A View into the Oil and Gas Business in Brazil1
Humberto Quintas
Vice President, Legal, BP Energy do Brasil Ltda.
Rio de Janeiro, Brazil
Danielle Valois
Partner at Trench Rossi Watanabe
Rio de Janeiro, Brazil
Gabriela Bezerra Fischer
Senior associate at Trench Rossi Watanabe
Rio de Janeiro, Brazil
1 Disclaimer: the opinions contained herein are those of the authors and do not reflect in any way those of the institutions to which they are affiliated. The views and opinions provided herein are based on information of public domain. 1
§ 1.01 The Brazilian Oil and Gas Industry
[1] Introduction
The Brazilian petroleum industry has evolved significantly over the past decades and is undergoing its greatest reform since the flexibilization of the Federal Union's monopoly over oil and gas exploration and production started back in 1995.
Brazil is currently the 10th largest oil and gas producer in the world and the largest in
Latin America, having overcome Mexico and Venezuela. Oil and gas represents approximately 11% of the country's industrial GDP and approximately 50% of its internal energy supply.
Oil and gas production in Brazil is an average of 2.65 million barrels per day2 and has been increasing over the past years. In 2017, the pre-salt3 production exceeded the post-salt production for the first time.
Despite this production level and with proven reserves amounting to 12.6 billion oil barrels4, distributed among pre-salt (51%), post-salt (44%) and onshore (5%), these numbers still do not reflect the country's overall potential.
Over the past decades, relevant nationalist measures were taken by the Brazilian government in respect to hydrocarbon exploration and production, which included enforcing a strict - and, to some experts, impossible to comply with - local content policy and
2 Source: National Petroleum, Natural Gas and Biofuels Agency (“ANP”), Brazil’s main regulator to oil and gas-related activities. 3 “The pre-salt is a sequence of sedimentary rocks formed more than 100 million years ago (...). After a process, which involves high temperatures and pressures, the organic matter was transformed into oil and gas (...) Due to the arid climate prevailing at that time (the Aptian), the intense evaporation of marine water(...) led to the accumulation of salts, which resulted in a thick layer of salt that served as a seal to prevent the oil from escaping and reaching the surface. (...) the pre-salt polygon is among the most important discoveries of oil and natural gas in the last years. (...)”. Source: ANP, at http://www.anp.gov.br/wwwanp/exploracao-e-producao-de- oleo-e-gas/rodadas-de-licitacoes/2-e-3-rodada-de-partilha-de-producao-pre-sal/2nd-and-3rd-pre-salt-bidding- rounds/the-pre-salt 4 Source: ANP 2
implementing an entirely new regulatory framework for pre-salt, aimed at increasing the government’s participation and control over pre-salt production.
On top of this, low global oil prices and the lack of bidding rounds for five years after the pioneer pre-salt discovery of the Lula oil field (formerly Tupi oil field)5 contributed to the slow-down of upstream activities in Brazil. While in 2011, 238 wells were drilled in the country, this number dropped to 39 in 2016. Also, in 2012, 173 declarations of commerciality were submitted by concessionaires, against only 22 in 2016.6
Thus, after President Dilma Rousseff’s impeachment in 2016 and the eruption of
Operation Car-Wash, which uncovered a corruption scandal of gigantic proportions, the
Brazilian oil and gas industry urged for change.
Following these events, several regulatory changes are being implemented by the current administration aimed at boosting investment in the Brazilian oil and gas sector. This includes the launching of an ambitious multi-year schedule of bid rounds, as well as legislative and regulatory reforms targeting a more transparent and clean industry, including stricter governance requirements for state-owed and state-controlled companies.
However, to better understand these reforms and what they represent to the country, it is important to understand the history of the Brazilian oil and gas industry.
[2] The Flexibilization of the Monopoly
From 1953 to 1997 all oil and gas exploration and production activities in Brazil were performed by Petrobras. During this period, other players were only authorized to supply goods and services to the Brazilian oil and gas industry as Petrobras contractors.
5 Source: The Economist, at: http://www.economist.com/node/10677726 6 Source: ANP 3
To boost national oil production (and revenues) through private investment in Brazil, on November 10, 1995, Brazil’s Congress enacted Constitutional Amendment Nº. 97 allowing the Brazilian government to contract public or private companies to perform activities within the federal government’s monopoly, including the exploration and production of oil and gas.
The enactment of Constitutional Amendment Nº. 9 was the turning point which introduced a variety of changes to the national petroleum sector, and the Brazilian legal framework had to adapt to the new open market reality.
In 1997, a series of institutional bodies were put in place to oversee all oil-related activities, as well as create and enforce national regulations. More importantly, the government chose the concession regime as a vehicle to involve its new industry partners. All these innovations were brought about by the enactment of the Petroleum Law.8
Among other important changes, the Petroleum Law established the Brazilian energy policy, regulated activities within the federal government oil and gas monopoly, created the
National Council of Energy Policy (“CNPE”) and the National Petroleum Agency (“ANP”).
The CNPE is a political council linked to the President of Brazil and chaired by the
Minister of Mines and Energy, whose responsibilities involve proposing to the Executive
Branch the national policy for the energy industry. The ANP is the federal regulatory agency, designed to act technically and independently from the central government, in charge of contracting, regulating and inspecting Brazilian oil and gas sector.
The Petroleum Law confirms the federal government monopoly over exploration and production activities and further states that these activities may be carried out – upon
7 Constitutional Amendment Nº. 9 amended Article 177 of the Brazilian Constitution. 8 Brazil Federal Law No. 9.478/1997. 4
concessions or authorizations – by companies incorporated under Brazilian law, with head offices and administration in Brazil. There is no legal restriction as to the nationality of the quotaholders/shareholders of these companies, meaning that foreign companies are free to establish subsidiaries or branches in Brazil to engage in oil and gas exploration and production activities.
The concession regime has been highly beneficial from an industry perspective, and proven to be a successful model throughout its two decades of existence.
[3] The Discovery of Pre-Salt
As expected, opening the market resulted in an increased flow of public and private funds to the sector and several breakthroughs have been made since then. The most important was the discovery of the pre-salt reserves in or about 2007. The allegedly lower exploratory risks and considerable profitability potential of these pre-salt areas led the government to suspend all concession rounds in 2007, until a new, more convenient regime to be applicable for the new findings could be better studied.
In 2010 the government finally enacted a new regulatory framework applicable to the pre-salt, based on the premise that the government should have more control over, and participation in, the wealth generated by the pre-salt exploitation. It accordingly amended the
Petroleum Law to create a production sharing regime, in parallel with the concession structure, and enacted the Pre-Salt Law.9 Brazil now has a mixed system whereby production sharing agreements will regulate exploration and production activities in the pre-salt area (a predetermined region following map coordinates established by the Brazilian Government, also referred to as the “pre-salt polygon”) and other strategic areas, and the remaining territory outside such pre-salt polygon and strategic areas will continue to be managed
9 Law No. 12.351/2010. 5
through the grant of rights via concession. Brazil has, in addition, grandfathered all concession contracts that were already in effect over pre-salt polygon areas at the time the
Pre-Salt Law was enacted, resulting in the existence of both concession and production sharing within the pre-salt polygon itself. Lastly, Petrobras was also directly awarded the right to produce up to 5 billion of barrels in some fields within the pre-salt polygon, a system that was called “onerous assignment”. Below we will closer examine these different regimes and how Brazil manages a hybrid granting system.
[4] Current Granting Instruments Applicable in the Brazilian Oil and Gas
Industry
[a] Production Sharing Agreements
In Brazil, production sharing agreements only apply to pre-salt and other strategic areas. Most of the pre-salt province is already defined by an Annex to the Pre-Salt Law, but new sites may be added to these categories by a federal government order.
In summary, the original set of rules enacted for pre-salt and strategic areas can be described as follows:
designates Petrobras as the mandatory operator, with at least 30%
participation, of all pre-salt and strategic areas (which was recently changed,
as further detailed below);
allows the government to award production sharing agreements directly to
Petrobras, without a formal bidding process; and
reserves to the national public company Pré-Sal Petróleo S.A. – PPSA, created
to represent the economic interests of the federal government in consortia, the
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right to nominate at least 50% of the voting seats, including the chairman of
the operating committee of all consortia under a production sharing agreement.
The operating committee has the power to define exploration and production plans, determine the annual work program for submission to the ANP and generally supervise all joint operations. The operating committee’s chairman appointed by PPSA will have special veto and voting rights. In addition to the members appointed by PPSA, the other half of the committee will be appointed by the other contractors, in accordance with their respective shares.
Aside from production sharing agreements occasionally awarded directly to Petrobras, all others must be preceded by a public bidding process, and participant companies shall evidence their legal, technical, fiscal and financial good standing to qualify and present bids.
The winning bidder will be the one that offers the highest share of profit-oil to the federal government. In addition to profit oil, the winning bidder must also pay a signature bonus and royalties over its hydrocarbon production. The customs and tax incentives that currently apply to the Brazilian oil industry will also apply to activities under the production sharing regime.
[b] Concession Regime
The Brazilian concession regime has also evolved since it began in 1997. All companies interested in acquiring rights to explore, develop and produce hydrocarbons in areas outside the pre-salt and strategic categories must participate in a transparent public bidding process. The rules of this process are defined either by the Petroleum Law, by the applicable tender protocol or by other associated regulations.
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Once enrolled to participate in a bidding round, a company may elect to bid individually or jointly with other qualified companies. In joint bids, the group of companies awarded a concession must organize a consortium (i.e., a non-incorporated joint venture).
The winning companies must submit to the ANP the qualification documents specified in the bid invitation, which aim at qualifying companies technically, legally and financially. Each consortium member must qualify individually, but specific requirements apply to operators and non-operators.
[c] Onerous Assignment
In addition to production sharing agreements and concession agreements, since 2010 there has also been a third regime for exploration and production activities in Brazil, which only applies to Petrobras. This is known as the “onerous assignment” or “transfer of rights”.
In lieu of a bidding procedure, the federal government transferred directly to Petrobras the right to produce up to 5 billion barrels of oil in the following pre-salt fields: Franco, Florim,
Nordeste de Tupi, Sul de Tupi, Sul de Guará, Entorno de Iara and Peroba.
Petrobras’s rights under the onerous assignment are non-transferrable to third parties and the onerous assignment agreement provides for a renegotiation after a declaration of commerciality in the subject areas. There is currently a bill of law before the Brazilian
Congress to allow the transfer of rights over these areas to third parties, but it is still uncertain whether it will be approved.
Independently from these assignment discussions in Congress, the CNPE had already acknowledged, through its Resolution no. 01 dated June 24, 2014, that several onerous assignment areas would contain volumes in excess of the 5 billion barrels. Through such resolution, the CNPE also approved the possibility of directly awarding new production
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sharing contracts to Petrobras, through which such excess volumes could then be produced.
The federal government ultimately elected not to use such CPNE authorization for a direct award, and the resolution paved way for such areas to be the object of yet another bid round, under the production sharing regime, for continuation of production activities following the completion of onerous assignment contracts. The government currently expects to be able to offer those areas later in 2018 - pending a delicate price renegotiation with Petrobras, who argues the onerous assignment was designed under past oil price assumptions and thus require revision - and such a round, if materialized, should attract significant attention from private investors.
[5] Government Takes 10
Government take is a group of financial mechanisms through which the Brazilian
Government gets compensation for the exploration and production of oil. The following may be applicable depending on the exploration and production regime, as better detailed as follows:
[a] Signature Bonus
The signature bonus is the amount to be paid by the winning bidder in order to execute the granting instrument. In the concession regime the signature bonus is one of the judgement criteria, therefore a minimum amount is established by the tender protocol and companies will prepare their proposals on or in excess of this minimum amount. In the production sharing regime, however, the signature bonus is not a judgment criteria and the total amount to be paid by the winning bidder is fixed under the tender protocol.
10 For onshore blocks, the law also provides for what is commonly called the “Owner’s Take”, which consists of a payment to the surface owners of the property equivalent, in local currency, to a variable percentage between 0.5% and 1.0% of the petroleum and natural gas production, according to ANP’s criteria. 9
The signature bonus must be paid in Brazilian currency, in a lump sum, prior to the execution of the granting instrument.
[b] Royalties
Royalties are monthly amounts that must be paid by the concessionaire or contractor, in Brazilian currency, from the date at which the commercial oil and gas production starts in a given field.
For the concession regime, the Petroleum Law establishes a royalty rate at 10% of the hydrocarbon production, based on its reference price. The ANP may reduce this royalty rate, in the corresponding tender protocol, down to a minimum of 5% of the production, taking into account geological risks, production forecasts, and other relevant factors. For the production sharing regime the Pre-Salt Law provides for a royalty rate fixed at 15%.
[c] Special Participation
Special participation is an extraordinary financial compensation to be paid quarterly by the oil companies only in cases of large production volumes, in connection with each field of a given concession area. The special participation only applies to the concession regime and will be assessed by applying progressive rates over the net revenue of the production of each field. The applicable rates vary depending on the location of the area, the number of years of production, and the relevant volume of quarterly production.
[d] Payment for Occupying or Retaining the Area
The tender protocol and the concession agreement specify an amount payable by the concessionaire to occupy or retain the concession area, per square kilometer. This payment
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will be assessed each calendar year, as from the execution date of the concession agreement, falling due every January 15 of subsequent years, and only applies to the concession regime.
[e] Reference Price
Until December 31, 2017, the reference price used for calculating the government takes was based on the market price of the oil effectively sold by the oil companies in normal market conditions or the minimum price established by the ANP, whichever was higher.
However, from January 1, 2018, the reference price for each field will be determined by the
ANP based on a basket composed of up to four similar types of oil quoted in the international market.11
§ 1.02 Recent Changes to the Brazilian Oil and Gas Market
[1] Petrobras Ceases to be the Mandatory Operator of Pre-salt
As mentioned above, the original wording of the Pre-Salt Law provided that Petrobras would be the mandatory operator of all pre-salt areas awarded by the Brazilian government under the production sharing regime, holding at least 30% participating interest in the relevant consortium.
Three years after the enactment of the Pre-Salt Law, the government carried out
Bidding Round 1 under the production sharing regime. In this bidding round the giant pre-salt area called Libra, located in the Santos Basin, was awarded to a consortium formed by
Petrobras, Shell Brasil Petróleo Ltda., Total S.A., CNPC International Ltd and CNOOC
International Limited.
11 This change was introduced by Decree No. 9,042/2017 and further regulated by ANP Resolution No. 703/2017. 11
Even though the bidding round was considered profitable, generating approximately
USD 5 billion in signature bonus for the government, it was marked by a lack of competitiveness since there was a single consortium which submitted a proposal bearing the very minimum profit-oil percentage allowed by the tender protocol: 41.65%.
Aiming to attract the interest of the majors and other private investors, in late 2016, the Pre-Salt Law was amended12 to withdraw Petrobras's mandatory operatorship, instead providing for a right of first refusal. Thus, under the current regime, after the areas to be offered in the production sharing regime Bidding Rounds are selected by the CNPE,
Petrobras has 30 days to advise whether or not it will exercise its right of first refusal to be the operator and its intended participating interest, which cannot be less than 30%.
For the areas which Petrobras exercises the right of first refusal, bidders must form a consortium with Petrobras. For the other areas, private companies are permitted to be operators and form partnerships as they deem appropriate.
This legislative change was a huge step for the Brazilian oil and gas industry. As opposed to Bidding Round 1 for the Libra field in 2013, Bidding Rounds 2 and 3 promoted in
October 2017 raised the interest of the major oil companies, including Shell, ExxonMobil,
Statoil, Total and BP. Also, private companies such as Shell and Statoil will now operate in the pre-salt under the production sharing regime.
[2] Bidding Rounds Calendar
Another important recent change in the Brazilian oil and gas industry was the establishment of a bidding rounds calendar. Since the opening of the Brazilian market the bidding rounds have occurred sporadically, without a pre-defined, multi-year schedule. This
12 Law No. 13,365/2016. 12
lack of predictability harmed not only oil companies but the entire oil and gas supply chain as some investments could be attracted if there was visibility on the long-term demand for goods and services.
For 2018-2019 ten bidding rounds have been scheduled, including both in and outside the pre-salt polygon.
[3] Permanent Offer of Areas
In order to predict investment opportunities in the industry, in 2017 the federal government has announced a permanent offer of areas, where selected areas outside the pre- salt polygon that have already been offered in previous bidding rounds but were not awarded, or areas that have been relinquished by the concessionaires, will become permanently available. Companies interested in these areas will have the opportunity to submit proposals.
In 2017 the ANP approved the process for offering these areas and selected those that will become permanently available. There will be a total of 846 exploratory blocks available in this first permanent offer, located in 13 basins, including onshore and offshore. Also, 15 areas with marginal accumulations were included, located onshore. With this initiative, the
Brazilian government aimed at capturing the interest of small, medium and major oil companies.
The ANP is expected to launch a simplified process to regulate the award of these areas and enable competition for areas where there is more than one company interested in participating.
[4] Extension of Exploration Phase in Bidding Rounds 11 and 12
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In 2017 the ANP approved a two-year extension to the exploration phase of the concession agreements awarded in Bidding Rounds 11 and 12, which occurred in 2013. The
ANP’s decision was in line with the CNPE's recommendations and met an industry requirement, in spite of some discontentment with the inflation adjustment index used by the
ANP to update the minimum exploration program-related guarantees over the extension period, as that doesn’t match the deflation of costs generated by the low oil prices scenario of the last few years.
Bidding Round 11 raised the interest of the majors as it included areas in the Brazilian
Equatorial Margin, composed of Foz do Amazonas, Pará-Maranhão, Barreirinhas, Ceará and
Potiguar basins. These areas are known for having geological features similar to the ones found on the Guinea Gulf and French Guyana, where several material discoveries were made. However, the environmental licensing for drilling in these areas remains a major challenge, and is taking up to 2,190 days.
When Bidding Round 12 took place in 2013, shale-prone areas were offered prior to the enactment of a proper regulation for environmental permitting and production of shale oil and gas in Brazil. This led to several lawsuits suits hampering the execution of the concession agreements and caused significant delays in environmental licensing.
Areas offered by the ANP in its bidding rounds are subject to prior analysis by the environmental authorities therefore delays in the environmental licensing represents a serious and undesirable legal uncertainty to market players.
Thus, the ANP’s decision to extend the exploration phase was crucial for the continuity of the exploration activities in these areas, as well as providing adequate legal certainty to investors. This decision is independent from the possibility that oil companies have to either request a suspension to the term of Round 11 and Round 12 contracts or to 14
solicit a devolution of time due to delays on the permitting process, both hypotheses set forth by the concession agreements. The ANP has been sympathetic to those requests, whenever there is evidence that the delays were beyond the companies’ reasonable control, thus not caused by their actions or omissions.
[5] Improvements in the Granting Instruments
For Bidding Round 14 under the concession regime and Bidding Rounds 2 and 3 under the production sharing regime, the ANP has improved and simplified the relevant contracts and tender protocols.
For example, the exploration phase that previously encompassed two separate periods was substituted by a single exploration phase, simplifying the concession agreement.
Also, distinct royalty rates were applied to higher risk, new frontier areas and mature basins, potentially increasing commercial feasibility for such projects. Also, access costs were reduced to the latter, as the minimum net equity required for the financial qualification of non-operators was reduced from 50% to 25% of the minimum net equity required for the operator of the relevant area.
The tender protocol was also changed to allow the possibility of private equity funds participating in the bidding rounds, qualifying as non-operators and acquiring participating interest in the assets.
[6] Local Content
Local content has always been a major challenge for companies operating in Brazil and, for the concession regime specifically, it has historically been part of the judgement criteria (together with signature bonuses and minimum work obligations) in awarding the
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bidding rounds. During Concession Bidding Rounds 1 to 4 (from 1999 to 2002), the ANP did not require a minimum local content commitment. The companies bidding for blocks were free to declare a local content goal, which was used as one criteria to award a concession agreement. Thus, in the past, the higher the local content commitment, the better the chances of winning. Whilst this structure was aimed at fostering the local goods and services industry, insertion of local content offerings in the bid award criteria was controversial and, over time, found to have resulted in certain distortions, as further outlined below.
Concession Bidding Rounds 5 and 6 (2003 and 2004) introduced a minimum local content commitment for bidders, which varied depending on the location of the block: onshore, shallow or deep water.
At that time, there was no certification method to prove that local content rules were fulfilled, therefore a simple statement from the exploration and production companies to the
ANP declaring the domestic origin of the hired suppliers was enough.
However, in 2005, in the context of Bidding Round 7, the local content rules were further regulated and a process was established to measure the local content of goods and services provided under the concession. These rules, created from Bidding Round 7, were applied to subsequent bidding rounds until Bidding Round 13.
This local content policy was extremely complex, requiring companies to predict, at the moment of the bidding round, detailed percentages of local content to be offered in the exploration phase and development stage, to be applicable to hypothetical discoveries - that could or not occur - and with technical characteristics that could massively vary and influence the use of local infrastructure, goods, suppliers and services. This has generated several fines over past years due to the companies’ inability to meet the high percentages committed, many times due to serious competitiveness issues of local goods and services, or their outright 16
scarcity in the local market – circumstances which could not be predicted years earlier, at the time a bid round offer was produced.
In 2016, the “Program to Stimulate Supply Chain Competitiveness and for the
Development and Improvement of Oil and Gas Sector Suppliers” (PEDEFOR)13 was published. The program aims at encouraging suppliers to invest in productive capacity, technology and innovation in Brazil.
In this context, for Bidding Round 14, the first promoted under President Michel
Temer’s administration, the government eased and simplified local content requirements, and local content ceased to be part of the judgment criteria. Also, a global local content percentage has been set for each contract phase, as opposed to the previous regime which provided for both global and per item requirements. The new percentages of local content were applied to Bidding Round 14 (2017) as follows:
Onshore: (i) exploration phase: 50%; (ii) production: 50%
Offshore: (i) exploration phase: 18%; (ii) construction of wells: 25%; (iii) collection
and drainage systems: 40%; and (iv) Stationary Production Units: 25%
Also, based on the new rules, the minimum penalty for non-compliance with local content obligations was reduced from 60% to 40% of the non-achieved local content.
However, companies will no longer be authorized to request waivers of local content requirements from the ANP in specific situations, which was possible under the previous regulation.
Despite the recent achievements towards a more clear and feasible local content requirement that have been commended by the industry, the Brazilian local content policy for
13 Decree 8,637/2016. 17
the oil and gas industry continues to be one of the most complex policies in the world, therefore local content remains a hot topic for both oil companies and service providers operating in Brazil.
[7] REPETRO extension
REPETRO is a Special Customs Regime that applies to the export and/or temporary import of goods used in activities of research, development and production of oil and gas in
Brazil.
Under REPETRO, taxes levied on the import of goods are completely or partially suspended. Given Brazil's complex and burdensome tax system, REPETRO is deemed a key element to the oil and gas industry's attractiveness and competitiveness.
After several discussions in the Brazilian Congress, the benefits arising from the
Special Customs Regime have been extended until 2040. This extension was considered critical to ensure the success of the multiple bidding rounds being planned by the government, as well as the industry's growth as a whole.
§ 1.03 Conducting Business Post-Car Wash Probe
[1] What is Operation Car-Wash?
Operation Car-Wash is Brazil's massive initiative against corruption and money laundering. It began in 2014 with an investigation into four criminal groups led by operators of the foreign exchange black market. As the investigations progressed, the Federal Police uncovered a cartel scheme involving Brazil’s major construction companies, politicians and
Petrobras employees.
[2] The Growth of Compliance Concerns
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Much before Operation Car-Wash, concerns about compliance and anti-corruption have significantly increased worldwide. Several jurisdictions have implemented legal instruments to fight corruption, including international treaties and internal and extra- exterritorial compliance legislation, such as the U.S. Foreign Corrupt Practices Act (FCPA) and the U.K. Bribery Act (UKBA). Authorities in many jurisdictions have increased their efforts to fight money laundering and foreign exchange evasion.
As a signatory of OAS14 and OECD15, Brazil has not lagged and in 2013, its Clean
Company Act16 came into effect. Brazilian anti-corruption legislation is as strict as many of its international analogues and requires companies to take several actions to mitigate their exposure and comply with the legislation. Therefore, compliance has become a major concern for companies interested in doing business in Brazil, especially in the oil and gas sector.
[3] Clean Company Act
[a] General Aspects
Inspired by the FCPA and the UKBA, the Clean Company Act is the first Brazilian law dealing solely with preventing and fighting corruption in the corporate realm. Prior to its enactment, corporate corruption had only been regulated generically in the Brazilian Penal
Code, and the Public Procurement Law and Administrative Improbity Law.
[b] Liability
14 Organization of American States 15 Organization for Economic Co-operation and Development 16 Law No. 12,846/2013 was later deregulated by Decree No. 8,420/2015 and complemented by several normative instructions issued by the Comptroller General (CGU). States such as São Paulo, Espírito Santo and Minas Gerais have also enacted state legislation on compliance and anticorruption matters. 19
The Clean Company Act deals strictly with administrative and civil liability and does not address criminal liability. Its provisions apply to (i) business organizations and ordinary partnerships (incorporated or not), irrespective of their form of incorporation or corporate structure adopted; (ii) foundations or associations formed by entities or individuals; and (iii) foreign entities with an office, branch or representation in Brazil.
The Clean Company Act is based on a strict liability regime. This means that companies will be held liable for illegal acts committed by any of its agents or employees, regardless of evidence that the company’s management had actual knowledge of or approved the specific improper acts. The authorities only need to demonstrate that the illegal acts were committed for the benefit or interest of the legal entity.
On the other hand, company liability does not exclude the civil or criminal liability of any individual who contributed to the corrupt act provided that the individual’s liability is negligence-based and in proportion to their participation in the illicit act.
The Clean Company Act also provides for successor liability in the event of amendments to the articles of association, transformation, merger, acquisition or spinoff of the company. In respect to mergers and incorporations, successor liability will only apply to the obligation to pay fines and the integral recovery of the damages caused, up to the value of the assets transferred, except for cases of fraud or misrepresentation, duly evidenced.
Successor liability is a major red flag for M&A transactions in Brazil, including farm in and farm out, and it increases the importance of compliance due diligence in such transactions, as further detailed below.
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Currently, 26 companies17 have been penalized under the Clean Company Act at the federal level.
[c] Prohibited Acts
In addition to corruption, the Clean Company Act also applies to other illicit acts committed against local and foreign public administrations. The Clean Company Act provides for the following prohibited acts (i) promising, offering or giving, directly or indirectly, an undue advantage to a public agent, or related third person; (ii) financing, supporting, sponsoring or funding, in any way, the performance of a wrongdoing; and (iii) using an individual or legal entity to conceal or dissimulate its real interests or the identity of the beneficiaries of wrongful acts.
With regards to public tenders which, where applicable, encompass the bidding rounds promoted by the ANP as well as Petrobras's procurement process, it is prohibited to:
to frustrate or defraud, through an arrangement or any other means, the
competitive character of a public tender;
to inhibit, disturb or defraud the performance of any act of a public tender
procedure;
to remove or try to remove a bidder by fraudulent means or by the offering of
advantage of any type;
to defraud a public tender or contract arising therefrom;
to incorporate, in a fraudulent or irregular manner, a legal entity to participate
in a public tender or enter into an administrative contract;
17 Source: Federal Comptroller General. 21
to obtain an undue advantage or benefit, in a fraudulent way, from
amendments or extensions to agreements entered into with the public
administration, without the proper authorization by the law, the tender protocol
or the relevant contract; or
to manipulate the economic and financial balance of the contracts entered into
with the public administration.
The Clean Company Act also prohibits the hindering of investigation or auditing activities by public authorities. The law specifies that it is an offense to interfere with authorities work, including within the scope of regulatory agencies (which for the oil and gas sector includes the ANP) and supervisory bodies of the national financial system.
[d] Penalties
(i) Administrative penalties
Administrative penalties include a fine varying from 0.1% to 20% of the legal entity’s gross revenue accrued in the relevant fiscal year18 preceding the beginning of the administrative proceeding, excluding taxes. The fine shall not be less than the advantage obtained, whenever it is possible to estimate. The decision imposing the relevant penalty will be published, exposing the offender.
In cases where it is not possible to use the above criteria of the legal entity’s gross revenue, the fine will range from R$ 6,000.00 (approximately USD 2,000.00) to R$
60,000,000.00 (approximately USD 20,000,000.00).
(ii) Judicial penalties
18 In Brazil the fiscal year is the calendar year. 22
Judicial penalties include (i) loss of assets, rights or amounts representing, directly or indirectly, the advantage or benefit gained by the offender; (ii) partial suspension or interdiction of activities; (iii) mandatory liquidation of the legal entity; and (iv) prohibition against receiving incentives, subsidies, grants, donations or loans from public entities and from public financial institutions or institutions controlled by the government, varying from one to five years.
The imposition of penalties under the Clean Company Act does not affect the imposition of sanctions arising out of violations of other Brazilian laws.19
Of note, although criminal liability in Brazil generally stems from longstanding statutes (such as the Criminal Code and other laws), precedents evidence a rising application of more stringent doctrines – such as theories of fact domain – particularly in the aftermath of
Operation Car-Wash. Such evolution highlights the possibility of dire criminal repercussions to executives of corporations that could find themselves implicated in wrongdoing, and underpins how compliance programs have grown ever more relevant to the oil and gas - and nearly all other - businesses in Brazil.
[e] Factors taken into consideration in applying penalties
The factors that will be taken into consideration in applying penalties under the Clean
Company Act include, the seriousness of the offense; the advantage gained or intended by the offender; whether the offense was consummated or not; the level of the damages; the negative effects produced by the offense, among others.
In line with international anticorruption legislation, such as the United States and
United Kingdom, the Clean Company Act also considers two additional factors when
19 Improbity Law (Law No. 8,429/92) or General Public Procurement Law (Law No. 8,666/93). 23
imposing penalties: the adoption of an effective compliance program and the cooperation of the legal entity with the investigations.
This has been a significant change to the Brazilian anticorruption legislation and is of utmost importance for companies operating in Brazil, in order to mitigate their exposure to compliance risks.
[4] Complying with Brazilian Anti-Bribery Legislation
[a] Compliance Programs
After the enactment of the Clean Company Act establishing, maintaining and updating specific mechanisms and procedures to prevent, detect, and correct prohibited acts has become a major concern for companies in Brazil to avoid and identify possible wrongdoings.
Having a compliance program in place will also allow companies to decide whether they wish to make voluntary disclosures to local authorities, as well as obtain credit in cases of possible wrongdoing.
However, merely creating and revising a compliance program is not enough and
Decree No 8,420/2015 and Federal Comptroller General's ordinances and manuals further detail the requirements and guidelines for establishing a robust compliance program.
The compliance program should be broadly distributed and effectively applied throughout the company. Also, it is key to update compliance programs and personnel training thereon on a regular basis and conduct a risk assessment to evaluate the key risk factors to which the company is exposed, considering the size, nature of the operations, location and other factors. The compliance program should be designed to address the specific risks identified. The commitment and engagement of company's management with the compliance matters is also taken into consideration by the authorities when evaluating the effectiveness of a compliance program.
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It is common for oil companies to have global compliance programs in place, which apply worldwide, including to the Brazilian entities of the same economic group. However, given the specifics of Brazilian anti-corruption legislation, it is advisable to have any relevant compliance program reviewed by a specialist with deep knowledge of the Brazilian legal system to ensure compliance with all aspects of the law.
[b] Training
Compliance training programs are one of the pillars of a robust compliance program.
Training should include not only company's employees, but also its management and third parties acting on behalf of the company. Training should cover key anti-bribery laws, codes of conduct, as well as all company's internal policies and procedures.
In addition, companies should intensify training in the areas related to public tender, public contracts and interactions with public officials. It is common for company employees to commit wrongdoings not only because they are unfamiliar with the law, but also because they do not know how to react in certain situations. This is specifically important for companies engaged in oil and gas activities, which are strictly regulated and, therefore, require great interaction with the public authorities.
In this context, it is advisable to conduct interactive training, in the local language, with practical examples.
[c] Third Party Due Diligence
Given the broad liability regime provided under the Clean Company Act, anticorruption due diligence on third parties and in corporate transactions is key to mitigate the risks caused by third parties with which the company does business.
As per the provisions of the Clean Company Act, legal entities may be held liable for the wrongdoings performed in their interest or benefit, even if performed by any third parties.
Therefore, companies should undertake the required precautions to ensure that they form
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relationships with reputable partners, as well ensure the integrity of their contractors and suppliers. In this context, implementing an effective anticorruption due diligence process on third parties is an extremely important factor to reduce risk.
Likewise, given the successor liability provided under the Clean Company Act, mergers and acquisitions do not extinguish the liability for acts committed by the acquired company prior to the transaction, the buyer must be aware of the implications of the Clean
Company Act in the context of corporate transactions. In addition to the common due diligence usually performed in such transactions, companies must also conduct specific integrity and anticorruption due diligence.
In addition to the above, specifically for oil and gas companies third party due diligence in advisable both for joint bidding and farm in transactions.
[d] Internal Investigations
Companies are advised to have “hotlines” or ombudsmen in place, through which employees are encouraged to report suspicious conducts and complaints. Such reports should receive appropriate treatment and be further investigated whenever they indicate the occurrence of wrongdoings or illicit acts.
In addition to being able to prevent, mitigate and repair the damages caused by such wrongdoings, both Brazilian and international anticorruption legislation give credit to companies that respond rapidly and effectively by conducting internal investigations.
Likewise, by conducting a robust internal investigation, companies will be better positioned to decide whether they should be making a voluntary disclosure to the authorities or negotiating a leniency agreement.
Internal investigations should be governed by specific internal policies, including general protocols to be followed in these situations, in order to be prepared to promptly respond to an allegation of wrongdoing.
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[5] Public Companies General Law
[a] Background
The Brazilian Federal Constitution provides for both (i) state-owned companies, which corporate capital and control belong entirely to the government and (ii) state-controlled companies, which corporate capital is held both by the government and by private parties, but the government holds the corporate control of the company. The latter is the case of Petrobras and this is why being familiar with the legislation applicable to state-controlled companies is so important for oil and gas industry players. Although after the flexibilization of the monopoly private companies may acquire E&P rights in Brazil, Petrobras still plays a significant role in country's industry, being responsible for 82.5% of Brazil’s overall production in 201620.
Both state-owned and state-controlled companies must abide by public law principles and certain public law provisions must apply. As a result, historically, state-owned and state- controlled companies, especially those engaged in economic activities such as oil and gas, have struggled to balance their public law principles with the agility and flexibility required for them to compete with private companies in the market.
In 1998 the Brazilian Constitution was amended to include a provision that a law would be created to establish the legal statutes to be followed by state-owned and state- controlled companies, governing, among others, their procurement processes.21
After almost 20 years, on June 30, 2016, the Public Companies General Law22 came into effect to meet this constitutional requirement and make the activities of state-owned and
20 Source: ANP Oil, Natural Gas and Biofuels Statistical Yearbook. 2017 21 Constitutional Amendment No. 19/1998. 27
state-controlled companies more transparent. These companies have until June 2018 to abide by the new law, creating their own internal rules and policies for the procurement of goods and services, in compliance with the general provisions of the law.
The Public Companies General Law is highly relevant to the oil and gas sector as it will apply to Petrobras and cause it to change several internal rules and structures. These rules will impact both service providers and oil companies since changes have been made to
Petrobras’s procurement process and partnerships/divestment policies. Also, the Public
Companies General Law was published in the context of the fight against corruption post
Operation Car-Wash and aims at, among others, reducing the political influence over state- controlled entities.
[b] Administration and Management Rules
To increase governance standards and decrease political influence in state-owned and state-controlled companies, the Public Companies General Law introduced certain technical requirements and restrictions on individuals occupying positions in these companies’ board of directors and executive board.
Individuals must have an academic education compatible with the position to which they were nominated and either (i) 10 years of prior experience in the same or similar area of activity of the company; or (ii) four years in leadership positions in a company of equal size or with similar corporate activities; or (iii) four years in positions of commission/trust in the public sector; or (iv) four years in a teaching/research position in the same field of activity of the company or as a professional in the area.
22 Law No. 13,303/2016. 28
In addition, the following individuals are not allowed to hold positions in a board of directors or executive board: ministers; officers of regulatory agencies; state and municipal secretaries; occupants of term of office on the legislative branch; occupants of superior positions in the public administration that are not public employees; and leaders of political parties.
In line with the Clean Company Act, the Public Companies General Law provides that state-owned and state-controlled companies must establish specific compliance departments and statutory audit committees, as what has already been implemented by
Petrobras.
[c] Public Procurement and Contract Rules
The Public Companies General Law provides that, as a general rule, all contracts with state-owned and state-controlled companies must be preceded of a proper tender procedure, including service contracts, acquisition of goods and divestment of assets.
For civil engineering contracts and related services, which are common in the oil and gas industry, a semi-integrated procurement model is preferred. This model requires that the basic design must be in place prior to the bidding process and may only be changed to reduce costs or time or increase work quality. The author of the basic design is not authorized to participate in the tender, directly or indirectly, nor companies in which the author is an administrator, controller or shareholder holding interest over 5% of voting capital.
Some of the maximum amounts for waiving public procurement have been increased.
For example, for civil engineering and related services the limit was raised to BRL 100,000
(approximately USD 33,000) and for other services and purchases it was raised to BRL
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50,000 (equivalent to USD 17,000), which may be changed by a decision by the board of directors to reflect cost variations.
Also, for public procurement conducted by state-owned and state-controlled companies, the Public Companies General Law does not provide for the invitation model, which was commonly used in the Brazilian oil and gas industry. The invitation model had been based on an specific Decree23 that has been cancelled by the Public Companies General
Law. All processes will become public as from June 2018 and all companies interested in participating and that meet the bidding requirements will be authorized to submit a proposal.
In this sense, the Public Companies General Law provides that for the procurement of common goods and services the preferred model will be reverse auction.
On the other hand, to allow state-owned and state-controlled companies to remain competitive, the Public Companies General Law provides for two situations in which the bidding procedure will not be required: (i) direct marketing, rendering of services or performance of other activities specifically related to the corporate purpose of the state- owned or state-controlled companies; and (ii) in cases in which the choice of the partner is associated with the partner's particularities, relating to specific business opportunities, subject to justification. This allows strategic partnerships in the oil and gas industry, especially considering that oil companies and service providers tend to operate in partnerships globally.
§ 1.04 Summary
The Brazilian oil and gas industry is undergoing significant reforms. With low oil prices and fierce competition from other Latin American countries, notably Mexico, the
Brazilian Government is engaged in meeting old industry claims in order to make Brazil
23 Decree 2,745/98 30
more competitive and attractive to investors. Crucial changes have been recently implemented and many more are on the pipeline, showing that oil and gas is a top priority of the current federal administration. With an open-door policy for investors, a transparent dialogue has been established among governmental authorities and industry players, enabling key decisions to be taken with business logic.
On top of that, the legacy of Operation Car-Wash has resulted in a safer business environment, stricter compliance rules, and stronger enforcement of these rules by the
Brazilian competent authorities.
As for the state-controlled companies, new rules are being put in place to ensure the transparency of procurement and partnerships processes, allowing newcomers into the
Brazilian oil and gas industry.
Thus, Brazil is on the right path to recover its prominence in the international oil and gas market and better explore its full potential, which has already been confirmed by the strong interest of the majors in the 2017 bidding rounds.
The multi-year bidding round calendar and the Petrobras divestment plan, in which blue chip assets are at stake, are considered strategic opportunities for oil companies and service providers who are ready to take the lead in the international oil and gas market.
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