How Brazilian restrictions on the acquisition of rural land by foreigners have an impact on corporate transactions

The acquisition of rural real estate by foreigners is governed by Law No 5,709, enacted in 1971 (“Law 5,709”), and although several bills amending this law have been passed around commissions in the National Congress over the past 10 years (bill nº 2,289/2007, bill nº 3,483/2008, bill nº 4,240/2008, bill nº 4,059/2012, bill nº 1,053/2015 and bill nº 6,379/2016), Law 5,709 remains in force.

Considering that 2018 is election year, and the fact that the current political instability makes it difficult to pass bills on controversial subjects, no change in this matter should be expected this year. However, the Ministry of Mines and Energy announced its intention last February 9^th to remove restrictions on the acquisition of rural land by foreigners who intend to invest in the energy sector.

Law 5,709 contains restrictions on the purchase of rural property by foreigners which, as will be explained below, also concern Brazilian companies directly or indirectly controlled by foreigners. As such, ownership of rural land by Brazilian companies of which foreign investors intend to obtain  control (“Target Company”) may present a hindrance to the transaction. In fact, a corporate transaction of this kind amounts to an indirect acquisition of rural land by foreign investors in Brazil. However, the applicable legislation expressly requires that the restrictions on ownership of rural land by foreigners be observed in (the execution of) corporate transactions.

According to Law 5,709, the acquisition of rural property by Brazilian companies controlled by foreigners is subject to the submission of an exploitation project intended for agricultural, livestock, forest, industrial, touristic or colonization purposes, which must be approved by the National Institute of Colonization and Agrarian Reform (“INCRA”).

Furthermore, the acquisition of rural properties by Brazilian companies controlled by foreigners (i) larger than a certain size which varies from 300 to 10,000 hectares, depending on the municipality in which the property is located, (ii) which are located within a 150-kilometer strip along the country borders or (iii) which are located in a zone considered to be essential for national security requires prior approval by the President and/or the National Congress.

The threshold mentioned under (i) above applies cumulatively to all rural properties owned by the company. This means that the total surface of all rural properties owned by a Target Company must be taken into account in order to determine whether or not the threshold is reached.

The law also provides that, in general, foreigners shall not own rural land corresponding to more than ¼ of the surface of a municipality. Furthermore, foreigners of the same nationality shall not own more than 40% of the aforesaid ¼.

Back in the 90s, the Federal Attorney’s Office (“Advocacia Geral da União, AGU”), took the stance in two opinions that the application of the abovementioned restrictions to Brazilian companies directly or indirectly controlled by foreigners was unconstitutional.

In the legal opinion No. GQ-22, dated June 7, 1994 (Legal Opinion AGU/1994), the reasoning was based on the fact that the Federal Constitution did not allow any distinction between Brazilian companies and Brazilian companies controlled by Brazilian national equity holders (i.e. with a majority of the shares controlled by Brazilian nationals). This position was maintained in Legal Opinion No. GQ – 181 dated December 17, 1998 (Legal Opinion AGU/1998).

Therefore, the restrictions to the acquisition of rural property by foreigners provided for in Law 5,709 did not apply to Brazilian companies directly or indirectly controlled by foreigners.

The AGU, in its Legal Opinion No. LA-01 dated August 19, 2010, published on August 23, 2010 (Legal Opinion AGU/2010), through a new interpretation of the Constitution, introduced a new analysis of whether Law 5,709 was constitutional. According to this analysis, the provision was in fact considered to comply with the Constitution. Indeed, the AGU understands that the Federal Constitution authorizes the legislator to reserve sectors to national capital companies which are essential for the national technical development.

Consequently, after the publication of Legal Opinion AGU/2010, the restrictions on the acquisition of rural properties by foreigners set out in Law 5,709 became also applicable to Brazilian companies controlled by foreigners.

During a long period after the AGU issued its divergent opinion, there was some uncertainty in relation to the validity of the aquisition of rural land by Brazilian companies controlled by foreigners from 1994 to 2010. On December 14, 2017, INCRA issued a regulation (Normative Instruction 88/2017) which recognizes the right to ownership by Brazilian companies controlled by foreigners of rural properties purchased between June 7, 1994 and August 22, 2010.

The Normative Instruction 88/2017 also makes clear the proceedings that should be observed by foreigners, including Brazilian companies controlled by foreigners, when acquiring rural land. It achieved transparency by explaining what evidence and documents must be submitted as part of the request to INCRA to authorize an exploitation project. It also clearly defines foreign control, not restricting it to the ownership of the majority of the voting rights, but also including the power to conduct the deliberations at the shareholders’ meetings, conduct the activities of the company, guide the functioning of the bodies of the company and appoint the majority of the directors of the company.

Furthermore, the Normative Instruction stipulates the duties of the authorities in charge of public registrations, which include the Real Estate Registry and the Commercial Registries. Pursuant to the Normative Instruction, they are required to only register transactions that comply with the law under penalty of civil and criminal liability. On July 13, 2010, the Brazilian National Council of Justice (“Corregedoria do Conselho Nacional de Justiça, CNJ”) had already given strict instructions to the Real Estate Registry Offices (“cartórios extrajudiciais de notas e de registro de imóveis”) to ensure that the restrictions laid down in Law 5,709 also applied to Brazilian companies controlled by foreigners. The Commercial Registries and the Brazilian SEC also received instructions in order to make sure that Law 5,709 is duly enforced and complied with.

However, in practice, the registries do not always exercise control effectively. This is especially so in cases of corporate transactions that appear not to have the purpose of transferring rural land.

Nevertheless, it is essential to only acquire a Target Company after careful due diligence  as non-compliance with the above requirements renders the transaction void. Depending on the outcome of the due diligence, alternative compliant structures may be implemented in a way that will not jeopardize the investment.