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THE ROLE OF LAWYERS IN THE CREATION
AND IN THE DEVELOPMENT OF NEW
BUSINESSES IN BRAZIL
How Brazilian lawyers can reduce transaction costs in commercial
operations.
Tilburg University Law School
International Business Law Program 2011/12 Master’s Thesis
Ullysses Augusto Ferreira Parisi – ARN 960784
Supervisor: Diogo Pereira Dias Nunes
2
Master’s Thesis Tilburg University
International Business Law Program – 2011/12
Number of credits: 12 Subject: Business Law Approved: _____ Grade: _______
Student: Ullysses Augusto Ferreira Parisi – ANR: 960784
Supervisor: Diogo Pereira Dias Nunes - LLM
Jury: Prof. Dr. Erik P. M Vermeulen:
Jing Li:
3
To my family, with profound love.
4
CONTENTS:
PREFACE.....................................................................................................................................................5
1 - INTRODUCTION …………………………………………………………………………………..7
1.1 – A general view on Law and Economics………………………………............................7
1.2 – The plan of this thesis…………………………………………………………………….11
2 – THE MAIN POINTS OF RONALD COASE’S THEORY………………………......................14
2.1– A general view on market transactions…………………………………………………...14
2.2 – The transaction costs and the rise of firms……………………………………………...15
2.3 – The role of governments………………………………………........................................19
2.4 – The criticism on Coase’s theory………………………………………………………....21
3 – A GENERAL VIEW ON COMMERCIAL OPERATIONS. …………………………………...24
3.1 – On economic systems and the new transaction costs………………………………….24
3.2 – The private equity and venture capital concepts…………………………...................28
3.3 – The rise of Silicon Valley…………………………………………………………………30
3.4 – The social and technical barriers………………………………………….......................34
3.4.1 – Lawyers as “transaction-cost engineers”………………………….................34
4 – THE NEW ROLE OF LAWYERS……………………………………………………….................38
4.1– The main difference between civil and common law………………………………….38
4.2 – How governments might contribute to create business environments…………......40
4.3 – Lawyers as agent of changes………………………………………………….................45
4.4 – The corporate restructure law matter in Brazilian legal structures. The pivotal aspects of Law n. 11.101/2005…………………………………………………………………50
5 - BRAZILIAN ECONOMY OVERVIEW…………………………………………………………..56
5.1– A general overlook on Brazilian economy……………………………………………...56
5.2 – Economic aspects to be improved…………………………………………....................59
5.3 – New business opportunities………………………………………………......................60
5.4 – PE and VC industry in Brazil………………………………………………....................62
5.5 – The new lawyer’s posture………………………………………………………………..65
6 – A FEASIBLE SOLUTION TO REDUCE TRANSACTION COSTS………………………….67
6.2 – How new business can be created………………………………………………………67
7 – CONCLUSION……………………………………………………………………………………...76
BIBLIOGRAPHY………………………………………………………………………………………..79
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PREFACE:
"I don't think so. . . " René Descartes, just before dying
In the slavery period in Brazil, there was a story said by rich farmers about
mangos and milk. The farmers used to say that people could die whether they eat
mango and drink milk in the same meal. Many years later a famous Brazilian writer
published a book reveling that those farmers had created this story to avoid pantry
robberies. The farmers started saying to slaves that mixing mango and milk in the same
meal could be lethal. More than two hundred years later many people still believing in
such myth, and even my grandmother (she passed away believing it) told me this story;
and until my fifteen years old I could not eat mango and drink milk in the same meal.
My point is: we are created under paradigms and even while scientific data
proving the contrary we still believing in such myths. In my opinion the same happens
with businesses. Some paradigms were created and we still living with it.
As a lawyer in Brazil, I was feeling such paradigms leaning over my shoulders.
The legal market in Brazil was over saturated of lawyers. Brazil has more than 1.200
(one thousand and two hundred) law schools that place in the market approximately
10.000 (ten thousands) lawyers each year. The number of lawyers attached to the
Brazilian bar association is impressive: 750.000 (seven hundred and fifty thousands).
Most of Brazilian lawyers have a litigious culture and are noosed in the belief that the
law and businesses are two distinct issues and most of them consider a heresy to
combine it. This scenario obliged me to find out and explore new alternatives.
A Chinese proverb says that the better way that somebody has to describe the
shape of a mountain is going down to the plains. Brazilian scenario was bothering me
somehow, because I believed that it was practicable set law and business on the same
path.
6
In this paper I try to bind all dots. My attempt is to discuss theory by using
academic studies and I also describe some real experiences. I want to demonstrate that
lawyers can be more than simply lawyers and get a more active posture in the market.
I am not saying that this paper will break all paradigms or revolutionize theories
on the economics and law. I will not provide solutions for every problem, and much
less issue new trends. My goal here is try to prove that lawyers can and should act in a
different way and unlike concepts may be scrambled.
7
1 – INTRODUCTION.
1.1 – A general view on Law and Economics.
When Ronald Coase received the Nobel Memorial Prize in Economics in 1991, it
was in some way settled that economics and law had established a “great partnership”.
Professor Bruce Arckman of the Yale Law School described the economic approach to
the law as “the most important development in legal scholarship of the twentieth
century”1, and in my opinion he was absolutely correct. According to the doctrine,
economics and law have began working together after Coase’s article: The Problem of
Social Cost, and the article of Guido Calabresi, Some Thought of Risk Distribution and the
Law of Torts.
Traditionally, economics merely exercised influence on some areas of the law,
such as antitrust law, regulated industries, tax and determination of monetary damages.
However, Coase’s article inaugurated a new room of discussion and the economic
analysis of law has spread to other areas of the law such as property contracts, tort,
criminal law and procedure, and constitutional law2.
The economic analysis of law provides us another conception about these two
subjects (economics and law). Economics demonstrates that law is more than a tool
used to provide justice, but also, is a powerful mechanism to comprehend public
policies and to change behaviors (implicit prices) and instruments for policy objectives
(efficiency and distribution). Alternatively, law can bring to economics better
understanding about legal institutions as propriety and contracts.
Throughout the text, I try to observe how economics and law are working and
what the role of lawyers would be in this scenario. Special attention is given to
demonstrate the significance of all economic principles and why lawyers should keep
their eyes and minds opens for events around them. Furthermore, I try to demonstrate
1 Robert Cooter and Thomas Ullen, Introduction to law and Economics (3rd Ed, Addison Wesley Longman 2000) 2. 2 ibid 7.
8
how lawyers can develop a key role in negotiation phases and reduce transaction costs
on private equity and venture capital operations.
I
When I left law school3 and I started working as a lawyer, I noticed a vertiginous
growth on corporate restructuring requests, and a reduction of bankruptcy requests. I also
noticed that the fact that many companies adopted the corporate restructuring
procedure, had two principal reasons: first, due to several factors in the Brazilian and
worldwide economy, and second, the new legislation that had been enacted: Law n.
11.101/2005 (New Bankruptcy Law)4.
This legislation offered a new landscape in corporate governance in Brazil, and
the judicial requests were extended to the whole country. More attention will be given
to this law, but for now, it is necessary to know that the new act provided a sort of safe-
harbor for companies that had real conditions of development5 and that could be
recovered, but due to several aspects, were facing some problems in their operations.
At that time, I did not have a complete idea about the entire economic aspects and legal
issues involved, but my first impression was that the economic scenario and the new
Act offered lawyers a fantastic opportunity to create something innovative. However, I
also noticed that only these factors would not be enough and something was missing.
The previous experiences in other countries (Japan and USA, for instance)6 confirmed
that only law reforms are not the unique aspect, but one of many that are necessary to
provoke true changes. According to Olive Hart:
“It is important to recognize that bankruptcy reform should not be seen in isolation; it may be
necessary to combine it with legal and others reforms, e.g., the training of judges, improvements in
3 It was in 2007. 4 More information will be provided in Chapter 3. 5 This subject will be further explored in Chapter 3; however, the meaning of development in this particular case is for companies which hold conditions to run its activities, but were facing some financial problems. 6 Oliver Hart, Different approaches to bankruptcy (Harvard Institute of Economics, Research 2000) 1-2.
9
corporate governance and the strengthening of investors rights, and possibly even changes in the
international financial system7.”
Thus, I tried to detect what sort of legal or even economic aspects could be
combined to create innovative outlets for the new perspective.
II
I was born in a small town and later on I moved to one of the largest cities in
Brazil to attend my first course, and these facts forced me to acquire another perspective
on businesses and law. I started comparing two different sorts of behaviors among large
and small cities. Besides all the differences, both cities had two aspects in common at
that time: i) the growth of recovery request (because of the new legislation) as I
mentioned before, and ii) entrepreneurs and businessmen complaining about the
economic scenario (lack of investments) and the legal system.
The enigma was that Brazil was experiencing significant changes in economic
standards and there were many business opportunities, on the one hand, and of course,
there were many sorts of obstacles which included finance and legal aspects on the
other hand. Then, I started asking myself how lawyers could help, or in some way,
intervene positively in the economic matters, and above all how could a lawyer handle
all these aspects and create something new?
Brazil is a paradoxical country with many rich regions and poor parts. It has 26
(twenty six) states and more than 5000 (five thousand) municipalities8, and for each one
it is possible to find out particularities and common aspects. The same phenomenon
occurs in businesses. In sum, besides industries and service activities, in most cities
there are i) innovative businesses that need capital; ii) companies that need money to
grow9, and iii) companies in phase of bankruptcy (due to several factors). Afterwards, I
7 ibid 3. 8 IBGE Cities: http://www.ibge.gov.br/cidadesat/topwindow.htm?1 9 Typical targets of private equity and venture capital industry, respectively. I provide more details in Chapter 3 and Chapter 5 on these issues.
10
realized that these three different scenarios did not communicate with each other, but
they could do if there was someone to put them together.
Naturally, these sorts of activities demand lawyers’ expertise and skills, but what
sort of them? From my point of view it was extremely clear that lawyers could write
agreements, represent their clients before courts – in judicial recovery or bankruptcy
cases, for instance, – write memorandums or provide legal advice. However, what more
could be done? Were lawyers able to create something new? Were there limits? It was
difficult to accurately identify how a lawyer could work to intervene in the market and
to keep business opportunities alive and, at the same time, create and develop new
businesses.
After all, the economic outlook was highly favorable (and as I will show, it still is
for doing business); there were (and still are) opportunities and demands, but I noticed
that there was missing a person (or a legal entity) to turn the abstract into something
real.
Because always demanded for resolving contentious disputes or providing
specialized memorandums, lawyers developed a function of lower expressivity in the
Brazilian businesses scene. Besides they were demanded only in the end of the
negotiation process10. Lawyers, in my opinion, are capable to act along the negotiation
process. Hence, what I try to develop in this text is to drive attention to other functions
that lawyers are able to perform.
III
Generally speaking, the fact that lawyers know the legislation (and procedures),
monopoly on legal advice11 and can analyze a wide variety of social phenomena, turn
them able to make the connection between different businesses and overall reduce the
transaction costs and foster new ventures. Lawyers can take a posture that precedes the
10 Here I am expressing my impressions about advocacy activity in Brazil from my former experiences. 11 Larry Ribstein, Practicing theory: Legal Education for the Twenty-First Century (Iowa Law Rev. Vol. 96, 1649-1676) 1664.
11
dealings and create and develop new businesses supported by a multidisciplinary
firm12. The idea is that lawyers hold control of more negotiation stages to foster it in
order to reduce transaction costs.
In general, lawyers do not participate in the negotiations and only step in when
all the conditions are already discussed, and then their role is limited to charge fees to
advise that a series of issues should be revisited and others which should be removed.
Therefore, I try to demonstrate that lawyers can bring more lifeblood to business
environment if they use their expertise and knowledge to act more as businessmen than
purely lawyers helping in the creation and the development of new businesses.
1.2 – The plan of this thesis.
The text is divided in three main parts: theoretical, empirical and a part
dedicated to provide a feasible solution to the problem which is the role of lawyers in
fostering business opportunities. The text goes as follows: In Chapter 2, I deal with
fundamental aspects of Ronald Coase theory. As I have mentioned previously, Coase
developed, in my opinion, the most influential theory on law and economics, and gave
an additional perspective of the economic analysis of the law. His theory about the
nature of the firms and social costs opened a new room of debates and provided to
academic perspective a new spectrum of analysis. Firstly, I drive my attention to the
importance of firm and its vital role in the economic theory. Afterwards, my spotlight is
on the transactions costs and the way firms can allocate them.
In Chapter 3, I discuss two issues: the “new” transaction costs and the
importance of Silicon Valley for the venture capital and private equity industry.
Actually, my objective in Chapter 3 is to figure out the real transaction costs that are
creating obstacles to glean businesses. In the end of Chapter 3 I lay down my analysis
on some feasible exits to create a positive business ecosystem having as benchmark the
Silicon Valley’s case.
12 Larry Ribstein, The Death of Big Law (Wisconsin Law Review, No. 3, 2010) 798.
12
In Chapter 4, my attention is on demonstrating the limits that Brazilian lawyers
face. Lawyers’ activity in Brazil is highly regulated and imposes on lawyers a series of
limits. Furthermore, lawyers in Brazil are not able to “sell” their expertise and their
services in the market. Thus, my first purpose is to identify all the limits (legal, social
and moral) that lawyers are facing and soon after demonstrate that even with all the
limits it is feasible for lawyers to stand an active posture. I bring some examples of real
cases and an interview with a partner from one of the biggest Brazilian law offices to
support my arguments.
Throughout real cases, I try to demonstrate that lawyers can expand their scope
and promote changes in different areas of economics, politics and legislatures, and also
reveal that there are some areas which should be more explored by lawyers. Interest is
also given to the role of lawyers of common law and civil law countries. I try to reveal the
main differences between these two systems and investigate what Brazilian lawyers can
learn from a different system. In the end of Chapter 4, the attention is pitched on Law n.
11.105/2005. This new legislation had a considerable influence of lawyers in it
conception, and in my opinion, could be used and better explored by lawyers. I think
that a better explanation on the mechanisms of this new regulation would be useful.
In Chapter 5, the spotlight is on Brazilian economy. Brazil has dealt with all
internal and external factors very well, which in turn has provided a veritable virility in
the economy and offered the achievement of various new businesses. Therefore, the text
in Chapter 5 deals primarily with the economic scenario, the main strengths and
weaknesses of Brazilian economy and investigates with statistics basis, the venture
capital and private equity industry behavior in the last decade. I also provide arguments
to support the facts that make Brazil a country of vast opportunities.
Afterwards the theory and the practical aspects have been debated, I drive my
attention to the role of lawyers in shrinking transaction costs in commercial operations
(more attention is given to private equity and venture capital operations) and how to play a
13
more relevant role in the creation and the development of new businesses in Brazil.
Inevitably some questions arose during the elaboration of my text: Do legal limitations
prevent lawyers to acquire an active role in the articulation of businesses? If there were
not strict limitations, lawyers could do more businesses in Brazil? Does the conflict of
interest prevent developing and structuring of new businesses? Could Brazilian rules be
less rigid in this respect? I try answering all these questions properly.
In Chapter 6, my attempt is to gather all the information and theory described in
the previous chapters and outline a feasible solution for lawyers and demonstrate how
they can reduce transaction costs in commercial operations taking into account i) all the
limits imposed by laws, ii) the legislation available and iii) the current Brazilian
economy scenario.
The text does not have any ambition to bring a new theory or draw new
procedures; instead, the paper’s ambition is to expose some ideas and try to organize
them systematically.
14
2 – THE MAIN POINTS OF RONALD COASE’S THEORY.
"Don’t listen to authorities. Find out what the problem is, get the facts, and make up your own mind. Use the scientific method to work things out."
(Endel Tulving)
In this Chapter, I address my analysis to different aspects of Ronald Coase’s
theory. Firstly, I discuss the importance of the creation of firms in order to reduce
transaction costs. Secondly, I argue how Coase reached the conclusion that firms could
play a crucial role in the economic system. Finally, I examine the impact of governments
in order to structure and enhance new business environments.
2.1 – A general view on market transactions.
Thinking broadly there are at least two methods to acquire a product: to produce
it or to acquire it in a costly way. In the first option it is necessary, depending on the
product, to have several ingredients to make it and for the second option, it is necessary
to have a place to purchase the product. Whatsoever the form chosen, market13 is the
most appropriate place to hold up the negotiations. Let us think only on the first option,
and let us take the product bread, as an example. Most people are capable to produce
bread, and several ingredients are necessary to produce it. Let us suppose further that
“A” produces wheat, and decides to make bread. In this way “A” would have to
purchase (or to acquire) salt from “B”, and also to acquire yeast from “C”, and these
exchanges (contracts) would need an environment to occur which shelter all these
individuals allowing them to negotiate on a fair way.
13 In this case I refer to market as an institutional environment capable to shelter the players of different negotiations in an equally way. As a matter of fact, market is a place sheltering institutions, social relationships, and procedures and so on, whereby parties engage to exchange (goods, services, labor force, etc.). “A” can exchange your labor force for some money. “B” is able to buy goods and service from “C”. In sum, market is a place where prices of goods and services are established, and in the end it is necessary that someone sell and somebody buy in order to complete the economic circle.
15
The idea that "A" conducts a business (contract) with “B” and “C” and that
negotiation represents a null cost and all property rights of parties involved shall remain
intact, would be an idyllic scenario for all involved and the market would be the perfect
place to perform this sort of negotiation.
Let us take the scenario presented above and add a new element called: “D”. “D”
is also a wheat producer and decides to make bread as “A”. “D” also needs to acquire
yeast from “C”, which only supplied “A”. “C” decides that it will continue to produce
the same quantity produced earlier and says that “A” and “D” should divide the yeast.
There are, at least, three possible scenarios: i) “A” and “D” accept the imposition of "C";
ii) “A” (or “D”) waives to acquire yeast from “C” and try to find other yeast supplier, or
iii) “A” rejects the proposal and states that it should receive more yeast than “D” since
he was making bread before, and consequently a long battle with “D” begins.
Independently of the solution presented, it will be very difficult to respect property rights
entirely, and that there are no transaction costs involved in this chain of events.
In fact, the existence of the market for those types of negotiations was a
determinant factor for the expansion of Western14 economies, which generated greater
economic growth and raised life social standard. Nonetheless, the greater sophistication
of production systems15 has spurred new sorts of institutions enable to replace the prior
market concept, which was not more sufficiently capable to organize all the transactions when
the production process became more complex and with multiple stages.
2.2 – The transaction costs and the rise of firms16.
14 My reference here is to European countries that conquered other countries and imposed new social, economical and political concepts. 15 My reference here is to the Industrial Revolution, period from 1750 to 1850, where changes in agriculture, manufacturing, mining, transportation, and technology had a profound effect on the social, economic and cultural conditions of the times. Of course there were other important periods along the history, but in my opinion the Industrial Revolution was the beginning of the major changes. 16 Ronald Coase argues that inside a firm the market transactions are eliminated and the entrepreneur function takes place in order to direct the production; in Ronald Coase, The Nature of the Firm (Economica, New Series, Vol. 4, No. 16, Nov 1937) 388.
16
Ronald Coase noticed that there were a number of transaction costs17 to use the
market18 and the costs of obtaining a good or a service using it were actually more than
the price of the good itself. The emergence of Ronald Coase’s theory had crucial
importance because he invoked the notion of transaction costs as search and information
costs19, bargaining costs20, and policing and enforcement costs21 to explain the emergence of
firms as institutions, and to discuss the determinants of their limits. In this context, firms
arose as fundamental institutions to the development of modern economies:
“It is hoped to show in the following paper that a definition of a firm may be obtained which is not
only realistic in that it corresponds to what is meant by a firm in the real world, but is tractable by
two of the most powerful instruments of economic analysis, developed by Marshall, the idea of the
margin and that of substitution.”22
“…The firm represents such an alternative to organizing production through market transactions.
Within the firm individuals bargains between the various cooperating factors of production are
eliminated and for a market of transaction is substituted an administrative decision. The
rearrangement of production then takes puce without the need for bargains between the owners of
the factors of production.”23
These arguments suggest that firms will arise when they can arrange to produce
internally the goods that they need and when they can reduce the costs mentioned
previously24. According to Coase, there is a natural limit to what can be produced
17 In economics and related disciplines, a transaction cost is a cost incurred in making an economic exchange (the cost of participating in a market). For example, a) the commission paid to a broker is a transaction cost of doing a stock deal;, b) if somebody decides to buy something from a store, this person should take into account the costs besides the price of the product: the energy and effort it requires to find out which products that person prefers, where to get them and at what price, the cost of traveling from your house to the store and back, etc. 18 See footnote n. 11. 19 Search and information costs are costs such as those incurred in determining that the required good is available on the market, which has the lowest price, etc. 20 Bargaining costs are the costs required to come to an acceptable agreement with the other party to the transaction, drawing up an appropriate contract and so on. On asset markets and in market microstructure, the transaction cost is some function of the distance between the bid and ask. 21 Policing and enforcement costs are the costs of making sure the other party sticks to the terms of the contract, and taking appropriate action (often through the legal system) if this turns out not to be the case. 22 Ronald Coase, The Nature of the Firm (Economica, New Series, Vol. 4, No. 16, Nov 1937) 386. 23 Ronald Coase, The Problem of Social Cost (The Journal of Law and Economics, Volume III, 1960) 8. 24 See footnotes n. 15, 16 and 17.
17
internally. Coase also noticed decreasing returns on the entrepreneur function25, and an
increasing on overhead costs, and on the other hand an increasing propensity for a
manager makes mistakes in resource allocations, what he named the countervailing
costs to use firms26.
Coase argues that the size of the firm is the result of finding an optimal balance
between the competing tendencies of the costs previously outlined. In general, in
making the firm larger27, it will be advantageous in the beginning, but the decreasing
returns will eventually prevent the firm from growing indefinitely28.
Historically, firms had never played a decisive role in the theory of the economy
prior to Ronald Coase and they always were seen as abstract unities instead as
economic phenomenon. Economists were worried much more in elucidating the
quantity theory of money, to explain the emergence of a social institution, that forgot to
consider the role of institutional arrangements in other contexts. According to the
traditional economic theory, firms were regarded as black boxes responsible only for
combining inputs to maximize profits29.
“For a long time the firm’s appearance in economic models was anorexic: more bones than flesh.
The firm was treated as a glorified profit-making machine (…) Almost no attention was paid to
basics questions such as: how is production organized within a firm, on whose behalf is the firm
run; or, most fundamentally what is a firm? Of course, a literature has existed on some of these
25 Coase (n 22) 392 – 95. 26What can be said roughly is that Ronald Coase analyzed (highlighted) transaction costs (search costs, negotiation costs and monitoring costs) associated with information flows in market interactions, which most other economists ignored. What can be concluded is that the size of the firm is determined by the levels of these “overhead” costs. The lower they are, the smaller the optimal size of a firm for given conditions, and if you take that costs to zero, you get a firm-less economy of free agents. 27 Coase (n 22) 405. 28The rise of the Internet, for instance, on the nature of the economy is to lower transaction costs, leading to the broad, sweeping conclusion that the average size of firms will likely shrink rapidly, both by way of shrinkage of existing enterprises as they reduce themselves to infrastructure hubs with surrounding ecosystems, and directly, by way of growth in SMBs and freelance work in the economy (though a few mega firms, larger than any in history, may still emerge, for other reasons, the average will shift downwards). 29 This is a general view on what neoclassical economy theory says on the economy system. I explore more this issue in Chapter 3. Coase started a line of thinking in economics that viewed the firm as the fundamental structure of the economy. Nothing in either Keynsenian or Friedmannian economics really implies or underlines the role of the firm.
18
question at least since Coase`s famous 1937 paper, but this wasn`t integrated into the theoretical
mainstream30.”
The wisdom behind this perspective was that the variant "price system" could
explain very well the problems concerning the allocation of resources, but unfortunately
there was not any theory to explain costs’ allocation. Thus, once noticed by Coase that
transactions were often costly, it became necessary the establishment of new institutions
(firms) - in order to reduce these costs31. In sum, according to Ronald Coase, firms are: i)
institutions able to allocate - totally or defectively - the transaction costs existents in the
market, through administrative decisions, and ii) institutional arrangements based on
an inextricable network of contracts32.
Firms provide an alternative model of co-ordination to the market, and the
rationality behind the creation of firms is closely (or exclusively) related to transaction
costs. Put in another way, if transaction costs are virtually zero there would be no reasons
to create firms, because the allocation of costs would occur through individual
contracts. Therefore, the presence of transaction costs explains the phenomenon of
firms’ expansion, which occurs when the allocation of costs in the firm (internally) are
greater than would be via contract in the market33.
In this aspect, firms can be characterized by the leeway of the decisions taken
from a family of open contracts and incomplete in terms of details. Firms can also be
portrayed as a set of contracts that binds to the outside world through other contracts,
causing a specific distribution of rights and obligations. According to the Coase’s vision,
firms should be understood as part of the economic structure34 composed by different
30 Oliver Hart, Capital Structure as a Control Mechanism in Corporations, (Canadian Journal of Economics, Vol. XXI, N. 3, 1988) 467. 31 Coase (n 22) 391. 32 ibid 392. 33 ibid 404. 34 Ibid 398.
19
institutional arrangements, and by the effort of economic agents to keep transaction
costs within an acceptable minimum level.
2.3 – The role of governments.
Another important aspect of firms is that they emerge in a certain institutional
framework wherein they are subject of positive35 and negative36 externalities37. Under
this specific topic, I would like to drive a special attention to the negative externalities.
According to Ronald Coase, governments, in general, should intervene on
institutions and agents that can provoke social damages in the market (bribing, for
instance). For this purpose governments must use instruments such as rules in order to
impede the social damages to cause negative externalities. These rules,38 however, might
be used only when firms cannot close a fair deal using the market. This solution leads to
a more efficient allocation of resources and at the same time try to regulate the
relationships in the market. Although it does not mean that this action is more efficient
or better, instead it only means that in some cases such action is necessary because firms
could not agree on some result.
“The government is, in a sense, a super-firm (but of a very special kind) since it is able to influence
the use of factors of production by administrative decision. But the ordinary firm is subject to
35 Positive externalities or beneficial externality include: Increased education of individuals that can lead to broader society benefits in the form of greater economic productivity, lower unemployment rate, greater household mobility and higher rates of political participation. A beekeeper keeps the bees for their honey may lead the pollination of surrounding crops by the bees. The value generated by the pollination may be more important than the value of the harvested honey. Home ownership creates a positive externality in that homeowners are more likely than renters to become actively involved in the local community. 36 A negative externality is an action of a product on consumers that imposes a negative side effect on a third party; it is "social cost". Many negative externalities (also called "external costs" or "external diseconomies") are related to the environmental consequences of production and use. Air pollution, Anthropogenic climate change, Water pollution by industries that adds poisons to the water, which harm plants, animals, and humans. Individuals do not consider this efficacy cost when making usage decisions, leading to socially sub-optimal antibiotic consumption. 37 In economics, an externality, or transaction spillover, is a cost or benefit not transmitted through prices that is incurred by a party who did not agree to the action causing the cost or benefit. The cost of an externality is a negative externality, or external cost, while the benefit of an externality is a positive externality, or external benefit. In the case of both negative and positive externalities, prices in a competitive market do not reflect the full costs or benefits of producing or consuming a product or service. 38 Ronald Coase draws attention to the tributary sphere and the individuals’ right.
20
checks in its operations because of the competition of other firms which might administer the same
activities at lower cost and also because there is always the alternative of market transactions as
against organization within the firm if the administrative cost became too great. The government is
able, if it wishes, to avoid the market altogether, which a firm can never do.”39
“Furthermore the government has at its disposal the police and the other law enforcement agencies
to make sure that its regulations are carried out. It is clear that the government has power which
might enable it to get some things done at a lower cost than could a private organization (or any
rate one without special government powers). But the governmental administrative machine is not
itself costless. It can in fact the restrictive and zoning regulations, made by a fallible administration
subject to political pressures and operating without any competitive check will necessarily always
be those which increase the efficiency with which the economic system operates.”40
The example given at the beginning of this Chapter demonstrates that if every
property rights were properly defined and the transaction costs were nil, the market (by
itself) would be a perfect scenario and the agents could negotiate contracts in a
voluntary way and solve the issues that impede the negotiations happen. In this case
the production would be more efficient in use of resources and a legislation to ensure
the welfare and initial rights and obligations for individuals, would not make any
sense, because the best solution could be find voluntarily. Thus, the non-existence of
transaction costs makes the government intervention unsuitable since the individual
arrangements (voluntary agreements) turned the situation more efficient.
Alternatively, the intervention of government in adverse conditions, i.e., in
which transaction costs are not zero, can generate a more efficient allocation of
resources than the market. Nevertheless, it is necessary that the government acts with
extreme rationality, and then the allocation could be done as efficiently as possible
without causing harms to the parties involved41. In other worlds, since the transaction
39 Ronald Coase, The Problem of Social Cost (The Journal of Law and Economics, Volume III, 1960) 9. 40 ibid 10. 41 This question is further debated by Coase in The Problem of Social Cost when he brings the case Sturges v Bridgman into discussion. In this case, a doctor had moved to a nuisance sweet maker, and both went to the court to see who should have to move. According to Coase independently the result reached in the Court, the law should produce an outcome similar to what would result if the
21
costs may restrict the negotiation through the market, the institution of rights becomes
highly relevant to allocate different resources, and the role of government institutions is
to distribute these rights in rationality way among members of the society.
According to Coase, market is not only restricted to a systematic exchange of
goods and services, but also an environment in which rights can be traded. Thus, state
intervention is always the best alternative only when: i) agents cause social damages, ii)
transaction costs are not null, and iii) governments can reduce the difference between
private output and the social product. The exchange of rights in the society in which
there are transaction costs is vulnerable, and the responsibility of government
institutions is to determine individual rights and privileges through legislation.
Generally speaking, governments should limit their role to facilitate bargaining
and to elaborate policies to enforce contracts faster and in a more objective way. If all
the conditions that Coase mentioned apply (property rights well defined, people act
rationally and minimal transaction costs) the parties involved can bargain, and
consequently solve the problem of externalities voluntarily. Nonetheless, if the prior
conditions do not apply, government might intervene minimally to regulate
relationships.
2.4 – The criticism on Coase’s theory.
I
Coase, however, does not offer a negotiation method and criticism might go
further if the analysis is on the scarce or absence of government intervention. Let us
take the example given in the beginning. Let us replace the actors (“A”,“B”, etc) for
transaction costs were eliminated. Coase believes that Courts, in general, should be guided by the most efficient solution. The ultimate analysis that can be extracted by this discussion is that law and regulation are not as important or effective at helping people as lawyers and government planners believe, and in the end of the day, the doctor and the sweetmaker, could be reached a reasonable solution without the Court verdict.
22
huge companies. Let us suppose that one of those companies is a dye producer, which
is causing great pollution damages. Let us suppose further that the first firm bribes the
second one. The first firm would suffer no negative consequences because the
government would not know about the bribing, and the damage can be perpetual to the
nature and can affect economically other companies.
Troubles with the Coase Theorem can also occur when there is a huge company
involved and damages are affecting a large number of people. How can all the
individuals negotiate with the company?
Let us suppose oil leaking from a huge international oil company that
contaminates a river. Let us suppose further that this problem affected the health
condition of a large number of individuals who had drunk the water, causing different
sorts of diseases. It is very difficult, or almost impossible, for each person to negotiate
with the company. Hence, the most common approach might be the government
intervention that should fine the firm by using rules.
In sum, Ronald Coase argues that if all parties involved can easily organize
payments in order to pay each other for their actions, then an efficient outcome can be
reached without government intervention. This argument can be carried further and
make the political claim that governments should restrict it their roles to facilitate
bargaining among firms or individuals and enforce contracts.
II
My purpose in this chapter was to demonstrate the main aspects of Ronald Coase
theory regarding firms and transaction costs. It is important to note that firms have a
crucial role in the economy in order to reduce transaction costs systematically. I also
highlighted the minimal government intervention in the economic system. Throughout
the next chapters I will provide more detailed explanations on how these concepts can
23
apply in the business world. I believe that individuals can establish better solutions, and
I also understand that governments should only act to repair some social damages that
individuals could not deal with.
24
3 – A GENERAL VIEW ON COMMERCIAL OPERATIONS.
"You can't change anything by fighting or resisting it. You change something by making it obsolete through superior methods"
(Buckminster Fuller)
“Public attempts to foster innovation that do not focus on changing human behavior are doomed to fail” (Victor W. Hwang and
Greg Horowitt)
In this Chapter my goal is firstly to demonstrate that the neoclassical economic
theory failed because it did not locate individuals properly on it analysis. Secondly, as I
mentioned before, firms could solve (partially) the costs involved in some market
transactions, however other costs remain alive. In order to reduce these costs I purpose
that lawyers act to change some behaviors. Finally, I take the Silicon Valley’s case to
illustrate how a place may achieve success combining new ideas, capital and legal
innovation.
3.1 – On economic systems and the new transaction costs.
If it were possible to summarize the way in which the economic system works,
probably it would be describing as a constant flowing of capital to different investment
projects. Put it differently, people who hold land, gold, animals or cash, must flow these
capital42 into projects to build factories and to hire people. Besides that, to bind these
two sides, it is necessary that a financial system exists to better allocate the capital into
an investment projects in order to grow the gross domestic product. In a very simple
description, this is the way that economic systems work. It is also tangible to say that, a
developed country, which holds a leading economic power, has these three structures
well defined, i.e., the capital are always flowing to investment projects, and the financial
system is working constantly in order to allocate the capital in a profitable way.
42 This is not the Marxist conception on capital which implies the labor force exchange and productive forces and so on. The point I am trying to make here is to describe capital in a general form, and considering it as a sort of wealth.
25
In this sense, the most basic and crude idea of an optimal economic system is the
continual transference of capital (inputs) into the economic system to create outputs.
This concept was broadly diffuse for years long by the neoclassical economic theory43.
According to this theory, output is determined by inputs such as land, labor, capital and
technology; however, the neoclassical theory does not consider the human beings as
crucial players in the economic system44.
The economy is not made only by gears or intangible figures; instead it is
constituted by human beings. They are in reality “who sign leases, who work hours,
who invest money, and who invent ideas”45. Given the prior mentioned inputs, they
should be managed for different persons: “the land might be controlled by a landlord,
the labor by an engineer, the capital by an investor, and the technology by a scientist”46.
As I mentioned before, the system based on the good exchanges had evolved and
a more complex (not necessary better) system settled place, and the creation of entities
to reduce the transaction costs arose (firms)47. At first glance, this new scenario leads to
conclude that the complexity of the economic system, with different sorts of industries
and companies, will conduct the society to an infinity growth of firms in order to reduce
the transaction costs flanked by individuals. What is learned from Coase (well
developed in his Theorem) is that in the absence of transaction costs or regulatory
barriers, resources will flow to their most valuable use. Faster, better broadband will
depends on getting spectrum freed up. In this sense, firms suggested by Coase have
obtained great results in the length of years, by reducing costs. This fact leads to
recognize that firms (in general) can reduce the costs that generated more impact in the
society48.
43 The neoclassical economic school arose in the end of XIX Century with Carls Menger (1840-1921), William Stanley Jevons (1835-1882) and Léon Walras (1834-1910). Others authors also deserve to be mentioned due their huge philosophic contributions as Alfred Marshall (1842-1924), Knut Wicksell (1851-1926), Vilfredo Pareto (1848-1923) and Irving Fisher (1867-1947). 44 Victor Hwang and Greg Horowitt, The Rainforest, The Secret to building the next silicon Valley (Regenwald, Los Altos Hills, California, 2012) 3. 45 ibid 3. 46 ibid 4. 47 See Chapter 2. 48 Coase (n 22) 391.
26
Following this premise, it would be logical to conclude that the Coasean world49 is
closer than never, since firms are still being created and as a consequence the costs still
are being reduced; which in turn leads to a less government’s interference, and so forth.
Conversely, this scenario is not as simple to be achieved.
Transaction costs still are alive in the contemporary economic system and still are
generating great obstacles. The more economy evolves, the more costs rise up in
different forms. Probably Ronald Coase is glad seeing his theory about firms getting
more powerful and perhaps unhappy because the ideal “world” will not be
implemented soon (or never). The idea of transaction costs persist in different sorts of
relationships, and most of the time it is very tricky to observe all of them. Victor W.
Hwang and Greg Horowitt50 bring some important traces of these “new” transaction
costs:
“Scientists are discovering that innovation and human emotion are intertwined. Human nature,
with its innate prejudices, creates enormous transaction costs in society. Thus, what we think as
free markets are actually not that free. They are still constrained by transaction costs caused by
social barriers based on geographical distance, lack of trust, differences in language and culture,
and inefficient social networks. Those social barriers can be high, and they can keep people
isolated, and thus not transacting with one another. Social barriers create transaction costs that
stifle valuable relationships before they can be born51”.
Ronald Coase provided a general view of firms and demonstrated their
importance to reduce the transaction costs such as bargain costs, search and
development, politic and enforcement52. But what can be said about cultural costs? Are
they biased costs? And the most important question: How to reduce (or eliminate) these
costs?
49 See Chapter 2. 50 Victor W. Hwang is a venture capitalist and entrepreneur living in Silicon Valley. He is co-founder of T2 Venture Capital, a Silicon Valley’s firm that grows startups, manages capital, and advises on global development and innovation policy. Greg Horowitt is co-founder of T2 Venture Capital where he has invested in a variety of technology and life science startup companies. 51 Hwang and Horowitt (n 44) 4. 52 See footnotes 15, 16 and 17.
27
It can sound weird, but a careful analysis should demonstrate that the greatest
economic value is created in transactions between people who are the most different
from one another53. The history proved that whilst ideas and money are put together,
they can work very well and produce amazing devices. In other words, a scientist and a
businessman can establish a great partnership54. It is possible to verify this fact
throughout the human history, and also to learn from former experiences that richness
were created while great leaderships, good management, entrepreneurs and capital
were put to work together.
It is not totaling incongruous to say that almost the entire human history is based
on the necessity of the creation of new devices to improve the production process and
to elevate life standards. Going deep in such premise, it is feasible to state that all the
society improvements started with a novel idea, which in turns, at some point became
real because it received capital to be developed.
I am tempted to say that Brazil, for instance, resulted from a great combination
between new ideas, entrepreneurship and capital. At that time, some entrepreneurs,
headed by Pedro Alvares Cabral, convinced the Portuguese Empire55 that there was a
vast uncovered territory overseas and it was possible to conquer such territory and
explore its natural resources. By using caravels, a high-risk gadget, they reached to the
mysterious land. Once in Brazilian territory, Portuguese navigators dominated it, and
immediately started sending gold, silver, and all species of goods to Portugal. To make
the story short: five hundred years ago some entrepreneurs (brave and visionary
navigators) with a great idea and technical knowledge, convinced other persons
(Portuguese Empire) to provide capital in order to sponsor a high-risk plan. As
guarantee, the entrepreneurs promised richness and lushness of goods (nowadays
known as profits).
53 Hwang and Horowitt, (n 44) 10. 54 ibid 12. 55 Private Equity and Venture Capital Industry – 2nd Brazilian Census. / Brazilian Agency for Industrial Development, Center Management and Strategic Studies - Brazilian Agency for Industrial Development, 2009, p.55.
28
I could retrace great episodes of history since Cristovalo Columbus56 and Pedro
Alvares Cabral, crossing by JP Morgan57 and Georges Doriot58, until the growth of
Silicon Valley59. Yet, the main idea is that different people, different skills, shall work in
the same direction to generate great results. The currently well-known tool responsible
to finance these elements is venture capital and private equity60, but the original concept is
elderly.
For the sake of transparency, I provide a fast explanation on PE and VC concepts
(3.2) and afterwards, my spotlight is on the creation of an innovative ecosystem having
the Silicon Valley case as a benchmark.
3.2 – The private equity and venture capital concepts.
Apparently, PE and VC definition, and all the terms involved, are getting more
blurry, given the dynamic and evolution of the economy. It is possible to verify angel
investors now competing with VC’s on small or very early stage deals, while some of
the buyout and hedge funds are doing larger VC-type deals. But what all these terms
mean? What is the main difference between the PE and VC?
For the purpose of this study, I will consider the VC as subset of PE. Technically,
the PE operations are simply operations that are not available for public participation,
which can includes VC, angel investing, hedge funds, buyout funds, and so forth. They
both invest in companies, they both recruit former bankers, and they both make money
from investments rather than advisory fees, and in the end of the day PE and VC firms
do investments in companies and make money by exiting, say, selling their
investments.
56 A Spanish navigator who was responsible to conquest the North and Central America sponsored by Spanish realty. 57 Later, J. Pierpont Morgan's J.P. Morgan & Co. would finance railroads and other industrial companies throughout the United States. In certain respect, J. Pierpont Morgan's acquisition of Carnegie Steel Company from Andrew Carnegie and Henry Phipps for $480 million represents the first true major buyout known nowadays. 58 The "father of venture capitalism” (founder of INSEAD and former dean of Harvard Business School), with Ralph Flanders and Karl Compton (former president of MIT), to encourage private sector investments in businesses run by soldiers who were returning from World War II. ARDC's significance was primarily that it was the first institutional private equity investment firm that raised capital from sources other than wealthy families although it had several notable investment successes as well. 59 I will provide more attention to this subject later. 60 For the sake of simplicity I will use from now on the letters “VC” to indicate venture capital and “PE” to indicate private equity.
29
Nevertheless, in a bottomless analysis it is feasible to verify some essential
technical differences between these two institutes. At first glance, the term “venture
capital” was used to designate investments in early “start up” companies, and the PE
refers to bigger funds that do later stage deals, hedge and buyouts – the types of deals
that traditional VCs do not do. The term “private equity” refers to money invested in
private companies, or companies that become private through the investment. It is also
tangible to mean “private equity” as firms that buy companies through leveraged
buyouts (LBOs)61. PE firms buy companies across all industries; whereas VCs are,
generally speaking, focused on technology, bio-tech, and clean-tech. PE firms almost
always buy 100% (one hundred percent) of a company in a leverage buyout, whereas
VCs only acquire a minority stake – less than 50%.
VC investments are much smaller – often below $10 million for early-stage
companies. VC firms use only equity62 whereas PE firms use a combination of equity
and debt. PE firms buy mature, public companies whereas VC’s invest mostly in early-
stage – sometimes pre-revenue – companies.
VCs expect that many of the companies they invest in will fail, but whether, at
least, one investment will generate huge returns and make the entire fund profitable.
Venture capitalists invest small amounts of money in dozens of companies, so this
model works for them. But it would never work in PE, where the number of
investments is smaller and the investment size is much larger – if even 1 company
“failed,” the fund would fail. So that is why they invest in mature companies where the
chance of failing in 3-5 years is close to 0% (zero percent).
PE funds may not always restore the company operations, but they certainly
work to improve them, finding ways to expand – especially when there is a recession or
there is not much buying and selling operations. In theory, venture capitalists should
61 Some claim that private equity firms simply buy companies, fire people, saddle them with debt, and then sell the company without doing anything to improve operations. While that can happen, it was far more common during the LBO boom of the 1980s. 62 “Equity” refers to using cash rather than debt, not to shareholders’ equity, equity value, or anything else (the terminology can get confusing).
30
have a greater incentive to improve company operations because they are working with
early-stage companies. In practice, their involvement depends on the firm’s focus, the
stage of the company, and how much the entrepreneur wants them involved.
3.3 – The rise of Silicon Valley.
In a straightforward assessment it is easy to perceive the similarities between the
Portuguese conquests and the creation of a hi-tech device. They both were results of an
innovative idea, they both received capital to be developed and they both intended
profits. Nonetheless, as previously discussed, ideas and capital should work together,
and to optimize this premise it is necessary an environment capable to shelter all players.
The capital is not the answer for all the questions; rather, it is a necessary component to
bind ideas and turn abstract into something real. Essentially, the PE and VC industry
depend on the other components in order to work satisfactory well, such as institutions
dedicated to researches, incubation programs, government policies to encourage PE and
VC activities, high level education provided by universities and specialized
professionals to connect all these players.
The Innovation Ecosystem63
It is clear that new ideas and capital are the triggers to protrude new businesses,
but it is also necessary other important factors and players to create an innovative
63 Hwang and Horowitt (n 44) 11.
31
environment. It is necessary that firms and specialized professionals emerge in order to
reduce the costs between players - investors and entrepreneurs. It is also necessary that
governments play its roles. In sum, all the points drawing in the diagram above ought
to flow to the same way: the innovation. For this reason, I drive now my analysis to the
most recent episode on innovation, the Silicon Valley64; which was in my opinion, the
most emblematic sample of PE and VC industry in the recent days.
“The rise of Silicon Valley is mainly attributed to the growth and commercialization of research
and development (R&D) activities by Stanford University and its graduates. Their belief that a
symbiotic relationship between industry researches would emerge in a campus-like environment
was paramount to the success of the Valley and the development of applicable, market relevant
and innovative technologies. The fact that California courts historically refuse to enforce post-
employment covenants not to compete surely helps explain the rapid growth of the high-tech
district compared to the other regions with high technology universities. Others give a more sexual
explanation for the difference between Silicon Valley and other high-growth technology centers.
They reason that a poor public transportation system and a lack of bars in the Valley encourage
nerdy activities and, subsequently, innovation and technological inventions.65”
I do agree with the premises above, but I think that something else should be
added to get a more complete view of this phenomenon. I share the vision exposed by
Victor W. Hwang and Greg Horowitt arguing that the most important thing in a
business environment is the recipe and not the ingredients66. The key issue on the Silicon
Valley analysis is the fact that the players could overcome the transaction costs caused by social
barriers67 to maximize the free flow of talent, ideas and capital building new products.
64 The rules of garages from HP: Believe you can change the world. Work quickly, keep the tools unlocked, work whenever. Know when to work alone and when work together. Share tools, ideas – Trust your colleges. No policies, no bureaucracy (this is ridiculous in a garage). Radical ideas are not bad ideas. Invent different ways of working. Make a contribution every day. If it doesn’t contribute, it is doesn’t leave the garage. Believe that together we can do anything. Invent. http://arnoudm.wordpress.com/2009/01/07/the-rules-of-the-garage-from-hp/. 65 McCahery J A. and Vermeulen E P M, Venture Capital Beyond the Financial Crisis: How Corporate Venturing Boosts New Entrepreneurial Clusters and Assists Governments in Their Innovation Efforts (Lex Research Topics in Corporate Law & Economics Tilburg Law School Research Paper No. 011 2010) 1. 66 Hwang and Horowitt (n 44) 11. 67 See footnote 51.
32
“The key factors in the strength of human innovation ecosystem are: diversity of talents, trust
across social barriers, motivations that rise above short-term rationality, and social norms that
promote rapid, “promiscuous” collaboration and experimentation among individuals. This is the
culture of the Rainforest”68.
The authors also discuss historical data about the origins of Californian people to
justify the innovative and collectivism culture. I am not able to evaluate such ethnic and
genetic record information, but the collectivism culture rooted in California, used by the
authors as a key assumption, can provide good answers.
I shall admit that the culture of informal rules69 created in order to allow
strangers to work together efficiently on temporary projects formed a place where
individualism behavior is always tempered to work within a community. I might also
agree that in this type of community, informal rules are created when formal rules cannot
provide the best solutions for the practical cases of real-worlds interactions. “A
successful Rainforest benefits from lower transaction costs because of unwritten
behavioral norms that fill gaps when traditional social structures do not exist”.70
What can be deducted from all the arguments exposed above is that an
innovative environment business depends on: a plenty of ingredients and an efficient
recipe. The most important aspect to verify in the Silicon Valley case is the fact that it
was created a genuine industry of innovation using the tools available at that moment.
This fact turns Silicon Valley’s model a replication almost impossible in other places,
and the reasons are not that difficult to find out. The creation and the development of
rainforest71 such as the Valley requires specific forms of leaderships and capital sources,
68 Hwang and Horowitt (n 44) 11 69 Rule #1: Break rules and dream, Rule #2: Open doors and listen; Rule #3 Trust and be trusted; Rule #4: Experiment and iterate together; Rule #5 Seek fairness, not advantage; Rule #6: Err, fail, and persist; Rule #7: Pay it forward; in V W Hwang and G Horowitt, The Rainforest, The Secret to building the next silicon Valley (Regenwald, Los Altos Hills, California, 2012) 11. 70 Hwang and Horowitt (n 44) 11. 71 According o the authors “a rainforest is an environment example with special characteristics – the air, the nutrients in the soil, the temperatures, for example – they encourage the creation of new species of animals and plants that are greater than the sum of their elements. A rainforest takes lifeless inorganic matter and creates systems of thriving organic matter…The rainforest model we propose is similar. When we think of innovation systems, we should not try to force individual innovations into existence, but we should try to design and shape the proper environment that cultivates such innovations to be born and thrive”; ibid 3.
33
i.e., leaders should enforce and practice social norms, in order to bind different sectors of the
community to attend a common action.
Possibly these facts provide substantial explanations on the difference between
the technological development of San Diego and Chicago72. Both cities hold a similar
profile: they both have large industries, they both have a well developed PE and VC
industry, and they both have a high level education system, counting with great and
well-known universities. However, San Diego has much more success in technology
start-ups, and a highly productive system of innovative activity than Chicago73. How to
explain the differences?
“Innovation ecosystems are not merely like biological systems, they are biological system. Human
systems become more productive faster that the key ingredients of innovation-talent, ideas, and
capital – are allowed to flow throughout the system. Measuring the velocity of such nutrients can
provide us the tools with which to measure the health of an innovation ecosystem by observing
dynamic activity over time, rather than statistic points in time. When particular social behaviors
allow the movement of talent, ideas and capital to be freer – as they are in Rainforest – we find that
human networks can generate extraordinary patterns of self-organization”.74
Thus, beyond people, ideas, culture, capital and so forth, it is also necessary that
someone binds all the dots, and above all conducts to a common action. Hereafter my
analysis lays down on lawyers. I believe that lawyers should be capable to reducing the
transaction costs between people and assist to build a rainforest. But how can lawyers
reduce these transaction costs? How can lawyers help to change behaviors? Professors
Joseph McCahery and Erik Vermeulen address a similar issue: “Could lawyers or
another group of professionals act to catalyst in the establishment of new geographical
or perhaps sector specific high-tech clusters? Or alternatively, could governments be
involved in these activities to structure the framework for a new venture capital era?75”
72 ibid 15. 73 ibid 16. 74 Ibid 11. 75 Joseph A.MacCahery, Erik P.M Vermeulen, Masato Hisatake and Jun Saito, The new Company Law, What Matters in a Innovative Economy (Law Working Paper, n. 75, 2006) 4.
34
3.4 – The social and technical barriers.
The transaction costs perceived by Coase could be reduced by creating firms.
However, those costs will increase systematically given the economic evolution path. At
the same time, other costs still are arising in the market. Most of them, as I stressed
before, are costs created in the interpersonal relationships76. Essentially, the invisible
transaction costs causing by human natures and the creations and development of
social rules to overcome those transactions will be address from now on. In sum, the
social and technical barriers shall be challenged by lawyers in the new economic
scenario.
In my humble opinion the existence of these two sorts of transaction costs require
an agent to escort changes. This agent might be responsible to act in two different
directions: i) in order to change behaviors (minimizing social barriers), and ii) in order
to improve and change technical issues77. Thus, in this scope I believe that lawyers can
carry this task forward. I would like to discuss item “i” and afterwards, in the next
chapter, I discuss item “ii”.
3.4.1 – Lawyers as “transaction-cost engineers”78.
Larry Ribstein79 provides some important traces on the changes that are
occurring in the traditional model of law. In sum, the professor argues that the
changing environment is creating new market for skills not taught in law schools and
the globalization phenomenon has changed the legal education80. He also drives his
analysis on the impact of Internet and on websites dedicate to provide legal advices,
76 See footnote 51. 77 In Chapter 3, I will provide more details on this issue. 78 Ronald Gilson, Value Creation by Business Lawyers: Legal Skills and Asset Pricing (Yale L.J, 1984) 94. 79 Larry E. Ribstein passed away in 2011. He was the Mildred Van Voorhis Jones Chair in Law and the author of leading treatises on limited liability companies. His books also include The Sarbanes-Oxley Debacle and The Constitution and the Corporation (both with Henry Butler), The Law Market (with Erin O'Hara), The Rise of the Uncorporation (2009) and The Economics of Federalism (with Kobayashi). He also has written or co-authored approximately 140 academic articles. 80 Ribstein (n 11) 1658.
35
and how this phenomenon may somehow cause changes and/or improvements in the
legal market81.
However, in my opinion the best of Ribstein’s analysis lays down on the rise of
the legal-information market. The traditional law practice is designed to ensure that
lawyers might work in client specific demands, i.e., that lawyers cannot work in firms
owned by non-lawyers, which somehow turns the lawyer activity extremely limited.
Thus, the author brings into discussion Ronald Gilson’s theory which suggests that
lawyers could capture some of the rents that otherwise flow to accounts and finance
experts by becoming “transaction-cost engineers”.
“This raises the question of whether transaction-cost work is best done by lawyers or by
business or financial experts. Gilson suggested that lawyers have an inherent advantage over other
types of advisors since their monopoly on legal advice makes them the passkey to business
transactions. Several law schools have built on this intuition by developing courses, programs and
clinics in transaction law. Multidisciplinary collaborations may become may become more
common as traditional markets for legal services shrink and lawyers seek jobs outside traditional
law firms. This trend could accelerate if the move toward deregulation discussed below results in
relaxation of rules, such as the one against lawyers practicing in nonlawyer financed firms. Law
students may need to learn how to move beyond rendering “legal” advice to becoming member of
types of teams that render various types of advice of services82.”
It is clear that lawyer’s activity has been drag to other fields and thus obliging
new lawyers to find out other ways in the market. In this sense I believe that lawyers
may start providing to entrepreneurs and businessmen new perspectives by showing
that there are other alternatives to do businesses. It is essential to keep in mind that the
market is not free as we think and the prejudices can kill negotiations before they are
born, and to avoid this assumption an agent (I would suggest lawyers) would become
necessary to bind and foment the business relationships.
81 ibid 1664. 82 ibid 1664.
36
“Not only are law firms and individual lawyers responsible for drafting innovative contractual
provisions that protect high-risk investors, for instance angel investors and venture capitalists,
from the relation and the performance risk associated with investing in young entrepreneurs that
need and their innovative ideas. The lawyers’ broad network and involvement in both non-legal
and legal activities, such as dealmaking, matchmaking, gatekeeping, and conciliating, serve as an
effective sorting device for entrepreneurs that need more than just an investor to fertilize their
start-up business83.”
In the same path, Richard Susskind84 argues that lawyers and legal services have
changed and ought to change more in the future. According to the professor, the
Commoditization and IT will shape the lawyer behaviors in the coming years85. He also
describes a new sort of ‘legal hybrids’, professionals with multi-disciplinary
backgrounds86. He predicts five new types87 of lawyers in the next future, however one
of these types called my attention the most and deserves to be highlighted:
“My final category of future lawyer is the ‘legal hybrid’. My premise here is that successful lawyers
of the future, wherever they sit on my evolutionary path, will be increasingly multi-disciplinary.
Many already claim that they are deeply steeped in neighboring disciplines, as project managers,
strategy and management consultants, market experts, deal-brokers, and more. In truth, though,
these forays into other fields are not strategically conceived, and piecemeal initiatives. In contrast,
legal hybrids of the future will be able to extend the range of the services they provide in a way
that adds value for their clients.88”
I believe in such premises and I am tempted to say that this new kind of
professional will generate more results for business in general. In this way lawyers will
carry a huge duty to improve and try to reduce the social barriers and the prejudices that
cause obstacles on the new business articulations. The traditional law system will be
83 McCahery and Vermeulen (n 65) 2. 84 Richard Susskind is an author, speaker, and independent adviser to international professional firms and national governments. He is It Adviser to the Lord Chief Justice of England and Wales, Visiting Professor in Internet Studies at the Oxford Internet Institute at Oxford University, and Emeritus Professor of Law at Gresham College, London. His numerous books, including The Future of Law (Oxford, 1996) and Transforming the Law (Oxford, 2000) have influenced a generation of lawyers around the world. 85 Richard Susskind, The end Of Lawyers? (Oxford University Press Inc., Newyork, 2010) 2. 86 Ibid 6. 87 Ibid 270. 88 Ibid 273.
37
replaced for a more dynamic and business related form, i.e., that lawyers will be closer
to the society’s demands and more prepared to deal with new requests.
38
4 – THE NEW ROLE OF LAWYERS.
"The goal of science is to build better mousetraps. The goal of nature is to build better mice" Anonymous
"New scientific truth usually becomes accepted, not because opponents become convinced, but because opponents die, and because the rising generation is familiar with the new truth at the outset"
(Max Planck)
This Chapter is divided in two main parts. In the first part, I discuss the
differences between lawyers in common law countries and civil law countries, and I also
argue the importance of governments in the creation and the development of new
businesses. I also drive my attention to the limits imposed by Brazilian laws on the
lawyer’s activity; and in the end of the first part, I confer some alternatives that lawyers
can exploit to develop a more powerful role in the economic scene. In the second part, I
drive my attention to a significant regulation enacted in Brazil in 2005 related to
corporate restructuring. I bring this regulation into the discussion for two reasons: i) first,
because this rule had a massive participation of lawyers in its creation, and, ii) second,
because this new regulation provides an incredible opportunity to develop new
businesses. 89
4.1 – The main difference between civil and common law.
As I stated above, I try to detect some other functions that lawyers can develop,
and for that purpose I would start sheding some light on the differences between
lawyers in common law countries and lawyers in civil law countries90.
89 This assumption is related to the new trends that I explained in the previous Chapters. 90 “The find of a rule of law by a court of the English king created a precedent that future courts were expected to follow. Precedent was followed flexibility, not slavishly, so the law changed gradually. Over many years, the king’s court “found” many important laws, especially in the areas of crimes, property, contracts, and accidents (torts). These “findings” are called “the common law” because they are allegedly rooted in the common practices of people. Common law is still applied in the English language countries, excepted where superseded by legislation. The history is different in France and the other countries of Europe: When France revolted at the end of eighteenth century, the revolutionaries thought that judges were as corrupt and worthless as the king, so they killed the king and extinguished his laws, thus abolishing the common law of France. A comprehensive set of statutes was required to fill the void, so people would know what count as property, how a valid contract is formed, and who is to bear the cost of accidents. Napoleon supplied them by commissioning legal scholars to draft the rules the Code of Napoleon, which was promulgated in 1804. The scholars who drafted it took as their model the Corpus Juris Civillis (“The Body of the Civil Law”), which was compiled and edited in AD 528-534 at the behest of the Roman Emperor Justinian. Thus the French revolutionaries looked to
39
A quickly overview demonstrates that commercial operations (in special PE and
VC activity) are found in larger numbers in common law systems than in civil law
systems91. I might choose, for instance, the United States and England as two illustrative
cases; however, what is the relationship between common law countries with PE and VC
activity? Is there a discernible relationship between common law and these sorts of
operations? Taking these questions further: are there symbiotic relationships between
lawyers in common law system and the creation of new businesses?
Former experiences demonstrated that more flexibility on legal infrastructure is
capable to attract more investors and to develop new businesses92. But which system is
better for business and to attract investors? Professor Francisco Reyes and Professor
Erik P.M Vermeulen also discuss this subject:
“One of the goals in this paper was to assess whether common law system outperform their civil
counterparts in terms of legal innovation. To test this hypothesis, we have attempted to strengthen
our understanding of the introduction and acceptance of new hybrid business forms in both
common law and civil law jurisdictions. We have found that interest group pressures play a
pivotal role in the success of hybrid business entities in both common and civil law jurisdictions.
Without these pressures, the chance of successfully introducing new business forms outside the
established company framework and doctrines decreases more significantly in civil law countries.
The reason for this is that, in general, common law corporate lawyers appear to be more pro-active
in terms of anticipating their clients’ needs. It is therefore fair to say that the common law systems
tend to be more open to legal change and innovation.”93
There is no a magic formula to attract investors in order to develop new
businesses, but in countries in which there is more legal innovation, with hybrid business
forms (more flexibility and freedom of contract, for instance) there is, consequently,
more contractual certainly and innovative corporate lawyers. On the other hand,
ancient sources and pure reason for law, rather than to the more immediate heritage derived from medieval times.” In R Cooter and T Ulen, Law and Economics (Addison Wesley Longman Inc., 2000, 3rd Edition) 58. 91 Francisco Reyes and Erik P.M Vermeulen, Company Law, Lawyers and “Legal” Innovation, Common Law versus Civil Law (Lex Research Ltd, Topics in Corporate Law and Economics 2011). 92 ibid 32. 93 ibid 33.
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countries with a tradition model of company law (stricter rules for public companies, for
instance) seem to have more traditional corporate lawyers and tradition businesses94. In
the same argumentative sense professors Joseph McCahery and Erik Vermeulen argue
that “if Europe were to replicate the US market it should give priority to establishing
high labor mobility and risk tolerance, a well-developed stock market and large,
independent sources of venture capital funding95”. This means there are many
components to create a proper place to attract investors and create new businesses96.
Some of these components are related with individual action, which means
depending on the professionals and parties involved. Other components, as mentioned
above, are linked with government actions. Hence, to create an environment to attract
and create new businesses, in both systems (common and civil law) laws ought to be
enacted by governments. Accordingly, this perspective leads to address an important
issue: the government intervention.
4.2 – How governments might contribute to create a business environment.
The Coasean world, as previously exposed, is a place where the property rights are
often respected, transactions costs are null, and the information is perfect, and then
government intervention is unnecessary. Nevertheless, this world is almost impossible
to be achieved.
Given this fact, governments must intervene in the market in order to create a
fair environment (easy to bargain), enforce contracts and reduce the social damages.
Therefore, company law provisions are necessary in order to i) establish the framework
in which firms will play, and ii) also to create tools to enforce contracts between parties.
Under this prism, it is essential to demonstrate the importance of economics and
the law, and how concepts brought by economics are essential to the analysis of
94 ibid 32. 95 Joseph A. McCahery and Erik P.M. Vermeulen, Limited Partnership Reform in the United Kingdom: A Competitive, Venture Capital Oriented Business Form (TILEC Discussion Paper, DP 2004-24) 4. 96 See footnote 63.
41
corporate law. Economics can assist lawmakers to identify the main issues, the needs
and the requirements of the parties involved in different sorts of businesses; moreover
economics can also offer to law better and different alternatives to governance structures
in order to steer individuals and firms to achieve their objectives faster. It seems that
lawmakers worldwide are promoting legal upgrades in their company law forms
focuses on the simplification of formation requirements97.
“The contractual theory of the firm, which dominates the thinking of efficiency-minded
lawmakers, can assist lawmakers to identifying the central problems that business parties
encounter, and the role that company law plays in helping to resolve these problems…In the real
world, however, lawmakers could approximate the hypothetical world by offering legal products,
in the form of default and possibly mandatory rules that minimize transaction costs and remove
impediments to private ordering arrangements between the business parties98.
Law can provide valuable solutions for economic matters and a better business
environment to the parties in order to create more opportunities and new businesses. In
such way, lawmakers might ratify laws containing more flexibility and contract
freedom.
“In the United States, state legislatures have embraced hybrid business forms to improve the legal
infrastructure and business environment. Interest groups pressures and the competitive incentives
of not losing local fillings to other states have moved legislatures into hasty action. The expansion
of new business forms appears to be based on compelling logic: it allows firms easy access to a
range of governance structures designed to provide limited liability, reduce complexity and limit
transaction costs.”99
In this way, there are two different conducts by which governments shall
intervene in the economy: directly and indirectly.
In the first model, governments may intervene in the economy providing grants
and loans in R&D projects and providing income sources to innovative startups. In the
97 Reyes and Vermeulen (n 91) 9. 98 Joseph A. McCahery and Erik P.M. Vermeulen, Corporate Governance of Non-Listed Companies (Oxford University Press, 2008). 99 Reyes and Vermeulen (n 91) 33.
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second form, governments may create a business ecosystem to entrepreneurship and
innovation through regulatory reforms, by upgrading jurisdiction rules and providing
tax and fiscal incentives. In my opinion, governments can and should intervene100 in
order to create an innovative business ecosystem; nevertheless, precautions should be
taken to avoid potential downsides of government interventions101.
Despite the fact that many arguments support the idea of direct interventionism,
mostly to invest in the early stages of innovative startups, I dare this conception, at least
in countries which do not have well-developed economical structures102. Evidently
direct intervention provides certification to the market and signals that investments in
such innovative ecosystem are safe and can generate positive externalities. However,
some countries in the world present a high level of corruption and frauds
(unfortunately) which make the direct intervention passive of irregularities.
In addition, the incompetence of many governmental structures and the
disconnection with the entrepreneurship market’s needs, result in a hard relationship
between bureaucrats and entrepreneurs and this scenario cause a high costly via for
investments to get towards the right destine.
Thus, I restrict my analysis on indirect intervention. I do understand that indirect
intervention through governments shall maintain state bureaucracy far enough of
private negotiations; and close enough to enact regulations while indispensable in order
to create a powerful business environment. I might say that I am not totally convinced
that the indirect intervention is the greatest proposal because this sort of behavior
permits, indirectly, that governs sit down on some private activities creating more
100 See chapter 3. However, this intervention only might occur when the parties could not reach on agreement. 101 It is necessary to avoid that governments takeover on essential aspects of economic system. 102 Here my reference is on countries which are in the developing process. Brazil, for instance, is a case of developing country and is creating stronger mechanism to protect investments and investors, and also to avoid corruption. However, Brazil still has a high level of corruption and state bureaucracy which cause some great impediments.
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bureaucracy103. On the other hand, I believe that indirect intervention may work if
governments play a minimal role104.
In this way, governments ought to keep it attention on all sorts of events to
establish an attractive business environment. Governments should create different and
more dynamic business forms approximating separate legal personality; governments
should provide more contractual freedom, and pass rules to make corporate
governance structure more flexible, for instance. Technology and the Internet can help
in the exchange of experiences worldwide. Local governments are able to verify what is
happing in different jurisdictions around the world. In this way, common law
experiences can assist the civil counterparts to deal with different issues as preferred
shares, dual-class shares, and full legal enforceability of shareholders agreements.
Former common law experiences can also assist on the structuring of limited
partnership business forms105.
Governments can also facilitate venture-backed firms’ access to public capital
markets by creating low-regulated IPO markets and low-regulated carve-out. Finally,
governments can set some efforts on the tax system to reduce capital gains taxes in
order to increase incentives for PE and VC investments, boosting these activities.
Professors Joseph A. McCahery and Erik P.M. Vermeulen shed light on the role
of governments assessing countries that, at least in theory, are more capable to receive
investments and create new businesses:
103 An example to illustrate this case is what occurs in Brazil with the Brazilian development bank (BNDES in Portuguese). “The Brazilian Economic Development Bank (BNDE) was established on June 20, 1952, under Law 1628, as a government agency, with the aim of developing and carrying out national economic development policies. Subsequently, according to Law 5662, of June 21, 1971, BNDE was converted into a state-owned company under private law, which resulted in more flexibility to raise and invest funds, besides less political interference.” http://www.bndes.gov.br/SiteBNDES/bndes/bndes_en/Institucional/The_BNDES/history.html However, the institution which is essentially state-owned is somehow invading the private sphere lending money and participating of important investment projects. In my opinion this is not a good signal for the economy, since the bank may take over some essential components of the market. If companies do not have a great environment to develop it is useless borrow money from the bank, because if a given company default payment the loan, for instance, the bank might take over the assets. In the cases in which the loan is from a state-owned bank the assets will be takeover by the state. 104 See Chapter 3. 105 See Joseph a. McCahery, Erik P.M. Vermeulen, Masato Hisatake, Jun Saito, The New Company Law, What Matters in an Innovative Economy? (ECGI Working Paper Series in Law, Working Paper n. 75, 2006) and Joseph a. McCahery and Erik P. M. Vermeulen, Limited Partnership reform in the United Kingdom: a Competitive, Venture Capital Oriented Business Form (TILEC Discussion Paper, 24, 2004).
44
“The first position is located on the left side of the spectrum and closest to stasis – where virtually
no effective legal changes can occur and where only the idea of reform clashes with legal tradition
and standardization pressures. Along or near the mid-point of the spectrum, company law changes
are less impeded by tradition and standardization factors, but more influenced by interest group
pressures. We see the United Kingdom occupying this position. Japan can be seen as a more
adaptable jurisdiction located toward the right end of the spectrum and therefore better able to
create and introduce more functional legal rules and institutions that turn the traditional view of
company law around. It is submitted that Singapore is located on the right side of the spectrum at
its legislature is aware of the need to adapt the legal system to international business practices in
order to develop a distinct jurisprudence, acclaimed for its efficiency and integrity, which is set
apart from the English legal system106.”
The assumptions described above are easily confirmed when websites are
accessed. These websites provide key analytic sources on the creation of business in
different countries worldwide. In one of these websites107, for example, Brazil appears
ranked at 126 spot, whilst Singapore holds the first place. Generally speaking, and
resuming my analysis simply looking at data108, investors would choose Singapore,
given the nicer environmental for doing business, than Brazil. Complexity in the tax
system and the lack in infrastructure are salient points analyzed in the countries´
assessment. Colombia and Chile, other South American countries, for instance, have
realized that less bureaucracy and complexity in rules can provide a better place to do
business and are better ranked than Brazil.
In this way, inexorable questions arise: If Brazil is the country of the future (as
claimed by analysts) and possibly the country that will receive a massive amount of
investments in the following years, how might one explain this position? How tp
explain to future investors and convince them that Brazil is a promissory place to invest
their money? How can these obstacles be removed?
106 Joseph A. McCahery and Erik P.M. Vermeulen, Corporate Governance of Non-listed Companies (Oxford University Press, New York, 2008) 142. 107 www.doingbusiness.org 108 I am not taking into account the size of the Brazilian population, which is a key aspect when choosing a place to invest in.
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Brazil has a vast number of laws, and the main problem in Brazil is the
enforcement procedure. Brazil has a legal system structure divided in three levels of
jurisdiction: federal, state and municipal. Given the fact that Brazil is a large country,
with immense governmental structures, mainly in the federal level, with a high rank of
bureaucracy, it is extremely difficult to harmonize each law and enforce it within the
entire country. This is not the best excuse, but helps to explain this problem.
Thus, an emblematic puzzle is established: i) (minimally) government
intervention is necessary to create great business environments; however ii) some
places, like Brazil, has complex political structures which turns difficult to implement
changes quickly; iii) market demands increase persistently and faster as well as the
claiming for changes and improvements; on the other hand there is a lack of
communication between market demands and government posture. These facts lead to
different approaches and inquiries: How do the novel business demands ought to be
analyzed faster? Who are able to carry on these new demands to the political sphere?
How to demonstrate that changes and improvements are more than necessary to create
a more dynamic and efficient business environments?
4.3 – Lawyers as agent of changes.
Ronald Gilson has a pivotal role in the academic universe. Besides all his
contributions, an important paper calls the attention. In 1984 Ronald Gilson published
Value Creation by Business Lawyers: Legal Skills and Asset Pricing. At that occasion, the
professor concluded that lawyers add value as “transaction cost engineers109” which
means that lawyers might bridge the parties divergent expectations about returns on
the asset by drafting an earn out “which makes the price contingent on its returns
between the signing of the deal and the closing; and overcome lack of information
(principally of the buyer) by arranging efficient production and verification of
information. From these findings Gilson also recommended that legal education for
109 Ronald J. Gilson, Value Creation by Business Lawyers: Legal Skills and Asset Pricing, (94 YALE L.J. 1984) 239-41.
46
business practice downgrade traditional subjects (like analysis of appellate cases and
knowledge of relevant regulatory law) in favor of corporate finance and transaction cost
economics.110”
Corroborating this idea, Professor Ronald Ribstein111 argues that lawyers should
stand new postures and hold different functions given the current economic scenario.
Ribstein suggests that a new model must arise in which theory and practice stand a
closer relationship112.
The author goes further arguing that the old model of advocacy should be
abandoned due to the new economical and behavioral trends of society. According to
him, lawyers ought to be trained to be competitive with other sorts of services in a clear
opposition to the traditional practicing lawyers. Finally, the author draws attention to a
variety of functions that lawyers may achieve, but for the purpose of this paper, I would
address my focus to lawyers as lawmakers. I am a big believer that lawyers hold the
skills to intervene somehow in this chaotic economic scenario by carrying market
demands to political sphere:
“In the legal markets, lawyers might increasingly be involved in design laws and not just applying
them. This could result in part from increased jurisdictional competition throughout the United
States and the world. Also, industries might sponsor work on codes and standard-form contracts
like those developed by standard-setting organizations.”113
It seems clear that lawyers shall exercise more frequently in designing laws.
However, this sort of behavior just makes sense whether lawyers participate somehow
in the market. In other worlds, in my opinion lawyers must participate actively in the
market negotiation to be able to suggest legislation improvements.
110 George Dent, Business Lawyers as Enterprise Architects (The Business Lawyer, Forthcoming; Case Legal Studies Research Paper No. 08-25, September 2008) 2. 111 See footnote 76. 112 Ribstein (n 11) 1652-58. 113 ibid 1667.
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In theory many things could be changed if lawyers start getting a more active
posture, participating more of political matters. In this way laws could gain more, say,
efficiency and dynamism. Obviously this is not that easy. At least in Brazil lawyers face
several legal limitations. The law activity in Brazil is highly regulated by the Code of
Ethics and Discipline and also by the Brazilian Bar Association Statute114, and both
emphasize two significant limitations: the prohibition of commercialization of law and the
conflict of interests.
Brazilian lawyers are forbidden to treat advocacy as mercantile form, or provide
services an unrestricted basis as products, and cannot act when there is a conflict of
interests, i.e., while parties have common demand interests. These thresholds turn
impossible lawyers acting as businessmen and impede them to develop new businesses.
Then: How could a lawyer without trade skills assist on the elaboration of new rules
that will improve (at least in theory) the business ecosystems?
In the attempting to clarify such issues, I interviewed Guilherme Leite115, partner
lawyer of Pinheiro Neto Advogados116, one of the largest law firms in Brazil and Latin
America, regarding the limits on lawyer’s activity in Brazil, which restricted lawyer’s
participation on issues involving businesses or in the development of new endeavors.
Guilherme Leite drew attention to three different situations experienced by PNA
lawyers that were invited to participate in different law projects.
The first project focused on tax reforms on the Brazilian legislation. For a long
time, the project was discussed with a huge lawyer’s presence, but, unfortunately, due
to political matters, suggested reforms were not adopted.
114 Law n. 8.906 /1994. 115Lawyer since 1997. Areas of Practice: Banking, financial and corporate law; M&A; capital markets; structured finance; project finance; foreign investments. Education: LL.B. degree from the São Paulo University (1996). LL.M. degree from Columbia University, New York, USA (2001). International Law Institute, Washington, D.C., USA - Orientation in the U.S. Legal System, 1995. http://www.pinheironeto.com.br/curriculum.php?c=86 116 For the sake of simplicity I will refer “PNA”. “Founded in 1942, Pinheiro Neto Advogados is one of the largest law firms in Latin America and one of the most well-established in Brazil. Its tradition of excellence is evident throughout its nearly 800 member legal and administrative staff. The firm maintains offices in the cities of São Paulo, Rio de Janeiro and Brasília and also has an extensive network of correspondents throughout the country.” Available on http://www.pinheironeto.com.br/historico.php
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In the second example, a team of lawyers were invited i) to participate of a project
involving international accounting standards (IFRS) to be implemented in Brazil and ii)
to formulate guidelines on these new concepts that would be introduced in Brazilian
legislation. Both projects involved different sort of professionals (engineers, economists,
accountants, etc) and the presence of lawyers in this multidisciplinary environment
demonstrated that they were able to contribute actively exchanging experiences and
knowledge with other academic fields.
The last experiment mentioned by Guilherme Leite is related to corporate
restructuring (Law n. 11.101/2005)117. Lawyers of PNA, and from other offices, were
invited to provide technical supports for a new corporate restructure legislation. The
contemporary legislation gave to the economic scenario more mobility, greater security
to lenders and allowed businessmen to continue runing their companies, and also
permitted the creation of new businesses118.
Finally, Guilherme Leite drew attention on issues that still hamper the economic
development and the creation of new businesses. The delay of the labor laws, the lack of
rationalization of tax rules, the complexity of environmental laws and the lack of
criteria of social security laws were cited by counsel as serious obstacles to the creation
of new businesses in Brazil119. Guilherme Leite also shares the idea that limits depletion
on regulatory laws on lawyer’s activity in Brazil, would create more opportunities for
developing new businesses.
Those experiences have showed that lawyers are able to take action on matters
directly related with other fields of knowledge. It is also valid to highlight that lawyers
can and should demonstrate they are able to provide practical viewing and dynamic
solutions to the business world and carry out market demands to politic sphere. Offices
117 I will provide more details in the next section. 118 Very similar concepts can be found in Chapter 7 and 11 of United States Code. In essence when a business is unable to service its debt or pay its creditors, the business or its creditors can file with a federal bankruptcy court for protection under either Chapter 7 or Chapter 11. 119 See Chapter 5.
49
like PNA are valuable120 because they can tie market demands and suggest improvements
or changes on the legislative stage by identifying aspects that in some way are
obstructing the development of businesses. Companies have law firms as important
“partners”, because law firms can bring that impeditive aspects to the court’s analysis
or take away the issue to government examination121.
In the later alternative lawyers hold the opportunity to participate actively in the
market, because they can bring to legislative houses the main businessmen requests
transforming these needs in suggestions to improve or change fusty laws.
Unfortunately, at least in Brazil, only large companies with sizeable demands are able
to bring to large offices such impeditive dots.
I believe that lawyers can act in the same way in all jurisdiction levels (federal,
state and municipal), i) getting more familiar on company’s demands and playing
actively in the development of local businesses; ii) bringing market demands to the
legislative sphere.
Apparently, there is a lack of communication between market demands and
legislative houses. In many cases governments overtake its role and pass laws that do not
assist the business development, and in other cases, governments overlook some rules
that are essential to establish a pleasant business environment122.
This phenomenon occurs because people in charge123 for such issues do not
posses enough expertise to evaluate the best solutions and do not have enough
technical knowledge124. Thus, I think that lawyers should play an important role
connecting market demands to political sphere making legislative houses pass rules to
120 Larry Ribstein shares somehow this conception at “The Death of Big Law” (wisc. L. Rev. Vol. 2010, n. 3) 749-815. 121 In Brazil the litigious culture is very ingrained and many cases go to the court. My purpose here is approaching the law firms of legislative houses in order to explain the better ways to conduct businesses. 122 Direct and indirect government intervention. 123 My reference here is on congressmen and aldermen. 124 My reference here is on legislative power which is in charge to elaborate and enact laws.
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attend business purposes, saving time and posterior unnecessary litigation on courts.
This kind of posture can reduce significantly the transaction costs.
A company takes into account many aspects by deciding where to install its
production basis, and in this way, places125 must provide pleasant business
environment. I am not saying here that governments shall create a specific policy, rule
for each single company. The point is: most of demands brought by one single company
are common complaints of other companies. Following such premise, whether rules are
improved or in some cases changed, it will benefit everyone.
Since lawyers are involved in the creation and in the development of (new)
businesses they are more prepared to suggest reforms to facilitate deals in the market.
In my humble opinion, governments should count with lawyers in order to establish a
better connection between market demands (market) and law provisions, but for this to
occur, it is necessary that lawyers take a step further and participate more incisively in
the businesses.
Despite all the limits imposed by Brazilian statutory laws, lawyers are able to
play a decisive role as transaction cost engineers126 supporting companies to find out
solutions and develop new businesses and also play an important role as lawmakers. By
bringing facts and trends from economic world (market demands) to legislative
dimension, lawyers will demonstrate that laws must support commercial activities
rather than create obstacles for it.
4.4 – The corporate restructure law matter in Brazilian legal estructure. Pivotal aspects
of Law n. 11.101/2005.
I
There are several sorts of companies and businessmen in Brazil127. There are
entrepreneurs who were employees but quit their jobs because they were not satisfied
125 Countries states and municipalities. 126 See footnote 78. 127 I restrict my analysis on Brazilian cases.
51
with their careers and decided to run their own company. In most cases, these
entrepreneurs do not have any knowledge or expertise in administrative tasks and end
up not achieving success running their ventures. Moreover, there are talented
entrepreneurs with a great know-how, combining technique and practice, but due to a
series of external factors - economic, political and financial – end up closing their new
endeavors. Finally, there are businessmen acting in bad faith, and trying to defraud
creditors and tax authorities constantly.
For all those cases, there was a sole bankruptcy law, which put all sorts of
businessmen mentioned above in the same basket. According to that law, the only
getaway for companies (including new ones) was bankruptcy. Then, how to enact rules
to shelter all those sorts of companies and businessmen and treat them in an equal way?
Do they deserve the same treatment? How is it possible to distinguish reputable
companies with reasonable development conditions, and economic viability from
companies without commitment with the market and costumers?
Trying to solve this issue, the obsolete bankruptcy law128 was replaced recently by
new corporate restructuring bill, Law n. 11.101/2005, in order to provide more
dynamism, pace and to maintain companies, which are facing financial difficulties,
alive. The new legislation has a substantial economic influence, and despite some
criticisms (especially in relation to the treatment of micro and small enterprises), the
novel legislation has worked remarkably well. It is easy to test this argument by
verifying courts throughout the country which have received a large number of
corporate restructure requests129 instead of bankruptcy requests, and for this new tendency
lawyers should receive laurels.
128 Law n. 7.661/1945. 129 Judicial corporate restructure requests: http://www.equifax.com/about_equifax/judicial/pt_br Bankruptcy requests http://www.equifax.com/about_equifax/falencias/pt_br and Extrajudicial corporate restructure http://www.equifax.com/about_equifax/extrajudicial/pt_br
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What does it mean? The involvement of lawyers in the formulation of Law n.
11.101/2005, had crucial importance in the structuring of a more dynamic law
concerned on solving problems quickly in order to return back to business world viable
and better solutions. Lawyer’s participation has provided more dynamic clauses and
directly related to market demands. In this particular, lawyers provided a new
economic perspective to Law 11.101/2005, by having created rules to fit better on
market demands.
I might start highlighting Article 47 of Law n. 11.101/2005130. This article
provides to companies which are facing financial problems the possibility to claim
judicial corporate restructure or extrajudicial corporate restructure before going bankrupt.
This is the main difference between the former legislation and the current bill. In many
cases companies are facing some financial problems and for inexplicable reasons, they
are not doing well, but they might well recover. The new legislation opens a new room
and also provides chances for companies being restructured.
Obviously, the law itself cannot retrieve a company131, neither can it impact
directly in the economic sectors. However, well formulated legislation is able to provide
better tolls (new methods and techniques, for instance) by which lawyers and other
professionals, including businessmen, can use to deal with management and financial
matters.
As I mentioned previously, Article 47 exposes the real purpose of Law
11.101/2005 as well as the other articles also point out that the social function matters.
The point I am trying to clarify here is that lawyers were indispensable building and
structuring this new law. In this sense, my focus now is to verify the opportunities that
Law n. 11.101/2005 provides to the business environment and how lawyers can use it to
create innovative solutions and to reduce transaction costs.
II 130 http://www.planalto.gov.br/ccivil_03/_ato2004-2006/2005/lei/l11101.htm 131 See footnote 5.
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The rationality behind Law 11.101/2005 is to provide companies and
entrepreneurs with additional chances to recover their business, to be granted to
companies that are still working. An example of this rationality is the possibility of
companies to claim for extrajudicial restructure. Companies which are facing financial
problems can elaborate a plan and present it to creditors (banks, suppliers, and others).
Once presented it, two likely possibilities opens. In the first alternative, creditors can
consensually or partially132 accept it. In both cases, the acceptation constitutes a
guarantee, i.e., whether the company does not perform the plan creditors are able to go
to the court claiming for their rights. In the second possibility, creditors can reject the
plan presented, and in this case, companies’ feasible exits are judicial restructure or
bankruptcy.
In my view, the extrajudicial restructure model is the closest that Coase's theory
can get133. In this model the parties try to reach the best solution, without any claim for
court’s decisions or court’s intervention. At this point, lawyers can be useful in two
different ways: i) elaborating the debtor’s restructure plan and consequently supporting
the negotiations, and ii) bringing into scene other players, like private equity funds134.
Lawyers are able to intervene in such process to facilitate negotiations and create new
opportunities for investors.
To make myself clearer, I understand that lawyer’s interventionism ought to be
made objectively and with a more economical and practical sense to obtain faster
solutions to conflicts and also to provide to the parties involved a better environment
for businesses development. The extrajudicial corporate restructure procedure is a powerful
mechanism that Law 11.105/2005 provides.
However, in some cases default companies cannot reach an agreement with
creditors (given the size of these companies), and for these cases those companies can
132 At least 3/5 of them. 133 See Chapter 3. 134 I explore this subject further in the Chapter 6.
54
claim for a judicial restructure or to go straight forward to bankruptcy. Attending the
purpose of this paper, I drive my spotlights on judicial restructure’s mechanism first.
The judicial restructure is divided in postulate, deliberative and enforceable phases.
In the postulate phase, companies should fulfill some requisites prescribed in articles 53,
54 and 55 to claim for their rights. Generally speaking, companies should demonstrate
before courts, the origins of the debts and how the company will conduct the restructure
process. This process takes some time because companies must bring to the court all
sorts of documents to prove that the restructure is possible, but even so it is a much
better option than bankruptcy.
Once met all the prerequisites in the first phase, the court adjudges the
restructure request, and the second phase get started. The judge determines the
suspension of all litigious demands against the company and nominates a person to be
responsible for accounting and also for the administrative issues of the company during
the judicial restructure process. In this phase, companies must expose its restructure plan to
creditors which can be accepted or refused. If creditors accept the plan the restructure
process continues; if they do not accept the company should resort to bankruptcy.
Assuming that all creditors accept the restructure plan, the default company
ought to carry out it. During the entire restructure process, the company must perform
the plan exactly in the way it was proposed, by not doing so the company can go to
bankruptcy and consequently lose all the benefits offered by judicial corporate restructure.
Obviously, this is only an uncluttered view of judicial corporate restructure
procedure. Despite its complexities, I do understand that lawyers are able to play a
decisive role. For this purpose, lawyers shall acquire an economic holistic view on the
legal environment around them, in order to provide more dynamism to the companies’
55
(judicial or extrajudicial) restructure procedures, by bringing into the process
individuals and companies to maintain companies working135.
Put in another way, since lawyers are involved in the corporate restructuring
procedure they might take advantages facilitating investments in the default company.
The phases mentioned above require the presence of lawyers, and once they can wage
the process, they can articulate with investors bringing them into the judicial or
extrajudicial corporate restructure process.
II
The goal of this Chapter was to point out two main functions that lawyers can
explore in different ways: i) in the creation and in the development of new business,
and ii) as lawmakers. Despite of all the limits imposed by Brazilian statutory legislation,
which might be reduced, lawyers must create new sorts of approaches to improve the
business environmental connecting different economic activities, and acting as an
engineer’s of new business to implement new techniques. In Chapter 6, I demonstrate
how these actions can be taken in the real world, using the concepts exposed above, to
reduce transaction costs in the commercial operations. In sum, lawyers must rethink
their posture behalf the market and reshape their acting model, by trying to escape of
their day-to-day activities.
135 More details will be provided in Chapter 6.
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5 - BRAZILIAN ECONOMY OVERVIEW.
"If you torture the data long enough, it will confess."
Ronald Coase
In Chapter 2, I have described the significant points of Ronald Coase theory, the
importance of firms to reduce transaction costs and the role that governments might
play in the economic circumstances. Chapter 3 is dedicated to carve the new transaction
costs that impede the development of new business and to find out how it is possible to
avoid them. Moreover, in Chapter 4, my purpose was to demonstrate how lawyers can
play a pivotal role in the economy, creating a better business environmental. Hence, my
main goal in Chapter 5 is to gather all the information on Brazilian economy and the
principal aspects that can be improved and others which shall be changed in order to
develop a better business ecosystem, drawing the portrait wherein lawyers and
businessmen might work together.
5.1 – A general overlook on Brazilian economy.
Brazil observes one of the best economic circles in its history, resulting of two
decades of political and economic stability. Brazil has also experienced several
structural changes and reforms during the last 20 (twenty) years, and I might point out
here at least 4 (four) aspects that impacted in the economic scene such as currency
stability, swelling international reserves, solid macroeconomic, and a fast expanding internal
consumer market136. These aspects have made Brazil to be recognized as a promising
economy in the 21th century.
The country, which for many decades was known for the high soccer level and
carnival, has directed business´ awareness to the development of a strong economy in
solid foundations.
136 http://www.pwc.com.br/pt_BR/br/publicacoes/assets/doing-deals-11-final-a.pdf
57
It is possible to say that Brazil reached a mature status guided by political stability
and a durable platform for growth of the economy, with a strongly regulated financial
system (which helped to mitigate the worst effects of the latest crisis)137.
Brazil has proved this fact being one of the last countries to suffer the effects of
the most recent global crisis and the first to go out of it. Besides that fact, other aspects
as the high level of diversification in the economy and its wide range of trading
partners, explained the Brazil’s success138. Nonetheless, some questions remain: How
could a country, of continental dimensions, with one of the best climates in the world
and vast natural resources, not be revealed to the world as a significant economic power
and play a leadership role? Why does Brazil only trade commodities rather than
technology?
It is not difficult to see Brazil’s importance on the world panel. Even being the
world's fifth largest economy in the world and the largest in South America. The
Brazilian economy is the largest in Latin America, with an estimated GPD of
approximately $2 trillion in 2010139.
In a quick overview, it is easy to verify that Brazil has diversified its economy
with large and well-developed agricultural, mining, manufacturing, and service
segments, and with a broad industrial base140. The entire country speaks one language
(Portuguese); it does not suffer from natural disasters such as earthquakes and
hurricanes; and it has massive resources in energy, minerals and raw materials141. Brazil
is also self-sufficient in oil and is a world leader in the improvement and production of
137 http://www.pwc.com.br/pt_BR/br/publicacoes/assets/doing-deals-11-final-a.pdf 138 www.insead.edu/facultyresearch/centres/global_private_equity_initiative/publications/documents/INSEAD_PwC_BrazilPEreport.pdf 139 http://www.pwc.com.br/pt_BR/br/publicacoes/assets/doing-deals-11-final-a.pdf 140 http://www.insead.edu/facultyresearch/centres/global_private_equity_initiative/publications/documents/INSEAD_PwC_BrazilPEreport.pdf
141
http://www.pwc.com.br/pt_BR/br/publicacoes/assets/doing-deals-11-final-a.pdf
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low mission fuel and biofuels such as ethanol. Finally, Brazil has a young workforce and
it is also highly urbanized when compared with other emerging countries142.
Beside these facts, the market has increased their rates and patterns of
consumption, with social and economic policies steer to a poor class, who for many
years had been forgotten by governments.
The middle class is increasing, generating improvements in real wages, and
consequently increasing the purchasing power and the consumption for more
sophisticated products such as refrigerators, televisions, computers, etc. This fact
provoked changes on the market and drove companies to meet new demands in order
to expand domestic consumer goods. Gathering all these components and the
international economic scenario, Brazil has also managed to create a significant
industrial base - automotive industries - and also a prominent civil aviation industry143.
Finalizing this quick overview on Brazil, it is also essential to say that the country
has a democratic regime and well-established governmental and administrative
institutions, constantly trying to adjust macroeconomic fundamentals in order to
improve stability of political institutions144.
The creation of new corporate governance known as the Novo Mercado145, for
instance, created a fresh atmosphere in the market. These new rules required strict
corporate governance, by reducing risk for investors and helping to boost demand for
Brazilian publicly traded companies146. This generated greater interest from local
142 Russia, India and China. 143 See www.embraer.com.br 144
http://www.insead.edu/facultyresearch/centres/global_private_equity_initiative/publications/documents/INSEAD_PwC_BrazilPEreport.pdf 145 “Novo Mercado is a listing segment designed for shares issued by companies that voluntarily undertake to abide by corporate governance practices and transparency requirements in additional to those already requested by the Brazilian Law and CVM (Brazilian Securities and Exchange Commission). It is based on the premise that stock valuation and liquidity are positively impacted and assured by shareholder’s rights and by the quality of companies´ information. The admission to Novo Mercado implies the compliance with corporate rules, known as "good practices of corporate governance", which are more rigid than those required by the current legislation in Brazil”. http://www.bmfbovespa.com.br/en-us/markets/equities/companies/corporate-governance.aspx?idioma=en-us 146 See McCahery J A and Vermeulen E P M, Hisatake M and Saito J, The New Company Law - What Matters in an Innovative Economy? (ECGI - Law Working Paper No. 75 2006).
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companies in accessing the capital markets to finance growth and provide liquidity for
existing shareholders147.
5.2 – Economic aspects to be improved.
Obviously Brazil is not a perfect place holding only positive aspects. There are
many aspects that Brazil should improve, and others must be changed. The country is
facing the same problems of most emerging countries; it still presents investment
challenges for actual and prospective domestic and foreign investors148. Drastic changes
must be promoted in legal and regulatory terms and macroeconomic environmental in
other to push domestic investors and to attract foreign ventures. Thus, despite the
economy increasing and confidence in Brazil, prospective investors still find obstacles
in the complex regulatory and legal matters which turn the investments in Brazil149.
In this sense, two key issues must be addressed in a rapid way: regulatory and
legal framework and the tax system. Brazil has a massive numbers of regulations which
cause problems for companies and investors due the fact that is extremely hard to
comply with; the costs are also large and the time consuming is also impressive150.
Besides these facts, Brazilian legal system permits numerous appeals and legal
instruments that can significantly stoppage the outcome of any lawsuit. Following the
same perspective, the tax system imposes a greater burden on companies than any other
system in the world151. Brazil has more than 19 (nineteen) taxes, and to complicate the
scenario, companies are required to pay taxes at three different levels federal, state and
municipal authorities152.
These aspects provoke direct effects in the economic development, generating a
high level of informal activity, which nowadays represents a large part of the Brazilian
147 See McCahery J A and Vermeulen E P M, Hisatake M and Saito J, The New Company Law - What Matters in an Innovative Economy? (ECGI - Law Working Paper No. 75 2006). 148 This aspect was previously discussed in Chapter 3. 149 See Chapter 3 and 4. 150 http://www.pwc.com.br/pt_BR/br/publicacoes/assets/doing-deals-11-final-a.pdf 151 http://www.pwc.com.br/pt_BR/br/publicacoes/assets/pe-in-Brazil-setting-the-scene-discussing-valuations-nov2011.pdf 152 See Introducing Private Equity and Venture Capital for Entrepreneurs - Brazilian Agency for Industrial Development, Center Management and Strategic Studies - Brazilian Agency for Industrial Development, 2011.
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economy. This problem often presents an immense challenge for private equity players
operating in Brazil, and it is common that they simply turn down their investment
opportunities because of the high degree of informal activity among companies.
In this way the debt availability and potential instability of the macroeconomic
environment are examples that worry investors somehow. Prior to the 1990`s, Brazil
presented high volatility in it economy and a hyperinflation scene which turned Brazil
almost unviable to investments153. Nevertheless, over the last 20 years, many aspects
have changed and the country improved on many fields (diminishing the gap among
riches and poors) but serious economic challenges have still remained.
In this aspect, the greatest problem is education. Brazil has a lack in the education
system and despite the fact that Brazil is the biggest economy in Latin America; the
same cannot be said about the education system.
Brazil also presents some problems in corporate governance aspects. Most
companies are held by block-holders (essentially for traditional families) or in other
cases companies state-owned. For the first case, the main problem is to establish a clear
separation of roles and responsibilities, and for the second, the monopoly and the
bureaucracy can retain the cash flow to the detriment of the market154.
5.3 – New business opportunities.
The fact is that the growth and the development of Brazil were not homogeneous
and it will not be, given its enormous territory. While, in some parts of the country, it is
possible to see clearly indicators of the first world countries, many others do not even
have basic sanitation or electricity, and public transportation is insufficient or in many
153 http://www.pwc.com.br/pt_BR/br/publicacoes/assets/doing-deals-11-final-a.pdf 154 See After Eron, Improving Corporate Law and Modernizing Securities Regulation in Europe and the US, Edited by John Armour and Joseph A. McCahery (Orxford and Portland, Oregon, 2006).
61
cases does not exist155. Nonetheless, Brazil presents as a place of outstanding
opportunities in different fields of the economy.
Healthcare is one of the sectors that can be more explored by investors. To get a
picture of the current scenario, the total sales in 2009 summed R$ 30 billion (thirty
billion reais) or almost US$ 18 billion, and the numbers keep on growing156. The same
happens on information technology, where Brazil has extensive experience in
technology outsourcing with a well-developed local market in information technology
outsourcing (ITO) and business process outsourcing (BPO)157.
The infrastructure is another sector that must be explored by investors. The
Football World Cup 2014 and the Rio Olympic Games in 2016 will require the largest
volume of infrastructure’s investment. The civil construction and urban building and
pavement sectors will demand a high level of investments.
The phenomenon followed by middle class expansion provided to market a new
perspective. Consumers are spending their money in nonfood items, which means, that
they are buying more clothes, personal hygiene products, and the most important, they
are acquiring more electronics devices. This circumstance also provides for PE and VC
firms opportunities to make investments, because, in most of the cases, the consumer
goods companies are still small, family-owned, and they do not have enough capital to
grow, and also the consumer goods industry is still highly fragmented158.
It is also important to highlight two other profitable sectors: oil-gas and
agribusiness. There are multiple private equity investment opportunities in this oil-gas
industry, especially in firms positioned in the supply chain of the large exploration and
production companies such as Petrobras and Shell. The same opportunities can be found
on agribusiness. 155 http://www.pwc.com.br/pt_BR/br/publicacoes/assets/doing-deals-11-final-a.pdf 156 http://www.pwc.com.br/pt_BR/br/publicacoes/assets/doing-deals-11-final-a.pdf 157 http://www.pwc.com.br/pt_BR/br/publicacoes/assets/pe-in-Brazil-setting-the-scene-discussing-valuations-nov2011.pdf 158
http://www.insead.edu/facultyresearch/centres/global_private_equity_initiative/publications/documents/INSEAD_PwC_BrazilPEreport.pdf
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Brazil’s agricultural sector has benefited from macroeconomic stability, high
international commodities prices, currency devaluations, and large capital inflows from
domestic and foreign investment. Brazil is extremely competitive in a number of
agricultural products, including beef, poultry, coffee, sugar, and orange juice, of which
it is the largest producer in the world159.
5.4 – PE and VC industry in Brazil.
After this Brazilian economic outlook, I focus my spotlight on other emerging
countries and how the PE and VC industry have been conducted in Brazil. As I
mentioned previously, Brazil improved in some sectors (economic atmosphere is no
longer volatile, there is increasing international trade and there are more policies
favoring exports, there are new rules favoring minority shareholders160; inflation has
been under control for almost a decade and a half). On the other hand, the tax legal
system is still a problem, the legal framework is quite heavy and the lacks in education
are considerable obstacles.
However, Brazil adopted over the years a friendly international policy, and
despite the fact that all four BRIC’s (Brazil, Russia, India and China) are globally
perceived as offering massive opportunities and potential for growth, the challenges for
investors in Brazil are smaller than for those in other emerging economies161.
It is a paradoxical problem to be solved. On one side Brazil presents a high
growth rate of GPD per capita and expanding middle class,; on the other side problems
still remain as poor infrastructure, inefficient governance, ineffective law and order,
widespread corruption, high levels of disparity and poverty. The way that governments
conduct these two sides will determine the success or failure of the economy162.
159 http://www.pwc.com.br/pt_BR/br/publicacoes/assets/doing-deals-11-final-a.pdf 160 See footnote 136. 161 My point here is based on the peaceful and diplomatic relationship that Brazil maintains with other countries. 162 I discussed the role of governments in the economy in the prior Chapters, and I believe that the influence of experts (lawyers, economists, accountants, etc) shall provide a dynamic and more attractive posture for the new emerging countries.
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Although some measures and plans take time to be implemented, Brazilian
government is increasing consciousness of the investment opportunities. However, here
a criticism must be done. The Brazilian government is not investing in technology or
capital goods industry and leaving commodities and agribusiness impetus play the
main role in the economy163. This means that the country exports raw material and then
imports consumer goods, technology and machines, and maybe in the future this math
cannot be done anymore, causing hard damages to the economy.
However, Brazil is taking the right north in other relevant aspects. The country
got an Investment-Grade rating by all the main risk agencies and the improvement in
the corporate governance and accounting and auditing standard with International
Financial Reporting Standards (IFRS) have been determinant to create bounds
worldwide164. Brazil presents a business-friendly environmental for US and European
investors, and it maintains peaceful relation with neighbor countries of Central and
Latin America and also play a pivotal role in the Mercosul, a free trade zone involving
Brazil, Argentina, Chile, Venezuela, Paraguay and Uruguay.
The domestic investment policy keeps its perception worldwide and tries to
attract foreign investors by providing fiscal and tax incentives such as deductibility of
goodwill, for example. All the circumstance combined with development in local capital
and debt markets increased the number of IPO’s in recent years165.
In 2009 the entire world was affected somehow by the crisis and the M&A
activity was also harshly affected; however, in Brazil PE activity reached record
163 And the fact that Brazil has the highest GDP of South America and an economy that is growing at very strong pace (about 7% per year) and much of this new scenario is because the exports that did not stop growing items as meat, chicken, sugar, orange juice, coffee and tobacco, not to mention the fact that one of the largest producers of iron mining in the world. 164
http://www.insead.edu/facultyresearch/centres/global_private_equity_initiative/publications/documents/INSEAD_PwC_Brazil
PEreport.pdf 165 http://www.ey.com/Publication/vwLUAssets/Global_Private_Equity_Watch/$FILE/Global_Private_Equity_Watch.pdf
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levels166. Part of PE activity in Brazil was directly involved in “cash for investments”
deals. Nevertheless, once middle class expanding, investors have other targets for years
to come. Investments in food and drink segments, consumer goods, education, and
energy are promissory sectors.
The milestone for PE activity in Brazil had started in the 1990’s with the capital
liberalization. This phenomenon increased competition from foreign companies and at
the same time provoked changing behavior for domestic companies to develop
productivity. Another event that contributed to the flourishing of PE industry in Brazil
was the privatization of state owned companies (low valuated), which brought into to
the country a large amount of investment to revitalize those inefficient companies. At its
apex in 1998, the Brazilian PE industry raised US$ 3.7 billion for investment into the
country167.
In the early 2000’s, Brazil went through a period of macroeconomic uncertainty
caused by Asia crisis, the bursting of the Internet bubble and the terrorist attacks of
September 11 2001 had a strong impact on financial markets, and Brazil economy felt it.
The set-up started to change again for Brazil, in 2005, when the macro-economic
environment was once again favorable and there was no sign of political instability.
Lula, the former president, maintained the previous government policies and
boosted income distribution policies for poor class. Ironically, the other two aspects that
were decisive to catch up more global attention on Brazilian economy were the facts
that Brazil will host 2014 World Cup and the Olympic Games in 2016.
The private equity activity in Brazil has been stimulated by a combination of factors
and if the conscious about the improvements in some item mentioned above happen
166http://www.ey.com/Publication/vwLUAssets/Global_Private_Equity_Watch/$FILE/Global_Private_Equity_Watch.pdf 167 http://www.pwc.com.br/pt_BR/br/publicacoes/assets/pe-in-Brazil-setting-the-scene-discussing-valuations-nov2011.pdf
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faster, Brazil will play a more significant role among the emerging countries, but also
for developed countries168.
5.5 – The new lawyer’s posture.
Despite all the difficulties the Brazilian economy has experienced and the
problems that still remain, there are many fields that can be invested and are clamming
for new businesses. Industries present the more visible expansion, faster results and as a
result, lawyer’s activity tends also to increase. A company that creates an exclusive
product needs to register its patent; companies need to sign contracts and tax planning,
and companies also need lawyers to defend them before courts. The question is: Would
lawyers be able to play a different role? Would lawyers be prepared to face new
challenges? And finally, would lawyers be willing to act like businessmen?
The market has changed, and, as mentioned above, it has provided a plenty of
opportunities to make businesses. Lawyers might be following other ways in order to
assimilate new functions and find out creative outlets to this new scenario. However,
further questions arise: what might be lawyers’ posture before those events? Shall
lawyers take a more active stance in the market or keep waiting to be triggered? Could
lawyers articulate and develop new business?
For me it is clear that lawyers might hold a new posture in response to the new
trends that are rising. However, this new sort of approach shall be done carefully since
lawyers, at least in Brazil, face legal limits, shall compete with other expertise areas and
fight against prejudices169. The intention of this Chapter was to sketch the scenario
wherein lawyers can play an atypical role and also make available to the market their
168 “A combination of factors, such as increasingly sophisticated and liquid capital markets (which have seen 181 IPO`s and follow-
ons over the past five years, 2007 being a record year with 76), new financing instruments and existing exit alternatives (such as
sales strategic players, capital market/IPO or sales to other PE`s or funds of funds), along with the continuing demonstration of
political and economic stability have opened de eyes of foreign PE investors to Brazil, which is now regarded as a serious player in
the global market”.
http://www.insead.edu/facultyresearch/centres/global_private_equity_initiative/publications/documents/INSEAD_PwC_Brazil
PEreport.pdf 169 See Chapters 3 and 4.
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dealing skills. In the next Chapter I present a sort of solution by which I believe a new
business approach for lawyers can be provided.
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6 – A FEASIBLE SOLUTION TO REDUCE TRANSACTION COSTS.
"I can't understand why people are frightened of new ideas. I'm frightened of the old ones"
(John Cage, American composer)
In a general view, thus far what is known is that, i) firms can reduce transaction
costs and government intervention is unnecessary whether parties can reach in a deal
by themselves; ii) the market is not free as we think (social barriers impede the creation
of new endeavors); iii) lawyers and legal services shall be changed and/or improved170
and iv), there are a plenty of opportunities to develop and create new ventures. Thus,
the question is: how to bind all these different aspects?
The economic development brought more dynamism to the relationship between
law and businesses and according to some doctrines the IT and the Commoditization of
law will shape lawyers activity171 in the future. However, I believe that lawyers might
create an alternative in which by using firms they can reduce transaction costs.
The issue is: if I agree with the premises of IT and Commoditization and other
trends that are rising up worldwide172, I might agree with the fact that the evolution
and changes on legal services must take more time in regions wherein there is a lack of
economic development173. In other worlds, the economic development path will
determine the course that law might take; and the market demands will establish how
law ought to behavior.174
170 In this sense, it must be understood that legal services are no different of other goods or services, and lawyers are not more a magic person which hold (or hide) vital information in a file. There is neither magic formula anymore, nor even a secret (Said by Professor Erik Vermeulen in the Last Lecture, event occurred on 27th of April, 2012: “The End of the Legal World as We Know It"). Nowadays, with the Internet phenomenon all kinds of documents can be reached or grasped in few minutes and the secret ingredient, which used to make lawyers special ‘sort of people’ was unveiled. 170 See Richard Susskind, The End of Lawyers? Rethinking the Nature of Legal Service (Oxford University Press 2000). 171 Ibid 6. 172 See Ribstein and Susskind (n 169). 173 Brazil might be included in such portrait. As I mentioned before some parts of Brazil are high economic developed, however others suffer a lack of economic growth. 174 See Ribstein (n 11) and Gilson (n 78).
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By doing so, it tangible to conclude that poor regions in which the economy is
not well developed will be more difficult implement or improve new law concepts and
legal services methods175.
Nonetheless, which appear be a huge problem to lawyers, is indeed an
opportunity to create new kind of businesses and develop new ideas. The key issues
are: How to generate richness from this scenario? How do lawyers can be involved in
this process?176
In my humble opinion lawyers may create firm to provide services to reduce
government and regulatory costs. To comply with this premise, a specific kind of firm
might be created. This specific kind of firm might be used in order to bind the dots, i.e.,
to reduce the transaction costs, to stimulate deals and to synchronize commercial
operations (PE and VC for instance177) regionally in order to put them work with other
legal tools178. I believe that a specific kind of firm179 may bind capital, ideas, companies
and businessmen in order to foster commercial operations in a given geographical
perimeter.
The idea presented below is the way that I believe that this firm may deploy the
concepts mentioned above. This sort of firm might act in two different ways: i) trying to
diminish social barriers and ii) improving and changing technical issues.
6.2 – How new business can be created.
I would like to start this part showing three different examples in which I believe
this specific kind of firm may act:
175 Susskind (n 169). 176 See footnote Chapter 3. 177 What I am saying is that the concepts of PE and VC, for instance, are very important (the methodology used in the agreements, the evaluation process and so on). Nevertheless, it would be very difficult or almost impossible, say, to apply the same model used in USA or UK in Brazilian. 178 The new corporate restructure legislation, Law n. 11.101/2005. 179 This is only a feasible nomenclature to designee this new sort of firm. I do not know a specific firm that could develop the services that I am imagining be possible, thus I named this new kind of firm as “specific kind of firm”.
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Sample 1: The Brazilian government through specifics entities makes available
for entrepreneurs who desire to create and develop their own business some specific
places. These places are called incubators180. The government also provides some
administrative services and professionals to orient entrepreneurs to develop their
businesses. 1) In one of those incubators, an entrepreneur had developed some
differentiated leather handbags, and received a large amount of requests. The inventor
of the new model of handbags was not a communicative person and did not have a
dynamic and holistic perception of businesses. 2) Some miles far from the incubator,
there was a leather bags factory which was performing a judicial restructure. The factory
was family-owned and was failed running the business. The factory counted with a
good infrastructure, with machines, employees and good raw suppliers. 3) Finally,
there was a famous businessman in another city nearby, who was running a leather
shoes factory and desired to expand the variety of his products. However, there was not
enough infrastructure around and borrow money from banks was not even a good
choice. Apparently these three scenarios were completely isolated, but actually they
could be connected, and for this case a specific kind of firm could be used in order to link
these businesses.
Sample 2: 1) Two scientists had developed a different sweetener from the sugar
cane bagasse and they needed capital to develop the process and to run the new
business. The problem was that the both scientists did not have friends, family or other
network capital sources to support the venture; and go for a loan was out of question181.
2) The scientists’ company was located in a place surrounded by sugar cane factories
which produce a large amount of sugar power and ethanol (kind of fuel).
180http://www.sebrae.com.br/customizado/sebrae/institucional/sebrae-in-english 181 In the PE and VC industry there are different ways to raise capital and both with pros and cons. Bootstrapping is one these ways. This method presents no loss of ownership, no monthly payments and no legal documents might be performed. Dell is a typical bootstrapping case. However, this method is unsophisticated, very difficult to make large capital commitments and hard to recruit top-notch talents. Debt is other method to raise money. The good news in this method is that the money comes from other people, and there is no loss of ownership at least in the beginning. The bad news is that lenders want a little bit every month and they will care about the repayment. Another method is raise capital through equity. By using this method, the entrepreneurs do not have pay monthly and a large dollar will be available in a long time horizon. The dark side of this model is that entrepreneurs will lose ownership and often control, founders might be report their actions to Board of Directors and there will be focus on strategy more than tactical opportunities. (Information based on the International Business Law I course, Lecture 9, Professor Erik P.M. Vermeulen).
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The amount of capital over there was amazing; however, would be necessary to
convince the sugar cane businessmen to invest their money in an innovative idea.
Indeed, there was a new promissory idea and also there was capital to finance this new
initiative, and there were costumers. Finally, the raw material was extremely cheap and
the sugar cane factories could also commercialize the new sweetener. Again, a special
kind of firm could be used to bind all these different scenarios.
Sample 3: 1) Two brothers had bought a ranch contained a water mine. They
took advantage on this fact and built a water bottling factory. Thus, they started
bottling the water and sell it. The siblings (partners) got all necessary certificates,
complied with all obligations relating to the bottling water business. For some years the
company worked perfectly. However, they had some problems, and decided to dispose
the ranch, and sold it with all facilities included. 2) At the same time, there was
information that a plastic packaging company (not far from the water bottling business)
was experiencing serious financial involvedness and went to judicial recovery to try
competing in the market.
The key aspect amidst the samples presented above was to detect a way to bind
different businesses and to deal with different aspects (culture, trust, prejudices,
distances, etc) at the same time. In most of the cases the endeavors were already done,
which means that businesses only needed a mechanism to communicate each other in
order to be more profitable. To attend this purpose, it seems that a specific kind of firm
could be a feasible solution to bridge endeavors, investors, capital and new ideas and
reduce transaction costs in a certain geographical perimeter. I am not saying that new
sort of firm must invest its own capital to restructure or invest in new ideas (coping PE
and VC model). I am saying this specific kind of firm might use its intellectual and
technical skills to show to different people (investors, entrepreneurs, etc) that there are a
plenty of opportunities that can be developed.
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Let us say that an investor (s) come up with a certain amount of money and
decide to invest in one of those cases presented above. Many problems could be solved,
right? However, a step back was necessary, i.e., to create a business to present to an
investor (s). An investor is more tempted to invest his capital in a bottling water company,
instead simply to buy a ranch with a great mine of water. It is also more interesting for
investors devote their capital in a sweetener factory or in a different leather bag company
than in a separate default businesses.
This specific kind of firm must be able to demonstrate to businessmen that what
seems be different kind of business can (and should) be combined. This specific kind of
firm might be able to i) convince people and deal with different profiles, ii) reduce
geographical distances between endeavors and iii) attract investors to new ventures.
The intent is to develop and leverage the skills of different cities located nearby
so as to take advantage of different materials, technologies, natural resources, and
infrastructure. Thus, it would be possible to create chains of production in specific areas
of the Brazilian territory in different investment cycles, using the principles of PE and
VC (if necessary).
In this sense this specific kind of firm could reduce transaction costs originated by
social barriers and technical issues.
1 – Reducing the geographical distances between businesses. This specific kind
of firm can reduce the geographical distances between businesses in different cities. In
my mind this specific kind of firms will only get success if work in a certain perimeters.
As shown, Brazil is formed by thousands of small cities182, and therefore this firm shall
reduce these distances and formed new areas of businesses enhancing the
communication between parties183. There is no ratio by trying to put together a leather
182 See footnote 8. 183 If this specific kind of firm delimit a perimeter of, say, 30 cities within in a 80 kilometers radius wherein the sum of this perimeter’s population is higher than 300.000 but lower than 1.000.000 for example; this firm will be able to find out new ventures and bind different perspectives.
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shoes factory and new models handbags if they are far away distant. The same can be
said on water bottling case (sample 3).
2 – Changing behaviors: By scanting geographical distances the specific kind of
firms shall be able to intervene on other aspects. The lacking of trust and the existence of
some paradigms are aspects that might be changed. To convince local businessmen to
invest capital in new ventures184 rather than buy stock options, for example, will be a
hard task. That specific kind of firm must to convince people and companies to invest in
micro, small and medium companies185. The key issue is to demonstrate to local
investors that there are other alternatives to invest capital. The importance of this
specific kind of firm is to display to a capitalist who does not understand anything about
bottling of water that there is a good investment opportunity. On the other hand, this
specific kind of firm may convince entrepreneurs of the importance in receiving
investments.
3 – Reducing difference in culture: Small cities are always viewed as places
without economic resources or less developed. Despite the geographical proximity
among these places, each city has a fussy profile in the way they conduct businesses,
deal with entrepreneur’s culture and establish development economic policies. This
specific kind of firm might reduce these differences by implementing new trends.
4 – Improving inefficient business networks: Despite the proximity, a plenty of
cities suffer with lacking of network among entrepreneurs and invertors in such places
and consequently missing great opportunities to do business. In my opinions a specific
kind of firm may build networks in order to facilitate the exchanges of all sort of
information.
184 In Brazil is very common that businessmen invest their money (or profits) buying stocks from listed companies. In many cases these businessmen just keep their money in bank accounts or saving accounts or in funds with low interest rates. 185 I believe that these companies (micro, small and medium) have the potential to receive investments and can generate significant profits.
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Law and economics concepts on the same path.
Lawyers holding different functions / they will be responsible to create the specific kind of firms.
The goal of such firms will be to reduce transaction costs. These sorts of firms must be multidisciplinary (does not
necessary mean a team of people with different backgrounds, but a team of lawyers with different
backgrounds.
These firms might choose a specific perimeter to
reduce geographical distances, improve network
reduce difference in culture and change
behaviors, etc.
1 – By reducing social barriers (lack of
trust, geographical distances, differences
in culture, building better network).
2 – By convincing people of new trends,
introducing new conceptions, new
business mentality.
1 - By acting as lawmakers (Law
11.101/2005, for instance).
2 - By acting as dealmakers (transaction-
cost engineers).
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A,B,C / D,E,F,G / cities = companies located in different cities. 1+ 2+ 3+ 4 = geographical perimeter = maximum 30 cities/300,000 ≤ 1,000,000 inhabitants.
The diagram illustrates how a specific kind of firm might reduce transaction costs
in commercial operations. The points 1, 2, 3 and 4 delimit a certain territory in which the
cities are separated in maximum 100 (one hundred) kilometers from M point (taken
randomly). The products PX and PY are result of exchanges between different
businesses respective cities.
Let us take as example the product "PX". Suppose that in the city "A" there is a
large coffee farm, but there is not a firm that carries out a quality roasting. Nevertheless,
in the city "B" there is a family that has machineries which is not being used for
undetermined reasons (usually the family want to unfasten and allocate the money
from the sale between the heirs). In the city "C" there is a manufacture of packaging
which this almost going bankrupt by financial derangements.
A
1
1
1
1
1
1
1
1
1
2
2
2
2
PX
PY
D
C
a
a
a
3
a
B
2
2
2
2
2
2
2
e
M SKF
F E
G
4 3
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In thesis are 3 (three) separate investments, or three different opportunities, but
not exactly. The idea was to articulate these three opportunities, creating a product (an
export coffee, for example). If lawyers are capable to create a firm in order to bind these
dots, or different scenarios, many other new businesses will arise. This specific kind of
firm shall reveal to small cities, for entrepreneurs and businessmen that there concepts
(PE and VC and Law 11.101/2005) that might be used to foster new venture. Diverse
law and economic concepts shall be used regionally and in small endeavors. This is the
way, I think, that lawyers may possibly play a different role on the new economic scene.
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7 – CONCLUSION.
Larry Ribstein argued that law is waiting for a different lawyer, a sort of Steve
Jobs (or Bill Gates) of law, and his argument goes further predicting that such person
will be more important than iPhone invention. In fact, I might agree with this
preposition, I also believe that lawyers might change their posture behalf the market
and businesses. I am a big believer that lawyers might expand their functions for other
fields and also change or improve the way that they exercise advocacy. My purpose on
this paper was to demonstrate that economic demands will shape the way that lawyers
face the law and will to compel lawyers to rethink their posture by forcing them to act
in objective way hanging a more business profile.
The way that the modern transaction costs are being unveiled, in my
understanding, provide to lawyers a new alternative to make new businesses. The social
barriers as it was argued gave to lawyers a new perspective to lead with ventures,
businessmen and market. Lawyers are able now to interfere in the economy by using
their well-known skills for different purposes. If they create a specific kind of firm they
will be able to reduce the social barriers and, as a result, the transaction costs.
As shown at Ronald Coase’s theory the importance of the creation of firms is in
the way they can reduce transaction costs by playing a crucial role in the economic
system. However, the rationality behind Coase’s theory should be more explored by
lawyers, i.e., they provide to the parties better outputs in a friendly way avoiding
(ironically) courts. In other worlds, the better and faster way the parties pursue to reach
in agreements is keeping away from institutions, bureaucracy and governments.
Lawyers might hold a transaction cost engineer role in other to promote deals.
The partial fail of neoclassical economic model by not giving the due importance
for individuals opened a new room of discussion, and the social barriers that in such
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way impede businesses occur are signals that the real transaction costs will never end
up.
I believe in such premises and I tempted to say that this new kind of professional
will generate more results in the market. In this way lawyers will be carry a huge duty
to improve and try to reduce the social barriers and the prejudices that cause obstacles on
the creation of new businesses. The traditional law system will be replaced for a more
dynamic and business related form, i.e., that lawyers will be closer the society’s
demands and more prepared to deal with new requests.
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