHN W. BOSCARIOLI JEAN PAUL CHABANEIX KRISTY L. BALSONEK MARCELA B. STRAS DANIEL MARIN MORENO MATTHEW ROBERT NICELY AMY STANLEY

Latin American & Caribbean International Corporate Counsel Mexico Committee Committee Committee JEAN PAUL CHABANEIX CAROL BASRI PATRICK DEL DUCA MARCOS RIOS RICHARD T WALSH ALEJANDRO SUREZ

—External Representatives—

DR. ERNESTO AGUIRRE DR. CARLOS GERSCOVICH PROF. ANA MACLEAN Washington D.C. Buenos Aires Lima

MR. LEE BUCHEIT PROF. BENJAMIN GEVA DR. HECTOR MAIRAL New York Toronto Buenos Aires

ALBERTO SALAZAR VALLE PROF. MICHAEL W. GORDON PROF. ANTONIO BORGES Toronto Gainesville Brasilia

LOUIS CAPIN PROF. LUIS MEJAN´ PROF. RICARDO OLIVERA-GARCIA Mexico City Mexico City Montevideo

PROF. EM. BEVERLY MAE CARL DR. EVA HOLZ DANA G. NAHLEN Santa Fe Montevideo Dallas

PROF. MARSHA ECHOLS HON. MIGUEL OTERO PROF. JULIO FAUNDEZ Washington D.C. Santiago Warwick

ANTONIO FRANCK PROF. BORIS KOZOLCHYK PROF. JOEL P. TRACHTMAN Mexico City Tucson Boston

MANUEL GALICIA PROF. ROSA LASTRA PROF. STEVEN T. ZAMORA Mexico City London Houston

DR. ALEJANDRO M. GARRO PROF. RAUL VINUESA New York Buenos Aires OFFICIAL CITATION LAW & BUS. REV. AM. WINTER 2015 Nothing herein shall be construed as representing the opinions, views or actions of the American Bar Association unless the same shall have been first approved by the House of Delegates or the Board of Governors or of the Section of International Law and Practice of the Association unless first approved by the Section or its Council. Southern Methodist University Dedman School of Law’s Law Institute of the Americas

(formerly SMU Centre for NAFTA and Latin American Legal Studies)*

Established in 1952, the LAW INSTITUTE OF THE AMERICAS at Southern Methodist University Dedman School of Law was originally designed to promote good will and to improve relations among the people of the Americas through the study of comparative laws, institutions and governments respecting the American Republics, and to train lawyers in handling legal matters pertaining to the nations of the Western Hemisphere. Today, in reviving the institution, the Law Institute of the Americas comprises meaningful academic research, teaching and programs pertaining to the “NAFTA/FTAA processes” and other Western Hemispheric integration efforts; to Latin and Central American law and judicial reform, particularly focusing on Argentina, Brazil, Chile, Guatemala, Mexico, Peru and Venezuela; and to a more limited extent, to Canadian legal issues, particularly as they interrelate to the NAFTA/FTAA. The Law Institute of the Americas also is concerned with increasing (regional and hemispheric) legal and economic interconnections between the “NAFTA/FTAA processes” and European and Asia-Pacific integration activities.

The officers of the Institute are as follows: the Honorable Roberto MacLean, President; Professor Joseph J. Norton, Executive Director; and Professor George Martinez, Associate Executive Director. The Institute is also supported by distinguished group of Professorial Fellows, Senior Research Scholars, Professional Fellows, and Student Research Fellows.

As the Institute focuses primarily on issues pertaining to the North American Free Trade Agreement and the pending Free Trade Area of the Americas, and the broader economic, political, legal, and social integration processes underway in the Western Hemisphere, Law and Business Review of the Americas is one of the International Law Review Association of SMU. Other parties of the journal are the Cox School of Business, the SMU Departments of Economics and Political Science, the London Forum, and the American Bar Association Section of International Law and Practice.

* From 1952 through the early 1970’s, the name was the Law Institute of the Americas: in 1993, it was reactivated as the Centre for NAFTA and Latin American Legal Studies; and in 1998, it returned to its original name. For further detailed historical information on the Law Institute of the Americas, please refer to the Law Institute of the Americas’ website at http://www.law.smu.edu/lia. Perspective

AN ETHICAL ANALYSIS OF THE 2014 FIFA WORLD CUP IN BRAZIL

Arjyo Mitra*

I. INTRODUCTION

RAZIL was officially named the host nation of the 2014 FIFA World Cup on October 30, 2007. This came after the country’s delegation successfully convinced the FIFA Executive Committee B 1 of the potential social and cultural benefits of hosting the tournament. Although then-president, Luiz Inacio Lula da Silva, and president incum- bent, Dilma Rousseff, publicly welcomed the responsibility of hosting the event, the Brazilian public repeatedly expressed its discontent at FIFA’s decision.2 61 percent of the Brazilian adults who participated in a 2014 survey by the Pew Research Center were against Brazil hosting the event.3 Public protests and riots reached their climax before and during the 2013 FIFA Confederations Cup, which precedes the World Cup, and regained momentum as the opening ceremony of the World Cup drew nearer.4 The protests were centered around the people’s demands for higher expenditure on healthcare, education, and public transport.5 But the hosting responsibilities included an estimated expenditure of $3.6 billion of taxpayer money for the construction of stadiums.6 Rampant corruption and organizational inefficiency detrimentally affected the nation’s preparedness for the event. This led to further widespread public disillu- sionment. There are several ethical concerns surrounding the govern-

* Arjyo Mitra studies Economics and Finance at The University of Hong Kong. His research interests include the Great Financial Crisis of 2008, and he has written several articles on this topic. This article was first published by Seven Pillars Insti- tute for Global Finance and Ethics, www.sevenpillarsinstitute.org, and is repub- lished with the permission of the Institute. 1. Brazil Confirmed as 2014 Hosts, FIFA (Oct. 30, 2007), http://www.fifa.com/world cup/news/y=2007/m=10/news=brazil-confirmed-2014-hosts-625695.html. 2. Zack Beauchamp, Could Brazil’s Epic World Cup Loss Cost its President her Job?, VOX (July 10, 2014, 10:40 AM), http://www.vox.com/2014/7/10/5882275/world-cup- loss-brazil-germany-dilma-rousseff-election. 3. Brazilian Discontent Ahead of World Cup, PEW RES. CENTER (June, 3 2014), http:/ /www.pewglobal.org/2014/06/03/brazilian-discontent-ahead-of-world-cup/. 4. Id. 5. Id. 6. Total Costs of the FIFA World Cup 2014 in Brazil (in Millions U.S. Dollars), STATISTA, http://www.statista.com/statistics/296493/total-costs-fifa-world-cup-2014- brazil/ (last visited Feb. 19, 2015).

3 4 LAW AND BUSINESS REVIEW OF THE AMERICAS [Vol. 21 ment’s diversion of taxpayer funds away from areas that urgently required investment and attention. This report provides a brief overview of the present condition of Bra- zil’s economy, public service systems (healthcare and education), and business environment. The description gives some context to the subsequent discussion. The next section describes the controversies about different aspects of the government’s overall World Cup-related expenditure, specifically: • FIFA’s tax exemption; • Construction of stadiums; • Construction costs exceeding budgets; • White elephants; • Crowding out of accompanying investments in infrastructure; and • Social costs to Brazilians. This report summarizes the ethical concerns raised by these controversies. These concerns are analyzed from the perspective of whether the decision to bid for the hosting rights for the 2014 FIFA World Cup was ethical and morally justifiable in light of the pressing need for extensive public investment. Additionally, the report utilizes a consequentialist approach to answer the question: do the ends justify the means?7 Here, the ends are the pre- dicted benefits from hosting the tournament. The means refer to the seemingly unethical use of taxpayer money for purposes other than the facilitation of immediate public welfare. The juxtaposition of these two contrasting perspectives on ethics sheds light on whether Brazil’s hosting of the 2014 FIFA World Cup was ethical.

II. BRAZIL: AN OVERVIEW

A. THE ECONOMY According to the International Monetary Fund’s (IMF) World Eco- nomic Outlook Database of October 2013, Brazil is the seventh largest economy in the world, with an estimated Gross Domestic Product (GDP) of $2.523 trillion (corrected for purchasing-power-parity valuation of national GDP) and per-capita GDP of $12,528 (the 79th largest in the world).8 The corresponding nominal figures are $2.169 trillion (7th) and $10,773 (63rd).9 Brazil’s annual GDP growth rate reduced from 7.5 percent in 2010 to

7. See JOHN MIZZONI, ETHICS: THE BASICS 104 (2010). 8. World Economic Outlook Database Oct. 2013, INT’L MONETARY FUND (IMF) (June 22, 2014), http://www.imf.org/external/pubs/ft/weo/2013/02/weodata/weorept .aspx?pr.x=38&pr.y=5&sy=2011&ey=2018&scsm=1&ssd=1&sort=country&ds=.& br=1&c=223&s=NGDPD%2CNGDPDPC%2CPPPGDP%2CPPPPC&grp=0&a=. 9. Id. 2015] ETHICAL ANALYSIS OF THE 2014 WORLD CUP 5

0.9 percent in 2012.10 The 2014 first-quarter results showed a 1.9 percent growth over the past twelve months.11

B. INCOME INEQUALITY AND POVERTY The country’s GINI Index—which measures the degree of income inequality—is one of the highest of the countries that form the dataset.12 The 2009 estimate was 54.7 (the 13th-highest of 150 nations in the dataset and 3rd-highest out of the 32 nations competing in the World Cup; only Honduras and Colombia suffer from worse income inequality)13 and the 2012 estimate was 51.9.14 Sixteen percent of Brazilian citizens live below the national poverty line, and thirty-one million people live on less than $1.25 per day.15

C. HEALTHCARE Brazil experienced dramatic improvements in public health over the last decade. But it still lags behind most countries in the Organization for Economic Cooperation and Development (OECD) in primary health in- dicators such as life expectancy (73.4 years versus OECD average of 80 years); health spending as a percentage of GDP (8.9 percent versus OECD average of 9.4 percent); and per capita health expenditure ($1,043 in 2011 versus OECD average of $3,322).16 Furthermore, the country faces significant challenges to universal access to primary healthcare. There is a deficit of primary care facilities and doctors.17 Crucially, the recent development of the private healthcare in- dustry and the underfunding of public sector health facilities created socioeconomic disparities in access to quality healthcare.18 Private

10. Brazil: Overview, WORLD BANK (June 23, 2014), http://www.worldbank.org/en/ country/brazil/overview. 11. Chris Wright, Will Brazil’s World Cup Pay Off For Investors?, FORBES (June 12, 2014), http://www.forbes.com/sites/chriswright/2014/06/12/will-investors-in-brazil- see-a-world-cup-dividend/#. 12. Data: The GINI Index, WORLD BANK, http://data.worldbank.org/indicator/SI.POV .GINI?order=wbapi_data_value_2012+wbapi_data_value+wbapi_data_value-last &sort=asc (last visited June 22, 2014). 13. Id.; see also Patrick Rishe, 2014 World Cup: The Economic Backlash of Brazil’s Public Relations Black Eye, FORBES (June 10, 2014), http://www.forbes.com/sites/ prishe/2014/06/10/2014-world-cup-the-economic-backlash-of-brazils-public-relations-black-eye/#. 14. The World Factbook, CIA, https://www.cia.gov/library/publications/the-world- factbook/fields/2172.html (last visited June 22, 2014). 15. Amy McDonald, Brazil Is Spending Billions On The World Cup, But How Are The Country’s Poor Managing?, DESERET NEWS (May 24, 2014), http://www.deser- etnews.com/article/865603847/Brazil-is-spending-billions-on-the-World-Cup-but- how-are-the-countrys-poor-managing.html. 16. Brazil, OECD BETTER LIFE INDEX, http://www.oecdbetterlifeindex.org/countries/ brazil/ (last visited June 22, 2014). 17. Martin Bortz, Analyzing Public Health in Brazil, RIO ON WATCH (Sept. 23, 2013), http://www.rioonwatch.org/?p=9941. 18. Id. 6 LAW AND BUSINESS REVIEW OF THE AMERICAS [Vol. 21 hospitals have increased prices by 20 or 30 percent since 2009,19 making Brazilian healthcare the most expensive in Latin America. Some operations cost within 10 percent of equivalent operations in the United States.20

D. EDUCATION The improvement in Brazil’s education has been markedly slower than its healthcare. Only 57 percent of 25 to 34 year-olds have earned the equivalent of a high school degree, causing Brazil to lag behind most OECD countries (the corresponding figure is 82 percent for OECD countries).21 The OECD Programme for International Student Assessment evaluated the general level of ability acquired by students in crucial sub- jects.22 Empirical results show the average Brazilian student ranked far below the average OECD student in reading literacy, math ability, and knowledge of science.23 Brazil’s public education system lacks the necessary facilities and fund- ing to improve these basic standards. Consequently, illiteracy levels are high.24

E. CORRUPTION IN THE PUBLIC SECTOR Based on eight different studies composited into the Corruption Per- ceptions Index (2012), Brazil’s public sector is the 69th least corrupt of 178 countries for which data was available.25 According to Transparency International, which compiled and published the report, some of the harmful effects of corruption include “human suffering, . . . failure in the delivery of basic services like education or healthcare[,]” and the derail- ing of “the building of essential infrastructure . . . .”26 Corruption also unfairly imposes a “dirty tax” on the poor and vulnerable.27 High taxes, bureaucratic corruption, and high borrowing costs form the “Brazil Cost” of doing business in the country.28 This significantly hin- ders the initiation of projects. In fact, Brazil is ranked 116th out of 189 countries in the ease of doing business.29

19. Peter Pallot, Expat Guide To Brazil: Health Care, TELEGRAPH (Sept. 6, 2011), http://www.telegraph.co.uk/health/expathealth/8737945/Expat-guide-to-Brazil- health-care.html. 20. Id. 21. OECD BETTER LIFE INDEX, supra note 16. 22. Id. 23. Id. 24. See id. 25. The Corruption Perceptions Index, TRANSPARENCY INT’L 2012, http://www.transparency.org/cpi2012/results (last visited June 22, 2014). 26. Id. 27. Id. 28. Alexander Ragir, Rousseff Crisis Spurred By Lula Debts As Brazil Boom Dimin- ishes, BLOOMBERG (Sept. 27, 2011), http://mobile.bloomberg.com/news/2011-09- 27/rousseff-crisis-spurred-by-lula-debts-as-brazil-boom-diminishes. 29. Ease of Doing Business in Brazil, DOING BUS. 2014 http://www.doingbusiness.org/ data/exploreeconomies/brazil/# (last visited June 22, 2014). 2015] ETHICAL ANALYSIS OF THE 2014 WORLD CUP 7

III. WORLD CUP CONTROVERSIES

A. FIFA’S TAX EXEMPTION Any direct or indirect expenses incurred by FIFA for the 2014 World Cup were granted full federal tax exemptions by Law Project 7422/2010, which was submitted to the Brazilian National Congress on May 31, 2010.30 These expenses include “imports carried out by FIFA itself, FIFA’s Brazilian subsidiaries,” or any third-party organizations hired by or associated with FIFA to help organize the event.31 Provisional Mea- sure 497/2010 described a special tax regime for the construction of stadiums for the 2014 tournament and the FIFA Confederations Cup 2013.32 The exemptions detailed in Law Project 7422/2010 included, but were not restricted to “[F]ederal excise taxes (IPI) due on customs clearance; [I]mport tax[es]; . . . Contributions for the Financing of Social Security (COFINS); [F]reight taxes (AFRMM); [and F]ee[s] for the use of the Foreign Trade System (SISCOMEX) . . . .”33 Furthermore, they applied to the imports of a wide range of durable goods and consumables that would be used exclusively during the tournament.34 Law Project 7422/2010 is also discriminatory in assigning the burden of tax payments to suppliers involved in the organization of the tournament. Again, it favors FIFA and its interests. Being a non-resident entity, FIFA receives exemptions from taxes levied on its own activities in connection with the World Cup, whereas its businesses that are registered in Brazil do not receive such benefits.35 Crucially, the law highlights that Brazilian suppliers, both individual and corporate, who receive payments from FIFA and its affiliates will not be exempt from taxation on income and capital gains. But FIFA’s Brazilian subsidiaries are granted the same exemptions from corporate income taxes.36 This indicates the shifting of the burden of income tax payments from FIFA to Brazilian companies not permanently associated with the foot- balling institution. Most of FIFA’s other operating and organizational expenses, such as compensation and prizes, also escape taxation, whereas income of Brazil-based sources continues to face taxation.37

30. David Roberto R. Soares da Silva, Brazil Considering Full Tax Exemptions for 2013, 2014 Soccer Cups, AZEVEDO SETTE (June 8, 2010), http://www.azevedosette .com.br/en/noticias/brazil_considering_full_tax_exemptions_for_2013_2014_soccer _cups/2409. 31. Id. 32. Memorandum from Souza, Schneider, Pugliese e Sztokfisz Advogados to Clients: Provisional Measure to No. 497/2010—Amendments to Tax and Customs Legisla- tion 1 (Aug. 4, 2010), available at http://souzaschneider.com.br/pdf/pt/memo/Memo %20%20MP%20497%20ENG.pdf. 33. Id. 34. Id. 35. Soares da Silva, supra note 30. 36. Kelly Phillips Erb, World Cup Mania: Figuring Out FIFIA, Soccer & Tax, FORBES (June 16, 2014, 12:23 PM), http://www.forbes.com/sites/kellyphillipserb/2014/06/16/ world-cup-mania-figuring-out-fifa-soccer-tax/. 37. Id. 8 LAW AND BUSINESS REVIEW OF THE AMERICAS [Vol. 21

According to Brazil’s Federal Revenue Department (FRD) 2010 estimates, the tax breaks associated with the 2014 FIFA World Cup and the 2013 FIFA Confederations Cup total around R$800 million ($475 million) between 2011 and 2015.38 It seems that while the temporary tax breaks limit costs for FIFA and its private suppliers, they also serve to limit potential tax revenue for the Brazilian government. This shortfall in tax revenue most likely translates to an increase in the burden of future taxation for the country’s citizens.

B. CONSTRUCTION OF STADIUMS

Estimates of the expenditure incurred by the Brazilian government in preparing the nation for the tournament vary from $11 billion39 to $14 billion,40 with some sources reporting estimates of $15 billion.41 But there is a broad consensus that the government has spent $3.6 billion (R$8 billion) on the infrastructural modernization of stadium facilities.42 This enabled the hosts to bring the total number of stadiums in use to twelve, a record for the tournament.43 Five cities built stadiums from scratch, one stadium was demolished and rebuilt to suit FIFA’s specifica- tions, and the other six underwent extensive renovations.44

1. Construction Costs Exceeding Budgets

In FIFA’s original inspection report of Brazil’s candidacy for hosting the 2014 FIFA World Cup, required investments for construction or renovation of the stadiums were estimated to be $1.1 billion.45 But costs had

38. Id. 39. Simon Romero, Soccer and Internal Discord, on Display for World to See, N.Y. TIMES, June 12, 2014, at A4, available at http://www.nytimes.com/2014/06/13/world/ americas/hundreds-of-brazilians-protest-outside-world-cup-stadiumin-sao-paulo .html?_r=1; see Rishe, supra note 13; see also Wright, supra note 11. 40. Associated Press, World Cup Set to be Most Lucrative Ever, ESPN FC (May 23, 2014), http://www.espnfc.com/fifa-world-cup/story/1830732/2014-world-cup-set-to- be-most-lucrative-ever. 41. Northern Trust, The World Cup Begins Amid a Series of Financial Controversies, FXSTREET (June 15, 2014, 23:48 PM), http://www.fxstreet.com/analysis/weekly-economic-commentary/2014/06/15/. 42. Vincent Bevins, Beyond the World Cup Stadiums, Architecture in Brazil Returns to Glory, L.A. TIMES (June 15, 2014), http://touch.latimes.com/#section/-1/article/p2p- 80478313/; see also Tariq Panja, Soccer World Cup Stadium Costs Soar by $435 Million in Brazil, BLOOMBERG (Nov. 27, 2013), http://www.bloomberg.com/news/ articles/2013-11-26/soccer-world-cup-stadium-costs-soar-by-435-million-in-brazil; Rishe, supra note 13. 43. See Mark Koba, World Cup by the Numbers: Most Expensive Ever!, CNBC (June 12, 2014, 8:00 AM), http://www.cnbc.com/id/101750395#. 44. 2014 FIFA World Cup: Where Are the 12 Host Stadiums in Brazil?, BBC SPORT (last updated June 6, 2014, 2:04 PM), http://www.bbc.com/sport/0/football/24897 388. 45. FIFA, BRAZIL BID INSPECTION REPORT FOR THE 2014 FIFA WORLD CUP 38 (Oct. 30, 2007), available at http://img.fifa.com/mm/document/affederation/mission/62/ 24/78/inspectionreport_e_24841.pdf. 2015] ETHICAL ANALYSIS OF THE 2014 WORLD CUP 9 run three times over budget by 2012.46

a. Arena Corinthians, Sao Paulo

Sao Paulo’s Arena Corinthians, also known as the Itaquerao Stadium, was originally estimated to require R$335 million in investments.47 But the final estimates increased to R$820 million to account for expenses required to enable the stadium to fulfill FIFA’s general requirements, with R$420 million of the costs funded by tax credits granted by the city.48 The stadium eventually cost R$965 million, 15 percent above its planned budget.49 This figure does not take into account the additional expenses that will be required to remove 20,000 seats after the World Cup.50 The Itaquerao Stadium was built in a city that already had a fully func- tional stadium, the Morumbi Stadium.51 The Morumbi was originally slated to be Sao Paulo’s only World Cup stadium.52 But the city’s or- ganizing committee failed to provide FIFA with financial guarantees for the required $135 million renovation that was required to update the structure and it was removed from the list of stadiums.53 This allowed Sao Paulo to accommodate plans for the Itaquerao Stadium, but at a much higher cost to the government and taxpayer.54 The necessity of building a second stadium at such high costs, especially when the first would have sufficed, is questionable.

b. Estadio Nacional Mane Garrincha, Brasilia

The demolition and subsequent rebuilding of Brasilia’s Estadio Na- cional Mane Garrincha in 2010 was originally supposed to cost $300 million.55 But government auditors revealed this cost tripled to $900 million, making the stadium the most expensive in Brazil and the second-most expensive football stadium in the world.56

46. Andrew Downie, Soccer-Brazil World Cup Stadiums on Track, but Costs Soar, REUTERS (Apr. 3, 2012, 9:49 AM), http://www.reuters.com/article/2012/04/03/soccer-world-brazil-idUSL2E8F2GG820120403. 47. Id. 48. Id. 49. Bernie Roseke, Project Management Disaster: The Arena de Sao Paulo, PROJECTENGINEER (June 7, 2014), http://www.projectengineer.net/project-management-disaster-the-arena-de-sao-paulo. 50. Downie, supra note 49. 51. Sao Paulo Dropped for 2014, SBS, http://theworldgame.sbs.com.au/article/2010/06/ 17/sao-paulo-dropped-2014 (last updated Nov. 12, 2012, 8:07 PM). 52. Id. 53. Id. 54. See Downie, supra note 49. 55. Marissa Payne, Five Sad and Shocking Facts About World Cup Corruption in Bra- zil, WASH. POST (May 12, 2014), http://www.washingtonpost.com/blogs/early-lead/ wp/2014/05/12/five-sad-and-shocking-facts-about-world-cup-corruption-in-brazil. 56. Id. 10 LAW AND BUSINESS REVIEW OF THE AMERICAS [Vol. 21

i. Price Gouging and Fraudulent Billing Allegedly fraudulent billing of expenses and the existence of widespread corruption at the bureaucratic level are blamed for the massive increase in prices.57 A team of auditors from the Audit Court in Brasilia found that as much as one-third of the stadium’s cost was attributed to overpricing.58 Their investigation of 75 percent of the project’s costs revealed $275 million in alleged price gouging.59 For instance, the auditors’ report indicates that the government was billed $1.5 million by the construction consortium formed by Andrade Gutierrez, a construction conglomerate, and Via Engenharia, an engi- neering firm, for the transportation of prefabricated grandstands that should have only cost $4,700.60 The auditors also uncovered additional expenses of $46.3 million incurred due to poor planning, delays in construction, and fraudulent accounting practices.61

ii. Corporate Corruption The extent of corporate corruption prevalent in Brazil is indicated by the discovery that Andrade Gutierrez, the company that won bids to build or renovate four stadiums in 2010, increased its corporate election campaign contributions from $73,180 in 2008 to $37.1 million in 2012.62 Odebrecht, Brazil’s top builder, also increased its political contributions from $90,909 in 2008 to $11.6 million in 2012, a 127-fold increase.63 Dur- ing that period of time, Odebrecht won four stadium contracts and the operational ownership of Rio de Janeiro’s Maracana Stadium for thirty- five years.64 “There must be some corruption,” Sergio Nogueira Seabra, Secretary for Transparency and Prevention of Corruption in Brazil’s Comptroller General’s Office, was quoted as saying in May 2014.65

1. White Elephants In addition to the enormous expenses incurred by the government for the preparation of the twelve venues, there have been significant fears that at least four, and as many as eight, of the twelve stadiums will fail to

57. See id. 58. Bradley Brooks, High Cost, Corruption Claims Mar Brazil World Cup, ASSOCI- ATED PRESS (May 12, 2014, 9:52AM), available at http://bigstory.ap.org/article/ high-cost-corruption-claims-mar-brazil-world-cup. 59. Id. 60. Brazil audit: ‘Corrupt World Cup Costs’, AL JAZEERA (June 23, 2014, 1:55 PM), http://www.aljazeera.com/news/americas/2014/05/brazil-audit-shows-corrupt- world-cup-costs-201451263240585772.html. 61. Brooks, supra note 61. 62. Payne, supra note 58. 63. Brooks, supra note 61. 64. Id. 65. Tariq Panja, Corruption to Blame for Some Brazil World Cup Cost Rises, BLOOM- BERG (May 23, 2014, 10:54 AM), http://www.bloomberg.com/news/articles/2014-05- 22/corruption-to-blame-for-some-brazil-world-cup-cost-rises. 2015] ETHICAL ANALYSIS OF THE 2014 WORLD CUP 11 generate revenues beyond their use during the tournament.66

a. Estadio Nacional Mane Garrincha, Brasilia For instance, the stadium in Brasilia hosted a few games in the 2014 FIFA World Cup and is slated to host the 2016 Summer Olympics in Rio de Janeiro. After that, the publicly funded stadium may be left unoccu- pied because there are no major football teams in Brasilia.67 The city’s clubs play in the third and fourth divisions of the national league and cannot attract sufficiently large crowds.68 High maintenance costs and limited inflow of revenues mean the stadium may never generate profits to justify the massive outlay on its construction.

b. Amazonia Arena, Manaus The newly constructed Amazonia Arena in Manaus cost $294 million, 25 percent over its planned budget,69 and finds itself in a similar situation. Manaus is a two million-strong metropolitan city located in the Amazon rainforest, and its best professional football team plays in the fourth divi- sion of the national league.70 Thus, the stadium is expected to remain vacant while racking up maintenance costs. The construction of the brand new 44,500-seat Arena Amazonia in Manaus has been described as “shameful.”71 Similarly, the Arena das Dunas in Natal and the Arena Pantanal in Cuiaba together cost R$820 million, but do not have sufficiently qualified club teams to occupy them.72

1. Crowding out of Accompanying Investments in Infrastructure The excessively large number of stadiums constructed for the World Cup and the associated infrastructural investments on airport, transportation, and accommodation greatly divided the attention of the Brazilian government.73 The organizational capabilities of the responsible companies were also stretched to the limit by the vast number of different projects. Huge delays and constantly increasing costs caused by bureaucratic and operational inefficiency hampered the achievement of the

66. Downie, supra note 49. 67. Panja, supra note 45. 68. See Brian Homewood, Not Much Football to Look Forward to in Brasilia, REUTERS (July 7, 2014), http://articles.chicagotribune.com/2014-07-07/sports/sns-rt- uk-soccer-world-brasilia-20140707_1_championship-stadium-mane-garrincha. 69. Jenny Barchfield, Costly Stadium No Answer to Manaus’ Traffic Woes, ASSOCI- ATED PRESS (June 13, 2014, 1:05 AM), available at http://news.yahoo.com/costly- stadium-no-answer-manaus-traffic-woes-040720937.html. 70. Sam Borden, Building a World Cup Stadium in the Amazon, N.Y. TIMES (Sept. 24, 2013), http://www.nytimes.com/2013/09/25/sports/soccer/in-building-world-cup-stadium-in-amazon-rain-is-just-one-challenge.html?pagewanted=all&_r=0. 71. Barchfield, supra note 72. 72. Report: How Much Did Brazil Spend on World Cup Stadiums?, STADIUMDB (Oct. 7, 2014, 9:58 PM), http://stadiumdb.com/news/2014/07/report_how_much_did_bra- zil_spend_on_world_cup_stadiums. 73. Rishe, supra note 13. 12 LAW AND BUSINESS REVIEW OF THE AMERICAS [Vol. 21 planned infrastructural goals.74 They also compromised the quality of the facilities built. This caused the construction of many planned facilities to be abandoned or extensively delayed.75 Approximately half of the infrastructure projects originally promised were not delivered or completed.76 Approximately one-fifth of all projects were dropped due to delays.77 Attempts to improve urban transportation were largely unsuccessful.78 Rail projects and bus corridors were dropped in up to six cities.79 Airports also suffered delays in construction, and many planned updates to design and technology were abandoned or postponed until after the World Cup.80 For example, the construction of the Amazonia Arena in Manaus suffered from numerous delays and additional expenses beyond the planned budget.81 This had a detrimental indirect effect on important infrastructural investments in the city, such as the expected $810 million investment in Manaus’ public transportation system.82 Despite being intended to combat the city’s traffic congestion problems, the plan was crowded out and eventually cut from the Sports Ministry’s official list of World Cup- related expenditures.83 The Guardian recently reported that Gianna, a resident of Copa do Povo (People’s Cup), a flash camp near Sao Paulo’s newly constructed Itaquerao Stadium, said, “We don’t have hospitals, we don’t have schools. But we have stadiums. Lots of stadiums.”84 This accurately captures the social injustice of Brazil’s expenditure on stadiums at a time when its public education and healthcare industries have been calling for extensive investments.

C. SOCIAL COSTS TO BRAZILIANS The construction of stadiums, the upgrading of accommodation facilities for tourists and national delegations and the creation of urban transportation facilities came at immense social costs to Brazilian citizens. Those suffering from poverty were most affected by the social displace- ment caused by the evacuation of favelas and other public housing

74. See id. 75. See id. 76. Anthony Boadle, World Cup Leaves Brazil Costly Stadiums, Poor Public Trans- port, REUTERS (June 5, 2014, 12:26 PM), http://www.reuters.com/article/2014/06/ 05/us-brazil-worldcup-infrastructure-idUSKBN0EG23H20140605. 77. Id. 78. Id. 79. Id. 80. Id. 81. Barchfield, supra note 72. 82. Id. 83. Id. 84. Owen Gibson, The World Cup is Really Just for the People in Helicopters, GUARD- IAN (June 11, 2014, 2:41 PM), http://www.theguardian.com/world/2014/jun/11/ world-cup-helicopters-streets-sao-paulo#. 2015] ETHICAL ANALYSIS OF THE 2014 WORLD CUP 13 facilities.85 Estimates suggest that between 250,000 and 1.5 million people have been forced to abandon their residences or evicted, with very few receiving adequate relocation assistance or monetary compensation.86 Some citizens received only 20 to 40 percent of the value of their houses in compensation in what has been termed “a programme of mass eviction of the lower classes set out in order to put on a glossy show for the rest of the world.”87

IV. SUMMARY The broad ethical concerns raised by the topics covered in these sections are summarized below. The Brazilian government decided to host the 2014 FIFA World Cup despite the country’s clearly apparent lack of infrastructural capacity, poor operational management capabilities, and ill-suited private and corporate business environment. The government has repeatedly neglected the requirements of society and its demands for improved healthcare, education, and public infrastructure. Instead, it has served to benefit FIFA, a private foreign institution, at its own cost and the cost of its citizens. Relaxed tax requirements and numerous exemptions offered to FIFA have robbed the government of tax revenues and increased the future tax burden on the Brazilian public. The government has not delivered on several secondary infrastructure projects that it promised, such as modernization of airports and urban and interstate transportation facilities. These projects would have brought real value to society by directly benefiting the Brazilian public. But the government sanctioned and financed the construction of expensive stadiums that will most likely not deliver returns on investment. The organization of the tournament came at the direct expense of the welfare of Brazilian citizens. Local housing facilities such as favelas were evacuated, and appropriate relocation measures were not enacted across the board. The acknowledgement of these ethical concerns lays the foundation for the subsequent theoretical analysis of the same from two unique perspectives.

85. Brazil’s Maracana Evacuation Spark Anger, ENCA.COM (Jan. 9, 2014), http://www .enca.com/world/brazils-maracana-evacuations-sparks-anger. 86. Compare Paula Daibert, Brazil’s Evicted ‘Won’t Celebrate World Cup’, AL JAZEERA (May 26,2014, 10:17 AM) http://www.aljazeera.com/indepth/features/ 2014/05/brazil-evicted-won-celebrate-world-cup-201452012437552695.html with Anti-World Cup Protests Rock Streets of Brazil, COUNCIL ON HEMISPHERIC AFF. (May 21, 2014), http://www.coha.org/anti-world-cup-protests-rock-streets-of-brazil/ . 87. John Burn-Murdoch, The 2014 World Cup and its Price on Brazil, OVAL LOG (Aug. 15, 2011), https://theovallog.wordpress.com/2011/08/15/the-world-cup-its- price-on-brazil/. 14 LAW AND BUSINESS REVIEW OF THE AMERICAS [Vol. 21

V. AN ETHICAL ANALYSIS

A. A DEONTOLOGICAL APPROACH Theories of deontological ethics broadly state that the ethical judgment of an action must depend solely on its adherence to basic moral duties or codes of conduct.88 Different versions of deontological theories focus on the roles played by agents and patients within the ethical frameworks they occupy.89

1. Agent-Relative Obligations The fundamental duty of any government body is to ensure an adequate standard of living and satisfaction for its citizens. This can be done by continuously targeting improvements in levels of education, primary health, employability, security and public infrastructure. Only once these goals have been achieved at sustainable levels should governments em- bark on secondary projects, such as hosting international events. These obligations are agent-relative, in that each government is obligated to attend to the needs of its citizens in particular.90 The discussion of Brazil’s poverty, income inequality, illiteracy, and poor health shows the government has not devoted enough attention to its citizens’ needs and demands. It has not fulfilled all its obligations to its citizens and therefore should not have undertaken the responsibility of hosting the World Cup. The taxpayer funds spent on tournament-related investments should have been used for improving existing public healthcare and education facilities, both of which are sorely lagging behind their private counterparts. Enabling regular access to quality education and primary healthcare has enormously beneficial impacts on the socioeconomic elevation of the impoverished.91 It can also result in several positive effects, such as a reduction in crime, violence, and substance abuse, all of which Brazil suffers from.92 In short, hosting the tournament represented a violation of the government’s duty and obligation towards its citizens and is unethical from a purely agent-relative deontological perspective.

88. ROSALIND HURSTHOUSE, VIRTUE ETHICS, IN THE STANFORD ENCYCLOPEDIA OF PHILOSOPHY (Edward N. Zalta ed, Fall 2013 ed. 2013), available at http:// plato.stanford.edu/archives/fall2013/entries/ethics-virtue. 89. See generally id. 90. See LARRY ALEXANDER & MICHAEL MOORE, DEONTOLOGICAL ETHICS, THE STANFORD ENCYCLOPEDIA OF PHILOSOPHY (Edward N Zalta ed., Winter 2012 ed. 2012) available at http://plato.stanford.edu/archives/win2012/entries/ethics- deontological. 91. See, e.g., Bridging the Gaps: Reducing Inequality and Poverty Through Social Re- form, OXFORD BUS. GROUP, http://www.oxfordbusinessgroup.com/analysis/bridging-gaps-reducing-inequality-and-poverty-through-social-reform (last visited Feb. 24, 2015). 92. See Lance Lochner, Non-Production Benefits of Education: Crime, Health, and Good Citizenship 9, 49 (Nat’l Bureau of Econ. Research, Working Paper No. 16722, 2011). 2015] ETHICAL ANALYSIS OF THE 2014 WORLD CUP 15

2. Patient-Centered Perspective Patient-centered deontological theories dictate that people have the right against being used by another entity for the user’s benefit without their prior approval.93 This definition becomes relevant when one considers the Brazilian public was largely against the organization of the World Cup. Brazilian citizens regularly organized riots and engaged in public displays of their disapproval of the huge investments on stadiums and the mass evacuation of housing facilities.94 It was abundantly clear the public was opposed to hosting the tournament and the manner in which the organization took place. Thus the patient-centered deontological theories reveal hosting the event violated the basic ethical rights of Brazilian citizens.

B. A CONSEQUENTIALIST APPROACH Consequentialism entails the weighing of the potential positive and negative impacts of a decision before rendering an ethical judgment. Thus, an action or decision can only be judged based on its consequences.95 An extension of this argument allows any foreseeable course of action to be undertaken if it produces desirable results.96 Consequen- tialism, therefore, considers Brazil hosting the 2014 FIFA World Cup to be ethical if it brings about positive consequences. Conversely, if the consequences prove to be negative or insufficiently positive, the act is unethical.97

1. Tourism It is estimated that the 2014 FIFA World Cup brought approximately 3.7 million people to the country from around the world.98 Tourists were expected to inject approximately $3.03 billion into the Brazilian economy through expenditure on accommodation, food, transportation and en- tertainment.99 Of course, expenditure on match tickets could not be considered because FIFA receives all revenue from ticket sales.100 In addition to these direct effects on the Brazilian economy, this money

93. ALEXANDER & MOORE, supra note 93. 94. See, e.g., Brazil World Cup: Clashes at Sao Paulo and Rio Protests, BBC, http:// www.bbc.com/news/world-latin-america-27811657 (last updated June 12, 2014, 7:36 PM). 95. ALEXANDER & MOORE, supra note 93. 96. Id. 97. Id. 98. Darren Heitner, 2014 FIFA World Cup Expected to Add $3.03 Billion to Brazil’s Economy, FORBES (May 14, 2014, 8:23 AM), http://www.forbes.com/sites/dar- renheitner/2014/05/14/2014-fifa-world-cup-expected-to-add-3-03-billion-to-brazils- economy/. 99. Id. 100. Michelle Sulahian, A Week from the World Cup, FIFA is Already the Big Winner in Brazil, FIELDS GREEN (June 5, 2014), http://thefieldsofgreen.com/2014/06/05/fifa- already-the-big-winner-in-brazil/. 16 LAW AND BUSINESS REVIEW OF THE AMERICAS [Vol. 21 could also have indirect impacts through the phenomenon of multiplier effects (i.e., the recirculation of the foreign money within the Brazilian economy in the form of local consumption). But these ex-ante estimates are not always reliable. It is difficult to statistically describe the net effects of the influx of foreigners during a World Cup or international event. This is partially due to the crowding out of certain foreigners who would have attended but for increased crowds and prices.101 For example, the tourist inflow statistics for At- lanta were identical during the summer months of 1995, 1996, and 1997, indicating that the 1996 Summer Olympics crowded out quite a few potential foreign visitors.102 As another example, tourism figures for Syd- ney declined for three successive years after the 2000 Summer Olympics, revealing that the purported ex-ante benefits of tourism may often be overestimated.103 The 2014 World Cup’s effects on tourism also depended on how the country’s reputation as a world-class tourist destination was affected by the international media coverage of the tournament. Positive events, such as superb organization, civil peace, and a flawlessly executed tournament, would have undoubtedly attracted foreigners. But this tournament was marred by controversies, intense public riots, and violent protests.104 Many foreigners will be tempted to avoid the civil unrest in Brazil. It is likely that ex-post estimates of the benefits to tourism will be underwhelming.105

2. Reputation of Brazil

The intention behind hosting the World Cup was to portray Brazil as a “vibrant, rich, diverse and sophisticated country” on the global stage.106 Hosting a successful tournament would have generated international awareness of Brazil’s economic development. It would also have indicated world-class management and organizational capabilities and a thriving business sector. In other words, the brand image of the country would have been significantly bolstered. But numerous instances of delays in stadium construction, allegations of corruption, and increases in construction costs tarnished the reputation of the country’s bureaucracy and infrastructural capabilities. Thus, the intended consequence of “putting Brazil on the map” was not achieved to the desired extent.

101. Andrew Zimbalist, Brazil’s Long To-Do List, AM. Q., Summer 2011, at 57, available at http://www.americasquarterly.org/zimbalist (last visited Feb. 19, 2015). 102. Id. 103. Id. 104. See Brazil World Cup: Clashes as Sao Paulo and Rio Riots, supra note 97. 105. Raymond Colitt, World Cup Didn’t Help Brazil’s Economy and Olympics Won’t Either, NEWSCRED (Jan. 18, 2015, 11:00 AM), http://skift.com/2015/01/18/world- cup-didnt-help-brazils-economy-and-the-olympics-wont-either/. 106. Zimbalist, supra note 104. 2015] ETHICAL ANALYSIS OF THE 2014 WORLD CUP 17

4. Accompanying Infrastructural Investments The preparations for the tournament involved updating, beautifying, and modifying various public infrastructural facilities, such as urban transportation and accommodation. While these will undoubtedly have lasting legacies, one can justifiably question whether investments could have been made independently of the tournament. The FIFA World Cup is often used as a driving factor for extensive plans for the urbanization of the host country’s facilities. But such investments could have been made even if Brazil did not host the tournament. The country was desperately in need of advanced highways, airports, schools, and hospitals; investments should have been made in these areas instead of fiscal expenditures on football stadiums. The expenditure of $3.6 billion on stadiums undoubtedly crowded out some necessary investments in much needed public infrastructure. This is another negative effect of the preparations for hosting the tournament. The observed investments in public infrastructure should not be considered a direct consequence of the FIFA World Cup. In fact, they are vic- tims of the tournament because many planned public infrastructural facilities were not completed by their deadlines or were abandoned due to the government’s focus on the tournament.

5. Harbinger of Structural Reform The buildup to the World Cup exposed the deficiencies in Brazil’s business environment and public service sector and signaled the immediate need for extensive structural reform. It is abundantly apparent the government will need to meet the demands of the public in order to reduce social unhappiness in the country. The World Cup directly contributed to this realization by pushing social unrest firmly into the spotlight and has, therefore, been a necessary evil. If the government undertakes mass investments that push Brazil onto the path of social prosperity and satisfaction, they will be a direct consequence of the glaring inefficiency of the World Cup’s organization.107 In purely theoretical terms, one can justifiably condone the Brazilian government’s decision to organize the tournament due to its exposure of deep-seated social disharmony. But this does not justify the decision to host the tournament. Had the hosting rights not been awarded to Brazil in the first place, the government would have been able to address the unrest and target structural reform much earlier. Perhaps the unrest would never have reached the levels observed. Targeting structural reform and socioeconomic prosperity should be the foremost prerogative of the government; it should not require a debacle on the scale of the World Cup’s organization for the government to become attuned to the needs of its citizens.

107. Wright, supra note 11. 18 LAW AND BUSINESS REVIEW OF THE AMERICAS [Vol. 21

Thus, it appears most of the intended positive consequences of hosting the tournament, such as improved international status and brand image, increased tourism, and advanced public infrastructure, may not be achieved as a result of the tournament. In fact, the tournament may not bring about any extraordinary consequences that would not have been achieved without the tournament. This indicates that the government’s decision to host the tournament is not one that survives the judgment of consequentialist theories of ethics.

6. Influence on National Team’s Performance A technical analysis of the performance of the Brazilian national team in competitive fixtures since 1960 suggests the national team performs dramatically better when playing at home.108 In fact, its chances of winning the World Cup increase from approximately 30 percent to 48 percent when home advantage is factored into the statistical model.109 Brazil was heavily considered to be a favorite to win the trophy, and doing so at home would have rid the population of the traumatic memo- ries from the 1950 World Cup final. Brazil lost that final on home soil despite being heavy favorites. Given that Brazil is known as a football- crazed nation, winning the 2014 edition in front of a home crowd would possibly have changed the public sentiment from one of brooding frustration to one of jubilant ecstasy. This would most certainly have been a positive consequence of hosting the tournament. Unfortunately, Brazil exited the tournament at the semi-final stage after a humiliating 1-7 loss to Germany. This result was arguably the worst in the history of Brazilian football. Thus, the possible positive consequence generated by hosting the tournament was certainly not achieved. In the weeks following the World Cup there were further exhibitions of the dissatisfaction and frustration due to the poor performance of the national team at home.110 This is clearly a negative consequence.

VI. SUMMARY From a football perspective, the 2014 FIFA World Cup proved to be one of the best in recent memory. The quality of football was outstand- ing, and Brazil’s football fans lived up to their reputation as welcoming, football-loving people. Happily, the tournament was staged without any significant operational glitches. But this does not spare the tournament’s organizers from intense scrutiny of the ethics of awarding the hosting rights to a country that clearly needed urgent public investment in various

108. See THE WORLD CUP AND ECONOMICS 2014, GOLDMAN SACHS 3-7 (2014), available at http://www.goldmansachs.com/our-thinking/archive/world-cup-and-economics-2014-folder/world-cup-economics-report.pdf. 109. Id. at 5. 110. See, e.g., Jeff Fick, Brazil Fans Turn on President Amid World Cup Failure, Give Rousseff 2nd Bronx Cheer, FORBES (July 8, 2014, 6:07 PM), http://www.forbes.com/ sites/jefffick/2014/07/08/brazil-fans-turn-on-president-amid-world-cup-failure. 2015] ETHICAL ANALYSIS OF THE 2014 WORLD CUP 19 infrastructural projects when the decision was made. Brazil’s government should have put the needs of its citizens before the allure of hosting an international event such as the World Cup. The hosting of the tournament can be deemed unethical because of its diversion of government funds and attention away from the immediate needs of the Brazilian public. This conclusion is supported by deontological and consequentialist theories of analysis. The manner in which the organization of the tournament took place—with the country’s organizational inefficiency, bureaucratic corruption, and the marginalization of the public occupying the spotlight—left the government faced with an uphill task to restore faith in its commitment to ensuring the satisfaction of society’s basic needs. 20 LAW AND BUSINESS REVIEW OF THE AMERICAS [Vol. 21 Articles

PRE-MERGER ANALYSIS IN BRAZIL: FIRST ROUND (2012-2014)

Carlos Emmanuel Joppert Ragazzo* and M´ario S´ergio Rocha Gordilho Junior** ´

ABSTRACT In spite of the initial skepticism shown by national and international media, Brazil’s new antitrust law (Law 12.529/11), which replaced Law 8.884/ 94, since coming into force, has brought several improvements for the Bra- zilian competition protection policy. Among the substantial structural changes made, one must note that the main change was, undoubtedly, the institution of the pre-merger analysis. The referred alterations, however, have proved to be insufficient in regards to the numerous challenges generated by the new system, creating the additional need for innovations also in the managerial field. Therefore, the present work aims to present and analyze such managerial innovations created by CADE’s General-Superinten- dence team, which have enabled the implementation of the new pre-merger analysis system established by Law 12.259/11.

KEYWORDS: Pre-merger Analysis–CADE’s General-Superintendence– Managerial Innovations–Law 12.259/11–CADE.

I. INTRODUCTION

N August 2012, The Economist magazine, using a free translation, called the a posteriori control of mergers a “Brazilian oddity.”1 This Ievaluation reflected the reaction to an outdated system for the management of transactions, which resulted in terms and analyses that were longer than the ones observed in developed countries. Only a few less

* Carlos Emmanuel Joppert Ragazzo is Adjunct Professor at Funda¸c˜ao Getulio ´ Var- gas Law School. He has a Master of Laws (LL.M.) in Private Law and Doctor of Juridical Science (J.S.D.) in Regulations of Public Utilities at the University of the State of Rio de Janeiro-UERJ, and a Master of Laws (LL.M.) in Trade Regulation and Competition Policy at the New York University–NYU. CADE’s Former Gen- eral-Superintendent. Email: [email protected]. ** Mario ´ Sergio ´ Rocha Gordilho Junior ´ is CADE’s General Coordinator of Antitrust Analysis (Triage Unit). He has a MBA in Public Administration at Ebape/FGV Bras´ılia and in Competition Protection at GV Law Sao ˜ Paulo and an Economist. Email: [email protected]. 1. “[This] year has seen the demise of a Brazilian oddity: an antitrust regime that allowed companies to merge first and the regulator to ask questions only later.” A Champion for Choice?, ECONOMIST (Aug. 25, 2012), available at http://www.economist.com/node/21560892.

23 24 LAW AND BUSINESS REVIEW OF THE AMERICAS [Vol. 21 influential economies adopted a system similar to ours, allowing the transaction to be completed before the approval by the competition authority. Despite the fact that Brazil’s competition policy has evolved ever since Law 8.884/94 came into force, from the beginning of 2000, there had been the feeling that something needed to be done.2 Despite the extensive managerial work purported by the three previous bodies of the Brazilian System for Competition Protection (SBDC) under Law 8.884/94,3 without drastic structural changes, there was little room for evolution. The ex post analysis system was antagonistic to the best international practices, and it was aggravated by the heavy bureaucratic structure composed of three analytic bodies, known as the “three counters.”4 The result was an inefficient system, with approval deadlines which were incompatible with the dynamics of global economy, as well as the ineffective policy.5 The government, aware of the relevance of the competition protection policy for the country’s economic development and after years of discussion within the legislative and executive powers, granted maximum priority to the pending bill in the National Congress, including it in the growth acceleration programme (PAC).6 Thus, by the end of 2011, the Congress enacted Law 12.259, which would eventually solve a good portion of the

2. One of the conclusions of Organisation for Economic Co-operation and Develop- ment’s (OECD) last Peer Review of the Brazilian competition policy was that the new antitrust law should adopt a pre-merger review system. See generally OECD, COMPETITION LAW AND POLICY IN BRAZIL: A PEER REVIEW 2010, (2010), available at http://www.oecd.org/daf/competition/45154362.pdf. 3. Under Law 8.884/1994 there were three antitrust bodies in Brazil: (i) the Secreta- riat for Economic Monitoring (Seae) from the Ministry of Finance; (ii) the Secreta- riat for Economic Law (SDE) from the Ministry of Justice; and (iii) the Administrative Council for Economic Defense (CADE) an independent agency. The first two secretariats were responsible for rendering opinion on mergers and for conducting investigation on anticompetitive practices. CADE, in its turn, was the tribunal responsible for judging these cases on the administrative level. See generally Lei No. 8.884/94, de 11 de Junho de 1994, DIARIO´ OFICIAL DA UNIAO˜ [D.O.U.] de 13.6.1994 (Braz.), available at http://www.planalto.gov.br/ccivil_03/ leis/l8884.htm. 4. OECD, supra note 2, at 11. 5. See id. 6. Created in 2007, during President Lula’s second mandate, the PAC promoted the recovery of the planning and execution of major infrastructure projects of social, urban, logistics and energetic relevance for the country, contributing to its rapid and sustainable development. The economic measures for growth acceleration en- compassed the following: (i) Credit Stimulus and Financing; (ii) Improvement of the Investment Environment; (iii) Tax Relief and Management; (iv) Long-term Fiscal Measures; and (v) Fiscal Consistency. The reform of Brazil’s antitrust policy was included as one of the most important measures to be taken in order to attract investments. TRIBUNAL DE CONTAS DE UNIAO˜ [COURT OF UNION ACCOUNTS], RE- LATORIO´ E PARECER PREVIO´ SOBRE AS CONTAS DO GOVERNO DA REPUBLICA´ EXERCICIO´ DE 2009 [PRELIMINARY REPORT AND OPINION ON GOVERNMENT AC- COUNTS OF THE REPUBLIC YEAR 2009] 169 (2009), available at http://portal2.tcu .gov.br/portal/page/portal/TCU/comunidades/contas/contas_governo/contas_09/ Textos/CG%202009%20Relat%C3%B3rio.pdf; see also Melhoria do Ambiente de Investimento [Improvement of the Investment Environment], MINISTERIO´ DO PLA NEJAMENTO, http://www.pac.gov.br/sobre-o-pac/medidas/melhoria-do-ambiente- de-investimento (last visited Apr. 7, 2015). 2015] PRE-MERGER ANALYSIS IN BRAZIL 25 structural problems known to all agents. Nevertheless, great challenges remained, because the new law clearly lacked managerial solutions for the implementation of the new system of prior analysis of mergers and acquisitions. These solutions were created by employees in the SBDC’s three bodies, while handling their increasingly demanding workloads. A few months before Law 12.259/11 came into force, several agents went to the press willing to express their concerns regarding the new system. Various pieces, political in nature, were published in a number of magazines and newspapers despite not devoted to specializing in reports on the economy. For example, the newspaper O Globo published a piece on April 22, 2012, emphasizing the concern regarding the lack of personnel for the functioning of the new CADE.7 Exame magazine was even more emphatic. In a long piece, published on June 13, 2012, it highlighted the excessive bureaucracy of the new body, affirming that with the new competition law, “[i]f an iron and steel mill buys a supermarket, it will have to present 58 documents [to the ‘Supercade’].”8 In Germany, it would suffice to send a letter.9 The criticism harshened in the rest of the piece—stating with regard to complex transactions, the old system required thirty-five documents, while the new one required 140.10 The magazine then continued criticizing the excess of bureaucracy of the new model, pointing out that there would be an overdose of papers even in transactions under the fast track procedure.11 Lastly, it estimated that an opinion would take up to forty-five days to be issued and that Supercade could stay inert for months.12 The diagnosis reflected in the national press showed that there was a great chance that the new competition protection system would actually deteriorate the conditions for companies dealing with CADE. Part of this diagnosis resulted from the low expectations created by a negative record regarding the managerial results of the competition protection bodies. These results showed that analysis took an excessive amount of time—sometimes longer than two years.13 The other part of the diagnosis came from the staffing problems of the new body.14 SBDC’s incapacity to deal with the ever-growing stock of mergers was notorious on top of its mission to fight off cartels and unilateral activi-

7. Falta de pessoal amea¸ca in´ıcio de funcionamento do Supercade [Lack of Personnel Threat Early Preparation of the Super-CADE], O GLOBO (Apr. 22, 2012), http:// oglobo.globo.com/economia/falta-de-pessoal-ameaca-inicio-de-funcionamento-do- super-cade-4711776. 8. Patrick Cruz, Lei da concorrˆencia veio para facilitar e complicou [Competition law came to help and complicated], EXAMEN (June 13, 2012), http://exame.abril.com.br/ revista-exame/edicoes/1018/noticias/lei-da-concorrencia-veio-para-facilitar-e-compli cou?page=3. 9. Id. 10. Id. 11. Id. 12. Id. 13. OECD, supra note 2, at 41. 14. OECD, supra note 2, at 47. 26 LAW AND BUSINESS REVIEW OF THE AMERICAS [Vol. 21 ties.15 In regards to the mergers, there lacked a clear policy in order to deal with the ordering of the mergers that were presented due to the growing stock and the reduced number of technicians.16 Even after the adoption of the fast track procedure in 2000, which provided an additional life span to the old system with considerable gains in productivity, the stock or mergers would not stop growing17 Therefore, the logic was basically to administer the increasing volume of stock, rather than the income and outcome flow of mergers.18 This paper aims to detail the creation process of managerial solutions, which culminated in new CADE’s positive performance during its first two years. We will demonstrate the path designed by its employees, starting with the approval procedure of Law 12.259/2011, including the description of structural changes and the transition work. Then, we will describe the managerial solutions developed, in order to ultimately achieve the results that were obtained.

II. THE TRANSITION TO THE NEW COMPETITION LAW In 2005, the Brazilian Government forwarded to the National Congress Bill 5.877, which intended to restructure the Brazilian Competition Pro- tection System. Generally speaking, it established the unification of the bodies of the system and the adoption of the pre-merger thresholds.19 In 2007, the bill regarding the restructuring of the competition protection policy was included as one of the priorities of the January 22nd Growth Acceleration Program (PAC), instituted by Decree 6.025.20 After that inclusion, the restructuring of SBDC became a priority. Two years after its inclusion in the PAC, the project of restructuring of the Brazilian competition protection policy was approved by the House of Representatives.21 A year later, it was approved by the Senate.22 Fi- nally it was definitively approved by the House of Representatives on October 5, 2011.23 Law 12.529/11 was enacted by the president a little

15. The management changes related to this point are based on Chapter 1—Strategic Planning and Prioritisation—of the International Competition Network (ICN)’s Competition Agency Practice Manual. See INT’L COMPETITION NETWORK, AGENCY EFFECTIVENESS: COMPETITION AGENCY PRACTICE MANUAL, 25 (2010), available at http://www.internationalcompetitionnetwork.org/uploads/library/doc744 .pdf. 16. See OECD, supra note 2, at 77. 17. Id. at 78. 18. Id. 19. Lei No. 5.877/05, de 12 de Setembro de 2005, CAMARAˆ DOS DEPUTADOS de 9.12.2005 (Braz.). 20. See Decreto No. 6.025, de 22 de Janeiro de 2007, D.O.U. de 22.1.2007 (Braz), available at http://www.planalto.gov.br/ccivil_03/_Ato2007-2010/2007/Decreto/D6025 .htm. 21. See generally Lei No. 12.529/11, de 30 de Novembro de 2011 D.O.U. de 30.11.2011 (Braz.). 22. See id. 23. See id. 2015] PRE-MERGER ANALYSIS IN BRAZIL 27 less than two months after, on November 30, 2011.24 During this time period, there was much debate, many agents were involved, and various modifications were made to Bill 5.877/2005.25 But the basic backbone was kept intact; namely, the institution of the system of ex ante analysis of mergers and the joinder of the tasks of the three bodies of the SBDC into a single body, which would keep the former name CADE but would present a structure more compatible to current challenges.26 Below is a brief discussion of the changes that had a significant impact on the new antitrust model.

A. STRUCTURAL CHANGES IN THE COMPETITION PROTECTION MODEL As previously mentioned, one of the main changes was the transforma- tion of the a posteriori control of the mergers to a prior control, which is one that prevents companies from closing their transactions before CADE’s approval.27 With this change, the imposition of measures that restrict competition were more easily implemented and less traumatic to the economy as a whole. Further, it placed the competition protection policy in a more equalitarian position with the main jurisdictions of the world, which also facilitated the cooperation in the handling of international transactions.28 The model’s other fundamental change was the joinder of tasks of the three Brazilian antitrust bodies in the new CADE. SDE was terminated and replaced within the structure of the Ministry of Justice by the Na-

24. CONSELHO ADMINISTRATIVO DE DEFENSE ECONOMICAˆ [ADMIN. COUNCIL FOR ECON. DEF.] (CADE), DEFENSE DE CONCORRENCIEˆ NO BRASIL: 50 ANOS [COMPE- TITION POLICY IN BRAZIL: 50 YEARS] 139 (2013), available at http://www.cade .gov.br/publicacoes/livro/CADE_-_DEFESA_DA_CONCORRENCIA_NO_BRA SIL_50_ANOS.pdf; see generally Lei No. 12.529/11, de 30 de Novembro de 2011 D.O.U. de 30.11.2011 (Braz.), available at http://www.planalto.gov.br/ccivil_03/ _ato2011-2014/2011/Lei/L12529.htm. 25. CONSELHO ADMINISTRATIVO DE DEFESA ECONOMICAˆ [ADMIN. COUNCIL FOR ECON. DEF.] (CADE), DEFESA DA CONCORRENCIAˆ NO BRASIL: 50 ANOS [COMPE- TITION POLICY IN BRAZIL: 50 YEARS] (2013), available at http://www.cade.gov.br/ publicacoes/livro/CADE_-_DEFESA_DA_CONCORRENCIA_NO_BRASIL_50 _ANOS.pdf. 26. See generally Lei No. 12.529/11, de 30 de Novembro de 2011 D.O.U. de 30.11.2011 (Braz.). 27. OECD, supra note 2, at 78. 28. After Law 12.529/11 came into force, CADE considerably increased its interaction with the world’s most important antitrust agencies. Some international merger reviews were carried out together with foreign agencies, which led to a significant exchange of information and ideas including discussions on the necessary remedies to be adopted in order to reduce the potential negative impact of the mergers on competition. Some examples of this new phase were the following cases: Merger Review No. 08700.006437/2012-13 (Syniverse Holdings e WP Roaming III) and Merger Review No. 08700.009882/2012-35 (Munksjo AB and Ahlstrom Corpora- tion). Both cases were approved by CADE’s Tribunal following the parties’ signing of commitments (ACC), and after extensive information exchange between CADE and the European Commission. For copies of these decisions, see Sei, CADE, http://sei.cade.gov.br/sei/institucional/pesquisa/processo_pesquisar.php? acao_externa=protocolo_pesquisar&acao_origem_externa=protocolo_pesquisar& id_orgao_acesso_externo=0 (last visited May 8, 2015). 28 LAW AND BUSINESS REVIEW OF THE AMERICAS [Vol. 21 tional Consumer Secretariat, which could also be considered a positive aspect of the new law because it strengthens a very relevant policy for society.29 Seae remained as a part of SBDC, but with a role devoted only to competition advocacy due to its performance over the last few years.30 This change aimed mostly at extinguishing what was formerly known as the “three counters” of SBDC.31 In order to clear a merger in Brazil, the companies had to wait for the approval by three distinct bodies, which were physically separated and had frequent communication problems, requiring double efforts.32 After Law 12.529/11, the tasks performed by the former Seae (except for the competition advocacy) were incorporated to a new body called CADE’s General-Superintendence (GS).33 This body, which will be the focus of the present work, also gained an attribution that plays a very relevant role in the new model adopted by the new Brazilian antitrust legislation—the power to review and decide on the transactions where there is no need for the application of competitive restrictions (i.e., ones that have no chance of having negative impacts on prices and/or quality in Brazil).34 On the other hand, all the mergers that have some kind of restriction suggested by the GS must be ruled on by CADE’s tribunal35 and the administrative tribunal, which investigates breaches in the economic order and offer recommendations for filing or conviction.36 Hence, the more relevant cases, which in a way contribute to the definition of the competition protection policy, are defined in the ruling ses- sions of the administrative tribunal. The Tribunal then becomes essentially a judicial body, which determines CADE’s case law and the country’s competition protection policy, leaving the reproduction of in- structions behind.37 Another legal innovation created by the new Brazilian competition law—a requirement which makes the submission to CADE of a given merger mandatory—also deserves attention in this paper. Under Law

29. José Gabriel Navarro, Governo federal cria a Senacon [Federal government creates Senacon], JORNAL DA TARDE (May 31, 2012, 6:59 AM), http://blogs.estadao .com.br/advogado-de-defesa/governo-federal-cria-a-senacon/. 30. OECD, supra note 2, at 79. 31. See Lei No. 12.529/11, de 30 de Novembro de 2011 D.O.U. de 30.11.2011, art. 4 (Braz.). 32. Cruz, supra note 8. 33. OECD, supra note 2 at 57. 34. Lei No. 12.529/11, de 30 de Novembro de 2011 D.O.U. de 30.11.2011, art. 13 XII, art. 54 I, art. 57, I (Braz.). 35. Lei No. 12.529/11, de 30 de Novembro de 2011 D.O.U. de 30.11.2011, art. 13 XII and art. 57 II (Braz.). 36. Lei No. 12.529/11, de 30 de Novembro de 2011 D.O.U. de 30.11.2011, art. 13 VII- VIII (Braz.). 37. CADE’s Tribunal is active in all the administrative proceedings opened to investi- gate anticompetitive conducts and all mergers contested by the GS. But the Tribu- nal has the power to arrogate any merger approved by the GS. See Lei No. 12.529/ 11, de 30 de Novembro de 2011 D.O.U. de 30.11.2011, art 65 II (Braz.); Resolu¸cão No. 1, de 29 de Maio de 2012 D.O.U. de 31.5.2012, art. 122 II (Braz.), available at http://cade.gov.br/upload/Resolu¸cão%201_2012%20-%20RICADE%20(2).pdf. 2015] PRE-MERGER ANALYSIS IN BRAZIL 29

8.884/94, the submission of any transaction which involved an economic group with gross revenues of more than R$400 million in the year prior to the transaction, with rare exceptions, was considered to be mandatory.38 This resulted in the overcrowding of SBDC with transactions that were mostly fairly simple from a competition standpoint. Needless to say, the mandatory character represented a considerable waste of both public and private resources, which resulted in inefficiency.39 After Law 12.529/11 was enacted, only the submission of transactions that involve an economic group with gross revenues greater than BRL 750 million and at least one more group with a gross revenues over BRL 75 million are considered to be mandatory.40 Along with this innovation, which helped to drastically reduce the number of mergers presented to CADE, came another equally important creation, namely the possibility of regulating the mandatory notification thresholds upon indication by the CADE’s tribunal, followed by a joint ordinance from the Ministries of Economy and Justice. This measure was adopted after the first day of effectiveness of Law 12.529/11 (May 30, 2012) with Interministerial Ordinance MF/MJ 994/12, elevating the figures of its mandatory filing thresholds (established in its article 88) to R$750 million and R$75 million.41 Finally, one has yet to emphasize the rules brought by the new law in regards to the rejection of notifications, via amendment. This point is of great relevance because it encourages the parties in a transaction to present all the information referring to it at the first opportunity, under penalty of rejection and amendment (which can only happen once) by the General-Superintendence. The amendment is the only time in the review procedure of a merger when its review term is interrupted and reinitiated because the information initially presented was considered to be insufficient for a decision by the General-Superintendence.42 Therefore, only when the parties notify CADE about the answer to such an amendment, does the review term begin again.43 Furthermore, in the event the answer to the amendment is not accepted by the General-Superintendence because it still contains defects and irregularities capable of hindering the judgment of the merits, the penalty will be the filing of the proceedings without the analysis of the merits.44

38. Lei No. 8.884/94, de 11 de Junho de 1994, D.O.U. de 13.6.1994, art. 54, ¶ 3 (Braz.) (which was overhauled by Lei No. 12.529/11). 39. See OECD, supra note 2, at 7. 40. Id. 41. See Portaria Interministerial No. 994, de 30 de Maio de 2012, GABINETE DO MINIS- TRO de 30.5.2012 (Braz.), available at http://www.cade.gov.br/upload/Portaria%209 94.pdf. 42. Id. 43. Id. 44. Lei No. 12.529/11, de 30 de Novembro de 2011 D.O.U. de 30.11.2011, art. 53, ¶ 1 (Braz.); see also Resolu¸c˜ao No. 1, de 29 de Maio de 2012, D.O.U. de 31.5.2012, art. 111 (Braz.). 30 LAW AND BUSINESS REVIEW OF THE AMERICAS [Vol. 21

Before proceeding to the next topic of this paper, it is important to mention that the mistrust in the new CADE was clearly demonstrated by the market’s level of tension soon after the enactment of Law 12.529/11. And this level of tension was externalized by the media, as shown in some examples already discussed.45 The most interesting part is that all of this negative news was published not only after the promulgation of Law 12.529/11 (some even after its coming into force), but also after the publication of all of CADE’s main infralegal regulations.46 This signals that the market had a great mistrust of the new CADE’s management ability. After all, even though the structural improvements were evident, they could be deemed innocuous without adequate management. Neverthe- less, as will be demonstrated, the work was already being developed way before these critics, trying to anticipate the main challenges to come.

B. TRANSITION WORKS FOR LAW NO. 12.529/2011 Soon after the approval of SBDC’s restructuring project by the Senate, and its forwarding to the House of Representatives for the final delibera- tion, President Dilma Roussef took office.47 After the initial concern over the degree of priority that would be given to this project by the new president, the Minister of Justice, Jose ´ Eduardo Cardozo, confirmed the new government’s support of the project’s approval.48 Therefore, the leadership of the SBDC (in particular SDE and CADE) decided to initi- ate the preparation for the changes at the beginning of 2011. There was much that needed to be discussed, from the infralegal framework that would have to be created, to the budget and personnel issues, the new physical structure, organizational charts, the compatibilization of different organizational cultures in a single body and, perhaps one of the main points, how to make the new system of prior analysis of mergers work in such a way so as to not frustrate the expectations surrounding the new Brazilian competition protection system. The preparation for the transition process was then initiated. It was thought that the process could unravel at any time because the six month period of vacatio legis would hardly be enough to solve all the issues in a satisfactory manner. Hence, CADE’s commissioners and employees, besides SDE’s and Seae’s employees––which would be incorporated to the

45. See A Champion for Choice?, supra note 1. 46. See generally Cruz, supra note 8; see also Molan Gaban & Juliana Oliveira Dom- ingues, Nova Lei permitirá a cria¸cão de monopolios ´ [New law will allow the creation of monopolies], FOLHA DE SAO˜ PAULO (July 8, 2012), http://www1.folha.uol .com.br/fsp/opiniao/53304-nova-lei-permitira-a-criacao-de-monopolios.shtml (an example of this negative news). 47. Dilma Rousseff sworn in as Brazil’s new president, BBC NEWS (Jan. 1, 2011, 10:17 PM), http://www.bbc.com/news/world-latin-america-12103312 (providing President Dilma Rousseff was sworn into office on January 1, 2011, succeeding Lu´ıs Inacio ´ Lula da Silva). 48. Gilberto Costa, Para Ministro da Justi¸ca novo CADE deve acelerar tramita¸cão de processos de defesa concorrencial, AGENCIAˆ BRASIL (Oct. 6, 2011, 1:35 PM), http:// memoria.ebc.com.br/agenciabrasil/noticia/2011-10-06/para-ministro-da-justica- novo-cade-deve-acelerar-tramitacao-de-processos-de-defesa-concorrencial. 2015] PRE-MERGER ANALYSIS IN BRAZIL 31 new antitrust body, according to the provisions in the bill––were distributed in six groups, supervised by CADE’s commissioners. These six groups were entrusted with the task of discussing, analyzing, and propos- ing actions to facilitate the transition. Therefore, in the first semester of 2011, the transition groups for the preparation of the “New CADE” were formed. The six groups were (a) the New Headquarters, responsible for evaluating the demand for a physical space that would accommodate the increase in the number of staff members and the peculiarities of the activities to be conducted; (b) Structure and Organizational Chart, which studied the structure of the positions, offices, and people that would be necessary in order to fulfill the new competences, including the functioning of the General-Superintendence, the Economic Study Department, and the Federal Attorney’s Office, together with CADE’s Tribunal; (c) Information Technology, created to identify technologic solutions that are more efficient and more adequate to new CADE; (d) Infralegal Rules, responsible for reviewing the existing rules, including new ones and editing the Internal Regulations; and (e) Mobilization and Alignment, entrusted with the task of motivating and boosting the participation of all employees in the transition work, as well as providing the exchange of information between the groups by means of newsletters.49 Besides the ones mentioned above, the pre-merger review group was also created and tasked with identifying the best competition protection practices at an international level. This group can be considered as the most important for the implementation of the new model, and it will be explained in detail below. Its main results were (i) the structuring of the General-Superintendence; (ii) the new information forms for the notification of mergers, creating specific forms for fast track and ordinary pro-

49. The main results of each transition group were the following: (a) New Headquar- ters: renting of headquarters in the end of Asa Norte, in Bras´ılia, which could accommodate the new employees incorporated from SDE and Seae; (b) Structure and Organizational chart—the task of this group was to study the necessary structure for the new CADE, which would receive the tasks previously performed by SDE and Seae, and create an organizational chart of the whole organization which had to reflect both the new tasks and the new procedural flows. This group had a strong interaction with the pre-merger analysis group, aiming at reflecting the new flows created in the institutional design of the new CADE; (c) Information Tech- nology: the primary task of this group was to study several possibilities of new systems presented, aiming at providing the new CADE with an informational system capable of satisfying both the internal public and the external one. This system is currently under development, but it is partly functioning; (d) Infralegal Rules: this group delivered as a main product CADE’s new Internal Regulations, performing great revision work of both the old Regulations and the infralegal rules of the former SBDC’s two Secretariats, which needed to be adapted to the new system; and (e) Mobilization and Alignment: this groups played a fundamental strategic role in the formation of the new CADE, in the sense that it sought to align all the expectations of employees from the three bodies with what was being done by the six transition groups. The open communication between the managers and the employees, with regular presentations in CADE’s Plenary, directed to everyone, was crucial for the motivation process of SBDC’s employees, reducing the resistance to change, common in these scenarios. 32 LAW AND BUSINESS REVIEW OF THE AMERICAS [Vol. 21 ceedings; (iii) a Resolution by CADE (Resolution 02/2012) aimed at regulating the new procedure of prior analysis of mergers, also specifying new criteria for submission; and (iv) the definition of the new procedural workflow within the General-Superintendence.50

C. THE WORK PLAN OF THE PRE-MERGER REVIEW TRANSITION GROUP In the first semester of 2011, several meetings with Brazilian and foreign lawyers that worked along with CADE were conducted.51 They tried to identify the main deficiencies present and confirmed CADE’s diagnosis. Along with these meetings with the main agents of Brazil’s antitrust policy, the pre-merger group initiated benchmarking studies with the best international practices related to the system of ex ante analysis of mergers.52 First, twenty questionnaires were sent to foreign authorities, with questions related to the functioning of their respective pre-merger systems, such as regulations adopted, organizational structures, information level required in notification forms, deadlines, procedural flows, etc.53 Some of the twenty consulted agencies responded to the inquiry performed by CADE.54 After these initial consultations, part of the pre-merger group set in loco interviews with authorities from some agencies that were chosen for technical reasons (i.e., their notorious expertise in competition protection) and also for strategic reasons because some of the chosen agencies had recently undergone similar transition procedures.55 It was not possible to import a ready-made model, without adaptations to the Brazilian reality, in particular because of the inequality between the number of technicians available at these agencies and the number of analyses of mergers performed each year. After the pre-merger transition team concluded that all of the products they had envisaged in their initial project, which was delivered on January 31, 2012 (almost four months before the new law would come into force), they were presented for validation and adjustments to all other teams, as well as to the leaderships in both CADE and SDE.56 The products and

50. ESCOLA NACIONAL DE ADMINISTRAC ¸ AO˜ PUBLICA´ [NATIONAL SCHOOL OF PUBLIC ADMINISTRATION], AC¸ OES˜ PREMIADAS NO 18O CONCURSO INOVAC ¸ AO˜ NA GESTAO˜ PUBLICA´ FEDERAL-2013 [AWARDED SHARES THE 18TH CONTEST INNOVATION IN MANAGEMENT FEDERAL PUBLIC-2013] 179 (Pedro Luis Costa Cavalcante, et al. eds., 2013), available at http://www.enap.gov.br/images//livro_acoes_premiadas_18 _concurso.pdf [hereinafter ESCOLA NACIONAL DE ADMINISTRAC ¸ AO˜ PUBLICA´ ]. 51. Id. at 189. 52. Id. 53. Id. 54. For instance, Australia, Canada, Denmark, Spain, France and United States of America. See id. 55. Lauro Jardim, O CADE vai a` Europa [CADE going to Europe], VEJA (Jan. 6, 2012, 5:54 PM), http://veja.abril.com.br/blog/radar-on-line/governo/o-cade-vai-a- europa/. 56. Dirigentes do SBDC elaboram proposta de novo Regimento Interno [SBDC Lead- ers Prepare Proposed New Bylaws], CONSELHO ADMINISTRATIVO DE DEFESA 2015] PRE-MERGER ANALYSIS IN BRAZIL 33 main results of each team were presented at seminars organized in places outside the headquarters of the referred bodies in two phases.57 During the seminars, each point of the products was discussed, through individual presentations, followed by a debate. The key objective of these en- counters was to validate the main products developed during the transition phase, in order to present them to the Brazilian society by means of public inquiries.58 The main product developed by the pre-merger team which was subjected to a public consultation was the Resolution that would regulate the mergers, including the two notification forms (fast track and ordinary proceedings), as well as its annexes.59 Hundreds of contributions were received during the public consultation process—many of them have been incorporated into the final versions of the texts—and were all duly answered. The participation of the major national agents and even of some international ones, such as the American Bar Association, was of great value to the development of the regulation which gave rise to CADE’s Resolution 02/2012, as soon as Law 12.529/11 first came into effect.

III. THE MANAGERIAL INNOVATIONS INSERTED BY CADE

After all the above mentioned, the structural changes promoted by the new Brazilian antitrust law would not be enough to guarantee, on their own, the good functioning of the new pre-merger system.60 With time, it became clear to the transition group responsible for thinking up the new pre-merger model, that a procedural flow focused on a model of prioritiz- ing the proceedings needed to be adopted. This was the only way the new body would be able to overcome the challenge of rendering higher quality analyses of mergers faster and more efficiently. Moreover, all the inefficiency of the old a posteriori control of mergers regime should be completely reversed. This is because a prior control would demand that the decisions of the mergers by the new CADE be conducted quickly enough in order to avoid preventing hundreds of transactions of mergers and acquisitions between companies that occur

ECONOMICAˆ (CADE), http://www.cade.gov.br/Default.aspx?c97d8d9c74a97e8591 be8ed969ee (last visited Nov. 7, 2014). 57. The first seminar was held on February 1, 2012, and the second between February 27 and March 2, 2012, both at the Israel Pinheiro Convention Center, in Bras´ılia. See id. 58. See id. 59. These two filing forms were published for public consultation by CADE on March 2012. See Consultas Publicas ´ Conclu´ıdas, CADE, http://www.cade.gov.br/Default .aspx?62d524f50f04181bef5def471f21 (last visited Nov. 7, 2014). 60. As previously said in item 2.1 of this paper, the new Brazilian antitrust law solved part of the structural problems, for example, reducing the inefficiency generated by the “three counters” by transforming them into one single body and all the costs derived from this system, and also creating one more threshold to be considered for the prior notice of mergers. 34 LAW AND BUSINESS REVIEW OF THE AMERICAS [Vol. 21 annually in Brazil.61 Therefore, the success of the new CADE depended on innovative managerial solutions in order to overcome the operational difficulties of a pre-merger system. The managerial problem was diagnosed based on the whole work plan of the pre-merger group. The administration of mergers is difficult because it requires the organization of procedures with different complexity levels that consequently require different levels of work within an administrative body such as CADE. This difficulty derives not only from CADE, but also from the companies’ representatives who submit their mergers, leading to a volume of necessary information varying according to the complexity level of the transaction. In the previous model, the cases were essentially analyzed based on a “first come, first serve” approach, causing more complex cases to block the analysis of the majority of simpler ones.62 The central theme of the managerial innovations developed by the pre- merger group was and continues to be to transform the system into a continuous flow of analysis to avoid any interruptions in one of the units of the General-Superintendence.63 In order to transform the administration of the proceedings, it would first be necessary to organize the entry of these proceedings into the General-Superintendence. This led to the following managerial innovations introduced into CADE’s General- Superintendence.

A. CREATION OF A SPECIFIC SECTOR FOR THE TRIAGE OF MERGERS Initially, the pre-merger transition group had to plan the new procedural flow within the General-Superintendence and decide the ideal organizational structure in order for this flow to work in an efficient manner, despite the scarce resources and slim chances of solution until the start of the body. A key element adopted by the General-Superintendence was the creation of the Triage sector, which continues to be tasked with identifying all cases that clearly do not raise competition concerns and deciding those

61. See Statistics, INST. OF MERGERS, ACQUISITIONS AND ALLIANCES, http://www.imaa -institute.org/statistics-mergers-acquisitions.html#MergersAcquisitions_Brazil (last visited Nov. 7, 2014). 62. See Laura Naime & Ligia Guimaraes, ˜ Conhe¸ca os passos para aprovar ou rejeitar a fusão Sadia-Perdigão [Learn the steps to approve or reject the merger Sadia, Perdi- gao], GLOBO—SAO˜ PAULO (May 20, 2009), at G1, available at http://g1.globo.com/ Noticias/Economia_Negocios/0,,MUL1161471-9356,00-CONHECA+OS+PASSOS +DO+CADE+PARA+APROVAR+OU+REJEITAR+A+FUSAO+SADIAPER DIGAO.html; see also Daniela Barbosa, Caso Sadia-Perdigão pode acelerar mudan¸ca na lei das fusoes ˜ e aquisi¸cões [Sadia, Perdigao case can accelerate change in the law of mergers and acquisitions], EXAME (June 9, 2011, 6:00 AM), http:// exame.abril.com.br/negocios/noticias/caso-sadia-perdigao-pode-acelerar-mudanca- na-lei-das-fusoes-e-aquisicoes; see also Bruno Boris, CADE–decisão que reprova compra da Garoto pela Nestlé [CADE-decision disapproves purchase of Garoto by Nestlé], MIGALHAS (Feb. 13, 2004), http://www.migalhas.com.br/dePeso/16,MI3649 ,71043-CADE+decisao+que+reprova+compra+da+Garoto+pela+Nestle. 63. ESCOLA NACIONAL DE ADMINISTRAC ¸ AO˜ PUBLICA´ , supra note 50, at 191. 2015] PRE-MERGER ANALYSIS IN BRAZIL 35 cases within thirty days.64 This deadline was created by the leaderships of the new CADE. Because more than 600 approvals using the fast track procedure were made within thirty days, it is highly probable that this is going to be incorporated into the body’s Internal Regulations following CADE’s last regulation review. The creation of a general department was a result of the fact that the ratio of proceedings per technician is higher in Brazil than in many other main foreign authorities.65 This department was designed to “separate the wheat from the chaff” or, more specifically, to separate the cases with less potentially offensive effects on competition (a procedure called fast tracking) from the cases that could negatively impact the competitive environment.66 This new institutional design broke up the structure adopted in the previous model of a posteriori review. Even though the fast track procedure has existed since the mid-2000s, none of three bodies of the former SBDC had a specific sector for such an activity. The use of two notification forms (one for fast track procedures and the other for all other cases) helped the congestion of the Triage sector. It comes down to a self-identification mechanism, which is one of the

64. See id. 65. According to the information found in the annual reports of some of the world’s most important antitrust agencies, in 2012, while CADE reviewed 660 cases with the assistance of eighty-seven public servants (average of 7.58 cases per public servant), France reviewed 2013 with the assistance of ninety-nine public servants (average of 2.15 cases per public servant), Spain reviewed 113 cases with 106 public servants (average of 1.06 public servants per case), Canada reviewed 232 cases with 282 public servants (average of 0,82 cases per public servant), and the United States of America reviewed 1.166 cases with the assistance of 722 public servants (average of 1.61 cases per public servant). See MINISTERIO´ DA JUSTICA ¸ [MINISTRY OF JUSTICE], PRESTAC ¸ AO˜ DE CONTAS ORDINARIA´ ANUAL: RELATORIO´ DE GESTAO˜ DO EXERCICIO´ DE 2012 [PROVISION OF REGULAR ANNUAL ACCOUNTS, ANNUAL RE- PORT FOR THE YEAR 2012], available at http://www.cade.gov.br/upload/Relat%C3 %B3rio%20de%20Gest%C3%A3o%20de%202012_CADE_vers%C3%A3o%20 final.pdf; see also AUTORITEE´ DE LA CONCURRENCE, PUSHING THE BOUNDARIES FOR A STRONG AND FAIRER ECONOMY: ANNUAL REPORT SUMMARY 2012, available at http://www.autoritedelaconcurrence.fr/doc/synthese_2012_en.pdf (providing France reviewed 2013 with the assistance of ninety-nine public servants); see also COMISION NACIONAL DE LA COMPETENCIA, ANNUAL REPORT: 2011-2012, available at http://www.cncompetencia.es/Inicio/GestionDocumental/tabid/76/Default. aspx?EntryId=186694&Command=Core_Download&Method=attachment (providing Spain reviewed 113 cases with 106 public servants); see also COMPETITION BUREAU CANADA, ANNUAL REPORT OF THE COMMISSIONER OF COMPETITION FOR THE YEAR ENDING MARCH 31, 2012, http://www.competitionbureau.gc.ca/eic/ site/cb-bc.nsf/vwapj/cb-doc-ar-2011-12-e.pdf/$file/cb-doc-ar-2011-12-e.pdf; see also FEDERAL TRADE COMMISSION, THE FTC IN 2012, http://www.ftc.gov/sites/default/ files/documents/reports_annual/ftc-2012/ftc-highlights-2012.pdf (last visited Apr. 25, 2015). 66. The first time that the triage system was discussed with the international legal community was in the Merger Enforcement in The Americas Conference, which was held on by the New York State Bar Association Antitrust Law Section, in conjunc- tion with the International Section of the NYSBA, the Brazilian Institute on Com- petition, Consumer Affairs, International Trade (Ibrac) and the Canadian Bar Association, in New York on July 17, 2012. See Remarks by Melanie L. Aitken, Commissioner of Competition, COMPETITION BUREAU, July 17, 2012, http://www .competitionbureau.gc.ca/eic/site/cb-bc.nsf/eng/03494.html. 36 LAW AND BUSINESS REVIEW OF THE AMERICAS [Vol. 21 ways to organize the queue (commonly used in customer service systems). In case the company presents an ordinary case as a case for the fast track procedure, it bears the risk of having its case amended and ultimately rejected if there is a lack of necessary information.67 This possibility of amendment and rejection discourages companies from supply- ing misleading or incomplete information, leading to a more efficient Triage sector.68 The Triage department is the core of the General-Superintendence’s intelligence and its role is to create and foster new management tech- niques and substantive reviews of the mergers that are filed with CADE. Because it receives all the mergers submitted to CADE, monitors transactions that are occasionally not presented (whether mandatory), and centralizes all the questions citizens may have regarding legal and infralegal rules that regulate CADE’s performance, the Triage department is central to the pre-merger review. Furthermore, because it possesses a broader vision of all the cases presented and of all the doubts already answered, the Triage department serves as a communication bridge between the Brazilian antitrust community and the General- Superintendence.69

B. CREATION OF CGS, SPECIALIZED IN GROUPS OF SECTORS BASED ON A “SCALE/SCOPE” LOGIC The creation of a Triage sector was not the only managerial innovation in terms of institutional design. The whole structure of the General-Su- perintendence was developed to function organically, favoring scale and scope gains with specialized departments (or “coordinations”) in different sectors of the economy. It also benefits not only from the accumulated expertise both in regard to the review of mergers and to abuse of dominance cases (another break from the previous system’s structure),

67. Lei No. 12.529/11, de 30 de Novembro de 2011 D.O.U. de 30.11.20113, art. 53 (Braz.). 68. The companies, motivated by a system of a posteriori analysis, which did not prevent the conclusion of the intended transaction, made little efforts to present their merger in a complete form with all necessary information for a correct analysis. To the contrary, in cases that were notably more complex, it was obvious that the parties intended to initially present the minimum amount of information possible, submitting additional information as it was required by SBDC’s bodies, through information requests, which suspended the legal term imposed by Law 8.884 (30 days for each Secretariat and 60 days for CADE, with the possibility of interrup- tion upon any request for supplementary information, both to the parties and to third parties). After all, the longer the analysis, the more difficult it would be to implement conditions for its approval, or even failure. This negative incentive generated by the a posteriori analysis system also existed for the SBDC’s employees who, pressured by the huge amount of transactions submitted and by the extremely short legal term, did not evade from sending requests for information, which were sometimes, unnecessary to the analysis. 69. Since the enactment of the new competition law, the Triage has been mainly at the service of antitrust law, basically answering questions on whether a given transaction is of mandatory filing with CADE, as well as questions on whether a given transaction can benefit from the fast-track proceeding. 2015] PRE-MERGER ANALYSIS IN BRAZIL 37 but also from the constant exchange of information between the departments. The creation of those specialized departments was based on empirical work (CGAA 1 to 4).70 Indexes with some variables71 were created based on all the mergers (not fast tracked) reviewed by the Seae/MF between 2007 and 2011, as well as, on the stock of administrative proceedings (except for cartels) from SDE/MJ in the beginning of 2012. These indexes were aimed at evaluating the “good stock” for each of the new departments of the GS by analyzing this stock both according to the amount of acts expected for each sector allocated in the departments and their degree of difficulty. The indexes also consider the possible scale and scope gains resulting from these divisions; analyzed both in terms of analysis of mergers and of unilateral behaviors. Because all of the general departments have the same legal compe- tence, there is a constant exchange of technicians between them whenever there is the necessity for a task force in a certain case, or even for a temporary reinforcement in a certain sector. This flexibility in the institutional design also allows the structure of the General-Superintendence to more easily adapt to the changing economy, enabling the technicians to also adapt to the demand. It is important to highlight that the “scale/ scope” logic in the formatting of general departments of the General- Superintendence is aligned with the organization of the line of mergers to render the flow of analysis more efficient.72

C. CREATION OF WORK FLOWS BASED ON DIFFERENT DEGREES OF COMPLEXITY The two previous innovations relate to the Triage department’s structure, as well as the creation of the sectorial departments (with the help of the two form models) and the goal of transforming stock into continuous flow of analysis is summarized in Image 1 (below). It also reflects the different treatment given to different degrees of complexity of the transactions presented to CADE.

70. ESCOLA NACIONAL DE ADMINISTRAC ¸ AO˜ PUBLICA´ , supra note 48, at 192–93. 71. For instance, average analysis time, average analysis time by sector, amount of cases analyzed by sector, amount of restrictions suggested by Seae per sector etc. Id. 72. Id. 38 LAW AND BUSINESS REVIEW OF THE AMERICAS [Vol. 21

Image 1–Mergers flow in the CADE’s General-Superintendence

The Triage department receives all the mergers and makes a first assessment, in order to verify if all the information and documents presented are enough for the start of the actual proceeding analysis.73 After this, the transaction’s notice is published in the Official Federal Ga- zette, as well as on the CADE’s website to give publicity of the transaction to third parties.74 But if the merger is ordinary (not subject to the fast track procedure), then the Triage department forwards the proceeding directly to the general department responsible for its review. Initially, this department will verify if all the information submitted is enough;

73. Id. at 193. 74. See Lei No. 12.529/11, de 30 de Novembro de 2011 D.O.U. de 30.11.20113, art. 53 (Braz.). 2015] PRE-MERGER ANALYSIS IN BRAZIL 39 then it will go through all the stages of an act submitted under the fast track procedure, as described Image 1. Afterwards, the department performs all necessary market tests, and, as the review progresses, it can request more information from the parties. Regarding the mergers submitted under the fast track procedure, if the Triage department believes that there is a lack of information for the start of the merger review, then it can try to clarify through direct questions to the parties via letters or phone calls. If the lack of information is essential for the con- tinuation of the case, then the Triage department can opt for an amendment. After clarifying the questions during the initial proceeding of the analysis,75 the Triage department decides, together with the specialized coordinator responsible for the review in the specific sector of the transaction submitted and the Adjunct Superintendent, whether to proceed with the review under the fast track procedure or to forward the transaction for review under the ordinary procedure by the respective specialized department. In the latter case, the decision by the GS to not grant the fast track procedure to a transaction is discretionary.76 This only means that the GS was not convinced, even after clarifications provided by the parties and third parties, that the transaction potentially has a less severe impact on competition; therefore, it requires a greater scrutiny by its team. In some specific cases, even before the publishing of its notice, the Triage department may request a waiver from the parties,77 which allows the GS to ask for information from third parties or other international antitrust authorities upon authorization by the parties. The waiver, also used by the other departments responsible for the ordinary acts, aims to speed up the review before it is published via notice, especially in cases that raise relevant questions, even if submitted under the fast track procedure. These procedures aim to speed up the review term in one of two ways: (1) through fast track procedure, which adheres to the thirty day dead-

75. This initial process does not necessarily refer to the procedures performed before the publication of the notice. In some cases, the Triage may publish the notice, if it understands that the parties have presented all the information available to them to enable the start of the analysis of the transaction in the GS after diligences with third parties (competitors, clients, suppliers etc.), it may decide, together with the specialized coordination and the Adjunct Superintendent, not to continue the analysis of this transaction under the fast track procedure in case the diligences performed have not made clear the irrelevance of the transaction in competition terms or even if these diligences have brought new doubts about the transaction. In these cases, which are an exception to the rule, the GS determines, through an order, that the transaction be changed to the ordinary procedure, and that new information to be requested. 76. Resolu¸cão No. 2, de 29 de Maio de 2012, D.O.U. de 5.31.2012, art.7 (Braz.), available at http://www.cade.gov.br/upload/Resolu%C3%A7%C3%A3o%202_2012%20 %20An%C3%A1lise%20Atos%20Concentra%C3%A7%C3%A3o.pdf. 77. Although CADE has not specifically regulated this issue, the waivers were adopted based on the best practices of the world’s top antitrust agencies. This instrument has been used in several cases with international repercussions. See No. 08700.006437/2012-1 Ato de Concentra¸cão, supra note 26; No. 08700.009882/ 2012-35 Ato de Concentra¸cão, supra note 26. 40 LAW AND BUSINESS REVIEW OF THE AMERICAS [Vol. 21 line, starting from the day of submission of the act to CADE; or (2) under ordinary procedure, under which the deadline depends on its level of complexity, even though it is legally limited to 240 days with restricted possibilities of extension.78

D. INSTITUTION OF THE “PRE-SUBMISSION” PHASE Inspired by successful experiences in international antitrust authorities, the transition team of the pre-merger group suggested the inclusion of a provision in CADE’s Internal Regulations79 aiming at establishing prior meetings for the mergers that are not eligible for the fast track procedure. These meetings allow the parties to present to the GS the general aspects of the intended transaction, as well as their view of the possible impacts on certain markets. This whole process is conducted in a secretive manner, but in some cases the parties can waive secrecy to allow the authority to access other international authorities or to allow the market to answer questions raised. Until now, this “pre-submission” phase has been generating positive feedback within the scope of the General-Superintendence. The GS can anticipate its first impressions of the transaction and information presented up to that moment, avoiding, in the majority of cases, delays by lack of information at the time of notice of the transaction to CADE because it is in possession of the main aspects of the transaction, or in many cases of a draft of the Annex 1 form of CADE’s Resolution n. 02/ 12. The main purpose of this stage is precisely to guarantee that the transaction be presented in the most complete manner as possible, considerably reducing the possibility of an amendment. This gain in quality regarding the information of the transactions submitted, resulting from the discussions during the pre-submission phase, have greatly contributed to faster review terms in these cases.

E. SYSTEM OF “CHECKS & BALANCES” In order to supplement the flow described above, a system of “checks & balances” was created for all mergers reviewed under the fast track procedure, which currently represent 90 percent of all the analyses ever conducted by the Superintendence. The central idea resides in using the expertise accumulated in the four general departments that deal with ordinary mergers for a counter-check of the analyses undertaken by the

78. In May 2014, the average term of analysis of a merger in the GS was sixty-seven days. In sixty-three cases already examined under the ordinary procedure in the GS, ever since the new law has come into force, the biggest term was 184 days, related to a transaction challenged in the Tribunal (CA n. 08700.006437/2012-13), and that was decided through a commitment (ACC-Concentrations Control Agreement). See ESCOLA NACIONAL DE ADMINISTRAC ¸ AO˜ PUBLICA´ , supra note 50. 79. See Regimento Interno Do Conselho Administrativo de Defesa Economica ˆ [The Internal Rules of the Board Economic Defense] de 07 de outubro de 2014, art. 114 (Braz.). 2015] PRE-MERGER ANALYSIS IN BRAZIL 41

Triage’s department under the fast track procedure. Additionally, this flow allows these departments to constantly exchange experiences of their analyses, facilitate the internal communication, and grant more quality and legal certainty to the GS’s decisions. This system works in the following way: after the development of the opinion on a transaction under the fast track procedure by a technician in the Triage’s department, the opinion is evaluated by its general coordinator. Then, the Triage’s general coordinator submits its fast track opinion for a revision by the general coordinator responsible for the analyses in the economic sector affected by that opinion. When revising the opinion issued by the Triage department, the general coordinator may suggest alterations or supplementations, may give its approval without alterations, and even request new diligences. The coordinator may also determine that the merger is not eligible for the fast track procedure, causing the transaction examined by the Triage department to be more accurately scrutinized for its coordination.80 But in case this general revising coordinator gives its approval to the opinion issued by the Triage department, it is then forwarded to the Adjunct Superintendent responsible for monitoring the mergers, who will proceed in a similar fashion as this revising coordinator. Only after the approval of the expedited opinion by the Ad- junct Superintendent, is the merger submitted for final approval by the General-Superintendent.81

IV. RESULTS The critics were wrong. Past the initial works phase, with the first and very satisfactory results, there was no shortage of compliments to the new CADE’s performance. Various national and international publications highlighted the promising start of the new system. The very Exame magazine, about three months after its piece that carried heavy criticism, completely reversed the setting, with a long piece praising the start of the new CADE. This piece was titled, “A promising start for the Supercade,” with the subtitle “in a little over two months, Supercade has prevailed over the skepticism and makes its debut approving the acquisition of companies in record time. The Brazilian economy says thanks.”82 But there were also many other pieces complimenting this “promising start” highlighted by Exame, with several positive statements by lawyers who

80. See ESCOLA NACIONAL DE ADMINISTRAC ¸ AO˜ PUBLICA´ , supra note 50, at 187. 81. It is worth noting that although this internal checks & balances system is not provided for in any specific rule, it was adopted internally by the GS with the purpose of guaranteeing both speed and quality in merger reviews, while encouraging information spill-overs between the departments. This process was based on Chap- ter 3: Knowledge Management of the Agency Effectiveness Handbook. See generally INTERNATIONAL COMPETITION NETWORK, AGENCY EFFECTIVE HAND- BOOK (2013) available at http://www.internationalcompetitionnetwork.org/uploads/ library/doc894.pdf. 82. See Patrick Cruz, Um come¸co promissor para o Supercade [A promising start to the Supercade], EXAME (Aug. 9, 2012, 05:55 AM), http://exame.abril.com.br/revista- exame/noticias/um-comeco-promissor-para-o-supercade. 42 LAW AND BUSINESS REVIEW OF THE AMERICAS [Vol. 21 work in the field: The Economist, Carta Capital, Reuters, Valor Econom- ˆ ico, among others.83 But which results motivated this change?

A. RESULTS DURING THE TRANSITION TO THE PRE-MERGER MODEL Before beginning its journey under new legislation and under a new model of pre-merger analysis, as a reflection of all the tension created before Law 12.529/11 and during the final period of submission of cases under the old model (a posteriori review, where the parties could conclude the transaction before the approval by CADE), fifteen work days after May 28, 2012, which marked the last day of effectiveness of Law 8.884/94, 141 mergers were presented.84 Besides these 141 transactions submitted over a period of less than one month, more than 100 mergers were inherited from Seae without the conclusion of its opinion because this body was no longer in charge of reviewing mergers after the new law came into force.85 But the difficulties did not stop there. During this transition period between the two laws, headquarters changed and the adaptation reforms were delayed for about three weeks, leaving the whole body practically without the minimal structural conditions for work. Nevertheless, none of these cases were delayed because the legal term for their analysis started counting from the day of notice, as established in Law 8.884/94, and the deadline would have to be met, with or without the structure.86 Right from the beginning, the Triage’s department started working, separating all transactions eligible for a fast track treatment from the ones that deserved greater scrutiny. This activity was conducted in about two weeks. With the collaboration of all teams responsible for the review of mergers at CADE, the result could not have been better. All the transactions that benefitted from the fast track procedure (approximately 70 percent) were reviewed by the GS in less than thirty days; until the end of 2012, almost all of the 141 cases submitted had already been examined by the CADE’s GS.87 In April 2013, the GS’s stock of mergers presented under Law 8.884/94 had ended. In May 2014, there were only three mergers, submitted under Law 8.884/94 left for the tribunal’s analysis.88 In June 2012, mergers started to be filed already under the new pre- merger analysis model. This marked the beginning of the test of the innovations of the new CADE. The results were extremely positive. The first

83. See id.; see also A Champion for Choice?, supra note 1; Por Leonardo Goy, Cade julga mais de 800 casos de fusao ˜ e aquisi¸c˜ao em 2012 [Cade thinks more than 800 cases of mergers and acquisitions in 2012], REUTERS BRASIL (Dec. 12, 2012, 11:26 AM), http://br.reuters.com/article/idBRSPE8BB03F20121212; Cade julga maior n´umero de casos em um ano [Cade believes more cases in a year], VALOR ECONOM-ˆ ICO (Dec.12, 2012, 7:19 PM), http://www.valor.com.br/empresas/2938174/cade- julga-maior-numero-de-casos-em-um-ano. 84. See generally ESCOLA NACIONAL DE ADMINISTRAC ¸ AO˜ PUBLICA´ , supra note 48. 85. See id. 86. See Lei No. 8.884/94, supra note 3, art. 54, paras. 6, 7 (repealed 2012). 87. See ESCOLA NACIONAL DE ADMINISTRAC ¸ AO˜ PUBLICA´ , supra note 50. 88. See id. 2015] PRE-MERGER ANALYSIS IN BRAZIL 43 case approved under the fast track procedure took twenty-seven days.89 Right after that, another three cases took less than fifteen days each.90 In the first three months of the new CADE, the average term for the analysis of the fast track cases was approximately twenty days.91 As to the ordinary ones, the success was also immediate. The first one was approved in forty-eight days,92 and the second within fifty days.93 In the first six months that Law 12.529/11 became effective, the average term for the review of ordinary mergers was forty-one days.

B. RESULTS AFTER THE TRANSITION FOR THE PRE-MERGER MODEL

Since the new law, the average terms for the fast track cases have continued to stay close to the initial average, even with the significant increase of cases submitted in 2013. But the average terms for the ordinary cases slightly increased mostly due to the degree of difficulty of some of them. Ten of those cases were sent to the Tribunal with a challenge by the GS.94 The average term for the ordinary cases between 2012 and May 2014 was approximately sixty-seven days in the GS (eighty-seven days total including review terms of the transactions decided by the Tri- bunal),95 complying with the international standards of leading antitrust agencies in the world.96 Below, we show the main statistics from CADE after Law 12.529 came into force, up until May 2014.

89. See Ato de Concentra¸cão No. 08700.003962/2012-87 de 09 de julho de 2012 CADE (Braz.), available at http://www.cade.gov.br/temp/D_D000000675581971.pdf. 90. See Barbara Rosenberg, Brazil: The Enactment of the New Brazilian Competition Law: An Important Shift, MONDAQ, http://www.mondaq.com/x/253956/Antitrust+ Competition/The+Enactment+Of+The+New+Brazilian+Competition+Law+An+ Important (last updated Aug. 26, 2013). This indicates that the fast track review takes less than thirty days for approval by the CADE. 91. See CA ESCOLA NACIONAL DE ADMINISTRAC ¸ AO˜ PUBLICA´ , supra note 50, at 197. 92. See Ato de Concentra¸cão No. 08700.006962/2012-39, de 16 outobro de 2012 CON- SELHO ADMINISTRATIVO DE DEFESA ECONOMICAˆ (Braz.), available at http://www .cade.gov.br/temp/D_D000000704881564.pdf. 93. See Ato de Concentra¸cão No. 08700.005310/2012-87, de 01 de Novembro de 2012 CONSELHO ADMINISTRATIVO DE DEFESA ECONOMICAˆ (Braz.), available at http:// www.cade.gov.br/temp/D_D000000708581248.pdf. 94. This figure takes into account the time elapsed between the coming into force of Law 12.529/11 and May 2014. 95. See Lei No. 12.529/11, de 30 de Novembro de 2011 D.O.U. de 30.11.2011, art. 53 (Braz.); See also Resolu¸cão No. 1, de 29 de Maio de 2012, D.O.U. de 31.5.2012, art. 111 (Braz.). 96. See generally Howard W. Fogt, et al, Timely Merger Clearance Becomes Increas- ingly Problematic As Complex Rules and Procedures for Required Approvals Spread Around the World, BLOOMBERG BNA (Aug. 23, 2013), http://antitrust.bna .com/atrc/7033/split_display.adp?fedfid=35698743&vname=atrcnotallissues&wsn= 499968000&searchid=23793196&doctypeid=1&type=oascore4news&mode=doc& split=0&scm=7033&pg=0. 44 LAW AND BUSINESS REVIEW OF THE AMERICAS [Vol. 21

Graphic 1–Comparison between the average merger review terms (Law 8.884/94–2009 to 2011–and Law 12,529/11–2012 and 2013) 200 182 180 156 160 154 140 GENERAL AVERAGE TIME FOR ANALYSIS OF 120 MERGERS UNDER LAW 100 12.529 80 GENERAL AVERAGE TIME FOR ANALYSIS OF 60 MERGERS UNDER LAW 40 8.884 21 26 20 0 2009 2010 2011 2012 2013 Source: CADE

Table 1–Statistics from CADE’s General-Superintendence (2012 to 2014)

No. Fast No. No. Average No. Average Track Ordinary Summary Time – Ordinary Time - Year (Entry)* (Entry)* Opinions Fast Track Opinions Ordinary Total 2012 121 17 106 18,7 8 41,3 138 2013 334 41 319 19,4 32 65,1 375 2014** 124 21 131 21,1 23 78,3 145 *including cases withdrawn **data updated up to 20 May 2014 658 Source: CADE-Data updated up to May 20, 2014.

Table 2–Average terms of the General-Superintendence only regarding ordinary cases (distributed by brackets of terms of discovery)

Representativeness Brackets Number of Cases Average (days) (%) Considering all cases 63 67 100 taking out only the ones 56 58 89 challenged by the GS (07) taking out only the ones above 53 51 84 100 days (10) taking out only the ones above 67 days (general average term) 42 44 67 (21) taking out only the ones above 29 39 46 50 days (34) Source: CADE -Data updated up to 20 May 2014. 2015] PRE-MERGER ANALYSIS IN BRAZIL 45

As easily noticable from the data presented above, the efficiency gain in the new prior analysis of mergers in comparison to the former system is undeniable. In as early as the first year, the decrease was drastic, going from an average term of 154 days in 2011 to twenty-one days in 2012 (representing approximately an 86 percent decrease in terms). Equally important, the average review period remained steady from 2012 on- wards, but the number of transactions considerably increased in 2013 and until May 2014. Currently, this average term is twenty-six days. It must be stressed that this term counts in all the procedures (fast track and ordinary) and also encompasses the discovery period carried out by the GS, as well as the ruling period by the Tribunal. In regards to ordinary cases, the term includes the period carried out by the GS and the Tribunal, which accounts for an average review term in April 2014 of eighty-one days—still below the maximum term (240 days, which can be extended for 90 more days) established by law. It should be noted that only one merger97 decision surpassed the 240 day deadline among the 619 current decisions.98 In relation to the ordinary cases, Table 2 clearly shows that the vast majority of the sixty-three cases already instructed by the GS had an analysis review term shorter than 100 days and also shorter than the general average (sixty-seven days in the GS). In the first case, only ten analyses surpassed 100 days, which means that over 84 percent of the cases were solved in a shorter time frame. In the second case, only twenty-one analyses surpassed sixty-seven days, which is the current average term for ordinary cases in the GS and means that almost 70 percent of the cases were solved in a term shorter than the average. Further, almost half (46 percent) of the total amount of ordinary cases already examined by the Superintendence was below fifty days. There are also five ordinary cases that were approved in a shorter term than the maximum term determined for the fast track procedure, which is thirty days. Finally, of the ten cases that surpassed 100 days of review, the “outliers” in the universe of ordinary cases already examined by the GS, six were challenged by the Tribunal (five of which with a declaration of complexity)99 and the other four had problems in the presentation of in-

97. This was the case of the merger between the higher education institutions, Anhanguera and Kroton, which had its term extended upon request by the Tribu- nal, having used 301 days until its final decision, for the approval conditional upon the fulfillment of a number of measures provided for in a Concentrations Control Agreement (CCA), entered into by CADE and the claimants. See Ato de Concen- tra¸c˜ao No. 08700.005447/2013-12, de 06 de maio de 2014 CONSELHO ADMINISTRA- TIVO DE DEFESA ECONOMICAˆ (Braz.), available at http://www.cade.gov.br/temp/ D_D000000776091737.pdf. 98. Data updated to 20 May 2014. See generally ESCOLA NACIONAL DE ADMINISTRA- C¸ AO˜ PUBLICA´ , supra note 50. 99. Article 120 of CADE’s Internal Regulations, which creates the “declaration of complexity,” as to regulate the GS’ request for an extension of term provided for in §2 of Article 88 of Law 12.529/11. Article 120 establishes in its main section that “The General-Superintendence may, through a duly reasoned decision, declare the transaction as a complex one and determine the realization of a new supplemen- 46 LAW AND BUSINESS REVIEW OF THE AMERICAS [Vol. 21 formation by the parties (some of those were even initially submitted as fast track). It should also be stressed that, even if we add up the terms used by the Tribunal to judge the cases that were challenged by the GS until May 2014 (ten in total) or that were arrogated by them (three), these averages would not be significantly altered. Lastly, it is worth mentioning that the good performance by CADE in the analysis of mergers generated a positive impact on its repressive mission concerning the fight against anticompetitive behaviors, especially cartels. In 2013, CADE judged the greatest number of proceedings referring to anti-competitive behaviors registered in the last years—thirty- eight cases (as per Graphic 2 below). Of these, twenty-two were convicted, including thirteen cartel cases. In total, the penalties applied by CADE add up to R$4916 million.100 These values are sent to the Collec- tive Rights Protection Fund and they may return to society under the form of financing of projects regarding the protection of consumer rights, the environment, historical and cultural heritage, among others. Ever since the creation of the new law, the GS concluded the analysis of 271 behavioral cases, filing them or forwarding them for ruling by the Tribunal.101 The stock of behaviors inherited from SDE by the new CADE, which was 444 proceedings on May 29, 2012, has been reduced to 296 in May 2014, also including the ones initiated during this period.102

Graphic 2–Anticompetitive behaviors cases judged by CADE from 2010 to 2014 18 16 14 38 16 40

30 22 25

20 Convicted 1 Filed 15 4 2 9 10 14 15 16 5 12 7 0 2010 2011 2012 2013 2014* Source: CADE

tary investigation, specifying the diligences to be performed.” See Lei No. 12.529/ 11, de 30 de Novembro de 2011 D.O.U. de 30.11.2011, art. 88, § 2 (Braz.); see also Resolu¸c˜ao No. 1, de 29 de Maio de 2012, D.O.U. de 31.5.2012, art. 120 (Braz.). 100. CADE, BALANCE 2013 14 (2014), available at http://www.cade.gov.br/upload/ Balan%C3%A7o%202013%20.pdf. 101. See ESCOLA NACIONAL DE ADMINISTRAC ¸ AO˜ PUBLICA´ , supra note 50, at 199. 102. See id. 2015] PRE-MERGER ANALYSIS IN BRAZIL 47

V. CONCLUSION As explained throughout this paper, the legal revision of the Brazilian Competition Protection System addressed the structural “bottlenecks” that hindered the execution of the Brazilian antitrust policy in a satisfactory manner. The data presented speaks for itself. In only one year, the average term of analysis of mergers was reduced by over 80 percent, compared to the best average reached during the effectiveness of Law 8.884/ 94 and not to its historical average. Further, the productivity gains in the analysis of mergers reached by CADE in these two first years also reflected directly on its repressive role with considerable gains in the numbers related to the fight against cartels and other unilateral behaviors. These results motivated a series of recognition acts concerning CADE’s managerial innovations. After the internal public and, mainly, the agents in the Brazilian antitrust policy demonstrated their recognition of the new bodies’ good start, the international antitrust community also took notice of the improvements. The “Global Competition Review” (GCR), an important international newspaper on competition protection in their annual ranking of antitrust agencies, granted in 2013 another half star to the new CADE, which already had 3.5 stars in the previous year, hoisting it to the top ten of the competition authorities in the world.103 Brazil went from the 13th position to the 8th position, going from the “good” category to the “very good” category, only behind renowned agencies such as the United States (FTC and DOJ), the European Commission, England (UK’s Competition Commission), Germany, France, and Japan. It boosted Brazil to the same level as Australia, the Netherlands, Spain, and England (UK’s Office of Fair Trade), and ahead of Canada, Korea, Italy, and New Zealand. Out of developing countries, Brazil appears in the first place.104 CADE’s main highlights in the evaluation made by GCR were (i) success in the transition to Law 12.529/11; (ii) prior analysis of mergers; (iii) new notification criteria; (iv) analysis of fast track mergers in an average term of 19 days––one of the fastest in the world; and (v) the refining of the fight against cartels.105 Towards the end of November 2013, the project, referring to the new process of analysis of mergers, was ranked within the ten first places (among 102 registered) in the 18th competition of innovation in the public service, promoted by the National School of Public Administration (ENAP) in partnership with the Ministry of Planning, Budget and Man- agement (MPOG), which was unprecedented for CADE.106 The purpose of the competition, which has been promoted for seventeen years, is to

103. See Rating Enforcement 2013, GLOBAL COMPETITION REV., http://www.autoritedelaconcurrence.fr/doc/gcr_rating13.pdf (last visited Nov. 7, 2014). 104. Id. 105. Id. 106. Information on this partnership was released by TVNBR, a Brazilian TV news agency, on April 10, 2014. See Iniciativa reduz tempo de an´alise de processos na area´ de defesa economica ˆ [Initiative reduces analysis time of economic processes in 48 LAW AND BUSINESS REVIEW OF THE AMERICAS [Vol. 21 stimulate the dissemination of innovative solutions in organizations of the Federal Government. On April 8, 2014, at an event taking place in ENAP’s headquarters, CADE was ranked 7th and obtained the innovation stamp, an already renowned brand in the Brazilian federal public service for the recognition of managerial practices, which have promoted innovations of proven efficiency in their fields of action.107 In conclusion, the managerial innovations refined the use of the institution’s human capital (always very scarce in the public sector), privileged the internal communication and the information flow—splitting responsibilities among all involved in an empowerment process, which generates the feeling of belonging to the organization for the whole group and, consequently, creates greater motivation and a good organizational atmos- phere.108 The costs involved in its development were low109 because it did not rely on complex information technology systems and completely focused on the human material available, which may very well be repro- duced in other bodies that have great volumes of demands with different complexity levels that are above the team’s production capacity.110

the area of defense], YOUTUBE (Apr. 10, 2014), https://www.youtube.com/watch?v =wiQv5doYxQ4. 107. The complete video of the award ceremony, which includes presentations on all the projects that were awarded that year, was released by TVNBR on April 9, 2014. See Prˆemio reconhece iniciativas inovadoras implantadas na Administra¸c˜ao Federal [Award recognizes innovative initiatives implemented in the Federal Ad- ministration], YOUTUBE (Apr. 9, 2014), https://www.youtube.com/watch?v=rbF_yn OxONM. 108. See ESCOLA NACIONAL DE ADMINISTRAC ¸ AO˜ PUBLICA´ , supra note 50, at 204. 109. See id. at 195. 110. See id. at 194–95, 203–04. PUERTO RICO: AMERICA’S TAX HAVEN OR VACATION PARADISE

Jason Sampas, C.P.A., Esq.*

I. INTRODUCTION

N this world nothing can be said to be certain, except death and taxes.”1 Puerto Rico passed some aggressive tax legislation dur- “Iing 2012 to entice affluent investors to relocate. The Puerto Ri- can government believes it will help boost their economy and the island’s general welfare,2 and might enhance its reputation as a vacation paradise. Puerto Rico has passed these types of laws in the past. A few examples of such legislation include: the Puerto Rico Industrial Incentives Act of 1954, the Puerto Rico Industrial Incentives Act of 1963, and the Puerto Rico Tax Incentives Act of 1987.3 Incentives included exempting income for up to ten years4 or excluding up to 90 percent of income from tax.5 As these tax incentives expired, Puerto Rico needed to pass new legislation to continue to attract wealthy investors and businesses. Plans to reduce tax and maintain wealth are not new concepts and are often powerful motivators to cause people to relocate.6 A tax haven is “[a] country, that imposes little or no tax on the profits from transactions carried on there or on persons residence there.”7 While the avoidance and reduction of tax is legal, tax evasion is illegal.8 This article will evaluate the financial decisions affecting an individual’s choice to relocate to a potential tax haven.

* LL.M. in Taxation candidate, University of San Diego School of Law, May 2015. He would like to express his gratitude to Jonathan Sampas, Nichole Sampas, Chris Salcedo, and Jennifer Jackson for providing him with creative naming assistance. He would like to thank Professor James Cooper and Mr. Howard Schweitzer for their feedback, the LAW & BUSINESS REVIEW OF THE AMERICAS staff for their assistance, his family for always being there, and Jennifer Jackson for her unwaver- ing encouragement, support, and assistance throughout this project. 1. The meaning and origin of the expression: Nothing is certain but death and taxes, PHRASE FINDER, http://phrases.org.uk/meanings/death-and-taxes.html (last visited Dec. 27, 2013). 2. 2012 P.R. LAW S no. 22, p. 2 available at http://www.lexjuris.com/lexlex/Leyes2012/ lexl2012022.htm. 3. P.R. LAW S ANN. tit. 13, §§ 10001, 10012, 10040 (2013). 4. Id. § 10001. 5. P.R. LAW S ANN. tit. 13, § 10040 (2013). 6. Katherine Burton et al., Puerto Rico’s no capital gains tax luring wealthy Ameri- cans, BLOOMBERG NEWS (Mar. 11, 2013), available at http://business.financialpost .com/2013/03/11/puerto-ricos-no-capital-gains-tax-luring-wealthy-americans/. 7. BLACK’S LAW DICTIONARY, 1502 (8th ed. 2004). 8. I.R.C. § 7201 (2014).

49 50 LAW AND BUSINESS REVIEW OF THE AMERICAS [Vol. 21

This article will discuss how the following three Puerto Rican incentives: (1) Act 20; (2) Act 22; and (3) Act 273, could affect three distinct groups of individuals who are considering moving from the United States to Puerto Rico. After explaining the rules, the section will apply those rules to our groups, and the article will demonstrate whether the rule/ code is favorable to the individual group. The United States and Puerto Rico both have vast and complex Inter- nal Revenue Codes (IRC). Therefore, this article is written within a vac- uum, ignoring certain items such as the following: deductions, expenses, credits, subpart F income, certain FDAP income, withholding issues, entity-formation issues, entity-relocation issues, entity-dissolution issues, fund-relocation tax issues, RICs, dividend received deduction, employment taxes, and the alternative minimum tax under both codes. Section I summarizes the three Puerto Rican legislative acts. Section II addresses the geographical definitions of the United States and Puerto Rico and its application to residency. Section III explains the similarities and differences between the United States’ Internal Revenue Code (IRC) and Pu- erto Rico’s Internal Revenue Code (IRC) regarding the definitions of interest, dividends, and capital gains. Section IV discusses the matter in which both IRC’s treat income sourcing related to retirement income, interest, dividends, and capital gains. Section V, the final section, compares the tax rates of both locations related to corporations, partnerships, and individuals. This article concludes by highlighting the tax advantages and disadvantages of the Puerto Rican incentives to each group, and then makes a recommendation for each group. The three groups are described below. The groups use fictitious scenarios to highlight the potential tax treatment that the Puerto Rican incentives offer based on his or her specific situations.

A. JASON AND JEN—THE RETIRED COUPLE Jason is a married, seventy-year-old retired, blue-collar worker. He and his wife Jen, also retired, survive solely on their retirement income that includes social security benefits and some investments income, including interest, dividends, and capital gains. Jen constantly nags Jason about the outrageously high United States tax rates. The tax rates are so high that both of them might have to go back to work to make ends meet. They both yearn for the “sweet life” and want to spend their final years in a sandy-beached paradise. Unfortunately, they cannot afford southern California or Hawaii, and despise the elderly stereotypes of Florida.

B. JON AND NICHOLE—THE ATTORNEY AND HEDGE FUND MANGER Jon is a married, world-renowned international law attorney who teaches at a prominent law school. His brilliant wife Nichole is an affluent investor who manages a hedge fund. The two are happily married with two children. Nichole made millions during the dot-com bubble, and started her own company that now manages a hedge fund. With Jon’s 2015] PUERTO RICO 51 continued support, Nichole continued to manage her hedge fund, which she primarily does from home despite their substantial wealth. Jon’s amazing success, combined with Nichole’s intuitive investment abilities made them a fortune, which they tucked away in a multitude of diversi- fied investments. Thus, a substantial portion of their income is from interest, dividends, and capital gains. They both worry the United States tax rates could jump back up to 80 or 90 percent in the near future. They both crave reduced workloads and retirement to a sandy-beached paradise to spend more time with each other and their wonderful children.

C. MIKEY—THE ENTREPRENEUR Mikey is a genius, hardworking, single entrepreneur. He has worked one year and a day on his current and third startup. His previous companies were amazingly successful. While his company is in the early development stages, he is confident it will be incredibly successful and sell for a large sum of money. He believes he paid too much tax when he sold his previous companies, and does not want to pay the same high tax rates when he sells his current company. He suspects the already high United States tax rates will significantly increase in the near future because the United States is facing so many budget problems. In addition to his United States concerns, the high California tax rates also concern him. If the tax incentives are significant enough, he is willing to relocate his company to a suitable alternative location.

II. SPECIFIC PUERTO RICAN LEGISLATIVE INCENTIVE ACTS As mentioned above, Puerto Rico has a long history of passing tax and business incentives to attract foreign investment.9 The new incentive acts acknowledge that while Puerto Rico is granting significant tax exemptions, the presence of these high net worth investors within the island will positively support its economy.10 Puerto Rico recently passed numerous incentive laws to entice businesses and individuals to relocate. This article focuses on three more recent and aggressive pieces of legislation: Act 20—The Export Services Incentives Act, Act 22—The Individual Inves- tor Act (both passed January 17, 2012),11 and Act 273—The International Financial Center Incentives Act (passed September 25, 2012).12

A. ACT 20—THE EXPORT SERVICES INCENTIVE ACT Act 20 incentivizes businesses to relocate its operation to Puerto

9. See generally P.R. LAW S ANN. Tit. 13, §§ 10001, 10012, 10040 (2013). 10. 2012 P.R. LAW S no. 22 p. 1, available at http://www.lexjuris.com/lexlex/Leyes2012/ lexl2012022.htm. 11. Id.; 2012 P.R. LAW S no. 20 p. 1, available at http://www.lexjuris.com/lexlex/Leyes 2012/lexl2012022.htm. 12. 2012 P.R. LAW S no. 273 p. 1, available at http://www.lexjuris.com/lexlex/Leyes2012/ lexl2012273.htm. 52 LAW AND BUSINESS REVIEW OF THE AMERICAS [Vol. 21

Rico.13 The act lists an abundance of approved business activities, but the most notable activities are as follows: research and development; consulting services for any trade or business; professional services such as legal, tax, and accounting; centralized management services; services performed by electronic data processing centers; shared service centers; call centers; investment banking and other financial services; and anything else allowed by the Secretary.14 If an individual relocates their business to Puerto Rico, their business could be exempt from the normal Puerto Rican IRC tax rates and subject to a flat 4 percent tax, which could become a 3 percent tax if the business is considered “strategic.”15 The exemption applies for twenty years with a ten year renewal.16 The business’s personal and real property are completely exempt from Puerto Rican state and municipal taxes for the first five years, and subject to a 90 percent exemption thereafter.17 Additionally, company benefits or dividends distributed to the shareholders, members, or partners could be exempt from Puerto Rican tax.18 To receive this exemption, the company must file the necessary application and sign a contract with the Puerto Rican government.19 The benefits granted under the exemption remain valid during the exemption period even if subsequent Puerto Rican laws invalidate the exemption.20

B. ACT 22—THE INDIVIDUAL INVESTORS INCENTIVES ACT Act 22 incentivizes individuals to move to Puerto Rico.21 The incentives are only available to individuals who are not a bona fide Puerto Rican resident within the last fifteen years,22 and meet the residency requirements discussed below.23 The Act exempts all passive income obtained from investments from Puerto Rican taxes.24 Investment income includes interest, dividends, and capital gains.25 If the individual moves to Puerto Rico with built-in capital gains, those capitals gains are subject to a 5 percent tax on the pre-move appreciation if the individual resides

13. 2012 P.R. LAW S no. 20 p. 1. 14. Id. at 7–8; P.R. LAW S ANN. tit. 13, § 30041(a)(12) (2013)(defining “the Secretary” as the Secretary of the Treasury of Puerto Rico). 15. 2012 P.R. LAW S no. 20 p. 10, available at http://www.oslpr.org/download/en/2012/ A-0020-2012.pdf (explaining how export services rendered are considered “strategic”). 16. Id. at 16–17. 17. Id. at 13. 18. Id. 19. See id. at 25; see generally DEPARTMENT OF ECONO. DEV. & COMM., TAX INCEN- TIVES APPLICATION, available at http://www2.pr.gov/agencias/oeci/Documents/So- licitudes/Solicitudes/Application%20for%20Act%2020%20Fillable.pdf (last revised Jul. 17, 2013). 20. 2012 P.R. LAW S no. 20 p. 34. 21. 2012 P.R. LAW S no. 22 p.1, available at http://www.lexjuris.com/lexlex/Leyes2012/ lexl2012022.htm. 22. Id. at 2. 23. Treas. Reg. § 1.937-1(e) (2013); P.R. LAW S ANN. tit. 13, § 30041(a)(30) (2013), 24. 2012 P.R. LAW S no. 22. p. 1. 25. Id. at 2–3. 2015] PUERTO RICO 53 in Puerto Rico for at least ten years.26 To obtain this incentive, the individual must notify the Puerto Rican Secretary of his or her intent to obtain residency, file the necessary application with the Puerto Rican government, and sign a contract with the Puerto Rican government, which is then valid until December 31, 2035.27

C. ACT 273—THE INTERNATIONAL FINANCIAL CENTER INCENTIVES ACT Act 273 focuses on setting up and relocating international banks to Pu- erto Rico.28 An individual can either move or incorporate his or her corporate bank in Puerto Rico. The move allows the investor to obtain significant financial incentives by signing a contract with the Puerto Rican government.29 The corporation must pay an initial $5,000 filing fee along with providing the necessary ownership information.30 If approved, the entity must pay a $250,000 license fee.31 There is also an annual $5,000 renewal fee.32 After securing the license, the entity is exempt from tax under Puerto Rico’s IRC and subject only to a flat 4 percent tax.33 The entity is also exempt from paying Puerto Rican municipal taxes, real or personal property taxes, or tangible or intangible property taxes.34 The exemption is valid for fifteen years.35 The entity can renew its exemption for another fifteen years by filing a renewal notice no more than six months before the initial fifteen-year exemption expires.36 Within six months of the thirty-year renewal’s expiration, the entity can apply for another fifteen-year exemption, for a total of forty-five years.37 During the last fifteen years, the Secretary has the option to either leave the entity’s tax rate at 4 percent or increase the entity’s tax rate up to 10 percent.38 If other Puerto Rican laws are inconsistent with this law, this law shall prevail.39 But the entity must employ at least four Puerto Rico re-

26. Id. at 3. 27. See id. at 1; see APPLICATION TO NOTIFY THE PUERTO RICO SECRETARY TO OB- TAIN RESIDENCY, available at http://www2.pr.gov/agencias/oeci/Documents/Solici- tudes/Solicitudes/Notification%20of%20Residency%20under%20Act%2022-2012 .pdf (last visited Apr. 13, 2015); see DEPARTMENT OF ECONO. DEV. & COMM., TAX INCENTIVES APPLICATION TAX INCENTIVES APPLICATION: ACT TO PROMOTE THE INTERNATIONAL FINANCIAL CENTER INCENTIVES ACT TRANSFER, http://www2.pr .gov/agencias/oeci/Documents/Solicitudes/Solicitudes/Application%20for%20Act %20273%20Incentives%2007_02_13.pdf (last revised Jul. 2, 2013). 28. 2012 P.R. LAW S no. 273 p. 1, available at http://www.lexjuris.com/lexlex/Leyes2012/ lexl2012273.htm. 29. Id. at 12. 30. Id. at 9. 31. Id. at 6. 32. Id. at 11. 33. Id. at 8. 34. P.R. LAW S . ANN. tit. 7 § 3101 (2013). 35. Id. § 3807 (a)(8)(e). 36. Id. 37. Id. 38. Id. 39. Id. § 3103. 54 LAW AND BUSINESS REVIEW OF THE AMERICAS [Vol. 21 sidents as full-time employees.40 Fortunately, a valid Act 22 exemption can waive this requirement.41 Some have criticized these aggressive incentives as making Puerto Rico a tax haven.42 While the United States has tax credits and incentives to encourage businesses and individuals to relocate and start business within the United States,43 Puerto Rico’s recent tax incentives are far more aggressive than any United States incentives.

III. GEOGRAPHICAL DEFINITION OF PUERTO RICO AND THE UNITED STATES APPLIED TO RESIDENCY The United States IRC’s geographical definition of the United States significantly affects income sourcing for Puerto Rico and the United States. Puerto Rico and the United States have their own independent IRCs, but the Puerto Rican IRC is modeled after the United States IRC, where both systems have exclusive authority to tax their own residents.44 Although, Puerto Rico and the United States have a tax coordination agreement, as opposed to a treaty, to help define how the two systems coexist.45 “The term ‘United States’ when used in a geographical sense includes only the States and the District of Columbia.”46 “The term ‘State’ shall be construed to include the District of Columbia, where such construction is necessary to carry out provisions of this title,” and includes the fifty recognized states.47 The United States and State geographical definitions exclude the United States possessions, which are Puerto Rico, Guam, American Somoa, and the Northern Mariana Islands (Possessions).48 Unless explicitly mentioned to the contrary, any reference to a Possession shall include Puerto Rico.49 To add some additional confusion to the already complex United States IRC, some United States IRC sections treat Puerto Rico as a foreign country,50 while others sections treat Puerto

40. Id. § 3092(a). 41. 2012 P.R. LAW S no. 22, art 5 available at http://www.oslpr.org/2009-2012/leyes/pdf/ ley-22-17-Ene-2012.pdf. 42. John Marino, Congressional chairman rejects Puerto Rico Exemption Proposal, CARIBBEAN BUS. PR, (Sept. 19, 2013), http://www.caribbeanbusinesspr.com/ prnt_ed/congressional-chairman-rejects-puerto-rico-exemption-proposal-8996 .html. 43. See, e.g., I.R.C. § 179(b)(1) (2014). 44. JOEL D. KUNTZ & ROBERT J. PERONI, KUNTZ & PERONI: U. S. INTERNATIONAL TAX (WG&L) ¶ D 1.02 (2015), 2000 WL 530248, available at https://a.next.westlaw .com/Document/Ifb5416a1c01111da8725eac5fdcb2c2d/View/FullText.html?origina tionContext=documenttoc&transitionType=CategoryPageItem&contextData=(sc .Default). 45. See generally Tax Coordination Agreement Between the United States of America and the Commonwealth of Puerto Rico, US-PR, May 26, 1989, 1990-1 C.B. 199 (IRS FIA), 1989 WL 253534. 46. I.R.C. § 7701(a)(9) (2014). 47. Id. § 7701(a)(10). 48. Id. §§ 7701(a)(9)–(a)(10),7701(d). 49. Id. § 7701(d). 50. Id. §§ 7701(a)(9), 872(b)(8). 2015] PUERTO RICO 55

Rico as part of the geographical United States,51 which complicates how Puerto Rican income and residents are classified. If Puerto Rico is not part of the United States by definition, logically, it should be a foreign country, its residents’ foreign individuals, its corporations’ foreign corporations, and income from Puerto Rico sourced to a foreign country.52 When determining if an individual is part the United States or a foreign country, the individual is classified as a United States citizen/person (United States resident), a resident alien, or a nonresident alien.53 A United States citizen is a person that applies for a “[U]nited States pass- port (or renewal thereof), or applies to be lawfully accorded the privileges of residing permanently in the United States as an immigrant in accordance with the immigration law.”54 A United States person means “a citizen or resident of the United States, a domestic partnership, [and] a domestic corporation.”55 The United States IRC treats an alien individual as a United States resident (which is referred to as a resident alien) for any year the alien individual is a lawful permanent resident within the United States for a calendar year, meets the substantial presence test (discussed below), or makes the proper first year election in accordance with the statute.56 “A nonresident alien individual is an individual who is neither a citizen of the United States nor a resident of the United States.”57 Some United States IRC sections define a nonresident alien individual to include a United States citizen living in Puerto Rico,58 while other sections do not.59 According to the Puerto Rican IRC, a nonresident alien “[m]eans an individual who is not a United States citizen and is not a resident of Puerto Rico.”60 If an individual is a United States citizen or resident alien, the United States will tax his or her worldwide income, regardless of location,61 subject to some exceptions.62 The United States also taxes nonresident alien individual income to the extent his or her income is from sources within the United States,63 subject to certain investment exemptions,64 or income “effectively connected” to a United States “trade or business.”65 While these provisions cast a large taxation blanket on United States based income, the United States IRC exempts a United States citizen’s

51. Id. § 881(b)(3)(A). 52. Rev. Rul. 56-616 (1956), 1956-2 C.B.589, 1956 WL 11256. 53. I.R.C. §§ 7701(a)(30), 7701(b)(1)(A)–(B) (2014). 54. Id. § 6039E(a). 55. Id. §§ 7701(a)(30)(A)–(C). 56. Id. §§ 7701(b)(1)(A)(i)–(iii). 57. Id. § 7701(b)(1)(B). 58. See Treas. Reg. § 1.861-2(a)(2) (2014). 59. See I.R.C. § 7701(b)(1)(B). 60. P.R. LAW S ANN. tit. 13 § 30041(a)(21) (2013). 61. I.R.C. § 1 (2014); Treas. Reg. § 1.1-1 (2008); see, e.g., Specking v. Comm’r., 117 T.C. 95, 101-02 (2001), aff’d sub nom Haessly v. Comm’r., 68 F.App’x 44 (9th Cir. 2003) and aff’d sub nom Umbach v. Comm’r., 357 F.3d 1108 (10th Cir. 2003). 62. I.R.C. § 911(a) (2014). 63. Id. § 871(b)(1). 64. Id. § 871(k)(1)(A). 65. Id. § 872(a). 56 LAW AND BUSINESS REVIEW OF THE AMERICAS [Vol. 21 foreign earned income if the United States citizen earns the income while residing in the foreign country, up to a certain amount adjusted annually for inflation.66 A United States citizen or resident alien is subject to United States tax on his or her worldwide income unless that income is Puerto Rican sourced.67 A United States citizen living in Puerto Rico is exempt from United States tax and subject only to Puerto Rico tax on his or her Puerto Rican based income.68 Additionally, an alien individual residing in a Pos- session is subject to United States taxation in the same manner as a United States alien resident.69 Although excluded from the United States and State geographical definition, Puerto Rico is part of the United States, and its residents are United States citizens.70 While the United States enters into treaties to bridge relations with foreign countries, Puerto Rico and the United States entered into an implementation agreement and not a treaty.71 The implementation agreement states the United States IRC, and not the Puerto Rican IRC, establishes the requirements to become a Puerto Rican resident.72 To become a Puerto Rican resident the United States IRC uses three tests: (1) the presence test;73 (2) the tax home test;74 and (3) the closer connection test.75 According to the United States IRC, a “[b]ona fide Puerto Rican resident means a person who is present for at least 183 days during the taxable year,” was present “for at least 549 days during the three-year period consisting of the taxable year and the two (2) immediately preceding taxable years,” provided that the individual was present in Puerto Rico for at least sixty days each year76 and does not have a closer tax home77 or a closer connection to the United States or a foreign country.78 An individual is present in the United States on any day in which he or she is physically present in the United States.79 Multiple factors determine a significant connection, like “a permanent home in the United States,” current United States voter registration, or a child in the United

66. Id. § 911(b)(2). 67. Id. § 933(1). 68. Id. § 933(2). 69. Treas. Reg. § 1.876-1 (b) (2014). 70. P.R. LAW S ANN. tit. 1, § 7 (2014). 71. See RUFUS RHOADES & MARSHALL LANGER, RHOADES & LANGER, UNITED STATES INTERNATIONAL TAXATION AND TAX TREATIES PUER § 8.07 (2014). 72. I.R.C. § 937 (2014); RHOADES & LANGER, supra note 71. 73. Treas. Reg. § 1.937-1(c)(1); see also, IRS, I.R.S. FORM 8898: STATEMENT FOR INDI- VIDUALS WHO BEGIN OR END BONA FIDE RESIDENCE IN A UNITED STATES POS- SESSION (2007), available at http://www.irs.gov/pub/irs-pdf/f8898.pdf (this form provides a non-exhaustive, but comprehensive list of what is a closer connection) [hereinafter I.R.S. FORM 8898]. 74. Treas. Reg. § 1.937-1(d)(1) (2014); see also, I.R.S. FORM 8898, supra note 73. 75. Treas. Reg. § 1.937-1(e)(1) (2014); see also, I.R.S. FORM 8898, supra note 73. 76. I.R.C. § 937(a); Treas. Reg. §1 .937-1(c). 77. Treas. Reg. § 1.937-1(d) (2014). 78. Id. § 1.937-1(e). 79. I.R.C. § 7701(b)(7). 2015] PUERTO RICO 57

States who is not there as a student or based on a custodial decree.80 The tax home test ensures that an individual does not have a tax home closer than his or her tax home in Puerto Rico.81 Alternatively, the Puerto Ri- can IRC defines a resident individual as an individual domiciled in Puerto Rico, and presumes he or she is a resident if they are present within Pu- erto Rico for 183 days82 An individual must file I.R.S. Form 8898 to demonstrate that he or she met the above three tests.83 This form notifies the United States Secre- tary of Treasury of the individual’s intent to become a Puerto Rican resident.84 Additionally, the individual must file a form with the Puerto Rican Secretary85 stating his or her intent to become a Puerto Rican resident.86 An individual does not become a Puerto Rican resident until he or she meets the three tests above for an entire year—only then can he or she exclude Puerto Rican sourced income from United States tax.87 These rules ensure that a person actually resides in Puerto Rico and does not merely rent a mailbox or residence in Puerto Rico to make that address his or her residence for documentation purposes. For the past fifty years, when the government challenges a residency claim the courts examine eleven factors to determine if there is substance to an individual’s move.88 Those factors are as follows: 1. Intention of the taxpayer; 2. Establishment of his home temporarily in the foreign country for an indefinite period; 3. Participation in the activities of his chosen community on social and cultural levels, identification with the daily lives of the people and, in general, assimilation into the foreign environment; 4. Physical presence in the foreign country consistent with his employment; 5. Nature, extent and reasons for temporary absences from his temporary foreign country; 6. Assumption of economic burdens and payment of taxes to the foreign country; 7. Status of resident contrasted to that of transient or sojourner; 8. Treatment accorded his income tax status by his employer; 9. Marital status and residence of his family;

80. Treas. Reg. § 1.937-1(c)(5) (2014); see also, I.R.S. FORM 8898, supra note 73. 81. Treas. Reg. § 1.937-1(d). 82. P.R. LAW S ANN. tit. 13 § 30041(a)(30) (2011). 83. I.R.C. § 937(c)(1); I.R.S. FORM 8898, supra note 73. 84. Id. 85. P.R. LAW S ANN. tit. 13 § 30041(a)(12) (2011) (the secretary “[m]eans the Secretary of the Treasury of [Puerto Rico]”). 86. See APPLICATION TO NOTIFY THE PUERTO RICO SECRETARY TO OBTAIN RESI- DENCY, supra note 27. 87. I.R.C. § 933(1) (2014); Treas. Reg. § 1.937-1(f) (2014). 88. Vento v. Dir. Of V.I. Bureau of Internal Revenue, 715 F.3d 455, 466–67 (3rd Cir. 2013) (citing Sochurek v. Comm’r, 300 F.2d 34, 38 (7th Cir. 1962)); see also, I.R.S. FORM 8898, supra note 73 (listing many factors that the Secretary of Treasury will use to evaluate if the move to the possession is valid). 58 LAW AND BUSINESS REVIEW OF THE AMERICAS [Vol. 21

10. Nature and duration of his employment; whether his assignment abroad could be promptly accomplished within a definite or specified time; 11. Good faith in making his trip abroad; whether for purpose or tax evasion.89 While no one factor is determinative, nor is a lack of any particular factor an immediate failure, they are evaluated in four groups.90 The four groups are (1) intent (factors one, two, seven, ten, and eleven); (2) physical presence (factors two, four, five, and seven); (3) a taxpayer’s social, family, and professional relationships (factors three and nine); and (4) the taxpayer’s own representations (factors six and eight).91 To determine the location of a corporation or partnership under the United States IRC, the term “domestic” as applied to a “[c]orporation or partnership means created or organized in the United States or under the law of the United States or of any State, unless in case of a partnership, the Secretary provides otherwise by regulations.”92 The United States IRC defines a “foreign corporation” or “partnership” as “a corporation or partnership which is not domestic.”93 A Puerto Rican domestic corporation or partnership “[m]eans created or organized in Puerto Rico or under the laws of Puerto Rico.”94 A foreign Puerto Rican corporation or partnership “[m]eans a corporation or partnership which is not domestic.”95 How do these residency tests affect our groups? These requirements mean that each group of individuals must move themselves, their businesses, and their families to Puerto Rico. Jason and Jen should not encounter transitional problems. As a retired blue-collar couple, they are unlikely to have significant business connections that would hinder their move. Their assets likely consist of a home that they would sell, a car that they could ship, personal belongings, and intangible assets like a bank or stock account. Retirement income and social security benefits should easily transfer too if they provide the necessary paperwork. To meet the presence test they can buy a new home in Puerto Rico which will become their new principal residence.96 They will meet the tax home test because they will give up their tax home in the United States when they establish a Puerto Rican tax home.97 They can meet the closer connection test by establishing a bank account to receive their retirement income, forming social and professional relationships in Puerto Rico, registering to vote in Puerto Rico, registering their car in

89. Vento, 715 F.3d at 466–67 (3rd Cir. 2013) (citing Sochurek, 300 F.2d at 38). 90. Id. 91. Id. at 467. 92. I.R.C. § 7701(a)(4) (2014). 93. Id. § 7701(a)(5). 94. P.R. LAW S ANN. tit. 13 § 30041(a)(6) (2011). 95. Id. § 30041(a)(7) (2011). 96. Treas. Reg. § 1.937-1(c) (2014); see also, I.R.S. FORM 8898, supra note 73. 97. Treas. Reg. § 1.937-1(d) (2014); see also, I.R.S. FORM 8898, supra note 73. 2015] PUERTO RICO 59

Puerto Rico, and obtaining a Puerto Rican driver’s license, among other things.98 Their biggest challenge is leaving their social and family relationships. Additionally, Jason and Jen must file the necessary paperwork and sign a contract with the Puerto Rican government to take advantage of the Puerto Rican incentives.99 Jon and Nichole’s situation is more complex. Jon will have to quit his teaching job because flying back and forth from Puerto Rico to the United States means he might not meet the presence test and he will have a closer connection to the United States than Puerto Rico due to his work.100 Jon might be able to circumvent this requirement if he could lecture via a podcast or video conference, but that is beyond the scope of this article. Nichole will have significant difficulty because she has an active home business. She must either move the entire entity to Puerto Rico or close this entity and start a new one in Puerto Rico to satisfy the closer connection test.101 The couple will also have to file the necessary paperwork depending on what exemptions they seek. Mikey may have more issues than the entire group combined. Not only must he uproot his entire life, but he must also relocate his business. To take advantage of Puerto Rico’s favorable tax incentives, he must seek approval from the Puerto Rican government, sign a contract with them, and actually conduct business.102 If approved, he must transfer his business, find a suitable location, move all his assets, and hire employees. The moving process might impose some barriers to entry because Mikey needs employees and machines, whereas Jon and Nichole require only computers and communication connections. While the United States and Puerto Rican systems share some similarities, they also have some differences. Puerto Rico and the United States have their own exclusive tax systems and exclusive Treasury systems.103 Additionally, Puerto Rican courts can enforce the tax laws of other States,104 so long as the State would enforce the Puerto Rican IRC in its courts.105 United States citizens who are Puerto Rican residents are not subject to United States tax on his or her Puerto Rican sourced income

98. Id. 99. 2012 P.R. LAW S no. 22 p. 1, available at http://www.oslpr.org/2009-2012/leyes/pdf/ ley-22-17-Ene-2012.pdf; see DEPARTMENT OF ECONO. DEV. & COMM., supra note 27. 100. See Bergersen v. Secretary, 109 F.3d 56 (1st Cir. 1997) (holding that a dentist did not meet the closer connection test to Puerto Rico, and his income was taxable by the United States where the dentist continued to maintain his dental practice and dental supply distribution company in Illinois, stayed at his parent’s house when he was back to service patients, continued to receive business mail for his practice and his dental supply company in Illinois despite the fact that he moved his family to Puerto Rico and re-headquartered his dental supply business to Puerto Rico). 101. Treas. Reg. § 1.937-1(e) (2014); see also, I.R.S. FORM 8898, supra note 73. 102. 2012 P.R. LAW S 20 p. 25, http://businessinpuertorico.com/documents/ACT-20-PG .pdf; see DEPARTMENT OF ECONO. DEV. & COMM., supra note 27. 103. I.R.C. § 2 (2014); P.R. LAW S ANN. tit. 13 § 30001 (2011). 104. P.R. LAW S ANN. tit. 13 § 343 (“[s]tate—Means any state, territory or possession of the United States of America”). 105. Id. §§ 342, 341. 60 LAW AND BUSINESS REVIEW OF THE AMERICAS [Vol. 21 even though the United States taxes the worldwide income of their citizens.106 Furthermore, many United States tax incentives require only filing a form with the tax return, rather than signing contract(s) with the government.107 In Puerto Rico, a taxpayer’s tax return is considered a public document available to inspection upon a validly approved request.108 In the United States, tax returns are confidential.109

IV. UNITED STATES INTERNAL REVENUE CODE AND PUERTO RICAN INTERNAL REVENUE CODE DEFINITIONS AND APPLICABLE TAX RATES FOR INTEREST, DIVIDENDS, AND CAPITAL GAINS

A. INTEREST Black’s Law Dictionary defines interest as “[t]he compensation fixed by agreement or allowed by law for the use or detention of money, or for the loss of money by one who is entitled to its use.”110 The United States IRC does not explicitly define interest, but some sections define various types of interest.111 Investment interest is any amount “paid or accrued on indebtedness properly allocable to property held for investment.”112 Puerto Rico offers definitional guidance by stating interest is “[a]ny interest on bonds, notes and other obligations issued by a domestic corporation or partnership, or by a foreign corporation of partnership.”113 Puerto Rico and the United States tax interest from income differently. Interest in the United States could be subject to the top United States individual ordinary income tax rate of 39.6 percent.114 Puerto Rico could tax interest income at the top Puerto Rican individual ordinary income tax rate, which depending on the year, ranges from 30 to 33 percent.115 However, a Puerto Rican resident’s interest income could be eligible for a special preferred tax rate of 10 percent, if the interest meets certain statutory requirements and the taxpayer makes the election.116 Puerto Rico’s Act 22 exemption eliminates the taxpayer’s liability for interest

106. I.R.C. § 933(1) (2014). 107. 2012 P.R. LAW S 20 p. 25 http://businessinpuertorico.com/documents/ACT-20-PG .pdf. 108. P.R. LAWS ANN. tit. 13 § 33213. 109. I.R.C. § 6103(a) (2014). 110. BLACK’S LAW DICTIONARY, 886 (9th ed. 2009). 111. RHOADES & LANGER, UNITED STATES INT’L TAX’N & TAX TREATIES § 25.02 (2014), available at https://advance.lexis.com/GoToFullDocumentFromHistory?vre questid=f136363-25e8-c93e-e762-7075e02699f5,e5fd3b2e-e1ca-df-de50-f700deb079 03,f377f25e-e85f-20db-ab64-3f3f3b9fafa,d3111e2e-4a75-990-eb63-911c27858cd8,f6f d9fb8-4cd6-33fb-99a1-39b74368461a&crid=3f4c43b9-f413-30b7-cad9- 5705e4ea60d3. 112. I.R.C. § 163(d)(3)(A) (2014). 113. P.R. LAW S ANN. tit. 13 § 30085 (b)(1) (2011). 114. I.R.C. § 1(a) (2014). 115. P.R. LAW S ANN. tit. 13 § 30061 (2011). 116. Id. §§ 30111(a)(4), 30085(b), 30084(1). 2015] PUERTO RICO 61 income,117 subject to sourcing issues discussed below. The United States has no such exemption, unless the interest is from municipal bonds.118

B. DIVIDENDS Both the United States and Puerto Rico IRC define a dividend very similarly, as “[a]ny distribution of property made by a corporation to its shareholders [whether it is money or property] out of its earning and profits accumulated after February 28, 1913, or out of its earnings and profits of the taxable year . . . without regard to the amount of the earnings and profits at the time the distribution was made.”119 For length and simplicity purposes, this article disregards specially taxed qualified dividends and preferred stock dividends.120 This means Puerto Rico and the United States will tax dividends as ordinary income.121 Therefore, they could be subject to tax at the top United States individual ordinary income tax rate of 39.6 percent.122 Puerto Rico could tax dividends at the top Puerto Rico individual ordinary income tax rate, which, depending on the year, could range from 30 to 33 percent.123 Although, a Puerto Rican resident’s dividend income could be eligible for a special preferred tax rate of 10 percent if the dividends meet certain statutory requirements and the taxpayer makes the election.124 Thus, if a significant portion of any of our group’s income is from dividends, Puerto Rico’s Act 22 exemption eliminates the Puerto Rican resident’s tax liability,125 subject to sourcing issues discussed below. The United States has no such exemption for dividends.

C. CAPITAL GAINS The United States and Puerto Rican IRC define a capital asset in the negative, which means that they define what a capital asset is not.126 Therefore, anything not specifically enumerated is a capital asset.127 In Puerto Rico, a capital asset is not inventory, depreciable property used in a trade or business, accounts receivable, energy credits, literary rights, musical rights, artistic rights, or any similarly created rights by the taxpayer.128 The United States definition is similar but leaves out the energy

117. 2012 P.R. LAW S no. 22 p. 3, available at http://www.oslpr.org/2009-2012/leyes/pdf/ ley-22-17-Ene-2012.pdf. 118. I.R.C. § 103(a) (2014). 119. Id. § 316(a) (2014); P.R. LAW S ANN. tit. 13 § 30149(a) (2011). 120. Id. §§ 245, 244, 243, 1(h)(11) (2014). 121. Id. § 1(a) (2014); P.R. LAW S ANN. tit. 13 § 30061(2011). 122. Id. § 1(a) (2104). 123. P.R. LAW S ANN. tit. 13 § 30061 (2011). 124. Id. § 30111(a)(6); P.R. LAW S ANN. tit. 13 § 30086 (2011). 125. 2012 P.R. LAW S No. 22 p. 3, available at http://www.oslpr.org/2009-2012/leyes/pdf/ ley-22-17-Ene-2012.pdf. 126. I.R.C. § 1221(a) (2014); P.R. LAW S ANN. tit. 13 § 30141(a)(1) (2011). 127. Id. § 1221(a); P.R. LAW S ANN. tit. 13 § 30141(a)(1). 128. P.R. LAW S ANN. tit. 13 § 30141(a)(1). 62 LAW AND BUSINESS REVIEW OF THE AMERICAS [Vol. 21 credits and adds “any commodities derivative financial instrument held by a commodities dealer,” any hedging transaction that is clearly identifi- able as a hedging transaction, and supplies “regularly used or consumed by the taxpayer in the ordinary course of a trade or business.”129 The United States additions could affect stock traders. Stock traders are a target group Puerto Rico hopes to attract and probably the reason why it was not included. The codes differ in how they define a long-term and short-term capital asset. In Puerto Rico, a capital asset sale is long-term if the taxpayer held the asset for more than six months, and short-term if held less than six months.130 In the United States, a capital asset sale is long-term if the taxpayer held the asset for more than one year, and short-term if held for one year or less.131 The long-term and short-term differences matter because both codes tax long-term assets at a lower rate.132 Puerto Rico taxes net long-term capital gains at a flat 10 percent.133 A taxpayer who moves to Puerto Rico with pre-move capital asset appreciation is subject to a 10 percent tax on the pre-move appreciation.134 If the individual is a Puerto Rican resident for more than ten years, this lowers the tax rate to 5 percent and excludes that pre-move gain from United States tax entirely.135 Act 22 exempts an individual’s passive investment income, which means long-term and short-term capital gains are exempt from Puerto Rican income tax.136 The exemption only applies to assets acquired after establishing his or her Puerto Rican residency.137 This is a significant advantage over the United States IRC because stock traders, whose business activities are typically all capital transactions, could exempt all of his or her income from tax. Furthermore, a Puerto Rican taxpayer may elect to treat his or her long-term capital gains as ordinary income and pay taxes according to his or her ordinary income tax rate.138 The taxpayer makes this decision after determining whatever scenario is more beneficial.139 A taxpayer is likely to make this election only if he or she is in the lower tax brackets. The United States automatically exempts a taxpayer’s long-term capital gains if the taxpayer is in the lowest two tax brackets.140 The United States taxes long-term capital gains on a progressive scale.141 United States long-term capital gains do receive a lower tax

129. I.R.C. § 1221(a). 130. P.R. LAW S ANN. tit. 13 § 30141(a)(2)–(9). 131. I.R.C. § 1222(a)(1)–(4). 132. I.R.C. § 1(h) (2014); P.R. LAW S ANN. tit. 13 §§ 30111(a)(2), 30082(a) (2011). 133. P.R. LAW S ANN. tit. 13 § 30082(a). 134. 2012 P.R. LAW S no. 22 p. 3, available at http://www.oslpr.org/2009-2012/leyes/pdf/ ley-22-17-Ene-2012.pdf. 135. Id. 136. 2012 P.R. LAW S no.22 p. 3–4. 137. Id. at 3. 138. P.R. LAW S ANN. tit. 13 §§ 30111(a)(2), 30082(a). 139. Id. 140. I.R.C. § 1(h) (2014). 141. Id. §1. 2015] PUERTO RICO 63 rate, but it depends upon the taxpayer’s ordinary income tax bracket.142 The long-term capital gain tax rate can range from 0 percent in the lowest two tax brackets, to 20 percent if you are in the highest tax bracket.143 Moreover, the Affordable Care Act added an additional 3.8 percent tax to long-term capital gains in the highest bracket,144 raising the top long- term capital gain rate to 23.8 percent.145 Of course, the United States tax rates mentioned include solely federal tax, and do not include state taxes. By adding state taxes, which could be up to 13.3 percent,146 an individual’s long-term capital gain could be subject to tax at over 30 percent. When compared to Puerto Rico’s 10 percent tax147 or Puerto Rico’s Act 22 complete exemption,148 an individual choosing to remain in the United States could pay between 20 to 40 percent more, despite the favorably lower tax treatment. While this article compares the Puerto Rican and United States IRCs, it should be noted that a United States resident and his or her company could also be subject to state taxes in addition to federal taxes, subject to sourcing issues discussed below. A Puerto Rican resident and his or her company are only subject to Puerto Rico tax subject to sourcing issues discussed below. Thus, the move could save the individual or company the applicable state tax on that income.

V. INCOME SOURCING Puerto Rico’s incentives only apply to income subject to taxation under Puerto Rico’s IRC because income not subject to Puerto Rico tax does not need Puerto Rico incentives, which is why sourcing is very important. The sourcing treatment can differ depending upon the type of income, the business’s location(s), the owners’ location(s), where he or she is conducting business, and the type of business, among many other factors.149 This article addresses only four income types: (1) retirement; (2) interest; (3) dividends; and (4) capital gains. Each scenario assumes that the individuals, the business, and its owners, are located solely within Puerto Rico or solely within the United States. Each group of individuals is still considered United States citizens subject to United States tax on their worldwide income.150 Fortunately, any United States citizen, who becomes a Puerto Rican resident and earns income within or has income sourced to Puerto Rico, is exempt from United States tax.151 Therefore, this article will not analyze the United States taxation of a United States

142. Id. § 1(h). 143. Id. 144. Id. 145. I.R.C. §§ 1411, 1(h) (2014). 146. CAL. REV. & TAX. CODE § 17041 (West 2013). 147. P.R. LAW S ANN. tit. 13 §§ 30111(a)(2), 30082(a) (2011). 148. 2012 P.R. LAW S no. 22 p. 3, available at http://www.oslpr.org/2009-2012/leyes/pdf/ ley-22-17-Ene-2012.pdf. 149. I.R.C. §§ 861-865, 871-872, 881-882. 150. Id. § 1; Treas. Reg. § 1.1-1 (2008). 151. I.R.C. § 933(1). 64 LAW AND BUSINESS REVIEW OF THE AMERICAS [Vol. 21 citizen’s worldwide income where the United States citizen is now a Pu- erto Rican resident and his or her income was earned within, or sourced to Puerto Rico. As stated earlier, certain sections explicitly treat United States citizens who are now Puerto Rican residents as nonresident alien individuals,152 or as United States citizens.153

A. SOURCING GENERALLY Rules similar to the rules for determining whether income is income from sources within the United States or is effectively connected with the conduct of a trade or business within the United States shall apply for purposes of determining whether income is from sources within a possession. As such, any income treated as income from sources within the United States or as effectively connected with the conduct of a trade or business within the United States shall not be treated as income from sources within any such possession or as effectively connected with the conduct of a trade or business within any such possession.154 Puerto Rico and the United States use the United States IRC to determine whether income is sourced within or outside the country, and whether that income is effectively connected to a trade or business within that country.155 Recently, Puerto Rico passed its own rules regarding income sourcing,156 which could complicate sourcing issues. Fortunately, the Puerto Rican IRC is very similar to the United States IRC. United States sourced personal or corporate income from a trade or business is trade or business income effectively connected to a United States trade or business and subject to United States tax.157 A foreign entity’s or foreign individual’s income is subject to United States tax, and is sourced within the United States if it is effectively connected to a United States trade or business.158 A “‘trade or business within the United States includes the performance of personal services within the United States at any time within the taxable year.”159 Aside from performing personal services within the United States,160 an effectively connected trade or business is negatively defined in the United States IRC, which states two exceptions that are not a trade or

152. Treas. Reg. § 1.861-2(a)(2) (2014). 153. I.R.C. § 7701(b)(1)(B). 154. Id. § 937(b). 155. Id. 156. P.R. LAW S ANN. tit. 13 § 30114 (2011). 157. I.R.C. §§ 882(b), 872(a), 861(b). 158. Id. §§ 937(b), 882(a)(1), 871(b)(2). 159. Id. § 864(b). 160. See id. § 864(b)(1) (trade or business within the United States does not include, “the performance of personal services for a nonresident alien individual, foreign corporation, foreign partnership not engaged in a trade or business within the [United States] or for an office or place of business maintained in a foreign country or in a possession of the [United States] by an individual who is a citizen or resident of the [United States] . . . ” if they do not exceed ninety days and the compensation is less than $3,000). 2015] PUERTO RICO 65 business.161 These two exceptions not considered a trade or business within the United States are (1) “performance of personal services for a nonresident alien individual, foreign partnership, or foreign corporation, not engaged in trade or business within the United States, or for an office or place of business maintained in a foreign country, or “ . . . possession by a [United States] citizen, resident [alien], . . . a domestic corporation, or a domestic partnership”; or (2) trading securities on a taxpayer’s own account so long as the taxpayer does not have an office or fixed place of business that conducts those transactions.162 While the United States taxes its citizen’s worldwide income,163 the United States only taxes nonresident aliens to the extent his or her income is sourced within the United States or is effectively connected to a United States trade or business.164 Puerto Rico similarly taxes nonresident alien individuals or corporations not engaged in a Puerto Rican trade or business to the extent the income is sourced within Puerto Rico.165 But during the year of the move from the United States to Puerto Rico, “[a]mounts received from sources outside Puerto Rico attributable to the period of residence outside of Puerto Rico” are exempt from Puerto Rico tax.166 When determining if the income is sourced to the United States or to the foreign country, “the name of the particular foreign country shall be used instead of the term United States, and the term domestic shall be construed to mean created or organized in such foreign country.”167 “[T]he term ‘foreign person’ means any other person other than a United States person, or a person who would be a United States person if references to the United States in section 7701 included references to a possession of the United States.”168 The rules for determining income sourcing and if a trade or business is effectively connected to the United States from foreign countries shall apply to possessions, unless otherwise stated.169 A foreign corporation or nonresident alien individual is engaged in a trade or business within the United States and has effectively connected income associated with that trade or business when (1) he or she generates a gain or loss from selling capital assets sourced within the United States and connected to his or her trade or business within the United States; (2) all gains or losses are from sources within the United States; (3) the income is sourced outside the United States and is effectively connected to the United States, if that income is attributable to an office or fixed place of business within the United States; (4) the office or fixed place of business within the United States receives interest or dividend

161. Id. 162. Id. 163. Id.§ 1; Treas. Reg. § 1.1-1 (2008). 164. I.R.C. §§ 871(b)(1) (2014). 165. P.R. LAW S ANN. tit. 13 §§ 30441, 30432, 30431 (2011). 166. Id. § 30102(a)(34)(A)(ii) (2011). 167. Treas Reg. § 1.863-6 (2014). 168. I.R.C. § 881(b)(3)(A). 169. I.R.C. § 893(b). 66 LAW AND BUSINESS REVIEW OF THE AMERICAS [Vol. 21 income from banking or similar businesses within the United States; (5) the income is “received by a corporation the principal business of which is trading in stocks or securities for its own account”; or (6) the income is attributable to selling capital assets through an office or fixed place of business within the United States.170 Income from sources outside the United States is not effectively connected if it “consists of dividends, interest, . . . paid by a foreign corporation in which the taxpayer owns” . . . or is considered to own “more than 50 percent of the total combined voting power of all classes of stock entitled to vote.”171 If a Puerto Rican resident trades securities within the United States, he or she is not effectively connected to a United States trade or business so long as the Pu- erto Rican resident does not have an office or fixed place of business within the United States that executes the transactions.172 The broad United States source rules ensure some of our individuals’ income is sourced within the United States. Jason and Jen will have very little trouble with sourcing issues because they do not operate a business and do not work. Their income consists of pension payments, social security, and possibly some investments. Even these limited income sources pose some problems, which are discussed below. Jon, Nichole, and Mikey will have significant issues because they operate businesses and provide personal services within the United States. Jon can not regularly fly back and forth to teach or service clients because he would then fail the closer connection test173 and source that income within the United States to an effectively connected United States trade or business.174 Nichole and Mikey both operate businesses and perform personal services for businesses that will source the income to the United States, effectively connecting that income to a United States trade or business.175 At a minimum, the salaries that Nichole and Mikey receive from their companies are sourced within the United States because their enti- ties are within the United States and they perform personal services for those companies within the United States.176 To avoid sourcing issues when Nichole and Mikey move to Puerto Rico, they should move their entire business to Puerto Rico, therefore ensuring there is no office or fixed place of business within the United States.177 Removing the office or fixed place of business from the United States ensures that the business’s income is sourced within Puerto Rico and is not effectively connected with a United States trade or business. Nichole will not have excessive sourcing issues because she primarily

170. Id. § 864(c) (2014). 171. Id. § 864(c)(4)(D); see also, I.R.C. § 952 (2014) (which describes subpart F income as it relates to controlled foreign corporations). 172. Id. § 864(b)(2)(C). 173. Treas. Reg. § 1.937-1(c)(5) (2014). 174. I.R.C. §§ 864(b)(1), 861(a)(3). 175. Id. 176. Id. 177. Id. § 864(b)(1); Treas. Reg. § 1.864-4(b)(5)(iii) (2013). 2015] PUERTO RICO 67 trades stocks. The sourcing rules carve out an applicable stock exception, provided Nichole does not have an office or fixed place of business within the United States.178

B. RETIREMENT INCOME An individual’s retirement income is sourced to his or her state of domicile.179 Puerto Rico is a state for purposes of retirement income sourcing.180 A United States citizen who is now a Puerto Rican resident should exclude his or her retirement income when he or she calculates his or her gross income from other United States sourced income or United States effectively connected income.181 The major difference between Puerto Rico and the United States is that a Puerto Rican resident is subject only to Puerto Rican tax on his or her retirement income, whereas a United States resident is subject to United States tax and state tax on the same income.182 Additionally, Puerto Rico exempts the first $15,000 of a resident’s pension from tax if the individual is sixty years or older,183 while the United States does not. Unfortunately, social security income is sourced within the United States no matter where the individual resides.184 A nonresident alien individual receiving social security benefits of any type has income not effectively connected with a United States trade or business, but sourced within the United States.185 The United States taxes only 85 percent of an individual’s social security benefits.186 Hopefully, all of our individuals will receive retirement income some- day. Currently, retirement income is only an issue for Jason and Jen. Ja- son and Jen’s pensions are sourced to their state of domicile, which could include Puerto Rico.187 Even though they are not effectively connected to a United States trade or business, 85 percent of their social security benefits are considered as income sourced within the United States and subject to United States tax.188 Jason and Jen will also enjoy Puerto Rico’s $15,000 exemption of their retirement income.189 Their remaining retirement income is still subject to Puerto Rican tax, which reaches a top

178. I.R.C. § 864(b). 179. 4 U.S.C. § 114(a) (2014). 180. Id. § 114(b)(3). 181. I.R.C. § 871(f)(1); see also, 4 U.S.C. § 114(a) (“[n]o State may impose an income tax on any retirement income of an individual who is not a resident or domiciliary of such State (as determined under the laws of such State)”); see also, I.R.C. § 933 (2014) (Puerto Rico sourced income is exempt from United States IRC taxation if the individual is a bona fide resident of Puerto Rico). 182. I.R.C. § 933(1). 183. P.R. LAW S ANN. tit. 13 § 30102(a)(13) (2011). 184. I.R.C. § 861(a)(8) (2014). 185. Id. § 871(a)(3). 186. Id. § 871(a)(3)(A). 187. 4 U.S.C. § 114(b)(3) (2014). 188. I.R.C. § 871(a)(3)(A). 189. P.R. LAW S ANN. tit. 13 § 30102(a)(13). 68 LAW AND BUSINESS REVIEW OF THE AMERICAS [Vol. 21 rate of 33 percent after $50,000.190 If they received $100,000 of retirement income and stay in the United States, then they will pay $16,233 in United States taxes, versus paying $20,740 if they moved to Puerto Rico, which could change based on the amount of social security income received. The calculation changes substantially if they received $75,000. In that case, they would pay $10,358 in United States taxes and $17,440 in Puerto Rican taxes.

C. INTEREST Interest income is sourced to the payor, regardless of how and where the interest was paid.191 Interest not sourced within the United States is sourced outside the United States.192 Thus, a nonresident alien individual living in Puerto Rico receiving interest income from a United States source has gross income sourced within the United States subject to United States tax.193 A nonresident alien individual’s taxable United States gross income does not include “interest on deposits with a foreign branch of a domestic corporation or a domestic partnership if such branch is engaged in the commercial banking business”194 or interest on business deposits not effectively connected with a trade or business within the United States.195 Additionally, United States sourced portfolio interest income received by a Puerto Rican corporation or Puerto Ri- can resident is not subject to United States tax.196 “[P]ortfolio interest means any interest (including original issue discount) which would be subject to tax under subsection (a) but for this subsection, and is paid on an obligation which is in registered form, and with respect to which” a United States person is otherwise required to withhold under IRC section 1441(a) and the United States person “receives a statement . . . that the beneficial owner of the obligation is not a United States person.”197 Portfolio interest does not include interest from United States obligations, interest received by a bank on a loan or extension of credit made in the ordinary course of business, interest received from a 10 percent shareholder of the company making the loan, or interest received from a related party’s controlled foreign corporation.198 A corporation is not a controlled foreign corporation if a United States citizen who is now a Puerto Rican resident owns 50 percent or more of the foreign corporation because a Puerto Rican resident is not a United States person for this section.199

190. Id. § 30061. 191. I.R.C. § 861(a)(1) (2014). 192. Id. § 862(a)(1). 193. I.R.C. § 861(a)(1). 194. Id. 195. Id. § 871(i)(2)(A) (2014). 196. Id. §§ 881(c)(1), 871(h)(1) (2014). 197. Id. § 871(h)(2). 198. Id. §§ 871(h)(2), 881(c)(3); see also id. § 864(d)(4) (defining related controlled foreign corporation); see also id. § 318 (defining corporate attribution rules). 199. Id. § 957(c) (2014). 2015] PUERTO RICO 69

A nonresident alien individual or corporation has interest income sourced within Puerto Rico and effectively connected to Puerto Rico if the interest is from “bonds, notes, or other interest-bearing obligations of resident persons, whether natural or juridical.”200 Interest is outside of Puerto Rico if (1) paid by foreign corporations, partnerships, domestic corporations, or partnerships engaged in business in Puerto Rico, except for a banking business, where less than 20 percent of the entity’s gross income for the three years ending when the interest was paid was from sources within Puerto Rico; (2) it is interest from deposits from Puerto Rican banks; (3) it is interest on mortgage payments secured by Puerto Rican land; and (4) it is interest on bonds, notes, or other obligations that derive or accumulate interest received by individuals that are citizens of the United States and are not residents of Puerto Rico.201 Interest income is from without Puerto Rico if it is interest other than that derived from sources within Puerto Rico as provided directly above.202 While endless scenarios could exist relating to the receipt of interest income, Jason, Jen, Jon, Nichole, Mikey, and their respective corporations are likely to encounter the same three scenarios described below. The first scenario occurs when someone has a bank account with a United States domestic bank that pays him or her interest. The interest payor is the United States bank, and the Puerto Rico recipient is treated as a nonresident alien individual or foreign corporation because he or she is a Puerto Rican resident.203 This means the interest is from sources within the United States.204 Although the interest received by the nonresident alien individual or foreign corporation is sourced within the United States, it is not effectively connected to a United States trade or business. Thus, it is exempt from United States tax.205 The second scenario occurs when a nonresident alien individual or foreign corporation has some type of United States government-issued security or bond, state-issued security or bond, or municipal bond. The payor is the United States government, which sources the income within the United States.206 If the United States sourced income is not effectively connected to a United States trade or business, then it is exempt from United States tax.207 Although, a banking corporation created under Puerto Rican laws operating as a bank in Puerto Rico that holds United States government obligations has income effectively connected with a United States trade or business, whether or not the Puerto Rican bank was operating within the United States.208

200. P.R. LAW S ANN. tit. 13 § 30151(a)(1) (2011). 201. Id. 202. P.R. LAW S ANN. tit. 13 § 30151(a)(1). 203. I.R.C. § 1441(e). 204. Id. § 861(a)(1). 205. Id. §§ 881(d), 871(i)(2)(A). 206. Id. § 861(a)(1). 207. Id. §§ 881(d), 871(i)(2). 208. Id. § 882(e). 70 LAW AND BUSINESS REVIEW OF THE AMERICAS [Vol. 21

The third scenario occurs when the nonresident alien individual or foreign corporation invested its money in the stock market or a mutual fund and the resulting interest income meets the portfolio income requirements.209 The interest income is sourced outside the United States, is not effectively connected to a United States trade or business, and is exempt from United States tax.210 While Puerto Rican residents are exempt from United States tax on the interest income,211 they are still subject to Puerto Rican tax on their interest income up to 25 percent.212 Fortunately, Act 22 exempts their interest income from Puerto Rican tax.213 If our group’s individuals remain in the geographical United States, their interest income is considered ordinary income subject to the top United States tax rate of 39.6 percent,214 which does not include state taxes. If our individuals keep their corporations in the United States, the corporations’ interest income is subject to corporate tax between 15 and 39 percent.215 By moving the corporations to Puerto Rico and obtaining an Act 20 or Act 273 exemption, the corporations are subject to Puerto Ri- can corporate tax at 4 percent,216 as opposed to the normal Puerto Rican corporate tax rates that could be up to 25 percent.217 If the Puerto Rican corporations have interest income from a trade or business effectively connected to the United States, then they are subject to a United States tax of 30 percent.218

D. DIVIDENDS The sourcing treatment for dividends differs from the interest treatment. The source of a dividend is the location of the corporation’s income responsible for paying the dividend.219 A nonresident alien individual residing in Puerto Rico, or foreign corporation organized under Puerto Rican laws, has income sourced within the United States if he or she receives a dividend from a United States domestic corporation.220 A United States domestic corporation distributing a dividend to a corporation organized under Puerto Rican laws is subject to a 10 percent tax, rather than 30 percent if the corporation satisfies certain statutory requirements.221 To qualify for the lower dividend tax rate, the

209. Id. § 881(c)(2) (stating the portfolio requirements). 210. Id. §§ 881(c), 871(h)(2). 211. Id. 212. P.R. LAW S ANN. tit. 13 §§ 30072, 30071(b) (2011). 213. 2012 P.R. LAW S no. 22 p. 3 – 4, available at http://www.oslpr.org/2009-2012/leyes/ pdf/ley-22-17-Ene-2012.pdf. 214. I.R.C. § 1 (2014). 215. Id. § 55(a) (2014). 216. 2012 P.R. LAW S no. 20 p. 10; 2012 P.R. LAW S No. 273 p. 10, available at http://www .lexjuris.com/lexlex/Leyes2012/lexl2012273.htm. 217. P.R. LAW S ANN. tit. 13 §§ 30072, 30071(b). 218. I.R.C. § 881(a). 219. Id. § 861(a)(2). 220. Id. §§ 881(a)(1), 871(a)(1), 861(a)(2). 221. Id. § 881(b)(1). 2015] PUERTO RICO 71

Puerto Rican corporation must have the following elements: (1) a United States citizen or Possession resident owns at least 75 percent of the corporation’s stock; (2) at least 65 percent of the company’s gross income for the last three years ending on the close of the taxable year is from a Pos- session resident or the United States; and (3) “no substantial part of the income of such corporation is used . . . to satisfy obligations to persons who are not bona fide residents of such a possession or the United States.”222 Nevertheless, the dividend is exempt from United States tax if the foreign corporation’s gross income from all sources for the three year period, or the corporation’s existence if less than three years—ending on the close of the taxable year preceding the dividend’s declaration—was more than 75 percent effectively connected to sources within the United States.223 Dividends received by a nonresident individual not engaged in a United States trade or business are exempt from United States tax.224 Puerto Rico defines a domestic corporation as any corporation “created or organized in Puerto Rico under the laws of Puerto Rico.”225 A dividend is from sources within Puerto Rico and effectively connected to Puerto Rico if the dividend is from a domestic corporation or partnership that derives more than 20 percent of its gross income from sources within Puerto Rico for the previous three years, ending on the close of the taxable year when the dividend was paid.226 “[D]ividends and benefits not derived from sources within Puerto Rico as provided” directly above are from outside Puerto Rico.227 Our individuals are likely to receive dividends from United States domestic corporations. Jason and Jen do not operate a business. Their dividends are unrelated to an effectively connected United States trade or business, so they are exempt from United States tax.228 Any dividends they receive are from sources within the United States, but exempt from United States tax.229 If they remain in the United States, then those dividends are taxed as ordinary income up to 39.6 percent,230 plus applicable state tax. If they move to Puerto Rico and obtain an Act 22 exemption, then those dividends are exempt from Puerto Rican tax.231 If Jason and Jen did not have the Act 22 exemption, then they would be subject to Puerto Rican tax up to 25 percent.232 Jon, Nichole, and Mikey might have dividends from a United States sourced trade or business. If so, as Puerto Rican residents, then they will

222. Id. §881(a)(1)–(b)(1). 223. Id. §§ 871(i)(2)(D), 861(a)(2). 224. Id. §§ 871(b)(2), 871(i)(2). 225. P.R. LAW S ANN. tit. 13 § 30041(a)(6) (2011). 226. Id. § 30151(a)(2). 227. Id. § 30152(a)(2). 228. I.R.C. §§ 871(b)(2), (i)(2) (2014). 229. Id. § 871(i)(2). 230. Id. §1. 231. 2012 P.R. LAW S no. 22 p. 3, available at http://www.oslpr.org/2009-2012/leyes/pdf/ ley-22-17-Ene-2012.pdf. 232. P.R. LAW S ANN. tit. 13 §§ 30072, 30071(b). 72 LAW AND BUSINESS REVIEW OF THE AMERICAS [Vol. 21 have income from sources within the United States effectively connected to a United States trade or business subject to United States tax at 30 percent.233 If their Puerto Rican based corporations receive a dividend from a United States domestic corporation, then the corporations are subject to a United States tax of 10 percent, instead of 30 percent.234 If their corporations remain in the United States and receive a dividend from another United States domestic corporation, then that dividend is taxed at the standard United States corporate tax rates that range between 15 and 39 percent.235 If the entity moved to Puerto Rico and did not have the exemption, the entity could pay tax up to 25 percent.236 If the corporation receives an Act 20 exemption, the corporation is subject to a 4 percent on their dividend income.237 Additionally, a valid Act 20 exemption will exempt the corporate shareholder from paying tax when the corporation distributes the income to them as a dividend.238 The Act 20 exemption from Puerto Rican tax on corporate dividends is exclusive of an Act 22 exemption. This is very useful because the Act 20 exemption could last for thirty years,239 and the Act 22 exemption expires on De- cember 31, 2035.240 An Act 273 exemption allows a corporation to pay a 4 percent tax on any dividend income.241 Furthermore, any dividends paid from the corporation to the owners are taxed at 6 percent during the exemption period, which could last up to forty-five years.242 The Act 273 exemption could also outlast the Act 22 exemption for individuals,243 which would provide significant benefits to the corporation’s owners when they receive dividend distributions from the corporation.

E. CAPITAL ASSETS When determining the source of a capital asset sale by a United States citizen who is a Puerto Rican resident, or a Puerto Rican based entity, the individual or entity is treated like a nonresident alien individual or a foreign corporation.244 “[T]he sale of personal property by a United States resident shall be sourced in the United States, or by a nonresident shall be sourced outside the United States.”245

233. I.R.C. § 871(a)(1)(A). 234. Id. § 881(b)(2). 235. Id. § 55(a). 236. P.R. LAW S ANN. tit. 13 §§ 30072, 30071(b). 237. 2012 P.R. LAW S no. 20 p. 13, available at http://www.oslpr.org/download/en/2012/ A-0020-2012.pdf. 238. Id. 239. Id. at 16–17. 240. 2012 P.R. LAW S no. 22 p. 1, available at http://www.oslpr.org/2009-2012/leyes/pdf/ ley-22-17-Ene-2012.pdf. 241. 2012 P.R. LAW S no. 273, p. 10, available at http://www.lexjuris.com/lexlex/Leyes 2012/lexl2012273.htm. 242. Id. at 11. 243. Compare 2012 P.R. LAW S no. 22, p. 2; with 2012 P.R. LAW S no. 273. 244. I.R.C. § 865(g)(1) (2014). 245. Id. § 865(a). 2015] PUERTO RICO 73

A nonresident alien individual who trades stocks, securities, or commodities, for business or for personal purposes, whether on his or her own, through an employee, a resident broker, a commission agent, a cus- todian, or other independent agents “whether or not any such” individuals have discretionary authority to execute the transaction, is not conducting a trade or business within the United States, or performing personal services within the United States.246 Such actions are not sourced within the United States, provided “[t]he taxpayer does not have an office or other fixed place of business within the United States through which or by the direction of” the transactions are executed.247 All of our individuals are likely to have some type of capital gains. Their capital gains will relate to the sale or exchanges of securities, investments portfolios, or the sale of some personal property or real property. Provided that the sale of capital assets such as these is unrelated to an office or fixed place of business within the United States, a Puerto Rican resident or corporation is exempt from United States tax on that sale.248 Jason and Jen will have the least difficulty with this issue. They are a retired couple who do not own, operate, or have a business within the United States or Puerto Rico. They would receive capital gains from their investments, which are not subject to United States tax.249 Al- though these distributions are taxable income to Jason and Jen in Puerto Rico, the Act 22 exemption eliminates the requirement to pay Puerto Rican tax.250 If Jason and Jen remained in the United States, any short- term capital gains are subject to ordinary income tax treatment at rates up to 39.6 percent.251 If their capital gains are long-term, they are subject to a maximum tax rate of 23.8 percent.252 By contrast, if Jason and Jen were to move to Puerto Rico, absent the Act 22 exemption, they would be subject to a 10 percent tax on their long-term capital gains,253 and up to a 25 percent tax on their short-term capital gains.254 Jason and Jen will benefit from the Act 22 exemption, but unless their income consists of significant capital gains, their benefit is minimal. Jon and Nichole might benefit the most from the lack of United States tax on capital gains distributed from United States sources to Puerto Ri- can residents or Puerto Rican corporations.255 Jon has substantial portfolio income, which likely includes capital gains. Act 22 will exempt those

246. Id. § 864(b)(2). 247. Id. 248. Id. § 864(b)(2); I.R.S. Notice 89-40, 1989-15 I.R.B. 16. 249. Id. § 864(b)(2). 250. 2012 P.R. LAW S no. 22 p. 3–4, available at http://www.oslpr.org/2009-2012/leyes/ pdf/ley-22-17-Ene-2012.pdf. 251. I.R.C. § 1(h)(2) (2014). 252. See id.; see also id. § 1411(a)(1). 253. P.R. LAW S ANN. tit. 13 § 30082(a) (2011). 254. P.R. LAW S ANN. tit. 13 §§ 30072; 30071(b) (2011). 255. See I.R.C. §§ 1445(b)(6), 864(b)(2) (2014); I.R.S. Notice 89-40, 1989-15 I.R.B. 16. 74 LAW AND BUSINESS REVIEW OF THE AMERICAS [Vol. 21 capital gains from Puerto Rican tax.256 Nichole’s hedge fund income will contain substantial capital gains, which can leave the United States tax- free.257 If Nichole made $10,000,000 in capital gains from trading stocks, that amount would be subject to a 10 percent Puerto Rican tax, which is $1,000,000.258 Conveniently, Nichole’s Puerto Rican-based income is exempt from United States tax.259 Therefore, when Nichole combines her exemption from United States tax with her Act 22 exemption on capital gains, she will pay no tax on her $10,000,000.260 If Nichole remained in the United States, her capital gains would be broken into long-term capital gains and short-term capital gains. The maximum tax on her long-term capitals gains is 23.8 percent,261 which is a tax of $2,380,000. The maximum tax on her short-term capital gains is 39.6 percent,262 which is a tax of $3,960,000. If Nichole were to keep her corporation within the United States, then that corporation’s $10,000,000 in gains will be subject to United States corporate tax amounting to $3,400,000.263 Comparatively, if Nichole moves to Puerto Rico and obtains an exemption under either the Act 20 or Act 273, her capital gains will be subject to Puerto Rican tax of 4 percent,264 which is $400,000. If Nichole’s corporation obtains an Act 20 exemption, income distributed as dividends to Nichole will be exempt from Puerto Rican tax.265 An Act 20 exemption could outlast an Act 22 exemption, which would allow Nichole to continue to exempt significant amounts of income. If Nichole obtains an Act 273 exemption for her corporation, then income distributed as dividends to her will be subject to a Puerto Rican tax of 6 percent,266 which is $600,000. Act 22 could eliminate this 6 percent tax until the exemption expires on December 31, 2035.267 At that point, the 6 percent tax under Act 273 would apply.268 Mikey’s situation is very different. He probably has some capital gain income from some investments, but that amount is likely minimal. Re- gardless, Act 22 will exempt the full amount of his capital gain income.269

256. 2012 P.R. LAW S no. 22 p. 3 – 4, available at http://www.oslpr.org/2009-2012/leyes/ pdf/ley-22-17-Ene-2012.pdf. 257. I.R.C. § 864(b)(2); I.R.S. Notice 89-40 (1989) 1989-15 I.R.B. 16. 258. See id. § 865(g)(2) (2014). 259. See id. § 933(1) (2014). 260. 2012 P.R. LAW S no. 22 p. 3–4, available at http://www.oslpr.org/2009-2012/leyes/ pdf/ley-22-17-Ene-2012.pdf. 261. See I.R.C. §§ 1411, 1(h). 262. See id. § 1(a). 263. See id. § 11(a). 264. See 2012 P.R. LAW S no. 20 p. 10, available at http://www.oslpr.org/download/en/ 2012/A-0020-2012.pdf; 2012 P.R. LAW S no. 273 p. 10, available at http://www .lexjuris.com/lexlex/Leyes2012/lexl2012273.htm. 265. See 2012 P.R. LAW S no. 20 p. 13. 266. See 2012 P.R. LAW S no. 273 p. 11. 267. 2012 P.R. LAW S 22, no. p. 1, available at http://www.oslpr.org/2009-2012/leyes/pdf/ ley-22-17-Ene-2012.pdf. 268. 2012 P.R. LAW S no. 273 p. 11. 269. 2012 P.R. LAW S no. 22 p. 3–4. 2015] PUERTO RICO 75

Mikey’s big benefit will come when he sells his business. Even with an Act 22 exemption, he must pay Puerto Rican tax on his business’s pre- move appreciation.270 Act 22 only exempts post-move appreciation from Puerto Rican tax.271 If he resides in Puerto Rico for more than ten years, then his pre-move appreciation is taxed at 5 percent272 rather than 10 percent.273 If Mikey remains within the United States, any capital gain income is taxed at a maximum rate of 23.8 percent.274 By moving to Pu- erto Rico, Mikey can save 23.8 percent on any post-move appreciation, and between 13.8 to 18.8 percent on any pre-move appreciation.

VI. UNITED STATES AND PUERTO RICO TAX RATE COMPARISON FOR INDIVIDUALS, CORPORATIONS, AND PARTNERSHIPS

A. CORPORATIONS AND PARTNERSHIPS The United States and Puerto Rico used to tax corporations and partnerships differently from each other. In 2011, Puerto Rico enacted an entirely new IRC.275 Before the new Puerto Rican IRC, Puerto Rico taxed corporations and partnerships with rates ranging from 20 to 30 percent, based on the entity’s income and number of Puerto Rican based employees.276 The Puerto Rican corporate tax now could reach 25 percent.277 This tax rate could change if the entity qualifies as a special entity,278 but the special entity designation is disregarded in this article because they do not qualify. A partnership does not have an entity level tax, but the partners are liable for tax on their individual tax returns.279 A nonresident alien individual who is a partner in a partnership that is engaging in trade or business in Puerto Rico “[s]hall be deemed as engaged in a trade or business in Puerto Rico with respect to its distributive share in the income . . . of the partnership.”280 United States corporations are taxed on a progressive tax scale starting at 15 percent of income not exceeding $50,000, but subject to 39 percent tax on income between $100,000 and $335,000, and topping out at 35 percent for amounts exceeding $18,333,333.281 Unfortunately, United States corporations, like Puerto Rican corporations, are subject to double taxation. The corporation is initially taxed on its income at the corporate level.282 Later, when the corporation distributes income as dividends or

270. Id. at 3. 271. Id. at 3–4. 272. Id. at 3. 273. P.R. LAW S ANN. tit. 13 § 30082(a) (2011). 274. I.R.C. §§ 1411; 1(h) (2014). 275. 2011 P.R. LAW S no. 1, http://www.oslpr.org/download/en/2011/A-0001-2011.pdf. 276. P.R. LAW S ANN. tit. 13 § 8415(b) (2010). 277. Id. §§ 30072, 30071(b) (2011). 278. Id. § 30071(c) (2011). 279. Id. § 30331(2011). 280. Id. 281. I.R.C. § 11(b) (2014). 282. Id. 76 LAW AND BUSINESS REVIEW OF THE AMERICAS [Vol. 21 benefits, the shareholders or employees are taxed upon receipt,283 thus, double taxation results. Like a regular Puerto Rican partnership, United States partnerships are not taxed at the federal level at all.284 A partnership is merely a flow through entity, where “[p]ersons carrying on a business as partners shall be liable for income tax only in their separate or individual capacities.”285 The character of income received at the partnership level will flow through to each partner maintaining its character.286 This article does not address any state taxes or fees on corporations or partnerships, which could be significant. The entity differences will not affect Jason and Jen because they do not operate a business. Jon, Nichole, and Mikey will benefit the most from the tax rate differences because a properly structured tax exemption could shelter significant amounts of income. Under Puerto Rican law, Jon could face an entity level tax if he starts a corporation.287 Thus, Jon should apply for the Act 20 exemption.288 The exemption would subject Jon’s corporation to a flat 4 percent tax, which would significantly reduce his corporate tax liability for up to thirty years.289 If Jon started a partnership, he should still apply for the Act 20 exemption because Act 20 also provides an exemption to recipients of company distributions and exemptions from property and municipal taxes.290 While Jon might have some concerns about an entity level tax, the major concerns revolve around Nichole. The tax treatment of her business depends on her entity choice. Hedge funds typically choose a flow-through entity like a partnership because the partnership’s income is taxed to the partners not the entity,291 and avoids the double taxation associated with a corporation. Nichole’s main issues revolve around income sourcing and the entity’s tax treatment. As a hedge fund manager, Nichole will conduct tens of thousands of capital transactions throughout the year. To conduct her business in Puerto Rico, Nichole must either associate herself with a Puerto Rican bank, an international bank within Puerto Rico, or, for the low price of $250,000, start her own bank!292 Starting her own bank means Nichole is not subject to frustrating bank fees or servicing issues, and potentially exempt from some banking usury laws.293 If she decides to start her own bank,

283. Id. §1. 284. Id. § 701. 285. Id. 286. Id. § 702(b). 287. P.R. LAW S ANN. tit. 13 §§ 30072, 30071(b) (2011). 288. 2012 P.R. LAW S no. 20 p. 10, available at http://www.oslpr.org/download/en/2012/ A-0020-2012.pdf. 289. Id. 16–17 290. Id. 15. 291. I.R.C. § 701 (2014). 292. 2012 P.R. LAW S no. 273 p. 7, available at http://www.lexjuris.com/lexlex/Leyes2012/ lexl2012273.htm. 293. Id. at 30. 2015] PUERTO RICO 77 she should apply for the Act 273 exemption that allows her entity to pay flat 4 percent tax294 for up to forty-five years.295 Although, the Puerto Rican Secretary has the discretion to modify the entity’s tax rate up to 10 percent for the last fifteen years.296 Another potential issue for the Act 273 exemption is the four-employee requirement.297 The cost and headaches associated with employ- ing four employees could outweigh the Puerto Rican law’s incentives. Fortunately, Act 22 grants Nichole’s banking entity an exception from the four-employee requirement.298 If Nichole did not have an Act 22 exemption, the Puerto Rican Secretary may waive the employee requirement upon Nichole’s request.299 If Nichole continues to reside in the United States, her primary benefit is the lack of an employee requirement if she is unable to obtain an exemption or waiver. Nichole’s share of partnership income will maintain its characteristics as it flows through to her personal tax return.300 Those amounts are then taxed at her applicable individual tax rates.301 Jon and Nichole are likely subject to the top ordinary income tax rates of 39.6 percent,302 and top long-term capital gain tax rates of 23.8 percent303 when they combine their income, excluding state taxes. If Nichole and Jon make $10,000,000, the most tax they would owe is $3,960,000,304 and the lowest tax they would owe is $2,380,000,305 provided they operated a partnership. If they operated a corporation, their corporation will pay an entity level tax of $3,400,000,306 meaning the most the corporation could distribute to them is $6,600,000. Then, whatever amounts the corporation distributed to them is subject to tax at their respective individual rates. If the corporation then distributed this entire amount to them, the most tax they would pay is $2,613,600307 and the lowest is $1,570,800.308 Alto- gether, they could pay tax ranging from $6,013,600 to $4,970,800, which is about 49 to 60 percent of their $10,000,000 income, excluding state taxes. If Jon and Nichole relocated their business to Puerto Rico, and became Puerto Rican residents with valid Act 22 and Act 273 exemptions, the

294. Id. at 10. 295. Id. at 17. 296. Id. 297. Id. at 24. 298. 2012 P.R. LAW S no. 22 p. 3, available at http://www.oslpr.org/2009-2012/leyes/pdf/ ley-22-17-Ene-2012.pdf. 299. 2012 P.R. LAW S no. 273 p. 24, available at http://www.lexjuris.com/lexlex/Leyes 2012/lexl2012273.htm. 300. I.R.C. §§ 1411, 702(b), 701, 1(a) (2014). 301. Id. §§ 1411, 1(a), 1(h). 302. Id. § 1(a). 303. See id. § 1(h), 1411. 304. Id. § 1(b). 305. See id. § 1(h), 1411. 306. Id. § 11(b). 307. Id. § 1(b). 308. Id. §§ 1411, 1(a), 1(h). 78 LAW AND BUSINESS REVIEW OF THE AMERICAS [Vol. 21 corporation will pay a tax of $400,000 on their $10,000,000,309 and a partnership will pay zero.310 A Puerto Rico move with a valid exemption will save them $3,000,000 in corporate tax. If Jon and Nichole started a Pu- erto Rican partnership, because partnership income maintains its character,311 Nichole will pay Puerto Rican income tax on anything Act 22 does not exempt. If the entity is a corporation or partnership and distributes interest, dividends, or capital gains, Act 22 will exempt these amounts from tax.312 Mikey’s situation differs from the others. His startup company is still not worth any money, but it is poised for rapid growth. He should relocate his company to Puerto Rico to source as much post-move appreciation to Puerto Rico, which is then eligible for Act 22 exemption. This requires him to establish a Puerto Rican residency before his business’s value skyrockets. The Act 20 business exemption will subject his entity to Puerto Rican tax of 4 percent313 for up to thirty years,314 rather than Pu- erto Rico’s entity level tax up to 25 percent.315 He will save up to 21 percent in Puerto Rican tax annually. If Mikey stays in the United States, the United States IRC will dictate his business and personal tax liability.316 If Mikey’s entity is a corporation instead of a partnership, he is subject to tax at the corporate level between 15 and 35 percent,317 and then tax at the individual level when the company distributes profits through dividends or pays him a salary.318 A Puerto Rico move would save Mikey 11 to 31 percent in corporate tax annually.

B. INDIVIDUALS As previously stated, the United States and Puerto Rico each have their own individual exclusive taxing systems,319 and both maintain a progressive tax structure.320 The top United States individual rate is 39.6 percent,321 and Puerto Rico’s top rate ranges from 30 to 33 percent, depending on the year.322 While the lower Puerto Rican rate looks more favorable, it applies to all income from $61,300 to $121,500, depending on

309. 2012 P.R. LAW S no. 273 p. 10, available at http://www.lexjuris.com/lexlex/Leyes 2012/lexl2012273.htm. 310. P.R. LAW S ANN. tit. 13 § 30331 (2011). 311. Id. 312. 2012 P.R. LAW S no. 22 p. 3–4, available at http://www.oslpr.org/2009-2012/leyes/ pdf/ley-22-17-Ene-2012.pdf. 313. 2012 P.R. LAW S no. 20 p. 10, available at http://www.oslpr.org/download/en/2012/ A-0020-2012.pdf. 314. Id. at 16–17. 315. P.R. LAW S ANN. tit. 13 §§ 30072, 30071 (2011). 316. I.R.C. § 1 (2014). 317. Id. § 11. 318. Id. § 1(c). 319. I.R.C § 1(c); P.R. LAW S ANN. tit. 13 §§ 30061, 352 (2010). 320. I.R.C § 1(c); P.R. LAW S ANN. tit. 13 § 30061(a). 321. I.R.C. § 1. 322. P.R. LAW S ANN. tit. 13 § 30061(a). 2015] PUERTO RICO 79 the year.323 This article will use the 30 percent rate that applies to income of $121,500 and over for all income earned after December 31, 2015.324 The top United States rate begins for single individuals at $400,000325 and for married joint filers at $450,000.326 In the United States, a single person making $500,000 would pay tax of $155,764, and a married individual would pay tax of $145,646.327 If the same person made $500,000 in Pu- erto Rico, he or she would pay tax of $133,600. The United States calcu- lations do not include state taxes, which could add between 0 and 13.3 percent328 or more depending on the specific states. All of our groups are likely have a capital transaction because each group should sell its house. A house is a capital asset because it is not explicitly defined as not a capital asset.329 Upon selling their homes, all are likely to qualify for a sale of personal residence exemption. This exemption excludes gains of up to $250,000 if single, and $500,000 if married filing joint.330 To qualify, he or she must have lived in the house for twenty-four of the last sixty months.331 Puerto Rico recently enacted a similar exemption, but it only applies to individuals who are sixty years and older who lived in their home for thirty-six of the last sixty months,332 and exempts only $150,000.333 Any amount exceeding the exemption is a long-term capital gain.334 The sale of United States real property is United States sourced income explicitly subject to United States tax, no matter where the individual lives and when the home was sold,335 making it ineligible for any Puerto Rican tax benefits. Assuming the sale results in a gain, this excess capital gain tax might affect our groups differently. Jason and Jen might receive the worst or best treatment. Assume that they bought their home many years ago. Their home likely appreciated significantly over the years, and may exceed the $500,000 exemption, which will push their other income into higher brackets (the worst treatment).336 This income increase could subject them to the top capital gain rate of 23.8 percent for any excess gain.337 This excess gain could also push their ordinary income tax to- ward the 39.6 percent bracket.338 Jason and Jen have limited retirement income and cannot work anymore. Thus, they are relying on this sale to

323. Id. 324. Id. § 30061(a)(6). 325. I.R.C. § 1(c). 326. Id. § 1(i)(3). 327. Id. §1. 328. CAL. REV. & TAX. CODE §§ 17043, 17041 (West 2014). 329. I.R.C. § 1221 (2014). 330. I.R.C. § 121 (2014). 331. Id. 332. P.R. LAW S ANN. tit. 13 § 30102(a)(16) (2011). 333. Id. 334. I.R.C. § 1221; P.R. LAW S ANN. tit. 13 § 30141 (2011). 335. I.R.C. § 861(a)(5). 336. Id. § 121. 337. Id. §§ 1411 (2014), 1(h). 338. Id. § 1(a). 80 LAW AND BUSINESS REVIEW OF THE AMERICAS [Vol. 21 fund their move and to purchase a new house. Conversely, the exemption could shield their entire gain up to $500,000 (the best treatment).339 Jon, Nichole, and Mikey are all young and able to work. They could work extra hours to offset the moving costs. Both groups should qualify for the exemption, shielding any gain from tax. These two groups are unlikely to have owned their homes for as long as Jason and Jen, thus, the exemption is likely to cover any applicable appreciation. While the home sale is likely an isolated capital transaction, there are other capital transactions that warrant more concern. Jon and Nichole are both highly successful and receive significant investment income. If Jon continues to teach or practice law, his wage income is subject to Puerto Rican taxation at rates ranging from 30 to33 percent.340 Act 22 exempts any investment income attributable to interest, dividends, or capital gains from taxation, but not wage or salary income.341 Nichole will have tens of thousands of long-term and short-term capital transactions during the year. The United States requires Nichole to hold a capital asset for one year and a day to become long-term.342 Puerto Rico only requires her to hold a capital asset for six-months to qualify as a long-term capital asset.343 The difference between the long- term classifications could have a significantly positive impact on her business, in addition to benefitting from the lower tax rates.344 Conveniently, Act 22 exempts capital gains whether long-term or short-term,345 an immense advantage to her. If Jon and Nichole stay in the United States, the United States IRC will dictate their tax liability.346 Jon and Nichole are likely in the top 39.6 percent tax bracket for ordinary income,347 which includes interest, dividends, and short-term capital gains.348 Long-term capital gains are taxed at a maximum of 23.8 percent.349 If they move to Puerto Rico, their wages are subject to the top Puerto Rican tax rate ranging from 30 to 33 percent depending on the year.350 Any long-term capital gains are subject to a 10 percent tax,351 absent an Act 22 exemption.352 By moving to Puerto Rico, Jon and Nichole could exempt interest, dividend, and capital

339. Id. § 121. 340. P.R. LAW S ANN. tit. 13 § 30061(a) (2011). 341. 2012 P.R. LAW S no. 22 p. 3–4, available at http://www.oslpr.org/2009-2012/leyes/ pdf/ley-22-17-Ene-2012.pdf. 342. I.R.C. § 1221(a)(3) (2014). 343. P.R. LAW S ANN. tit. 13 § 30141(a)(4) (2011). 344. 2012 P.R. LAW S no. 22 p. 3–4. 345. Id. 346. I.R.C. § 1 (2014); Treas. Reg. § 1.1-1 (2008). 347. I.R.C. § 1. 348. Id. § 1(a). 349. Id. §§ 1411, 1(h)(1)(C). 350. P.R. LAW S ANN. tit. 13 § 30061(a) (2011). 351. Id. §§ 30111(a)(2), 30082(a). 352. 2012 P.R. LAW S no. 22 p. 3–4, available at http://www.oslpr.org/2009-2012/leyes/ pdf/ley-22-17-Ene-2012.pdf. 2015] PUERTO RICO 81 gains from tax,353 which are subject to ordinary income tax rates in the United States up to 39.6 percent,354 a 39.6 percent. While Jon and Nichole enjoy significant Act 22 exemptions on their yearly income, Mikey will enjoy that exemption during one big sale. Mikey should hire an appraiser to value his company before he moves if his company’s value is not easily ascertainable. This will lock in the pre-move value and source any post-move appreciation to Puerto Rico. Any post-move appreciation generated while he is a Puerto Rican resident is eligible for the capital gain exclusion under Act 22.355 Mikey should reside in Puerto Rico for more than ten years so that his pre-move appreciation is subject to a lower 5 percent tax, rather than a 10 percent tax.356 Comparatively, if he continued to reside in the United States, the sale of his company should put him in the top long-term capital gain tax bracket of 23.8 percent,357 plus any applicable state tax. Mikey could save up to 18.8 percent by subjecting his pre-move appreciation to Puerto Rican tax, and fully exempt any post-move appreciation, which will save him 23.8 percent,358 plus any applicable state tax. If Mikey stays in the United States, his best option is to sell the business as a stock sale because he could exclude between 50 and 100 percent of the gain that does “not exceed the greater of $10,000,000 or ten times the aggregate adjusted basis of qualified small business stock.”359 To qualify, Mikey must meet IRC section 1202’s requirements, but because he started the company from the ground up, he is likely within its param- eters.360 But, a buyer of Mikey’s company is unlikely to select this option because a buyer usually benefits more from an asset sale. An advantage of an asset sale is that the buyer can depreciate the company assets again,361 and reject company liabilities. If the parties allocated any of the purchase price to goodwill, the buyer can amortize that amount over fifteen years.362 If Mikey sells solely the rights to his intellectual property, which has a set expiration date, the buyer can amortize the purchase price over the remaining life.363 Asset and intellectual property sales can be significantly more advantageous to a buyer than a stock sale, which is why it is unlikely. The following illustrates the benefits of selling Mikey’s business with Puerto Rico’s incentives versus staying in the United States and paying the United States tax. Mikey’s initial basis in his company is $500,000, his pre-move appreciation is $1,000,000, and after ten years, which is when he

353. Id. 354. I.R.C. § 1(a). 355. 2012 P.R. LAW S no. 22 p. 3. 356. 2012 P.R. LAW S no. 22 p. 3–4. 357. I.R.C. §§ 1411, 1(h). 358. See id. 359. Id. § 1202(b)(1)(B). 360. Id. §§ 1202(c)–1202(e). 361. Id. § 167. 362. Id. § 197(a), 197(d)(1)(A). 363. Id. § 197(d)(1)(D). 82 LAW AND BUSINESS REVIEW OF THE AMERICAS [Vol. 21 sells, the business appreciated to $40,000,000. If he stays in the United States, assuming no exclusions apply, when he sells his business for $41,500,000, he will pay a tax of $9,758,000,364 plus applicable state taxes. If he moves to Puerto Rico, the $1,000,000 pre-move appreciation is taxed at 5 percent, which is $50,000,365 and Act 22 exempts any post move appreciation from tax.366 If Mikey moves to Puerto Rico, he will pay a total tax of $50,000, on a business worth $41,500,000. The Puerto Rico move could save him $9,708,000 in taxes!

VII. CONCLUSION The Puerto Rican incentives provide very enticing financial incentives to encourage one to seek Puerto Rican residency. For individuals like Jason and Jen, who will receive minimal benefits, these benefits are not substantial enough, and therefore they should not move. The residency test, closer connection test, and tax home test ensure that an individual actually becomes a Puerto Rican resident and is not simply renting a mailbox or home in Puerto Rico to enjoy the benefits. The individual moving to Puerto Rico remains a United States citizen, even though the tax code often defines him or her as a non-resident alien individual. The significant financial incentives provided in the three Puerto Rican legislative incentives discussed are powerful motivators to persuade someone to relocate to Puerto Rico. For financially motivated individuals whose income consists primarily of interest, dividends, and capitals gains, these benefits are enormous. Jon and Nichole will benefit significantly from the exemption and should move to Puerto Rico. An Act 22 tax emption lasts until December 31, 2035367 and an Act 273 exemption can be valid up to forty-five years.368 While briefly mentioned, the Act 273 also exempts the corporation from paying municipal taxes and taxes on real or personal property or tangible or intangible property, which could be significant.369 Jon and Nichole could quickly amass a fortune upon which they may pay little to no tax. Mikey had a different situation throughout this entire article. Not only is he moving his life and business to Puerto Rico, but also he must find qualified individuals within Puerto Rico to help grow his business. Jon and Nichole both have the intellectual knowledge to conduct their business without outside assistance. Mikey needs workers to help his company grow, which Puerto Rico can provide. If Mikey desires to reap the benefits of the various Puerto Rican incentives, he should do so before his business significantly appreciates so he can source as much apprecia-

364. See I.R.C. §§ 1(h), 1411. 365. See 2012 P.R. LAW S no. 22 p. 3, available at http://www.oslpr.org/2009-2012/leyes/ pdf/ley-22-17-Ene-2012.pdf. 366. Id. at 4. 367. Id. at 1. 368. 2012 P.R. LAW S no. 273 p. 17, available at http://www.lexjuris.com/lexlex/Leyes 2012/lexl2012273.htm. 369. Id. at 29. 2015] PUERTO RICO 83 tion and income to Puerto Rico as possible. The potential tax exemption he receives upon selling his business is a major incentive that should persuade him to relocate. As stated above, this article discussed a variety of issues within a vac- uum and excluded a list of items, including, but not limited to deductions, expenses, credits, subpart F income, certain FDAP income, withholding issues, entity-formation issues, entity-relocation issues, entity-dissolution issues, fund-relocation tax issues, RICs, dividend-received deduction, employment taxes, and the alternative minimum tax under both codes. An individual contemplating a move to Puerto Rico for the purpose of benefiting from these tax incentives should consult a knowledgeable attorney and tax expert before he or she undertakes the journey. A tax haven is “a country, that imposes little or no tax on the profits from transactions carried on there or on persons resident there.”370 Is Puerto Rico America’s tax haven or simply a vacation paradise? Like the answer to almost any legal question, it depends; and depending on the situation, Puerto Rico could be America’s tax haven.

370. BLACK’S LAW DICTIONARY, 1600 (9th ed. 2009). 84 LAW AND BUSINESS REVIEW OF THE AMERICAS [Vol. 21 Case Note

PAST DUE: AN INTRODUCTION TO SOVEREIGN DEBT, THE ONGOING DISPUTE BETWEEN NML CAPITAL AND ARGENTINA, AND POSSIBLE RAMIFICATIONS OF THE DISPUTE’S OUTCOME

Jamison Joiner*

I. INTRODUCTION

F money is borrowed on credit and not repaid, then creditors come knocking. This is not a foreign proposition, and almost everyone has Ihad some experience with it, either directly or indirectly. People and companies are not the only ones that feel the creditor’s pinch when funds become scarce; countries can also default on their debt obligations.1 Ar- gentina is no stranger to this fact, and has defaulted seven times over the past 200 years.2 Further, Argentina’s 2001 default was “the largest sovereign default ever at the time.”3 The impacts of such an occurrence are not short-lived, and it appears that Argentina defaulted for an eighth time this July when it “missed a coupon payment on its restructured sovereign bonds.”4 Argentina hotly

* J.D. Candidate 2016, Dedman School of Law, Southern Methodist University; B.B.A. in Management and B.A. in Spanish, SMU 2011. The author would like to thank his family for its love and support. The author would also like to thank Courtney Floyd, the Hatton W. Sumners Foundation, and the SMU International Law Review Association. 1. While sovereign debt defaults do occur, they are not are not overly frequent and only forty occurred between 1970 and 2010. John A. E. Pottow, Mitigating the Problem of Vulture Holdout: International Certification Boards for Sovereign-Debt Restructurings, 49 TEX. INT’L L.J. 221, 223 (2014). Moreover, there are different standards for what constitutes a sovereign default. “According to Moody’s, a sovereign default occurs whenever a country defaults on any of its bonds.” Joy Dey, Collective Action Clauses Sovereign Bondholders Cornered?, 15 L. & BUS. REV. AM. 485, 493 (2009). “Standard & Poor’s (S&P) defines default as the failure of a borrower to meet principal or interest payment of its debt obligations on the due date.” Id. 2. Shane Roming, Argentina’s Long History of Economic Booms and Busts, WALL ST. J. MONEYBEAT (July 30, 2014, 7:43 PM), http://blogs.wsj.com/moneybeat/2014/ 07/30/argentinas-long-history-of-economic-booms-and-busts/. 3. Id. 4. Hugh Bronstein, Default? What Default? Argentina slams U.S. for using ‘D’ Word, REUTERS (Sep. 16 2014, 3:14 PM), http://www.reuters.com/article/2014/09/16/us-argentina-debt-idUSKBN0HB2B520140916.

85 86 LAW AND BUSINESS REVIEW OF THE AMERICAS [Vol. 21 contests that any default took place, and instead argues that it attempted to make the payment, but could not because of rulings by U.S. courts in ongoing proceedings between it and holdout creditors from the 2001 default.5 In response, Argentina recently passed legislation that allows it to bypass U.S. judicial decisions and repay holders of restructured sovereign debt without conceding to holdout creditors.6 The ongoing developments between Argentina, its creditors (both those that agreed to restructured debt exchanges and those that held out), and the United States will have far reaching implications.7 In Ar- gentina, the immediate effect of another default could cripple the nation’s ability to obtain credit.8 On a grander scale, the precedent set in this dispute could determine the course taken in the Eurozone’s resolution of Greece’s 2012 default, the largest in history, and, in effect, shape the future of sovereign debt defaults and restructurings.9

II. LEGAL BACKGROUND AND DEVELOPMENT

When considering sovereign defaults, it is important to keep in mind some key differences between the credit defaults of people and those of corporations. The most apparent difference is the vastly grander scope of a sovereign default than a personal or corporate default.10 The impact of a sovereign default affects not only that nation, but, given the intercon- nectedness of global economies, countries and people the world over.11 A less obvious, but arguably more important divergence between the two lies in the fact that sovereign debt defaults are not governed by a single, universally applicable and statutorily recorded bankruptcy code.12 In- stead of filing for bankruptcy, sovereign states “restructure their debt to prevent or resolve financial and economic crises and to achieve debt sus- tainability levels.”13 This approach presents a number of challenges, chiefly holdout credi-

5. Id. 6. Julie Deisher, Argentina passes law circumventing US Court ruling limiting debt repayments, JURIST (Sept. 12, 2014, 8:44 AM), http://jurist.org/paperchase/2014/09/ argentina-passes-law-circumventing-us-court-ruling-limiting-debt-repayments.php. 7. Daniel Huang, Don’t Cry for Them: The World’s Biggest Sovereign Defaults Since 2000, WALL ST. J. MONEYBEAT (July 2, 2014, 1:59 PM), http://blogs.wsj.com/ moneybeat/2014/07/02/dont-cry-for-them-the-worlds-biggest-sovereign-defaults- since-2000/. 8. Id. 9. Id. 10. Dey, supra note 1, at 493. 11. Id. 12. Id. at 495. 13. In layman’s terms, this typically involves a sovereign’s creditors agreeing to new repayment terms as part of an effort to allow the sovereign to pay off its debts (or at least a mutually agreed upon portion of them) while mitigating the negative effect on its economy. Rodrigo Olivares-Caminal, Understanding the Pari Passu Clause in Sovereign Debt Instruments: A Complex Quest, 43 INT’L LAW . 1217, 1218 (2009). 2015] PAST DUE 87 tors.14 In some cases, sovereign debt issues include a Collective Action Clause (CAC) that sets out “what percentage of a bond issue would have to agree to a restructuring for it to be possible to force that restructuring on the” rest of the bondholders, whether they agreed to it or not.15 When debt issues do not include CACs, small groups of holdout creditors can delay or even prevent restructuring efforts.16 Among holdout creditors, there exists a more contentious subset: vulture funds. Vulture funds buy sovereign debt at discounted rates from the original debt holder and then demand repayment at full value while refusing efforts at restructuring.17 While vulture funds are legal and make good business sense, the approach strikes many as morally reprehensible, especially those associated with the nation in default.18 Nevertheless, they are a part of the reality that a country must face when it defaults on its debt obligations.19 Argentina provides a prime example of just how confounding the pros- pect of default can be for a sovereign nation. In 1991, Argentina adopted an economic program called the “Covertabilidad” that linked the value of the Argentinean peso to the U.S. dollar as part of an effort to reduce debt and manage inflation.20 While the Convertabilidad was initially effective, it also made the Argentinian “economy vulnerable to foreign crisis.”21 The public was acutely aware of this fact and, in 2001, fear of a devaluation led to a bank run that caused Argentina’s financial system to spiral out of control. Ultimately, Argentina defaulted on over one-hundred billion U.S. dollars in external bond debt to its domestic and foreign creditors.22 In an effort to address “the $102 billion debt that the country maintained with its domestic and foreign creditors, the government opened two debt exchanges in 2005 and 2010, through which it managed to get

14. There are three basic parties involved in a sovereign debt restructuring: the sovereign, holders of original bonds, and holders of restructured bonds. The sovereign is the debtor on both types of bonds. “The old bonds are those held by the holdouts that did not participate in the exchange offer.” Id. “The new bonds are those that were issues to creditors as result of the exchange offer, i.e. as result of the tender of their old bonds for new bonds.” Id. Generally, holdouts (even when they are small in number or proportion) can hold up an entire restructuring agreement if they do not agree with it unless there is a collective action clause (CAC). Id. at 486. 15. Tim Wortsall, Argentina’s Default, Vulture Funds, And The Little Secret That Not Many Understand, FORBES (Aug. 2, 2014, 10:23 AM), http://www.forbes.com/sites/ timworstall/2014/08/02/argentinas-default-vulture-funds-and-the-little-secret-that- not-many-understand/. 16. Id. 17. Id. 18. See Cristina Fernandez Calls Vulture Funds ‘Economic Terrorists, TELESUR (Sept. 24, 2014), http://www.telesurtv.net/english/Cristina-Fernandez-Calls-the-Vulture- Funds-Economic-Terrorists-20140924-0057.html. 19. See id. 20. Joanna Somoes, ˜ Sovereign Bond Disputes Before ICSID Tribunals: Lessons from the Argentina Crisis, 17 L. & BUS. REV. AM. 683 (2011). 21. Id. 22. During the bank run, “approximately one billion dollars were withdrawn daily.” Id. Although the Argentinian government placed heavy restrictions on the with- drawal and transfer of funds, such measures were ineffective. Id. 88 LAW AND BUSINESS REVIEW OF THE AMERICAS [Vol. 21 support from 93 percent of the investors by providing them with a settlement at a 65 percent discount on the dollar.”23 The remaining 7 percent, however, consists of vulture funds that refused the restructuring offer.24 These holdouts, led by U.S. hedge fund NML Capital, embody the vulture fund mantra and bought Argentinian debt when it “was on the verge of default at a discounted price,” then sued Argentina in the Southern District of New York “for the full amount owed on the debt, plus interest,” when it failed to make payments.25 Almost unbelievably, it is Ar- gentina’s conflict with this small remainder of its sovereign debt holders that has the world on edge.

III. DEVELOPMENTS AND PROBLEMS

A. OVERVIEW OF ARGENTINA’S CONFLICT WITH NML CAPITAL AND OTHER VULTURE FUNDS Argentina’s conflict with NML Capital is not a one-off case, but a string of disputes—collectively referred to here as the NML v. Argentina saga—centered on efforts at debt collection stretching across multiple years.26 As stated above, “[t]he NML plaintiffs [collectively, NML], are a coalition of distressed debt funds and retail investors who sat out the restructuring, sued, and then launched a largely fruitless global search for Argentine assets.”27 Although the initial cases between NML and Ar- gentina began over a decade ago, discussion for the purposes of this analysis begins much more recently with a case decided in 2012 that set the social, political, and legal stage for how the NML v. Argentina saga will play out. In NML I, in addition to seeking money judgments that it worried would be uncollectable, NML also “held some Argentine bonds in reserve and returned to federal court in New York to demand specific performance of the underlying bond covenants.”28 NML’s stance is based

23. Argentina’s Debt Battle: Why the ‘Vulture Funds’ Are Circling, Knowledge@Whar- ton, WHARTON SCH. U. PA. (July 3, 2014), http://knowledge.wharton.upenn.edu/ article/argentinas-debt-battle-vulture-funds-circling/; see also Rodrigo Olivares- Caminal, To Rank Pari Passu Or Not To Pari Passu: That Is The Question In Sovereign Bonds After The Latest Episode Of The Argentina Saga, 15 L. & BUS. REV. AM. 745, 747 – 49 (2009); see also NML Capital, Ltd. v. Republic of Argentina (NML I), 699 F.3d 246, 251 – 54 (2d. Cir. 2012), cert. denied. 134 S. Ct. 201 (2013). 24. Alexcia Chambers, Moment: Implications of Argentina’s Default, DIPLOMATIC COURIER (Sep. 9, 2014), http://www.diplomaticourier.com/blog/2362-moment-implications-of-argentina-s-default. 25. Id.; see also The Economist Explains: Why Argentina may default on its debts, ECONOMIST (July 29, 2014, 11:50 PM), http://economist.com/blogs/economist-explains/2014/07/economist-explains-22 (explaining that NML Capital, along with the other vulture funds, “scooped up cheap defaulted debt in order to chase payment of full principal plus interest in the New York courts, under whose law the original bonds were written.”). 26. W. Mark C. Weidemaier & Anna Gelpern, Injunctions in Sovereign Debt Litiga- tion, 31 YALE J. ON REG. 189, 190 – 91 (2014). 27. Courts and academics generally refer to the plaintiff vulture funds as a single entity, NML. Id. 28. Id. 2015] PAST DUE 89 upon a quirky boilerplate provision called a pari passu clause.29 The pari passu clause in Argentina’s bonds stated that Argentina would “‘rank at least equally’ with all its other indebtedness,” which, at its core, means that if a debtor cannot pay all of its creditors then it must pay them equally as opposed to paying some and not others.30 Conversely, Argen- tina argued that the injunctive relief sought would violate the Foreign Sovereign Immunities Act (FSIA), which provides that “the property in the United States of a foreign state shall be immune from attachment arrest and execution.”31 Judge Griesa of the Southern District of New York was not persuaded by Argentina’s argument and issued an injunction in 2012, whereby “Argentina may no longer pay the holders of its restructured bonds . . . unless it pays NML in full, an amount now estimated at around $1.4 billion.”32 The Second Circuit affirmed Judge Griesa’s ruling based on the rationale that Argentina breached a contractual duty “when it prioritized paying holders of its restructured debt over the bondholders who held its defaulted debt.”33 In other words, “whenever Argentina pays on the bonds or other obligations that it issued in 2005 or 2010 exchange . . . , the Republic must also make a ‘ratable payment’ to plaintiffs who hold defaulted bonds.”34 To be sure, NML I and NML II seem like cut and dry cases: Argentina owes the holders of its sovereign debt and should treat each of them equally.35 Argentina, however, views the outcomes in a different light. As an initial matter, there is some debate whether pari passu clauses are

29. NML I, 699 F.3d at 263 – 64. 30. Id.; Felix Salmon, Hedge Fund vs. Sovereign: How U.S. Courts Are Radically Up- ending International Finance, FOREIGN AFF. (June 24, 2014), http://www.foreignaf- fairs.com/articles/141588/felix-salmon/hedge-fund-vs-sovereign. 31. Foreign Sovereign Immunities Act, 28 U.S.C. § 1609 (2014). While the FSIA directly addresses judicial “seizure and control over specific property . . . courts are also barred from granting ‘by injunction, relief which they may not provide by attachment.’” NML I, 699 F.3d at 262, quoting S & S Machinery Co. v Masinexportimport, 706 F.2d 411, 418 (2d Cir. 1983). 32. Basically, “the injunction allows Argentina to keep stiffing NML, but only if it also stiffs the exchange bondholders.” Weidemaier & Gelpern, supra note 26 at 191; see also NML I, 699 F.3d at 262 – 65 (explaining that the injunctions sought are not barred by FSIA because “[t]hey affect Argentina’s property only incidentally to the extent that the order prohibits Argentina from transferring money to some bondholders and not others), NML Capital, Ltd. v. Republic (NML II), No. 08 Civ. 6978 (TPG), 2012 WL 5895784 (S.D.N.Y. Nov. 21, 2012), aff’d, 2013 WL 4487563 (2d. Cir. 23, 2013), cert. denied, 134 S. Ct. 2819 (2014). 33. Max Slater, Federal appeals court orders Argentina to pay more than $1 billion to investors, JURIST (Oct. 27, 2012, 11:11 AM), http://jurist.org/paperchase/2012/10/ federal-appeals-court-orders-argentina-to-pay-more-than-1-billion-to-investors.php; See also NML I, 699 F.3d at 264 – 65 (2nd Cr. 2012). 34. John R. Crock, Contemporary Practice of the United States Relating to International Law, Second Circuit Affirms Orders Requiring Argentina to Treat Restructured and Holdout Bond Holders Equally; Argentina Seeks Certiorari in Related Extraterrito- rial Discovery Case, 107 AM. J. INT’L L., 930, 930 – 31 (2013). In NML II, the court clarified that the ratable payment requirements means “that whenever Argentina pays a percentage of what is due on the Exchange Bonds, it must pay plaintiffs the same percentage of what is then due on the FAA bonds.” Id. at 931; see also NML II, 2012 WL 5895786 at *2. 35. See generally NML I, 699 F.3d 246 (2nd Cr. 2012); NML II, 2012 WL 5895786. 90 LAW AND BUSINESS REVIEW OF THE AMERICAS [Vol. 21 at all binding during sovereign default proceedings.36 Argentina, framing the issue within that context, views NML I and NML II as judicial mal- practice and a “counterintuitive interpretation of a boilerplate provision [that] upsets settled financial market expectations and threatens all future sovereign debt restructurings.”37 In addition, Argentina already made efforts to treat all of its creditors equally “[i]n September 2013, [when] it suspended indefinitely its Lock Law (which was designed to ensure that holdouts would not be treated better than exchange bondholders).”38 Moreover, NML has “doggedly pursued Argentina for assets abroad” since NML I and has made attempts to repossess everything from Belgian diplomatic accounts; to the presidential helicopter, Tango 1; to an actual Argentinian warship, the ARA Fragata Libertad.39 Taken as a whole, NML I, NML II, and their ripples “turn[ed] the natural order of debt on its head.”40 These cases did not, however, mark the last time that NML would prevail against Argentina in a U.S. court.

B. WHERE’S MY MONEY? ARGENTINA, NML, AND POSTJUDGMENT DISCOVERY UNDER THE FSIA On June 16, 2014, the U.S. Supreme Court issued its most recent opinion in the NML v. Argentina saga, this time dealing with post-judgment discovery of extraterritorial assets.41 NML, in an effort to “accurately identify the places and times when [Argentina’s] assets might be subject to attachment and execution . . . served subpoenas on two nonparty banks, Bank of America (BOA) and Banco de la Nacion ´ Argentina (BNA), an Argentinian bank with a branch in New York City.”42 Both Argentina and BOA moved to quash NML’s subpoena on BOA, and NML subsequently moved to compel compliance.43 NML then narrowed its subpoenas to exclude the names of some officials during its search and “agreed to treat as confidential any documents that the bank so designates.”44 While “NML and BOA later negotiated additional changes to the BOA subpoena . . . BNA neither engaged in negotiation

36. Salmon, supra note 30; see generally, Lee C. Buchheit & Jeremiah S. Pam, The Pari Passu Clause in Sovereign Debt Instruments, 53 EMORY L.J. 869 (2004). 37. 10 Reasons Why NML v. Argentina Matters to All, Embassy of Argentina, embassyofargentina.us/embassyofargentina.us/argentinamonthly/10reason- swhynlmvargentinamatters.pdf, http://www.mecon.gov.ar/DESENDEUDAR/en/ doc/reports-folleto16.pdf (lasted visited Feb. 23, 2015). 38. Id. 39. Id.; Pottow, supra note 1, at 225. Argentina’s war “ship was released only after a ruling from the International Tribunal for the Law of the Sea.” Salmon, supra note 30. 40. See Salmon, supra note 30. “It used to be that having a bond was good but that having a judgment was much better. Now, however, it’s the other way around: judgments will get you nowhere, while bonds, if they have a pari passu clause, can make you all-powerful.” Id. 41. See generally Republic of Argentina v. NML Capital, Ltd., 134 S. Ct. 2250 (2014). 42. Id. at 2253. 43. Id. at 2253. 44. Id. 2015] PAST DUE 91 nor complied with the subpoena.”45 The district court subsequently granted NML’s motion to compel and “reaffirmed that it would serve as a ‘clearinghouse for information’ in NML’s efforts to find and attach Ar- gentina’s assets.”46 Of the three, Argentina was the only one to appeal the ruling.47 Similar to its position in NML I, Argentina argued “that the court’s order transgressed the Foreign Sovereign Immunities Act (FISA) because it permitted discovery of Argentina’s extraterritorial assets” based on the rationale that, because the statute is silent as to post-judgment discovery, the court should interpret the statute as granting “absolute execution immunity to foreign-state property.”48 The Court did not agree, and held that FSIA does not provide sovereign debtors with immunity from post-judgment discovery of extraterritorial assets, stating that U.S. courts lack the authority to execute against property in foreign countries and explaining that “even if Argentina were correct that § 1609 execution immunity implies coextensive discovery-in-aid-of-execution immunity, the latter would not shield from discovery of a foreign sovereign’s extraterritorial assets.”49 Justice Scalia went on to clarify that NML’s subpoenas were permissible under both the FSIA and the Federal Rules of Civil Procedures, because “[t]hey ask for information about Argentina’s worldwide assets generally, so that NML can identify where Argentina may be holding property that is subject to execution.”50 When such assets do turn up, any dispute between Argentina and NML regarding the immunity of specific assets will be settled by the district court.51 This much is clear—the Court’s ruling against Argentina did nothing to help Argentina’s struggle against NML. Arguably more important than the holding, however, is Scalia’s summary snippet buried in the middle of the opinion that states: “Thus, any sort of immunity defense made by a foreign sovereign in an American court must stand on the Act’s text. Or it must fall.”52 Said differently, under the guise of simple four corners contract interpretation, the Court can punt issues like “the fate of international bond markets, or the sanctity of concepts such as sovereign immunity.”53 The result has been pandemonium.54 Coupled with its denial of certiorari from NML II on the same day, the Court has put Argentina between a rock and a hard place.55 “Argentina wants to pay the exchange bondholders, but it can’t. Argentina doesn’t want to pay [NML],

45. Id. 46. See id. at 2254. 47. Id. 48. Id. at 2254, 2256 – 58. 49. Id. at 2557. 50. Id. at 2258. 51. Id. 52. Id. at 2256. 53. Salmon, supra note 30. 54. Id. 55. See generally NML II, 134 S. Ct. 2819 (2014). 92 LAW AND BUSINESS REVIEW OF THE AMERICAS [Vol. 21 but it has to.”56 Faced with two unappealing alternatives, Argentina opted for a third route and took matters into its own hands.

C. ARGENTINA’S COUNTER MEASURES AND THEIR RECEPTION After the U.S. Supreme Court ruled that the FSIA did not prevent post-judgment discovery actions against sovereign debtors and denied certiorari for NML II, Argentina felt that it was fighting NML on uneven ground, namely in an imperialist U.S. judiciary that favored the interests of a small group of investors over its sovereignty.57 In response, Argen- tina took action on two fronts: (1) action in the International Court of Justice and (2) passage of domestic legislation that supersedes the U.S. judiciary’s authority to prevent payment to holders of restructured debt.58 Shortly after the U.S. Supreme Court’s most recent NML v. Argentina decision, Argentina filed suit “against the United States of America, regarding a ‘Dispute concerning judicial decisions of the United States of America relating to the restructuring of the Argentine sovereign debt.’”59 In its submission, Argentina alleged that the United States “committed violations of Argentine sovereignty and immunities and other related violations as a result of judicial decisions adopted by U.S. tribunals concerning the restructuring of the Argentine public debt.”60 While a strong symbolic gesture, proceedings in the ICJ are exceedingly unlikely to bring an end to Argentina’s woes because the United States must consent to jurisdiction for the suit to progress, something that has only occurred twenty-two times over the past seven decades.61 Argentina, sensing that an ICJ proceeding likely would not yield the desired result, took direct action, and on August 19, 2014, announced “that, in an effort to sidestep the U.S. Court ruling which blocked payments on restructured debt . . . , the government [would] submit a bill to the Argentine Congress that lets overseas debt holders swap into new bonds governed by Argentine law with the same terms.”62 Despite receiving admonishments from Judge Griesa in the Southern District of

56. Salmon, supra note 30. 57. Corinne Ball & Veerle Roovers, Eurosource-deals and debt-August 2014, LEX- OLOGY (September 3, 2014), http://www.lexology.com/library/detail.aspx?g=f6312d fd-4c98-8ca7-c0c3ae9cff38. 58. Press Release, International Court of Justice (I.C.J.), The Argentine Republic seeks to institute proceedings against the U.S. before the International Court of Justice. It requests US to accept the Court’s jurisdiction. (Aug. 7, 2014), available at http://www.icj-cij.org/presscom/files/4/18354.pdf [hereinafter I.C.J. Press Re- lease]; Press Release, Embassy of Arg., A broad majority enacted into law the Sovereign Payment of the Debt (Sept. 11, 2014), available at http://www.embassyofargentina.us/embassyofargentina.us/en/news/140911mecon.html [hereinafter Arg. Embassy Press Release]. 59. I.C.J. Press Release, supra note 58. 60. Id. 61. Sovereign Debt Update, JONES DAY (Sept./Oct. 2014), http://www.jonesday.com/ Sovereign-Debt-Update-10-01-2014/?utm_source=Mondaq&utm_medium=syndi cation&utm_campaign=View-Original. 62. Id. 2015] PAST DUE 93

New York, the Argentine government continued to push the bill onto its Senate floor.63 These efforts proved fruitful, and on September 11, 2014, the Argentine Legislature enacted the Sovereign Payment of the Restruc- tured Debt Law.64 This law addressed three main issues: replacing the existing trustee (BNY Mellon, Corp.) with an Argentine trustee; granting creditors the option to voluntarily switch the governing law of their bonds to another jurisdiction; and validating the pari passu clause by making “deposits for 7.6 [percent] of the bondholders that did not participate in either of the restructuring processes carried out by Argentina in 2005 and 2010.”65 The net effect of these changes is to “encourage” investors to move their Argentine debt from the United States to Argentina or France.”66 Although the Sovereign Payment of the Debt Law is a recent development, Argentina put it to work immediately by depositing $161 million in a local bank, Nacion ´ Fedeicomisos, to act as trustee and “make good on an interest payment due Sept. 30.”67 That effort was thwarted, at least temporarily, when the district court foreseeably found Argentina in contempt of court for making an end around effort on its ruling.68 A less apparent effect of the court’s ruling, however, could indefinitely prevent the Sovereign Payment of the Debt Law from coming into effect.69 Ar- gentina’s sovereign “bond contracts state that the [trustee] role must be fulfilled by a bank that’s in good standing with U.S. federal and state law.”70 As such, it is unclear whether Nacion ´ Fideicomisos would be pre- cluded from serving “as a legally valid trustee”71 due to Argentina being held in contempt of court. The resulting confusion has left debt holders and banks with an unappealing decision to make: whether to be penalized by the U.S. judiciary or by an aggressive Argentine administration.72

63. Id. 64. Arg. Embassy Press Release, supra note 58. 65. Id. 66. Deisher, supra note 6. 67. Katia Porzecanski, How to Collect Argentina Bond Payment is Unresolved Riddle, BLOOMBERG (Oct. 2, 2014, 10:04 AM), http://www.bloomberg.com/news/2014-10- 02/how-to-collect-argentina-bond-payment-is-unsolved-riddle.html. 68. Alison Sacriponte, US judge declares Argentina in contempt of court, JURIST (Sept. 30, 2014, 2:18 PM), http://jurist.org/paperchase/2014/09/us-judge-declares-argentina-in-contempt-of-court.php. 69. See Porzecanski, supra note 67. 70. Id. 71. Id. 72. On one hand, those that try to orchestrate payments or debt swaps could face penalty at the hands of U.S. courts for cooperating with Argentina while it is held in contempt. Porzecanski, supra note 67. Conversely, banks that comply with the U.S. court’s order and refuse to make payments risk Argentina revoking their “permission to operate a local representative office.” Sovereign Debt Update, supra note 61. Argentina has gone so far as to threaten banks with “severe civil, regulatory and criminal risks” if they do not comply with its demands. Nicole Hong, Judge Thomas Griesa Rules Against NML Capital in Argentina Debt Case, WALL ST. J. (Sept. 10, 2014, 4:34 PM), http://www.wsj.com/articles/judge-thomas- griesa-rules-against-nml-capital-in-argentine-debt-case-1410381252 (citing Ci- tibank, N.A.’s Memorandum of Law in Opposition to Plaintiff’s Motion for Partial 94 LAW AND BUSINESS REVIEW OF THE AMERICAS [Vol. 21

Where this catch-22 leaves the situation going forward is anyone’s guess.73 As expected though, guesses are not in short supply.

IV. COUNTDOWN TO DEBT-ONATION: POSSIBLE REPERCUSSIONS OF THE NML V. ARGENTINA SAGA To be clear, there is little doubt that the outcome of NML v. Argentina will impact the future of sovereign debt issues.74 How significant that impact will be remains a question. As in every other aspect of this dispute, the answer depends on which of two drastically divergent view- points one subscribes to. From NML’s perspective, the outcome of the Argentine default will be limited to just that: Argentina’s default. Indeed, the American Task Force in Argentina, an organization supported by Elliott Associates, L.P, NML’s parent company, portrays the entire conflict as a threat to nor- malcy in the international sovereign debt market, with Argentina dis- rupting order and casting flux into the system.75 The Second Circuit also believes that its decisions will be of limited impact because of the pari passu clause’s “added provision that no creditor shall be subject to subor- dination, which the court presumed is not included in other sovereign debt contracts,” and Argentina’s firm stance to never pay its holdout creditors.76 “The court’s implicit suggestion [seems to be] that a debtor who was less brazen in its refusal to meet contractual obligations and less vocal about its general disregard for the orders of U.S. courts might not warrant the same treatment as Argentina.”77 In contrast, Argentina asserts that its fate will “have consequences for almost every sovereign that has issued international debt over the past

Reconsideration of the June 27, 2014 Order, NML Capital, Ltd. v. Republic of Argentina, No. 08 Civ. 6978, 2014 WL 3867736 (S.D.N.Y. July 17, 2014). 73. “It is too early to predict the long-term consequences of NML [b]ut it would be a mistake to dismiss the case as completely sui generis.” Weidemaier & Gelpern, supra note 26, at 192. 74. “Although sovereign bond agreements drafted after Argentina’s default contain more safeguard clauses meant to protect the debtor-sovereigns, the Second Cir- cuit’s opinion will likely make restructuring more expensive, if parties attempt it at all.” Jack Jrada, Closing the Book on Argentina’s Sovereign Debt Default: The Second Circuit’s Decision and its Ramifications for Sovereign Debt Restructuring in the Eurozone, 32 REV. BANKING & FIN. L. 222, 231 – 23 (2013). Even if none of the far-fetched predictions come to fruition, “[a]t the very least, the court injected more uncertainty into the sovereign debt market by giving new meaning to the pari passu clause, different from the interpretation that sovereign debtors held for so many years.” Id. 75. Robert J. Shapiro and Nam D. Pham, Discredited - The Impact of Argentina’s Sov- ereign Debt Default and Debt Restructuring on U.S. Taxpayers and Investors, AM. TASK FORCE ARGENTINA, 26, http://www.atfa.org/wp-content/uploads/2012/09/ atfa_1006.pdf (last visited Feb. 20, 2015). 76. Brett M. Neve, Note and Comment, NML Capital, LTD. v. Republic of Argentina: An Alternative to the Inadequate Remedies Under the Foreign Sovereign Immunities Act, 39 N.C. J. INT’L & COM. REG. 631, 657 – 58 (2014); see also NML I, 699 F.3d at 264 – 65. 77. Neve, supra note 76, at 658. 2015] PAST DUE 95

[thirty] years” and NML v. Argentina might set dangerous precedent for remedies against sovereign debtors in the future.78 The United States has submitted two amicus briefs in support of this position, arguing that the Second Circuit’s opinion runs contrary to U.S. interests and could undermine decades of work towards stability in sovereign debt restructurings.79 Much of the international community—both sovereign nations and institutions like the International Monetary Fund (IMF)—has aligned with this stance as well.80 Despite both sides’ rancorous contentions, however, the true implications of NML v. Argentina remain unclear. One factor that could miti- gate negative consequences is the growing prevalence of CACs, which “have been included in 99 [percent] of the aggregate value of New York law bonds issued since 2005.”81 This could be misleading, though, and many commentators argue “that [CACs], when present, can only affect restructuring where a supermajority of creditors agrees to ‘take a haircut.’”82 Relying on creditors to act so altruistically is a hairy proposition and many may prefer attempting “to emulate the success of Argentina’s holdouts in other courts.”83 If “[t]he copycat lawsuit brought by Taiwan to collect on Grenada’s defaulted debt less than sixth months after the Second Circuit’s NML ruling” is any indication, following in NML’s foot- steps instead of “taking a haircut” appears to be the more likely outcome.84 Indeed, many “[p]rivate claimants also have pressed for injunctions or similar relief against foreign sovereigns outside the debt context.”85 Of particular importance is NML v. Argentina’s effect on Greece’s default in the Eurozone. The prevailing fear is that, even though “New York law does not govern the bond agreements at issue in the Eurozone’s sovereign debt crisis, and the agreements include [CACs],” if NML suc- ceeds in forcing Argentina to pay its holdout creditors, holders of other sovereign debt will have a greater impetus to act similarly, which “will seriously hamper efforts to restructure sovereign debt in the Eurozone if . . . enough bondholders . . . take a risk and hold out.”86 “It may be hasty, however, to conclude that the crises in Argentina and Greece are comparable.”87 While there are some similarities between the two situations, namely that both defaults came from inflexible monetary policies tied to a currency that neither sovereign could independently control, “the reality is that the Argentine trajectory could not have applied to

78. 10 Reasons Why NML v. Argentina Matters to All, supra note 37. 79. Id. 80. Id. 81. Jrada, supra note 74, at 231 (quoting NML 1, 699 F.3d at 264). 82. Id. 83. Id. 84. Weidemaier & Gelpern, supra note 26, at 192. 85. Id. 86. Jrada, supra note 74, at 231 – 33. 87. Chambers, supra note 24. 96 LAW AND BUSINESS REVIEW OF THE AMERICAS [Vol. 21

Greece.”88 This is largely the result of one key difference—Argentina’s debt reformation efforts are controlled by the IMF, whereas Greece’s are led by a confluence of the European Union, the European Central Bank, and the IMF.89 Although NML v. Argentina may affect future debt holder expectations and strategy, it is unlikely to have the widespread impact that many have feared.90 The international community is also doing its part to ensure that NML v. Argentina does not have a systemic impact on the international sovereign debt market.91 In particular, the International Capital Market Asso- ciation has proposed a plan meant to limit holdout creditors’ ability to prevent restructuring efforts, the IMF has promulgated “a series of new proposals” meant to address collected actions problems like those faced by Argentina, and the United Nations has passed a resolution “to begin an ‘intergovernmental negotiation process aimed at increasing the efficiency, stability, and predictability of the international financial system.’”92 In addition, the United Nations Human Rights Council passed a resolution condemning vulture funds like NML Capital.93 These measures, however, are in the fledgling stages of their development and may not have a direct short-term effect.94 Until international efforts prove to be effective, one recent and two pending decisions are likely to shape the outcome of the NML v. Argen- tina saga. To further complicate the matter, more creditors are joining NML as holdouts every day.95 The recent decision, issued by a federal magistrate judge in Nevada, compelled 123 nonparty corporations to comply with NML’s post-judgment efforts to discover Argentine assets.96 Of the pending decisions, a relatively minor one that was filed in Dallas addresses NML’s efforts to compel company documents from energy companies engaged in joint ventures with Argentina.97 As of February 2015, both parties were engaged in good faith negotiations regarding the scope of the subpoenas and the motions to compel, and the company doc-

88. Id. 89. Id. 90. Id.; cf. Jrada, supra note 74, at 231 – 33. 91. Special Sovereign Debt Edition: EuroResource-Deals and Debt, JONES DAY (Oct. 2014), http://www.jonesday.com/EuroResourceDeals-and-Debt—Special-Sover- eign-Debt-Edition-10-27-2014/. 92. Id. 93. Id. 94. See id. 95. Katia Porzecanski, Owl Creek Said to Seek Group to Accelerate Argentine Debt, BLOOMBERG (Oct. 29, 2014, 1:28 PM), http://www.bloomberg.com/news/2014-10- 29/owl-creek-said-to-seek-group-to-accelerate-argentine-debt; Sheelah Kolhatkar, A New Twist in the Argentina Debt Saga, BUSINESSWEEK (Oct. 29, 2014), http:// www.businessweek.com/articles/2014-10-28/a-surpise-appearance-in-the-argentine- debt-drama. 96. See NML Capital Ltd. v. Republic of Argentina, No. 2:14-CV-492-RFB-VC, 2014 WL 3898021 at *12 (D. Nev. Aug. 11, 2014). 97. Khadijah M. Britton, NML, Argentina Fight Over Energy Co. Subpoenas, LAW 360 (Oct. 28, 2014, 4:17 PM), http://www.law360.com/internationaltrade/articles/5907 33/nml-aregentina-fight-over-energy-co-subpoenas-. 2015] PAST DUE 97 uments were stayed pending those negotiations.98 The other decision addresses “whether or not Citigroup . . . can process an expected interest payment by Argentina,” and will have direct implications on the conflict in U.S. courts and the Argentine legislature.99

V. CONCLUSION The conflict between NML and Argentina presents a quandary. The way out of the quandary and its larger implications, however, are un- known. While fears that Argentina’s fate could be transposed onto Greece are largely misplaced, the precedent set by the result of the NML v. Argentina saga could set the path for many future conflicts between sovereign debtors and holdout creditors, especially with regard to the interpretation of pari passu clauses.100

98. Order Staying Action, NML Capital, Ltd. v. Republic of Argentina, No. 3:12-MC- 00080, (Order Staying Action Feb. 2, 2015). 99. Nate Raymond, Citigroup to revisit U.S. Court over Argentina Bond Payments, REUTERS (Oct. 23, 2014, 1:28 PM), http://www.reuters.com/article/2014/10/23/us- argentina-debt-citigroup/idUSKNC0IC1NW20141023. 100. See Jrada, supra note 74, 231 – 33. 98 LAW AND BUSINESS REVIEW OF THE AMERICAS [Vol. 21 Updates

BEST BUSINESS PRACTICES: THE NEXT WEAPON OF TERROR IN ARGENTINA

Tony Godfrey*

Is evil something you are? Or is it something you do? —”Patrick Bateman,” American Psycho1

N April 30, 2009, one of America’s “big three” automobile man- ufacturers, DaimlerChrysler, announced that it was shutting Odown its factory in Twinsburg, Ohio.2 The factory opened in the 1950s, and, at the time of its closing, employed 1,250 residents of the small Ohio town with a total population of 19,000.3 At one point, the factory made up 90 percent of Twinsburg’s overall budget between company payroll taxes and property taxes.4 Such a large factory closing in a small town reliant on its business is always an earthquake to the local community. At times, it is also an unavoidable business decision.5 But in some countries, for some U.S.-based businesses, these decisions may be acts of terror.

I. ARGENTINA’S ANTI-TERRORISM ACT OF 20112011 On December 27, 2011, the Argentine Congress enacted Laws No. 26733 and 26734.6 The package was originally submitted in June 2011 by President Kirchner to address deficiencies found by the Financial Action Task Force (FATF) in Argentina to combat money laundering and other

* Tony Godfrey is on the cusp of completing his legal studies at the SMU Dedman School of Law. He earned his B.A. in English Literature and Political Science, cum laude, from Abilene Christian University. 1. BRET EASTON ELLIS, AMERICAN PSYCHO 376 (1991). 2. Michelle Jarboe McFee, Chryslers Plans to Close Twinsburg Plant by December 2010, Bankruptcy Documents Show, ASSOCIATED PRESS, (May 1, 2009), http:// www.cleveland.com/business/index.ssf/2009/05/associated_press_filechrysler.html. 3. Id. 4. Alison Grant, Twinsburg Stamping Plant: From Bright Beginning to Bleak Ending, CLEVELAND (March 22, 2011, 2:02 PM), http://www.cleveland.com/business/index.ssf/2010/07/twinsburg_stamping_plant_from.html. 5. See id. (discussing the changing landscape of the automobile manufacturing business as it related to Twinsburg specifically, and the business realities confronting Chrysler at the time that led to the factory closing). 6. Law No. 26733, Dec. 27, 2011, B.O. (Arg.), available at http://www.infoleg.gob.ar/ infolegInternet/anexos/190000-194999/192139/norma.htm; Law No. 26734, Dec. 27, 2011, B.O. (Arg.), available at http://www.infoleg.gob.ar/infolegInternet/anexos/ 190000-194999/192137/norma.htm.

101 102 LAW AND BUSINESS REVIEW OF THE AMERICAS [Vol. 21 acts that could finance terrorism.7 Passed together, these laws tightened Argentina’s restrictions on money laundering and other financial crimes,8 and provided a broad brush for combatting terrorism.9

A. TERRORIZING

Law No. 26734 specifically amended the Argentinian Penal Code, Arti- cle 41, by attaching Article 41(d).10 This section sets out: “When any of the offenses under this Code has been committed in order to terrorize the population or compel national authorities or foreign governments or agents of an international organization to do, or abstain from doing, any act, the minimum and maximum punish- ment will increase by twice the minimum and maximum.” This increase shall not apply if the act or acts are done on the occasion of or in the exercise of human, social, or any other constitutional right.11 This expansive amendment has been met with criticisms. In the ab- sence of reference definitions, or any case law clarifying the statute, acts done with the purpose of terrorizing the population has no definitive definition. The vagueness of this particular clause has concerned a number of human rights organizations.12 One common concern is the indeterminacy of the subject of the law, as the “act” in question is also undefined.13 Additionally, there are concerns that the law, despite its limiting second paragraph, could limit protests and journalism that the government does not approve of.14 This concern is not entirely unfounded. One journalist has already been threatened with the application of the aggravated charge of terrorism with the intent of terrorizing a population for filming and publishing alleged invalid arrests.15 The Inter-American Press Asso- ciation (IAPA) openly condemned the threat of the terrorism charge and

7. See Press Release, Fin. Action Task Force (FATF), Improving Global AML/CFT Compliance: On-Going Process (Oct. 28, 2011), available at http://www.fatf-gafi .org/countries/a-c/argentina/documents/improvingglobalamlcftcomplianceon-go- ingprocess-28october2011.html (discussing the commitment of Argentina’s executive branch in June 2011 to address the identified deficiencies). 8. Law No. 26733, Dec. 27, 2011, B.O. (Arg.), available at http://www.infoleg.gob.ar/ infolegInternet/anexos/190000-194999/192139/norma.htm. 9. Law No. 26734, Dec. 27, 2011, B.O. (Arg.), available at http://www.infoleg.gob.ar/ infolegInternet/anexos/190000-194999/192137/norma.htm. 10. Id. at art. 3. 11. Id. 12. Charlie Ramsey, Anti-Terrorism Law Causes Rights Concerns, THE ARGENTINA INDEP. (Jan. 25, 2012), http://www.argentinaindependent.com/socialissues/human rights/anti-terrorism-law-causes-rights-concerns/. 13. Id. 14. Argentine Human Rights Reference Openly Criticizes the Anti-Terrorism Law, MERCOPRESS (Dec. 27, 2011), http://en.mercopress.com/2011/12/27/argentine-hu man-rights-reference-openly-criticizes-the-anti-terrorism-law. 15. Newspaper Editor Facing 12 Years in Prison Under Anti-Terrorism Law, REP. WITHOUT BORDERS (May 14, 2014), http://en.rsf.org/argentina-newspaper-editor- facing-12-years-14-05-2014,46281.html. 2015] BEST BUSINESS PRACTICES 103 reaffirmed concerns surrounding the indeterminacy of the law.16 The American Civil Liberties Union (ACLU) echoed these concerns, worry- ing that such over-broad anti-terrorism statutes may be, and have already been in other countries, applied to “peaceful domestic dissent.”17 This open-ended definition of a terrorist and terrorist act and the doub- ling of criminal penalties associated with such a classification are particularly troubling when one looks to the organization that is claimed to have spurred Argentina’s change in law. As a member of the Financial Action Task Force (FATF), Argentina is bound by its membership to enforce the organization’s mandates and recommendations.18 The FATF has forty clear recommendations that it requires all members to implement in law to combat money laundering and the financing of terrorism.19 But even the FATF has a limited view of terrorism. At its broadest point, the FAFT uses similar language to Argentina’s sweeping definition but limits it to “situation[s] of armed conflict.”20

II. R.R. DONNELLEY: TERRORIST PRINTER On August 11, 2014, R.R. Donnelley Argentina S.A. filed for bankruptcy and liquidation in Argentina.21 R.R. Donnelley Argentina S.A. is a subsidiary of the U.S.-based RR Donnelley & Sons Company22, the world’s largest printing firm.23 As a part of the company’s bankruptcy liquidation, its printing facility on the outskirts of Buenos Aires was initially shut down, laying off about 400 workers.24 This marks one of the largest closures in Argentina this year.25

16. IAPA Voice Concern at Anti-Terrorist Law in Argentina, INTER AM. PRESS ASS’N (May 13, 2014), http://www.sipiapa.org/en/iapa-voices-concern-at-anti-terrorist- law-in-argentina/. 17. ACLU, “TAKE BACK THE STREETS”: REPRESSION AND CRIMINALIZATION OF PRO- TEST AROUND THE WORLD, 58 (2013), available at https://www.aclu.org/files/assets/global_protest_suppression_report_inclo.pdf. 18. FATF Members and Observers, FATF, http://www.fatf-gafi.org/pages/aboutus/ membersandobservers/ (last visited Mar. 25, 2015). 19. INTERNATIONAL STANDARDS ON COMBATING MONEY LAUNDERING AND THE FI- NANCING OF TERRORISM & PROLIFERATION: THE FATF RECOMMENDATIONS, FATF 11-22 (2012), available at http://www.fatf-gafi.org/media/fatf/documents/recommendations/pdfs/FATF_Recommendations.pdf. 20. Id. at 122. 21. RR Donnelley Letter Regarding the Bankruptcy of R.R. Donnelley Argentina S.A., GLOBE NEWSWIRE (Aug. 16, 2014), http://globenewswire.com/news-release/2014/ 08/16/659154/10094988/en/RR-Donnelley-Letter-Regarding-the-Bankruptcy-of-R- R-Donnelley-Argentina-S-A.html. 22. Id. 23. Open-Book Management, ECONOMIST (June 8, 2009), http://www.economist.com/ node/13809344. 24. Phil Rosenthal, R.R. Donnelley as an Argentine Terrorist is a Hard Zell, CHI. TRIB. (Aug. 23, 2014), http://www.chicagotribune.com/business/columnists/ct-phil-rosenthal-argentine-0824-biz—20140822-column.html. 25. Ken Parks, Christina Kirchner Threatens RR Donnelley with Criminal Charges for Layoffs, WALL ST. J. (Aug. 14, 2014, 11:21 PM ET), http://online.wsj.com/articles/ cristina-kirchner-threatens-rr-donnelley-with-criminal-charges-for-layoffs-1408072 907. 104 LAW AND BUSINESS REVIEW OF THE AMERICAS [Vol. 21

A. ARGENTINA’S THREAT OF ARTICLE 41(D) On August 14, 2014, Argentinian President Kirchner went on national television to respond to R.R. Donnelley’s bankruptcy.26 President Kirch- ner’s address alleged that the company’s filing for bankruptcy and closing of its printing facility was a purposeful attempt to disrupt Argentina’s economy.27 Such an act would fall within the wide confines of Article 41(d), and President Kirchner sought to invoke that very law to levy criminal sanctions against R.R. Donnelley.28 Argentina’s controversial anti- terrorism act, passed in 2011, was being used for the first time against a U.S.-based printing company.29 When one thinks of terrorist acts, this is not the image that comes to mind. It was certainly not thought a terrorist act in Twinsburg, Ohio. President Kirchner alleged that R.R. Donnelley’s bankruptcy was “an attempt by vulture funds to incite fear,”30 and a “fraudulent maneuver and attempt to sow fear in the population.”31 At the time of R.R. Don- nelley’s move to close its Argentine subsidiary, Argentina’s economy experienced inflation of 40 percent32, consumer prices had risen 16.7 percent, and unemployment sat at a high of 11 percent.33 R.R. Donnel- ley’s bankruptcy filing also came just two weeks after a U.S. court ruled Argentina in default of its debts to hedge funds; a decision that threatens to further the country’s economic woes.34

B. R.R. DONNELLEY’S BUSINESS RATIONALE It is no surprise that R.R. Donnelley takes issue with its characteriza- tion as a terrorist-minded vulture seeking to incite unrest and destabilize the Argentinian economy. In an open letter published on the same day it filed for bankruptcy, R.R. Donnelley outlined the rationale for its decision to shut down its Argentinian operations.35 The company cited a lack of profitability and the continued decline of its business operations.36 The reasons for this lack of profitability include “rising labor costs, inflation, materials price increases, devaluation, and an inability to pay debts

26. Cristina Fernandez ´ de Kirchner, CFK Anuncio ´ Denuncia Penal Contra Imprenta Multinacional Donnelley [CFK Announced Criminal Complaint Against Printing Multinational Donnelley], YOUTUBE (Aug. 14, 2014), http://www.youtube.com/ watch?v=DE8bBRAbFe4. 27. Parks, supra note 25. 28. Id. 29. Id. 30. Politics in Argentina: A Game of Polarisation, ECONOMIST (Sept. 1, 2014), http:// www.economist.com/blogs/americasview/2014/09/politics-argentina. 31. From Deadbeat to Despot: Argentina Harasses a U.S. Company for Closing Up Shop in Buenos Aires, WALL ST. J. (Sept. 3, 2014), http://online.wsj.com/articles/ from-deadbeat-to-despot-1409608642. 32. Id. 33. Rosenthal, supra note 24. 34. Parks, supra note 25. 35. RR Donnelley Letter Regarding the Bankruptcy of R.R. Donnelley Argentina S.A., supra note 21. 36. Id. 2015] BEST BUSINESS PRACTICES 105 as they become due.”37 The bankruptcy and printing operations closure also comes after months of ultimately fruitless negotiations with national and local labor unions to reduce labor costs and make profitability feasible.38 Taken together, along with Argentina’s overall economic instability, none of these factors reek of a terrorist agenda to incite civil unrest or fear, or to illicitly gain money. On the contrary, in a recent SEC filing, R.R. Donnelley expects to pay between $15 and $20 million to pull its operations from Argentina.39

C. ARGENTINIAN REVERSAL AND WORKERS’ RESPONSE

After President Kirchner’s impassioned criticism of R.R. Donnelley and its vulture intentions, the Argentine government ultimately declined to pursue its terrorist allegations against the company.40 Instead, the government is pursuing, in its courts, application of Law No. 27333 and its economic crime provisions.41 But this reversal is still no victory for R.R. Donnelley, as under the economic crime provisions Argentina seeks the arrest of R.R. Donnelley executives and prison sentences of up to six years.42 These laws and their application in the case of R.R. Donnelley have been compared to bills “that helped the Venezuelan government to expropriate 1,193 companies, close 400,000 stores, and more than 2,000 industries” by political opponents of President Kirchner.43 More recently, the judge overseeing the charges of fraudulent bankruptcy against R.R. Donnelley has permitted the impacted workers to form a co-op and take control of the facility.44 This also furthers the immediate attempts of workers to continue operations at the facility as soon as the day after its closure.45 The workers’ protests and control of the facility even included placing a handmade sign renaming the facility for themselves, the “Trabajadores RR Donnelley.”46

37. Id. 38. Id. 39. R.R. Donnelley & Sons Co., Current Report (Form 8-K) (Aug. 11, 2014), available at http://www.sec.gov/Archives/edgar/data/29669/000118143114028833/rrd414358 .htm. 40. Argentina Back-Steps on Applying ‘Anti-Terrorism’ Law on a U.S. Company, MERCOPRESS (Aug. 21, 2014), http://en.mercopress.com/2014/08/21/argentina- back-steps-on-applying-anti-terrorism-law-on-a-us-company. 41. Id. 42. From Deadbeat to Despot, supra note 31. 43. Id. 44. Judge Hands Donnelley Control Over to Workers’ Co-Operative, BUENOS AIRES HERALD (Oct. 6, 2014), http://www.buenosairesherald.com/article/171562/judge- hands-donnelley-control-over-to-workers-cooperative-. 45. Argentina: Workers Occupy RR Donnelley Factory After Illegal Foreclosure, REVOLUTION NEWS! (Aug. 13, 2014) http://revolution-news.com/argentina-workers-occupy-rr-donnelley-factory-illegal-closure/. 46. Id. 106 LAW AND BUSINESS REVIEW OF THE AMERICAS [Vol. 21

III. LOOKING AHEAD With the criminal litigation ongoing against R.R. Donnelley, there should likely be concern for other U.S.-based businesses in decline in Ar- gentina. Even though the threats of pursuing an Article 41(d) action were ultimately empty, their attempted use bolsters the concerns that such laws are overbroad and may be used to deter otherwise legal action for both individuals and businesses.47 At the very least, Article 41(d)’s prohibition of its use against acts exercising “human, social, or any other constitutional right”48 may not be strong enough to protect business actions that appear on face to be motivated by determinations of best business practices. The 150-year-old printing firm49 may not be forced to take arms against a sea of terrorist accusations.50 This is not due to exonera- tion, but instead due to the ever-changing whims of a government choosing not to use a law that it believes it has every right to use in cases such as this. The threat of the slings and arrows of outrageous fortune and governmental whims remain ever-present. Is evil something a business is, or something a business does? In Argentina the question remains unan- swered. Businesses would do well to consider the question seriously, as their answer may not align with Argentina’s.

47. ACLU, supra note 17. 48. Law No. 26734, Dec. 27, 2011, B.O. art. 3 (Arg.), available at http://www.infoleg .gob.ar/infolegInternet/anexos/190000-194999/192137/norma.htm. 49. Steven Rosenbush, Can 150-Year-Old Printer Go High Tech?: R.R. Donnelley Plunges Into Developing Market for Printed Electronic Parts, WALL ST. J. (Aug. 18, 2014, 7:47 PM ET) http://online.wsj.com/articles/can-150-year-old-printer-go-high- tech-1408405637. 50. See WILLIAM SHAKESPEARE, HAMLET act 3, sc. 1. TRANS-PACIFIC PARTNERSHIP–ISIT REALLY “NAFTA ON STEROIDS?”

Natalie Sears*

I. TRANS-PACIFIC PARTNERSHIP—IS IT THE NEW NAFTA?

ILL history repeat itself? That is the question many critics of the newest free trade agreement, the Trans-Pacific Partnership W(TPP), are asking. The Office of the U.S. Trade Representa- tive touts that the TPP is an ambitious, 21st century trade agreement that the United States is negotiating with eleven other countries throughout the Asia-Pacific region.1 The Office of the U.S. Trade Representative further claims it will unlock opportunities for American workers, families, businesses, and ranchers because of access to growing markets.2 Along with that claim, the government’s promise to eliminate tariffs, other barriers to goods and services trade, and investments with these eleven other countries sounds exactly like the promises made twenty years ago when the North American Free Trade Agreement (NAFTA) was implemented.3 Critics fear that history will repeat itself after the TPP is passed and the negative economic effects we have seen since NAFTA will be magnified with the TPP.4

II. WHAT IS THE TRANS-PACIFIC PARTNERSHIP?

A. NOT YOUR AVERAGE FREE TRADE AGREEMENT Negotiations surrounding the TPP began in 2003 and continue today.5 Although that amounts to twelve years’ worth of negotiating, many U.S. citizens are unfamiliar with the TPP because the press coverage has been minimal and the government has yet to release a single text or negotiat-

* Natalie Sears is a J.D. Candidate, May 2015 and has a B.B.A. from Texas Christian University. She would like to thank her family and friends for their continued support. 1. Overview of the Trans Pacific Partnership, OFFICE OF THE U.S. TRADE REPRESEN- TATIVE, https://ustr.gov/tpp/overview-of-the-TPP (last visited Feb. 11, 2015). 2. Id. 3. PUB. CITIZEN’S GLOBAL TRADE WATCH, NAFTA’S 20-YEAR LEGACY AND THE FATE OF THE TRANS-PACIFIC PARTNERSHIP 2 – 3 (Feb. 2014), available at http:// www.citizen.org/documents/NAFTA-at-20.pdf. 4. Id. 5. IAN F. FERGUSSON ET AL., CONG. RESEARCH SERV., THE TRANS-PACIFIC PART- NERSHIP (TPP) NEGOTIATIONS AND ISSUES FOR CONGRESS 1 (2015), available at https://www.fas.org/sgp/crs/row/R42694.pdf.

107 108 LAW AND BUSINESS REVIEW OF THE AMERICAS [Vol. 21 ing position to the public.6 Because of the secrecy surrounding the TPP negotiations and provisions, the only information we have to rely on is what the government gives us. The Office of the U.S. Trade Representative has provided an outline of the TPP’s provisions.7 The objectives of the United States in signing the TPP are reportedly to address issues such as: comprehensive market access, facilitation of production and supply chain among participating member-countries, promotion of trade/investment in innovative products and services, constant updating to accommodate new trade issues, and additional participating countries.8 With regards to the legal texts said to be included in the TPP, provisions regarding issues such as competition, consumer protection, e-commerce, environment, intellectual property, legal issues, and technical barriers to trade will be addressed.9 The government states that the TPP’s eliminated tariffs will benefit sectors such as agriculture and textiles by removing fees associated with these products’ exportation.10 For example, in Malaysia, the U.S. poultry faces a 40 percent tariff, and in Vietnam, U.S. auto parts face a 27 percent tariff.11 Both of these, and many more, will be eliminated after the TPP’s implementation.12

B. HOW DOES THE TPP COMPARE TO NAFTA? 1. The TPP Expands NAFTA’s Reach Although no one outside of the negotiating parties has access to the specific text of the TPP, the government has provided basic provisions to be included that show an immense similarity to NAFTA.13 In addition, portions of the TPP have been leaked to the public and those seen show an actual expansion from NAFTA’s framework and authority.14 The TPP, similar to NAFTA, will reportedly cover all aspects of commercial relations among the TPP countries.15 But the expansion in TPP is evident in its procedural practices. When NAFTA was implemented in 1994, the agreed participants were limited to the United States, Canada,

6. The Trans-Pacific Partnership Agreement, PUB. KNOWLEDGE, http://tppinfo.org/ (last visited Feb. 11, 2015). 7. Outlines of TPP, OFF. OF THE U.S. TRADE REPRESENTATIVE, https://ustr.gov/tpp/ outlines-of-TPP (last visited Feb. 11, 2015). 8. TPP Issue-by-Issue Information Center, OFF. U.S. TRADE REPRESENTATIVE, https://ustr.gov/trade-agreements/free-trade-agreements/trans-pacific-partnership/ tpp-issue-issue-negotiating-objectives (last visited Feb. 11, 2015). 9. Id. 10. Trade in Goods, OFF. U.S. TRADE REPRESENTATIVE, https://ustr.gov/trade-agreements/free-trade-agreements/trans-pacific-partnership/tpp-chapter-chapter-negotiating-0 (last visited Feb. 11, 2015). 11. Id. 12. Id. 13. PUBLIC CITIZEN’S GLOBAL TRADE WATCH, supra note 3, at 2. 14. Id. 15. See Outlines of TPP, supra note 7. 2015] “NAFTA ON STEROIDS?” 109 and Mexico.16 The TPP, however, may be the last treaty Washington ever writes because it is leaving the door open to any and all future willing participants.17 Although the TPP currently includes the United States and eleven other countries, the number of participants could potentially grow even after the TPP has been signed and implemented for years.18 In addition to the expansion on the number of participants, the TPP also plans to broaden the Investor-State Dispute Resolution provision found in NAFTA.19 Currently, NAFTA provides a private tribunal for foreign investors to resolve their issues with domestic governmental regulations.20 In the case that investors successfully claim these regulations interfere with their foreign investment, they can seek damages from the government for lost profits and economic harm.21 The purpose of these investor-state arbitrations is to encourage foreign investment among the participating countries. Criticisms of the current investor-state dispute resolution procedure found in NAFTA argue that an expanded version in the TPP would only undermine governments’ authority to procure regulations in accordance with the safety of its own citizens.22 Many worry that these investor-state arbitrations favor corporations that invest in foreign countries while enabling them to sue governments outside of their own domestic court systems.23 When evaluating the amount of settlements resolved in favor of foreign investors, it is easy to see that the criticisms have great merit. Since NAFTA’s implementation, governments have been forced to pay corporations more than $350 million following suits against matters like toxic bans, land-use policies, and forestry rules.24 Under NAFTA, there were only three governments and their accompanying foreign investors to worry about. When we consider the effect of twelve governments and thousands of foreign investors filing claims under investor-state arbitra- tion provisions, the amount of damages facing the governments could easily rise into the billions.

2. Why is the TPP necessary? Many of the countries currently in negotiations regarding the TPP al-

16. M. ANGELES VILLARREAL & IAN F. FERGUSSON, CONGRESSIONAL RESEARCH SERVICE NAFTA AT 20: OVERVIEW AND TRADE EFFECTS 1 (2014), available at https://www.fas.org/sgp/crs/row/R42965.pdf. 17. Lori Wallach, NAFTA on Steroids, NATION (June 27, 2012), available at http://www .thenation.com/article/168627/nafta-steroids#. 18. Id. 19. Id. 20. NAFTA Investor-State Arbitrations, U.S. DEP’T ST., http://www.state.gov/s/l/c3439 .htm (last visited Feb. 12, 2015). 21. Id. 22. See Wallach, supra note 17. 23. Id. 24. See generally Table of Foreign Investor-State Cases and Claims Under NAFTA and Other U.S. “Trade” Deals, PUB. CITIZEN (Feb. 2014), http://www.citizen.org/documents/investor-state-chart1.pdf. 110 LAW AND BUSINESS REVIEW OF THE AMERICAS [Vol. 21 ready have free-trade agreements with the United States.25 So why are so many countries getting on board with the TPP? It could be the expansive access to new markets and favorable investment incentives. In reality, it appears that the countries aren’t actually jumping on board with all of the United States’ recommended provisions after all.26 Australia announced that it would not submit to the parallel court system found in NAFTA’s investor-state dispute resolution provision.27 New Zealand rejected a U.S. proposal to allow pharmaceutical companies to challenge their government medicine regulations’ pricing decisions.28 In addition, every TPP participating country rejected the U.S. proposal to extend drug patent monopolies.29 Unlike many of the other countries’ negotiating teams, the U.S. advisory members include many corporate executives that are reaching for provisions similar to those rejected by the participating countries in the hopes of gaining every advantage they can when sending their business to another country.30 Many TPP opponents contemplate that because most of the tariffs between participating countries are already low, the TPP’s purpose must be to create regulations to favor corporate practices among the countries.31 One of the leaked portions of the TPP revealed that it is trying to strengthen patents and related restrictions on selling drugs, which would result in increased drug prices.32 But because the negotiating process has been so secretive, people can only hypothesize what other provisions, besides those governing free trade, the TPP will contain.33

C. OPPONENTS WORRY THE TRANS-PACIFIC PARTNERSHIP IS “NAFTA ON STEROIDS” In addition to expansive provisions, the TPP is open to any country’s participation, even after it has been signed and put into practice. Schol- ars worry that the TPP’s plan to expand on NAFTA’s framework could be troublesome for countries that can’t keep up with increased economic pressures, resulting in the crisis seen in Mexico today.34 When NAFTA was originally negotiated, it was seen as an experi-

25. Trans-Pacific Partnership and all free trade deals help the United States, WASHING- TON POST (Jan. 16, 2014), available at http://www.washingtonpost.com/opinions/ trans-pacific-partnership-and-all-free-trade-deals-help-the-united-states/2014/01/ 16/c595da66-7ef5-11e3-93c1-0e888170b723_story.html. 26. See Wallach, supra note 17. 27. Id. 28. Id. 29. Id. 30. Trans-Pacific Partnership (TPP): Job Loss, Lower Wages and Higher Drug Prices, PUB. CITIZEN, http://www.citizen.org/TPP (last visited May 3, 2015). 31. Dean Baker, The Trans-Pacific Partnership: Warnings From NAFTA, HUF- FINGTON POST (Jan. 20, 2014), http://www.huffingtonpost.com/dean-baker/the- trans-pacific-partner_b_4633675.html. 32. Id. 33. Id. 34. Id. 2015] “NAFTA ON STEROIDS?” 111 ment.35 NAFTA was a first of its kind in trade agreements, and the U.S. government made claims of economic and job growth that have yet to be seen in our country.36 In addition, since NAFTA, other trade agreements have adopted its framework and seen their own negative effects.37 For example, the original U.S.-Korea Free Trade Agreement was entered into in 2007 and re-formulated in 2011.38 Since its inception, there has been a “decline in U.S. exports to Korea”, but “a rise in imports from Korea.”39 The U.S. monthly trade deficit with Korea has increased 49 percent compared to the years before the U.S.-Korea Free Trade Agreement was signed.40 These losses equate to more than lost exports—they translate into thousands of lost jobs for American workers.41 The World Bank released reports that NAFTA led to rapid growth in Mexico, but the Center for Economic Policy and Research quickly dis- claimed their numbers as misleading because developing countries, like Mexico, should have much faster GDP growth rates than rich countries.42 In fact, Mexico had the second slowest growth of any Latin American country since NAFTA was implemented twenty years ago.43 The middle class of Mexico has reportedly grown, but the poverty population still remains high, equating to between one-fourth and one-half of the entire Mexican population.44 In addition, wages in Mexico have now dropped “below pre-NAFTA levels as price increases for basic consumer goods” exceed wage increases.45 NAFTA, rather than creating the hundreds of thousands of jobs proponents believed it would, has contributed to a huge trade deficit with Mex- ico and Canada.46 In 2004, only ten years after NAFTA was implemented, one million jobs were estimated to have been lost because of U.S. firms embracing NAFTA’s foreign investor privileges.47 More than 845,000 additional jobs have been lost from the transfer of U.S. production plants to Canada and Mexico.48

35. PUB. CITIZEN’S GLOBAL TRADE WATCH, supra note 3, at 2. 36. Id. 37. Id. at 3. 38. U.S.-Korea Free Trade Agreement, OFF. OF THE U.S. TRADE REPRESENTATIVE, http://www.ustr.gov/trade-agreements/free-trade-agreements/korus-fta (last visited Feb. 11, 2015). 39. PUB. CITIZEN’S GLOBAL TRADE WATCH, supra note 3, at 3. 40. Id. 41. Id. 42. MARK WEISBROT, ET. AL., GETTING MEXICO TO GROW WITH NAFTA: THE WORLD BANK’S ANALYSIS 4 (2004), available at http://www.cepr.net/documents/ publications/nafta_2004_10.pdf. 43. Baker, supra note 31. 44. William Booth and Nick Miroff, Mexico’s middle class is becoming its majority, WASHINGTON POST (Mar. 17, 2012), http://www.washingtonpost.com/world/mex- icos-middle-class-is-becoming-its-majority/2012/03/14/gIQA9R0KJS_story.html. 45. PUB. CITIZEN’S GLOBAL TRADE WATCH, supra note 3, at 5. 46. Id. at 3. 47. Id. 48. Id. 112 LAW AND BUSINESS REVIEW OF THE AMERICAS [Vol. 21

If the facts do not convince us that an expanded version of NAFTA would be a bad idea, then the public consensus agreeing with that notion should. In a 2012 Angus Reid Public Opinion Poll, 53 percent of Ameri- cans agreed that the “United States should ‘do whatever is necessary’ to ‘renegotiate’ or ‘leave’ NAFTA.”49 This was the popular vote among all U.S. citizens—no matter what political party.50 Today, we face the challenge of the TPP, an expanded version of NAFTA that has much farther- reaching implications. Not as many citizens know about the TPP because the government’s negotiations with participating countries have been very secretive and the media has been limited in its press coverage.51 When there is media coverage, the public outlets are primarily praising its objectives, similar to the way in which it portrayed NAFTA during its adoption in 1994. But some citizens are aware of the TPP and the majority of those that know about it do not support it. In 2014, a poll by Hart Research Associ- ates and Chesapeake Beach Consulting reported that 62 percent of U.S. voters opposed Fast Tracking the TPP.52 To fast track a trade agreement means to allow the President of the United States to negotiate international agreements that Congress can approve or disapprove but cannot amend whatsoever.53 Only 28 percent of U.S. voters were in favor of Fast Tracking this agreement, proving that the majority of those informed citizens aware of the TPP and its contents to not want to see it immediately come to fruition.54

D. EFFORTS TO STOP THE TRANS-PACIFIC PARTNERSHIP AGREEMENT Although the government is trying to keep the contents of the TPP covered up until negotiations are final, many people have already made up their minds about this giant free trade agreement.55 Efforts all across America are being made to inform citizens about the minimal information we do have about it because many worry that it will be a NAFTA repeat.56 Many people fear corporate and “political leaders of the Pacific Rim nations” are using the TPP to turn the regions into a “giant priva- tized corporate lake.”57 Multiple websites have been made in an effort to inform, criticize, and outright halt the TPP’s progress and negotiations.58 For example, one movement, called “STOP TPP” invites fellow citizens to inform others about what is wrong with the TPP and to join them “march[ing] in the

49. Id. at 5–6. 50. Id. at 6. 51. The Trans-Pacific Partnership Agreement, supra note 6. 52. PUB. CITIZEN’S GLOBAL TRADE WATCH, supra note 3, at 6. 53. Id. at 3. 54. Id. at 6. 55. See Stop TPP, STOP TTP, http://stoptpp.org/ (last visited Feb. 11, 2015). 56. Id. 57. The Call to Action, STOP TPP, htpp://stoptpp.org/the-call-to-action/ (last visited Feb. 11, 2015). 58. Stop TPP, supra note 55. 2015] “NAFTA ON STEROIDS?” 113 streets, with pots and pans, and banners and signs.”59 This group claims that the TPP would “create a super-treaty which would jeopardize the sovereignty of the nations involved by giving that power to large corporations like Wal-Mart, Monsanto, [and] Goldman Sachs.”60 Another website, called “Flush the TPP!” urges citizens to take a pledge to oppose the TPP and reach out to local senators and representatives in hopes of gaining their own support as well.61 It seems as though the efforts to gain political support has been some- what fruitful.62 Senator Elizabeth Warren (D-MA), Representative Alan Grayson (D-FL), Representative Michelle Bachman (R-MN), and Repre- sentative Walter Jones (R-NC) have all expressed opposition to the Fast Track of the TPP and seek the text’s immediate release.63 Senator War- ren wrote a letter to the United States Trade Representative, Ron Kirk, and stated that “if transparency would lead to widespread public opposition to a trade agreement then that trade agreement should not be the policy of the United States.”64 Many TPP opponents are hoping that a cross-partisan coalition can stop its implementation, similar to the four- teen other trade agreements stopped by this method within the past ten years.65 Public opposition to the TPP has not been found only in the United States.66 Other demonstrations have been seen in Japan and Malaysia, while the lead TPP negotiator in Chile resigned due to his concern that the agreement would “restrict Chile’s ability to shape public policies, control financial institutions and address issues of health, education and development.”67

E. WHAT IS TO BECOME OF THE TRANS-PACIFIC PARTNERSHIP? So the question remains—will history repeat itself? This is the question many scholars, protestors, and even petitioners of the Trans-Pacific Partnership are asking themselves. The government continues to reas- sure citizens and participating countries that the agreement is an ambitious, 21st century trade agreement that the United States is negotiating with eleven other countries throughout the Asia-Pacific region.68 Other

59. Id. 60. The Facts, STOP TPP, http://stoptpp.org/thefacts/ (last visited Oct. 17, 2014). 61. Stop the ‘Fast Track’ Train!, FLUSH THE TPP, http://www.flushthetpp.org/ (last visited Feb. 11, 2015). 62. Kevin Zeese, Protest against the Trans-Pacific Partnership. Secret Negotations behind Closed Doors, GLOBAL RES. (Sept. 29, 2013), http://www.globalresearch.ca/ protest-against-the-trans-pacific-partnership-tpp-secret-negotiations-behind- closed-doors/5352012. 63. Id. 64. Id. 65. Id. 66. Id. 67. Id. 68. See The United States in the Trans-Pacific Partnership, OFF. OF THE U.S. TRADE REPRESENTATIVE, https://ustr.gov/about-us/policy-offices/press-office/fact-sheets/ 2011/november/united-states-trans-pacific-partnership (last visited Apr. 26, 2015). 114 LAW AND BUSINESS REVIEW OF THE AMERICAS [Vol. 21 government officials praise its job-creating benefits.69 But many people question the government’s claims when they have seen the twenty-year effect of the North American Free Trade Agree- ment, which has brought increased illegal immigration and lost jobs. Promises made by proponents regarding the TPP sound very similar to those issued by the government twenty years ago. Critics believe that history will only repeat itself with the TPP, and fear that due to the high number of participating countries involved, the negative effects of its implementation will be witnessed on an even larger scale. Only time can tell this story.

69. See generally Trans-Pacific Partnership, OFF. OF THE U.S. TRADE REPRESENTA- TIVE, http://www.ustr.gov/tpp (last visited Feb. 11, 2015). SUCCESSION TO THE THRONE AND THE CANADIAN CHARTER OF RIGHTS AND FREEDOMS

Christopher Cornell*

HIS article looks at the legal challenge raised in Teskey v. Canada (Attorney General) (Teskey) against the pending changes to the Tlegal rules governing succession to the thrones of the sixteen countries of which Queen Elizabeth II is monarch, at least as far as they apply to Canada,1 as well as the pending changes themselves.** Part I explains the motivation to change the rules governing succession. Part II discusses the current rules governing succession to the throne and the background of those rules. Part III discusses the agreement that led to the pending changes to the rules of succession. Part IV discusses Teskey’s Charter challenge to the proposed changes to the line of succession and the relevant legal background information. And Part V concludes.

I. IMPETUS FOR CHANGE The rules governing the succession to the thrones of the sixteen king- doms of which Queen Elizabeth II (the Queen) is monarch have developed over the centuries in a manner that has left them with certain aspects that can charitably be described as unnecessarily unfair or discriminatory.2 Concerns over those discriminatory provisions governing the succession to their shared monarchy led David Cameron, Prime Min-

* Christopher graduated with a Juris Doctor from the SMU Dedman School of Law in May 2015 and served as the Canada Reporter for the SMU International Law Review Association for the 2014-2015 academic year. Prior to beginning law school he earned a Bachelor of Arts from Trinity University and a Master of Let- ters from the University of St. Andrews. Christopher would like to thank his family, friends, and professors for their continuing support of him in his academic endeavors. ** Editor’s Note: As this issue went to press it was announced that the legal and legislative process to implement the changes to the line of succession discussed in this article had been completed and that the changes would go into effect on March 26, 2015. E.g., Commencement of Succession to the Crown Act 2013: Writ- ten Statement - HCWS490, 24 Mar. 2015, PARL. DEB., H.C. (2015) 171WS; The Succession to the Crown Act 2013 (Commencement) Order 2015, SI 2015/894 (U.K.). 1. Teskey v. Canada (Attorney General), 2013 ONSC 6386, paras. 1-4 (Can. Ont. Sup. Ct. J.), aff’d, 2014 ONCA 612 (Can. Ont. C.A.). 2. See HOUSE OF COMMONS LIBRARY, SUCCESSION TO THE CROWN BILL 2012-2013, 2012-3, H.C. 12/81, at 6 (U.K.).

115 116 LAW AND BUSINESS REVIEW OF THE AMERICAS [Vol. 21 ister of The United Kingdom, to convene a meeting of all sixteen of the Queen’s prime ministers during the 2011 Commonwealth Heads of Gov- ernment Meeting in Perth, Australia.3 This meeting in turn led to the Perth Agreement, a unique sixteen-party agreement by the governments of the countries that share the Queen as their Head of State.4 The Perth Agreement represents a coordinated effort by all sixteen of the Queen’s governments to remove some of the discriminatory provisions governing the succession to the throne.5

II. LEGAL HISTORY AND DEVELOPMENT OF THE RULES OF SUCCESSION AND THE SHARED MONARCHY

A. ORIGINS OF THE CURRENT RULES GOVERNING THE SUCCESSION The rules of succession to the shared crown are derived primarily from the common law and three pieces of seventeenth and eighteenth century English and British legislation: The Bill of Rights, The Act of Settlement, and The Royal Marriages Act, 1772.6 At present, common law rules of succession to the throne operate along the same lines as feudal rules on hereditary land inheritance.7 To illustrate, the Crown goes from the reigning monarch to his or her children (or those children’s descendants) in the following order: oldest son to youngest son, and then oldest daughter to youngest daughter.8 The Bill of Rights, amongst other things, sets out the rule that the monarch may not be a Roman Catholic or married to a Roman Catholic by providing for the automatic removal from the line of succession of any person who was Roman Catholic, became a Roman Catholic, or married a Roman Catholic, while any non-Roman Catholic children of such marriages remain in the line of succession.9 As far as it affects succession, The Act of Settlement reiterates the restrictions on Roman Catholics from The Bill of Rights, limits succession to the legitimate Protestant descendants of Sophia, Electress of Hanover, and requires that the monarch become a member of the Church of England if not already a member at the time of his or her ascension to the throne.10 It bears pointing out that

3. Id. 4. See id. 5. See id. 6. See infra notes 7-17. 7. See CABINET OFFICE, SUCCESSION TO THE CROWN BILL EXPLANATORY NOTES, 2012-3, H.L., at 5 (U.K.). 8. See id. 9. See The Bill of Rights, 1688, 1 W. & M. c. 2 (Eng.); see also Claim of Right Act 1689, W. & M. c. 28 (Scot.). While certain provisions of The Bill of Rights regulate succession to the throne in most of the U.K. and all of the other realms, within the U.K. nation of Scotland The Bill of Rights is not the law and instead those areas of the succession governed by The Bill of Rights elsewhere are governed in Scotland by substantially similar language in the pre-union Scottish Parliament’s Claim of Right Act 1689. See Claim of Right Act 1689, supra. 10. The Act of Settlement, 1700, 12 & 13 Will. 3 c. 2 (Eng.); see also Union with En- gland Act 1707, Ann. c. 7 (Scot.). Similarly to the situation with The Bill of Rights, those provisions of The Act of Settlement regulating succession to the throne in 2015] SUCCESSION TO THE THRONE 117 while the restrictions on the religion of the spouses of persons in the line of succession only apply to and discriminate against Roman Catholics,11 the restrictions on the religion of persons in the line of succession, while originally aimed at Roman Catholics, are actually discriminatory against all non-Protestants because in order to be in the line one must be a Prot- estant.12 Further, the provisions affecting the monarch individually are even more restrictive as the monarch must belong to the Church of England.13 The Royal Marriages Act, 1772, applies to all descendants of George II (which after nearly 250 years for all intents and purposes includes everyone with any real chance of inheriting the throne) except his female descendants who marry into foreign families and the current monarch.14 The act stipulates that there are only two legal ways for affected persons to marry: (1) they must either receive the monarch’s permission for the marriage to occur, or (2) if they are over the age of twenty-five and have been refused the monarch’s permission, they may still marry if they declare to the Privy Council an intention to go through with their proposed marriage and twelve months pass without both houses of the U.K. Parlia- ment passing measures declaring their disapproval.15 The legal consequences for marrying against the act are rather interesting: a marriage entered into in violation of the act by any descendant of George II to whom the act applies—including Roman Catholics, who cannot even in- herit the throne—will legally be considered to have never occurred and therefore the position of any violator in the line of succession will not be affected.16 Their spouses, on the other hand, will have no legal recognition, and any children of a violating marriage will be considered illegiti- mate and, amongst other things, be unable to be in the line of succession.17

most of the U.K. and all of the other realms are not the law within the U.K. nation of Scotland and instead those areas of the succession governed by The Act of Set- tlement elsewhere are governed in Scotland by substantially similar language in the pre-union Scottish Parliament’s Union with England Act 1707. The one technical difference between the two is that under The Act of Settlement the monarch has to join the Church of England, while under the Union With England Act 1707 the monarch must, in Scotland, preserve and maintain the Presbyterian Church of Scotland. See Union with England Act 1707, supra. 11. See The Bill of Rights, supra note 9. 12. See The Act of Settlement, supra note 10. 13. Id. 14. Royal Marriages Act, 1772, 12 Geo. 3 c. 11 (Gr. Brit.). 15. Id. 16. See id.; see also VERNON BOGDANOR, THE MONARCHY AND THE CONSTITUTION 55 (1995) (discussing the restrictions of the act on Roman Catholic descendants of George II). One notable example of the restrictions in the act actually protecting the royal involved occurred in 1785 when the then Prince of Wales was secretly married, without permission being sought or granted, to Mrs. Fitzherbert who was Roman Catholic. If not for the Royal Marriages Act 1772 voiding his marriage, the Prince of Wales would have been barred by The Bill of Rights and The Act of Settlement from succeeding his father as George IV. See BOGDANOR, supra note 16, at 55. 17. See Royal Marriages Act 1772, supra note 14. 118 LAW AND BUSINESS REVIEW OF THE AMERICAS [Vol. 21

B. LEGAL HISTORY OF THE SHARED MONARCHY The historical and legal origin of the shared monarchy can be traced to the passage of the Statute of Westminster 1931 (the Statute), an act of the U.K. Parliament that established the legal framework that enabled Brit- ain’s self-governing colonies (then called dominions) to take complete control of their domestic and international affairs.18 The Statute itself was largely limited to ensuring that the U.K. Parliament could not pass legislation that was binding on any dominion unless the government of a dominion asked for such legislation.19 But the Statute also effectively established that the dominions were from that point largely independent. It also led to the later passage of domestic and U.K. legislation making the dominions fully independent, and helped to establish the model for Brit- ish colonial possessions to transition into fully independent nations (referred to as realms) with their own separate crowns linked via a shared monarch.20 It should also be noted that in discussing the implementation of the agreement there has also been some mention of the Statute’s preamble, which purports to set out a requirement that any changes to the laws regarding the line of succession or royal titles must be approved by the parliaments of all of the realms, not just the U.K. Parliament.21 The U.K. Government has, however, sidestepped this question in its entirety by pointing out that as the Statute of Westminster is an act of the U.K. Parliament, the preamble and its text cannot impose any legal requirements, though this would not be the case if the requirements in the preamble were part of the body of the statute.22 The Statute of Westminster and its related, subsequent developments can thus be seen as leading to the present shared monarchy where Elizabeth II is the queen of the sixteen fully sovereign nations commonly known today as the Common- wealth Realms.23 From a legal perspective, there is no disagreement that each of the realms maintains the option to unilaterally break its link with the monarchy and adopt another form of government of its choosing.24 But disa-

18. See PETER BOYCE, THE QUEEN’S OTHER REALMS 26-27 (2008). 19. Statute of Westminster, 1931, 22 & 23 Geo. 5 c. 4 (U.K.). 20. See BOYCE, supra note 18, at 27 – 29. 21. 13 Mar. 2013, PARL. DEB., H.L. (5th ser.) (2013) 309 (U.K.). 22. See id. 23. The sixteen Commonwealth Realms are the United Kingdom, Australia, New Zea- land, Canada, Jamaica, Antigua and Barbuda, Belize, Papua New Guinea, St. Christopher and Nevis, St. Vincent and the Grenadines, Tuvalu, Barbados, Gre- nada, Solomon Islands, St. Lucia, and The Bahamas. See, e.g., The Royal House- hold, What is a Commonwealth Realm?, OFFICIAL WEBSITE BRIT. MONARCHY, https://www.royal.gov.uk/MonarchAndCommonwealth/QueenandCommonwealth/ WhatisaCommonwealthRealm.aspx (last visited Apr. 24, 2015). 24. An early example of such a break would be India’s transition from colony to dominion upon independence in 1947 when George VI officially became King of India until the Indian Constitution had been drafted and entered into force in 1950, at that point India changed overnight from a kingdom to a republic and its official link with the king and the monarchy was unilaterally severed. See Pamela White, India, in COLUMBIA CHRONICLES OF ASIAN HISTORY AND CULTURE 312- 15 (John S. Bowman ed., 2000). 2015] SUCCESSION TO THE THRONE 119 greement exists as to whether a realm may retain the monarchy while unilaterally changing some aspect of the institution, for instance, the rules governing the line of succession, without doing so simultaneously with the governments of the other realms (though to date, no such change has been attempted).25 The one historical example of a fully implemented multilateral change to the nature of the shared monarchy is the legal process to implement the abdication of Edward VIII and the subsequent ascension of George VI to the throne.26 In that instance Edward VIII signed an instrument of abdication that was given legal effect when the His Majesty’s Declaration of Abdication Act, 1936 was enacted by the U.K., and with the consent of their governments, for Canada, Australia, New Zealand, and South Af- rica on December 11, 1936.27 The abdication was given legal effect in The Irish Free State the following day with the enactment by the Irish Oi- reachtas (parliament) of the Executive Authority (External Relations) Act, 1936.28 From the time of the abdication to the present, reform of various aspects of the monarchy connected to the succession has been a topic of intense discussion and even legislative proposals in the U.K., including a pledge to work for such change by then-Prime Minster Gordon Brown’s Labour Party in its manifesto for the 2010 U.K. General Election.29 But it was not until October 28, 2011 that any concrete progress was made in the push for reform. David Cameron and his fellow realm prime ministers held the discussion at the Commonwealth Heads of Government Meeting in Perth. This ultimately resulted in their agreement to the common program of reforms to the nature of the monarchy now referred to as the Perth Agreement.30

III. THE PERTH AGREEMENT, SUBSEQUENT DEVELOPMENTS, AND THEIR LEGAL IMPLEMENTATION

A. CHANGES TO BE BROUGHT ABOUT FOLLOWING THE PERTH AGREEMENT At the Commonwealth Heads of Government Meeting in Perth the sixteen realm prime ministers agreed to two concrete proposals to reform

25. See HOUSE OF COMMONS LIBRARY, supra note 2, at 8 – 9. 26. See id. at 8. 27. His Majesty’s Declaration of Abdication Act, 1936, 1 Edw. 8. c. 3 (U.K.). 28. Executive Authority (External Relations) Act, 1936, (Act No. 58/1936) (Ir.). Al- though there was no substantial legal consequence or harm from the Irish delay in giving legal effect to Edward VIII’s abdication and the resulting twenty-four hour period where the realms did not share a common monarch, it is reasonable to speculate that this incident may be one factor in the Perth Agreement’s requirement that the anticipated changes must be legally enacted in all sixteen realms before going into effect. 29. See HOUSE OF COMMONS LIBRARY, supra note 2, at 5 – 6. 30. See id. at 6 – 7. 120 LAW AND BUSINESS REVIEW OF THE AMERICAS [Vol. 21 the line of succession to their shared throne.31 After the meeting in Perth, it emerged that there was in fact a third proposal for reform that had been discussed by Cameron in the invitations he sent to his fellow realm prime ministers to attend the meeting; and that, though not originally a part of the earlier Perth Agreement, it had also been agreed to by all sixteen governments.32 The agreement to the third proposal effectively made it into a third component of the Perth Agreement. For the purposes of this article, unless otherwise specified, references to the agreement should be read as referring to all three proposals.

1. The First Proposal Under the first proposal, the common law of all sixteen countries is changed so that the position of an individual in the line of succession would be based just on when they were born.33 As a result, a daughter born into the line would no longer be bumped down the line if her par- ents subsequently have a son in the succession.34 It was also agreed that the law implementing the change would be written in such a way that this change would be retroactive to all births in the line of succession after October 28, 2011, the day of the agreement.35

2. The Second Proposal The second proposal agreed to at the Perth meeting allows anyone in the line of succession to marry a Roman Catholic, ending the centuries old discriminatory ban on persons in the line of succession marrying Ro- man Catholics while allowing them to marry spouses who are members of any other (Christian or non-Christian) religion, or who profess no religious faith at all.36 This would be accomplished by repealing the provisions of earlier legislation that remove persons who marry Roman Catholics from the line of succession.37 Notably, persons who had earlier been removed from the line of succession for marrying Roman Catholics would be restored to the line, though no person returning to the line via this change has a realistic chance of becoming monarch.38 But the existing requirements that the monarch be a member of the Church of En- gland and that persons in the line of succession be Protestant will remain in force.39 While in Perth, Cameron described the thinking behind and rationale for these two proposals by stating that, “The idea that a younger son should become monarch instead of an elder daughter simply because he

31. See infra notes 33-41. 32. See CABINET OFFICE, supra note 7, at 2, 5. 33. HOUSE OF COMMONS LIBRARY, supra note 2, at 6. 34. See id. 35. See id. at 10. 36. See id. at 6. 37. E.g., CABINET OFFICE, supra note 7, at 5. 38. Id. 39. See id. 2015] SUCCESSION TO THE THRONE 121 is a man, or that a future monarch can marry someone of any faith except a Catholic–this way of thinking is at odds with the modern countries that we have become.”40 Cameron also justified continuing the religious restrictions that apply to the monarch and persons who are in the line of succession by saying, “Let me be clear, the monarch must be in commu- nion with the Church of England because he or she is the head of that Church.”41

3. The Third Proposal

The third proposal agreed to by the sixteen governments would substantially reform the requirements for persons in the line of succession to seek approval for their marriages.42 This reform would be accomplished by repealing the Royal Marriages Act 1772 and instead only requiring persons who, at the time they intend to marry, are one of the first six persons in the line of succession to seek the monarch’s consent.43 Nota- bly though, under the proposal, if the monarch refused to consent and the person affected went ahead with the proposed marriage anyway, they and any children they might have would be removed from the line of succession; though for all other purposes, the marriage itself would be legal and any children would be legitimate.44 The third proposal also makes every marriage ever voided under the Royal Marriages Act 1772 legal. As long as the person involved was not at the time of the marriage one of the first six persons in the line of succession, consent to the marriage was not sought, and no notice of intent to marry was given to the Privy Council, it was reasonable for the person concerned to not know the act applied to them, and no one involved cited the act as a basis for voiding the marriage.45 At the same time, the proposal has one stipulation declaring that the newly validated marriages are valid for all purposes except for succession to the throne, keeping the historical line of succession intact.46 Effectively, this part of the proposal renders most of the marriages ever voided by the Royal Marriages Act 1772 valid, but with the caveat that, even though a marriage has been validated, the removal from the line of succession of the person involved and their descendants remains in effect.

40. Nicholas Watt, Royal Succession Gender Equality Approved by Commonwealth, GUARDIAN (Oct. 28, 2011, 7:29 AM), http://www.theguardian.com/uk/2011/oct/28/ royal-succession-gender-equality-approved. 41. Girls Equal in British Throne Succession, BBC NEWS (Oct. 28, 2011, 1:43 PM), http://www.bbc.co.uk/news/uk-15492607. 42. See CABINET OFFICE, supra note 7, at 5. 43. See, e.g., id. at 5 – 6. 44. E.g., id. at 6. 45. E.g., id. 46. Id. 122 LAW AND BUSINESS REVIEW OF THE AMERICAS [Vol. 21

B. THE LEGAL PROCESS OF IMPLEMENTING THE PERTH AGREEMENT At Perth, after coming to the agreement to change the rules of the succession, the sixteen prime ministers also agreed on a basic plan of action to implement the changes.47 This plan called for the Government of New Zealand to coordinate the multilateral sixteen party discussion as to how the language implementing the agreement should be drafted and then, once agreement on the language was reached, the U.K. Govern- ment would draft its own piece of legislation to implement it.48 That piece of legislation would then be presented to the U.K. Parliament only once the member of the U.K. Government responsible for coordinating with the other realms, Cameron’s then Deputy Prime Minister, Nick Clegg, had received written letters of consent from each of the realms indicating they were ready to begin taking the necessary steps to implement the changes.49 Clegg’s office confirmed on December 4, 2012, that it had received all of those letters, and on December 13, 2012, the bill was introduced and given its first reading.50 For purposes of this article, discussion will be limited to the passage of the relevant U.K. and Canadian legislation.

1. Implementation of the United Kingdom Legislation The U.K. legislation, the Succession to the Crown Act 2013 (Succession Act), is itself a rather short piece of legislation, consisting of less than three pages, one of which consists of just a schedule of items in previous legislation that need to be changed in light of the agreement.51 The Suc- cession Act consists of five sections in addition to the above-mentioned schedule.52 The first of these sections implements the changes in regard to gender, the second addresses the changes in regard to the religious requirements of royal spouses, and the third—which is larger than the first two combined—contains all of the technical minutiae required to effect the changes on consent to royal marriages.53 The fourth section of the Succession Act contains the technical details required to alter earlier legislation to make it compatible with the new changes. The final section contains the short name for the Succession Act and stipulates that it will go into effect immediately, but that the other sections will only go into effect once the government so stipulates.54 This delay was deliberately built into the Succession Act so the U.K. Government would be able to make sure that it implements the changes in unison with the other realms.55 The Succession Act was passed by the House of Commons on

47. See id. at 3. 48. See id. 49. See HOUSE OF COMMONS LIBRARY, supra note 2, at 9. 50. Id. at 13. 51. See Succession to the Crown Act 2013, c. 20 (U.K.). 52. See id. 53. See id. §§1 – 3. 54. See id. §§4 – 5. 55. See CABINET OFFICE, supra note 7, at 7. 2015] SUCCESSION TO THE THRONE 123

January 28, 2013, and was then introduced in the House of Lords on Janu- ary 29, 2013, where it passed on April 22, 2013, before being sent to the Queen, who signed it into law on April 25, 2013.56

2. Implementation in Canada On March 27, 2013, the Canadian Parliament’s Succession to the Throne Act, 2013 was signed into law.57 Through this act the Canadian Parliament assented to “[t]he alteration in the law touching the Succes- sion to the Throne” set out in the U.K. Succession to the Crown Act 2013.58 This choice of language is interesting in that it reflects that the Canadian Government believes that any change to the law of succession in the U.K. automatically applies to Canada as soon as it is assented to by the Canadian Parliament.59 The legal basis for this argument rests first on an inferential principle of symmetry in the Canadian Constitution, which provides that the person occupying the throne of the U.K. is automatically the monarch of Canada.60 Under that legal logic Canada should not have had to even pass its own legislation on the issue, but it would appear that under Canadian law (unlike U.K. law61) the preamble to the Statute of Westminster is a substantive provision of that act itself. Thus, for the change to the line of succession to apply in Canada it must first be assented to by the Canadian Parliament, as was done through the enactment of the Succession to the Throne Act, 2013.62 Despite the Canadian Parliament having passed legislation that it asserts implemented the Perth Agreement under Canadian law, that legislation has to date been attacked on two grounds. The first of these is the continuing bar on a Catholic monarch dealt with in Teskey and discussed in the next section.63 The second attack stems from what would appear to be a legitimate difference of legal opinion between the Government’s claim that no constitutional amendment was necessary to incorporate the changes to the line of succession into Canadian law64 and an alternate legal argument that such a constitutional amendment was necessary65 that will ultimately probably have to be settled by the Supreme Court of Canada. In a legal complaint filed with the Superior Court of Quebec on June 6, 2013, by two legal scholars from Laval University, Genevieve ` Motard and

56. Parliament of the U.K., Bill Stages—Succession to the Crown Act 2013, U.K. PAR- LIAMENT, http://services.parliament.uk/bills/2012-13/successiontothecrown/stages .html (last visited Apr. 24, 2015). 57. See Succession to the Throne Act, 2013, S.C. 2013, c. 6 (Can.). 58. Id. 59. See Peter W. Hogg, Succession to the Throne, 33 NAT’L J. CONST. L. 83, 89-90 (2014). 60. See id. at 92 – 93. 61. See supra text accompanying notes 21 – 22. 62. See Hogg, supra note 59 at 92. 63. See infra Part IV. 64. See supra text accompanying notes 57 – 60, 62. 65. See,infra text accompanying notes 66 – 71. 124 LAW AND BUSINESS REVIEW OF THE AMERICAS [Vol. 21

Patrick Taillon, it is asserted that under Canadian law the Succession to the Throne Act, 2013 is unconstitutional.66 The primary argument advanced by Motard and Taillon is that changes to the line of succession fundamentally alter the “office of the Queen” and therefore to be constitutional, any changes to the line of succession must be approved by both houses of parliament and the legislatures of all the provinces under section 41(a) of the Constitution Act, 1982.67 The complainants also make two secondary arguments. First they argue that the Succession to the Throne Act, 2013 is additionally unconstitutional under the Canadian Charter of Rights and Freedoms, which is part of the Canadian Constitu- tion, because the Act fails to remove the discriminatory requirement that the monarch must be a member of the Church of England (a legal claim that will be discussed below in relation to Teskey.)68 Their other secondary argument asserts that the Succession to the Throne Act, 2013 is unconstitutional because the United Kingdom’s Succession Act, which contains the changes that the Canadian act was passed to implement, was written in English, not in French.69 Interestingly, the challengers themselves did not file their complaint out of opposition to the changes made by the Succession to the Throne Act, 2013.70 Rather, they think that under the Canadian Constitution, the changes should have been approved by the provincial legislatures and Parliament and that before the Perth Agreement can be operative in Canada that the legislation implementing it must be consented to by the provinces.71 It bears pointing out that the Canadian Government has noted that when the Succession to the Throne Act, 2013 was being adopted, none of the provinces objected to not being consulted, with the obvious implica- tion being the provinces did not object because none of them thought

66. See, e.g., Janyce McGregor, Royal Baby Law Challenge Could End Up at Supreme Court, CBC NEWS (June 12, 2013, 8:48 AM), http://www.cbc.ca/news/politics/royal- baby-law-challenge-could-end-up-at-supreme-court-1.1415337. 67. See Motion to Institute Proceedings for Declaratory Judgment at 2, Motard v. At- torney General of Canada (2013) (Can. Que. Super. Ct.) (initiating motion for the current court proceedings filed before the Superior Court of Quebec by Motard and Taillon on 6 June 2013, please note that the court has yet to assign the case a public docket number) available at http://s3.documentcloud.org/documents/712552/ motard-taillon-requete-jugement-declaratoire.pdf; see also Constitution Act, 1982, being Schedule B to the Canada Act, 1982, c. 11 (U.K.), reprinted in R.S.C. 1985, app. II, no. 44 (Can.) (contains the constitutional provision Motard and Taillon claim requires the federal parliament and the provincial legislatures to consent to the changes to the line of succession for them to be constitutional). 68. See Motion to Institute Proceedings for Declaratory Judgment, supra note 67 at 3; see also Canadian Charter of Rights and Freedoms, Part I of the Constitution Act, 1982, being Schedule B to the Canada Act, 1982, c. 11 (U.K.), reprinted in R.S.C. 1985, app. II, no. 44 (Can.) (contains the constitutional provisions that Motard and Taillon claim render the Succession to the Throne Act, 2013 unconstitutional for failing to remove the requirement that the monarch be a member of the Church of England). 69. See Motion to Institute Proceedings for Declaratory Judgment, supra note 67, at 3. 70. See McGregor, supra note 66. 71. See, e.g., id. 2015] SUCCESSION TO THE THRONE 125 that they were constitutionally required to give their consent.72 Further, it can easily be argued that the Canadian Government’s approach is the correct one when implementing changes to ensure that the U.K. and Ca- nada have the same monarch, but if Canada were to alter its law so that it had a monarch other than the monarch of the U.K., then it would be necessary for both Parliament and the provinces to consent to the changes in the form of a constitutional amendment.73 Both the challengers and the Canadian Government believe strongly in the merits of their legal arguments, and as a result, this case will likely be litigated until the Canadian Supreme Court issues a definitive ruling.74 Such a ruling however might be some time coming as Motard and Taillon’s case will not be heard by the Superior Court of Quebec until June 2015.75

IV. TESKEY V. CANADA (ATTORNEY GENERAL) AND THE BAR ON A CATHOLIC MONARCH

A. TESKEY V. CANADA (ATTORNEY GENERAL) OR O’DONOHUE REVISITED Following the enactment of the Succession to the Throne Act, 2013, Bryan Teskey, a Canadian Roman Catholic who had recently completed legal studies at the University of Ottawa, challenged the law in the Onta- rio Superior Court of Justice.76 Teskey argued that the Succession to the Throne Act, 2013 and the Perth Agreement it meant to implement violated the Canadian Constitution, specifically its Canadian Charter of Rights and Freedoms, by not removing the legal ban on a Roman Catho- lic becoming monarch of Canada.77 The same issue of the discriminatory ban on Roman Catholics becoming monarch of Canada had been dealt with by the Ontario courts a decade earlier in O’Donohue v. Canada.78 In that case, Tony O’Donohue unsuccessfully argued that that the legislation setting out the ban on Ro- man Catholics becoming monarch, the Act of Settlement, was unconstitutional and should be struck down for violating the Charter.79 In addressing O’Donohue’s claim, the Ontario Superior Court of Justice ruled that the rules excluding Roman Catholics from the line of succession were part of the Canadian Constitution and thus were not subject to

72. See id. 73. See Hogg, supra note 59, at 93. 74. See McGregor, supra note 66. 75. Allison Jones, Royal Baby Law Stands as Court Dismisses Catholic Challenge, CBC NEWS (Aug 27, 2014, 7:32 AM), http://www.cbc.ca/m/news/politics/royal- baby-law-stands-as-court-dismisses-catholic-challenge-1.2748020. 76. Yamri Taddese, Law Grad Plans Appeal After Royal Succession Challenge Dis- missed, L. TIMES (Sep. 2, 2013, 8:01 AM), http://www.lawtimesnews.com/20130902 3425/headline-news/law-grad-plans-appeal-after-royal-succession-challenge-dis missed. 77. Id. 78. O’Donohue v. Canada, 2003 CarswellOnt 2573 (Can. Ont. Sup. Ct. J.) (WL), aff’d, 2005 CarswellOnt 951 (Can. Ont. C.A.) (WL). 79. Id. para. 1. 126 LAW AND BUSINESS REVIEW OF THE AMERICAS [Vol. 21 a challenge via the Charter because it does not apply to other parts of the Constitution.80 The court further ruled that because there was no valid constitutional challenge to be raised, O’Donohue did not have standing to bring a case.81 The Court of Appeal for Ontario affirmed the lower court ruling in a one-paragraph opinion stating that it agreed with the ruling of the lower court.82 In its ruling in Teskey, the Ontario Superior Court of Justice made it clear that this case was similar to O’Donohue and that its ruling was bound by earlier precedent.83 With that in mind, the court dismissed the case for the similar reasons of there being no issue for the court to consider and Teskey’s lack of standing to bring a claim.84 In setting out its analysis for why the case should be dismissed, the court liberally quoted from and cited to O’Donohue.85 In this case, Tes- key objected to the implementation of the Perth Agreement in Canada because the discriminatory provision barring a Catholic from becoming Canada’s monarch was to remain in place.86 This might have very likely been an attempt to get around O’Donohue by arguing that the new legislation opened the rules of succession to Charter review and presumably invalidation. In any case, with respect to the rules of succession, the court, while citing to O’Donohue, held that the rules were a part of the Constitution and thus not subject to Charter review.87 Teskey, like O’Donohue, argued that Canada could and should adopt a different (and non-Catholic excluding) set of rules—and possibly a different monarch from the U.K.—but the court rejected that outright by stating that such a change would fundamentally alter the Canadian Constitution and “would involve the court changing, rather than protecting, our fundamental constitutional structure.”88 The court further opined that the changes envi- sioned by the Perth Agreement and assented to by the Succession to the Throne Act, 2013 were properly implemented with respect to Canada as the U.K. had expressed a desire to modify some of the rules of succession and the Canadian Parliament had consented to those changes in accordance with the process established by the Statute of Westminster.89 In regard to standing, the court held that Teskey was: “[A] member of the Catholic faith but that appears to be his only interest in the issues raised in this application. He has no connection to the Royal Family. He raises a purely hypothetical issue which may never occur, namely a Roman Catholic Canadian in line for suc-

80. Id. paras. 36 – 37. 81. Id. para. 39. 82. O’Donohue v. Canada, 2005 CarswellOnt 951, para. 1 (Can. Ont. C.A.) (WL). 83. Teskey v. Canada (Attorney General), 2013 ONSC 6386, para. 7 (Can. Ont. Sup. Ct. J.), aff’d, 2014 ONCA 612 (Can. Ont. C.A.). 84. Id. 85. See, e.g., id. paras. 8 – 15. 86. Id. para. 8. 87. Id. paras. 12, 15. 88. Id. para. 13. 89. Id. para. 14. 2015] SUCCESSION TO THE THRONE 127

cession to the throne being passed over because of his or her religion. Should this ever occur a proper factual matrix would be available to the court to deal with a matter of this importance.”90 Effectively, setting aside the fact that the issue was already non-judicia- ble because of the rules of succession not being subject to the Charter, Teskey did not have standing to bring his case because although he was Roman Catholic, he was not a member of the Royal Family, and there was no overriding public interest to protect because there may very well never end up being a Roman Catholic Canadian excluded from the throne because of their religion.91 On appeal, in August 2014 the Court of Appeal for Ontario agreed with the lower court and dismissed Teskey’s appeal due to a lack of both standing and any issue for the court to decide.92 It would thus appear (pending any further judicial action to the contrary) that the prohibition on the Canadian Monarch being Catholic, while discriminatory, is perfectly—if not fundamentally—constitutional.

V. CONCLUSION Elizabeth II’s prime ministers set out to alter the rules governing the line of succession to make them fairer to those individuals to whom they applied. Teskey argued that because members of the Roman Catholic faith were still excluded from the throne, the changes to the rules of succession and the rules themselves were, in terms of Canadian law, uncon- stitutionally discriminatory under the Charter of Rights and Freedoms. The Ontario courts disagree, holding that as long as they were properly implemented, the changes to the rules of succession were themselves a part of the Canadian Constitution and thus protected from Charter review. Therefore, it would seem that if those provisions of the rules of succession that Teskey and O’Donohue deplore are to be changed or removed it will have to be accomplished politically and legislatively through another multilateral agreement similar to the Perth Agreement rather than judicially through the courts.

90. Id. para. 16. 91. See id. paras. 15 – 16, 19. 92. Teskey v. Canada (Attorney General), 2014 ONCA 612, paras. 5 – 6 (Can. Ont. C.A.). 128 LAW AND BUSINESS REVIEW OF THE AMERICAS [Vol. 21