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17 August 2016
Brazilian airlines and other operators such as air taxi companies have come under unprecedented financial pressure in the last 18 to 24 months due to a variety of circumstances. One source of pressure is the devaluation of the Brazilian real, which has lost around 30% of its value against the dollar. In addition, Brazil is in the midst of a major economic recession, with economic activity in Brazil declining by approximately 4% per year, resulting in significant reductions in the demand for air transport services. In 2016 the decline in demand averaged 6% to 7% in a month-by-month comparison to 2015. Further, international passenger demand fell for the first time since 2013. In the non-commercial sector, low oil prices have negatively affected demands for helicopters to service the offshore energy industry. To a lesser extent, corruption scandals with the state oil company Petrobras have also affected helicopter demand.
The government has taken several measures to alleviate pressure on the country's air operators, including greater tolerance of late departures and cancellations and consolidating flights. There have also been some tax concessions in the area of fuel supply.
Independent of the economic crisis, the Aeronautical Code 1986 is undergoing a comprehensive review and revision (for further details please see "Revisions to Aeronautical Code"). As this revision is taking longer than expected, in order to meet more immediate demands, the president promulgated interim legal measures earlier this year to alter a few articles of the code. These interim measures were effective for a few months and changed one area particularly relevant to air carriers – restrictions on foreign investment in airlines.
During the legislative approval process, new provisions were nearly added to the code in order to govern interchange agreements. However, on July 25 2016 the efforts culminated in final approval of a new law which vetoed these two important changes, leaving only a few modest changes in other areas.
Notwithstanding the ultimate vetoes, this update examines two independent areas – foreign investment restrictions and interchange agreements – because of their importance to the aviation sector and the likelihood that the interim changes, in some altered form, will probably be reconsidered by the government in the future. In particular, the final presidential veto of the relaxation of the foreign investment restrictions should not be viewed as a definitive decision to leave the existing laws unchanged, as that veto occurred because the executive and legislative branches had not yet agreed on what changes to implement.
The code establishes a 20% limit on foreign ownership of voting shares by investors of Brazilian air carriers. This restriction does not apply to non-voting shares. Brazilian corporations can issue non-voting shares subject to a 50% limit on the total capital. Thus, under the existing code, if a Brazilian carrier maximises the non-voting shares it is able to issue, foreign investors can hold as much as 60% of the total capital of a Brazilian air carrier. This policy has been in effect for decades.
On March 2 2016 then-President Dilma Rousseff issued an executive order altering the limit on voting shares from 20% to 49%. The executive order also included provisions to increase the 49% limit, although those increases would have required reciprocity with other countries and bilateral agreements. Rousseff's executive order became effective on issuance, although its continued effectiveness was dependent on congressional approval.
The lower house of Congress considered the executive order and, on June 21 2016, introduced a change that would have completely removed all restrictions on foreign investment. Under the lower house version, foreign investors would have been allowed to acquire 100% of the voting shares of airlines and other air carriers. The executive order, then in the form of a proposed law, was sent to the Senate for approval.
In July 2016 the Senate sent the proposed legislation to the president for approval. By this time, a change had occurred in the presidency. Rousseff was removed from office on an interim basis, pending impeachment proceedings. Thus, the new law was subject to the approval of Brazil's current president, former Vice President Michel Temer. However, before the Senate sent the legislation to Temer, after heated debate, an informal political agreement was reached under which Temer agreed to veto the increase to 100%, which he did on July 25 2016. Consequently, after months of considerable expectation, Brazil's rules remained unchanged, as did the 20% limit on voting shares.
Congress must now consider how to address situations where investors took advantage of the 49% limit while it was in effect. There are no reported cases of investments in major Brazilian airlines that exceeded the 20% limit, as major carriers were waiting for the final outcome of the process before selling shares over the 20% limit.
It is unlikely that the existing rules on foreign investment will remain unchanged in the mid-term. While the change from 20% to 100% may have been too drastic to implement at once, some change is likely in the coming 12 months.
The code still requires airline directors to be Brazilian nationals.
Another area of change that the new legislation almost altered relates to interchange agreements. These types of agreement have become increasingly popular worldwide, especially in South America. Many attribute the invention of the interchange agreement to the Chilean carrier Latam, which functions through a group of affiliated operators located in several jurisdictions, including Chile, Brazil, Peru, Mexico and the United States. Colombian carrier Avianca, which also has affiliates in Central America, Colombia and Brazil, uses interchange agreements or variations therein.
In essence, an interchange agreement is an agreement for a series of short-term dry sub-leases. The interchangor is the party with possession of an aircraft, either its owner or a lessee. The interchangee is a party that the interchangor allows to use the interchanged aircraft for occasional flights. An interchanged aircraft can move from one operator to another multiple times in a short period of time, even in a single day. Thus, an aircraft might begin its day with a crew and flight code from country A and arrive in country B, where an affiliate operator takes control of the aircraft and conducts internal domestic flights with its flight code.
Registration of interchanged aircraft do not change. Thus, the interchangees typically operate aircraft registered in the jurisdiction of the interchangor.
Brazil has been grappling with the implementation of interchange agreements for a few years. Initially, interchange agreements were virtually impossible to implement due to requirements that Brazilian airlines operate Brazilian-registered aircraft with Brazilian crews. In late 2013 the Brazilian Civil Aviation Agency (ANAC) issued new regulations concerning its registration policies which included a reference to registration of interchange agreements. However, the ANAC regulations provided only a reference to these agreements, rather than any actual details concerning their use.
In the version of the new law sent to the Senate by the lower house, four new articles were added to the code and one article was amended. The new articles commenced with a statutory definition of 'interchange agreements' and a provision requiring foreign aircraft operating in Brazil to pass technical inspections and be registered with the Brazilian Aeronautical Registry (RAB). As this registration could not have been full registration, the RAB would likely have had to establish a separate register for the aircraft.
One of the new articles also included a provision that the certificates of airworthiness issued for Brazilian-registered aircraft subject to interchange agreements mention the name of the interchangor, the interchangee and contain the owner's consent. Had this provision become law, it would have been unusual, as it both restricted interchange to certain aircraft and parties and seemed to require an owner's consent in the airworthiness certificate itself.
Another new article provided that an interchangee would be responsible for damages caused by an aircraft during any period in which it operated the interchanged aircraft. This follows the general Brazilian legal principle that operators, and not lessors or finance parties, have sole liability for aircraft that they operate.
The new law would clearly have allowed interchanged aircraft to operate all types of flight in Brazil, including domestic point-to-point passenger flights. To date, Brazilian airlines have had to limit register their to aircraft registered with the RAB.
Finally, the new law contained a provision that required Brazilian interchangees to use Brazilian crews on all flights.
The Senate vetoed all the foregoing provisions except for the last one. The result is odd, as the code now requires Brazilian operators to use Brazilian crews with interchanged aircraft, but does not define 'interchange agreements' or include any other provision relating to interchanges. Thus, Brazil continues to have vague legislation acknowledging that interchange agreements are permissible, but without any other statutory guidance.
Although many of the proposed changes were vetoed, these two areas of legislation still merit attention, as the failed legislative efforts of 2016 are indicative of future legislation. It is likely that some relaxation of foreign investment limits will occur in the near to mid-term. If any lesson can be gleaned from the 2016 legislative proposals, it is that a complete revocation of foreign investment restrictions may have been too drastic a change.
In relation to interchange agreements, Brazil's legal framework continues to be vague. There are now two loose references to interchange agreements, one in the code and one in the ANAC regulations. More statutory guidance is likely in the near future. In the meantime, operators are entering into interchange agreements, despite the uncertainties.
For further information on this topic please contact Kenneth D Basch at Basch & Rameh by telephone (+55 11 3064 8599) or email (firstname.lastname@example.org). The Basch & Rameh website can be accessed at www.baschrameh.com.br.
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