Luiz Felipe C. Dias de Souza*
Daniel Gatschnigg Cardoso**
original text in Portuguese

1.    Introduction

Recently the Senate passed a bill for a Constitutional Amendment – PEC No. 12/06 – claiming it hoped to thereby unravel a deep-seated and serious problem, namely that of resolving the “enormous volume of unpaid State and City precatórios.” This has invariably been the argument used by the Senate’s members and was repeatedly emphasized in the final report issued by the bill’s author, Senator Kátia Abreu. Yet her final report disregarded the alleged motivation behind the amendment, as provisions were included to benefit not only the states and towns, but also the Federal Government.

Amending the Constitution is an act of great seriousness, and must be given a level of attention and care befitting its repercussions on the nation, and indeed, across the world.

The changes which we shall reference in this paper will, if they remain in the final amendment to be incorporated into the Constitution, constitute an assault on the rights of creditors, and moreover, a step back for Brazil, for they represent the inclusion of economically irrational, legally faulty and ethically compromised provisions with grave consequences to the domestic and international communities.

For this reason, and bearing in mind that PEC No. 12/06 is yet to be approved by the House of Representatives, we shall forthwith present our arguments in the hopes they will open up the debate on some aspects of the bill that have thus far remained uncontested, and thereby contribute to the eventual alteration or veto of some of its provisions.

The method debated and suggested to solve the problem of the state and town judicial debts consisted essentially in creating a special system of debt settlement through which the precatório creditor who agreed to the largest discount would have preference to receive credit. This special regime is foreseen in Article 97 of the Constitutional Transitory Provisions Act (Ato das Disposições Constitucionais Transitórias – ADCT), of the bill.  Initially the Act stipulated that the special regime would apply to all Federal entities, including the Federal Government itself. However, as this would clearly be contrary to the bill’s original purpose, which aimed to resolve state and municipal problems only, revisions were undertaken in response to large criticism from the media and entities such as OAB – Ordem dos Advogados do Brasil (Brazilian equivalent to the BAR association) and the Federal Government was removed from the scope of the bill.

The regime provisioned in Article 97 is worthy of innumerous criticisms, which are being brought to light by several different bodies, not least of which is the Brazilian Bar Association, particularly by their Special Committee of Public Creditors (Precatórios) . Therefore we will limit ourselves to highlighting the changes that have been incorporated into the final draft of PEC No. 12/06, and which completely deviate from the bill’s original purpose. More specifically, these changes are those made to Art. 100 of the Constitution, which is not exclusively applicable to states and towns, and therefore is also applicable to the Federal Government. Yet the Federal Government has shown no difficulty in fulfilling their judicial obligations and does not need to benefit from a new ruling, so much so that it has been fully compliant to this date and has actually gained great credibility from this fact.

The first change we come is to the addition of Paragraph 9 to Art. 100, which permits the use of precatórios to offset debts owed by its creditors. Yet this provision was worded in such a way that it clouded the waters and caused uncertainty as to the extent of what can actually be offset against debts and whose debts the provisions refers to. This seriously undermined the judicial security of the precatório holders thus compromising their ability to market them.

The second is the insertion of Paragraph 11 of Art. 100 in the Constitution, which foresees the alteration of the accrual criteria of precatórios in general, drastically reducing its value , including those already issued and yet to be issued.

The third change relates to the insertion of Paragraph 12 into Article 100, by means of which a declaratory statute could create a special system for precatório payments (such as the one proposed under the draft of Art. 97 of the ADCT, or any other), and thus affecting not only States, Districts and Towns, but also the Federal Union.

The text below will further analyze these issues of the PEC bill approved by the Senate, beginning with the first point, as it implies a clear and grievous assault on the most basic principles of justice, legality and credibility of the nation before its citizens and the international community, and lacks economic rationale.

2.    Altering the rate of monetary correction applied to federal  precatórios

The proposed draft for Paragraph 11 of article 100 of the Constitution reads, “The accrual applied to precatórios pending payment, regardless of their nature, will be the application of the official monetary correction and interest rate applied to savings accounts.” (g.n.).

The adoption of this new accrual will imply in a substantial reduction of the value to which precatório creditors are entitled, both in short and long term payment installments (as is the case for those negotiated for 10 years). And, as you can see, this would affect not only the state and town precatórios, but also those owed by the Federal Government. Furthermore, depending on the interpretation of the paragraph in question, it could also affect (a) those precatórios scheduled for payment in installments pursuant to Art. 78 of the ADCT, or (b) even precatórios already issued.

There are at least five reasons why this provision must be vetoed, or at the very least, reworded. They are:

(i)    The current official rate of monetary correction on savings accounts is the TR  reference rate, and its application could imply an abrupt drop of more than 4% per annum (up to 30% in a ten year precatório) in relation to the current rate used for precatórios – the Special Extended Consumer Price Index (IPCA-E). This drop could even increase if the government follows through on its promise to reduce interest on savings accounts. Yet while reducing interest on savings accounts takes into consideration that its beneficiaries are exempt from income tax, the precatório holders will still have to pay regular taxes once they have received credit. Therefore applying the same rate to both situations is economically irrational and unfair, no matter what the rate applicable to savings accounts is;

(ii)    Altering the correction rate for precatórios in benefit of the Federal Government and to the detriment of its creditors cannot be justified. The Federal Government is not in need of such aid, as it has been meticulously complying with the payment of precatórios based on the current (and adequate) criteria, and for this same reason, the purpose and scope of PEC No. 12/06 is limited to the debts of the state and cities.

(iii)    The TR is currently the correction rate applied to savings accounts. But the TR is not a monetary correction and does not reflect the wear down of money. The Supreme Court and the Superior Court of Justice have already declared that the CPI (consumer price index) is the adequate rate for this purpose.

(iv)    Either way, changing the criteria cannot affect the precatórios scheduled for payment in installments pursuant to Art. 78 of the ADCT, which must be liquidated “for their true value”.  The wording in Paragraph 11, if it is not vetoed altogether, must be altered to clarify this point.

(v)    Further, if the paragraph is not vetoed, it should be redrafted to clarify that altering the criteria will not affect precatórios which have already been issued (and have begun to be paid, in the case of the Federal Government), otherwise, it will constitute changing the rules halfway through the game, engendering a grave slur to the nation’s integrity.

Let us carefully consider each of the five points above.

2.1.    The official correction rate of savings accounts is not adequate for the correction of precatórios

The official accrual applied to savings accounts cannot be adequately applied to precatórios. Interest paid on savings is exempt from taxes, while sums paid on precatório are taxable. Therefore, the net result of sums derived from precátorios would always be inferior to that derived from savings account, which does not justify, economically, applying the same accrual criteria to both situations

Accrual on savings accounts differs from other income generating assets in its fiscal aspects, something which the government itself has acknowledged. They have recently manifested the intention of defining the savings rate as a percentage of Brazil’s Selic rate, precisely because:  “contrary to funds or other investments, savings accounts are completely guaranteed by the government, have immediate liquidity, are exempt from income tax, and moreover, people who open savings accounts are exempt from bank administrative fees.” (ref. Agência Estado, 03/17/2009)

Furthermore, the current savings accrual rate – the TR reference rate, is much lower than the CPI, which is the rate currently being used to index federal precatórios. Therefore, such a change in rates will not only be inadequate, as we shall further discuss ahead, it will cause a massive drop in the value of the precatórios.  If, for instance, we consider the percentages occurring in the past few years, the difference between the rates currently used and savings rates would be over 4% (four percent) per annum, reaching 30% (thirty per cent) in drop by the end of the payment term of ten years in relation to the precatórios scheduled for payment in installments pursuant to Art. 78 of the ADCT. In other words, besides being submitted to the payment in installments, these creditors would lose a significant part of their credit.

Therefore, for all of the above reasons, it cannot be justified. It is economically irrational to apply the savings TR reference rate to precatórios.

2.2.    Changing the criteria in benefit of the federal Government cannot be justified and violates the purpose and reason behind PEC No. 12/06

The legal principle foreseen in Art. 5 is today seen as the “principle of proportional legal reserve” (proportionality) or due process of law, which requires, cumulatively: (a) the verification that changing the existing rules is necessary for a specific goal; (b) the adequacy between the purpose for the enactment of new rules and the means for such; (c) the reasonableness (proportionality in strict sense), which means the “prohibition of excess” brought by such new rule – they cannot be arbitrary, unfair or unreasonable.

It is obvious that the Federal Government does not need to benefit from a change in the accrual of federal precatórios, given that the Federal Government has never been late with a single precatório payment, regardless of its nature. Therefore, there is a clear discrepancy between the means used (altering Art. 100 of the Constitution to benefit all federal entities including the Federal Government) and the alleged purpose behind the means (the settlement of “enormous volumes of unpaid state and town precatórios”). Whichever changes have an aim of settling judicial receivables issued by federal entities should limit their scope to solving those debts accrued by states and cities.

The obvious incompatibility between the motivation behind PEC No. 12/06 and its paragraph 11, which benefits the Federal Government to the detriment of its creditors, highlights the need for this paragraph to be vetoed.

2.3.    The TR Reference Rate is not a monetary correction rate

The TR is the correction rate currently used for savings accounts. The purpose of monetary correction is to offset the corrosion money suffers through inflation. It is not a “bonus”, but a natural consequence of property right guaranteed by Art. 5, XXII, of the Constitution, following the same line of thought as preceding rulings by the Supreme Court and the Superior Court of Justice . Thus it is a constitutional right (“entrenched clause”) and cannot be suppressed by the proposed amendment to the Constitution (Art. 60, Paragraph 4, IV, of Constitution)

The Supreme Court understands that “The Reference Rate (TR) is not a monetary correction index because, as it reflects variations in the primary cost of rates in time savings account, it cannot be considered an index which reflects the variation of the money’s purchasing power.” (ADI 493/DF; Justice Min. Moreira Alves; Judgement 06/25/1992; Plenary)

Thus, the TR is a rate which can be used for the accruing of savings accounts, but not as a monetary correction index, as its calculation does not include have as a parameter the erosion of the purchasing power of money.

A monetary correction index is a percentage that represents, as faithfully as possible, the difference in value in money exchange during an allotted time period, accounting for the variation in the price of certain goods, commodities, services, salaries and so on. This index is used to “correct” a payment which is due over that time period and must account for these price fluctuations. This is the only method of ascertaining the “real value” of money. That is why the Supreme Court and the Superior Court of Justice have historically defined the CPI . – Consumer Price Index – as the index which best reflects the corrosion in the purchasing power of money due to inflation. It is also the reason behind the innumerous judgments by the Supreme Court and Superior Court of Justice on the subject of the so-called inflationary cleanses.

It is also for this reason that applying the savings rate (currently the TR reference rate) to precatórios is inadequate, as it does not constitute a monetary correction. Therefore the CPI or other index should be maintained as the rate which most accurately reflects the erosion of the purchasing power of money.

2.4.    Paragraph 11 does not apply to Art. 78 of the ADCT. In the event that this paragraph is not vetoed outright, it should be redrafted to clarify this point.

Changing the rate applicable to precatórios, as proposed by Paragraph 11 of Art. 100 of the Constitution, is not compatible with the provision foreseen in the caption of Art. 78 of the ADCT, according to which, “precatórios still pending by the date of the enactment of this Amendment, as well as those resulting from decisions filed by December 31st of 1999 shall be liquidated for their real value” (g.n.). Yet, as we have already shown, the TR reference rate does not bear the concept of “real value” indicated by this provision. Therefore, the systematic interpretation of the provision leads us to the conclusion that the precatórios scheduled for payment in installments pursuant to Art. 78 of the ADCT must remain under the current monetary correction index (CPI-E + 6% p.a.). But the current draft of Paragraph 11 of Art. 100 leads to an erroneous and uncertain interpretation – that of submitting the precatórios under Art. 78 to the new monetary correction as well. So Paragraph 11 of Art. 100 must be either vetoed or reworded to clarify that it is not applicable to those precatórios under Art. 78 of the ADCT, which must in turn remain under the correction currently in use, the CPI-E, plus legal interest, for this is the only way to guarantee they will be liquidated for their real value.

Adopting a different rate for these cases would violate the principles of equality foreseen in the opening lines of Art. 5 of our Constitution, which deals with inequality amongst the unequal. In one case payments are made in one installment and under section 78 of the ADCT they are payable in 10, which clearly puts them in different situations.

Given this background, if the paragraph is not vetoed, it should be redrafted to expressly exempt precatórios submitted to the installment payments under Art. 78 of the ADCT, in turn maintaining them under their current correction rate (the CPI-E), or using another rate which accurately reflects the effects of inflation over the determined period of time plus legal taxes.

2.5.    Changing the rules. Changing criteria for precatórios which have already been issued (and in the case of the Federal Government, are already being paid). Brazil’s credibility at stake.

Changing the rules in the middle of the game is a play which knowingly damns the image of those who do it. Thus altering the accrual rate by “riding” along on a bill whose initial purpose was to solve a different problem, and moreover, adversely affect processes already in effect, can be considered an action which seriously blackens the nation’s image before its citizens and the international community.

The steps being proposed by PEC No. 12/06 go against the grain of so many other steps which have helped to solidify the nation’s credibility in the past few years, and have displayed a serious attitude and a commitment to stability and rules, respect towards institutions and the separation of Powers. This is what is at stake in this debate.

We cannot disregard the fact that accepting the bill in its current state would allow for interpretations which would affect precatórios that have already been issued so adversely as to constitute an intolerable aggression to its holders.

These holders include the original creditors, the population in general, even domestic and foreign investors who placed their trust in the stability and respectability of the nation’s regulations. On an international level, the credibility Brazil built in the past few years has been fundamental to the growth in foreign investment in the financial and capital markets. A considerable number of these investments were made through the  Receivables Investment Funds or FIDCs (Fundos de Investimento em Direitos Creditórios), which are tied to precatórios. It is estimated that there are at least a few billion Reais invested in these FIDCs, which says much about the foresight of the constitutional legislator at the time of the amendment 30/00, who, foreseeing the scheduling of installments for precatório payments, did what he could to guarantee their free and clear trade (as Senator Kátia Abreu herself recognized in her report).

The investor’s trust is a decisive element in investment allocation. The foundation of this trust is security and certainty. Investments in these funds were undertaken under the premise that they would have the earning power estimated under the CPI and interest of 0.5% p.a. To change the correction rate to the savings rate, currently the TR, would cause enormous instability. Worse yet, by having this paragraph affecting precatórios which have already been issued (pending payment), the damage to the country’s image seems irreversible, as all current precatório holders, including national and foreign financial institutions, hedge funds and others, will have to reprice their assets according to the new monetary correction. The cost to the country’s respectability is too high, and the bill becomes pricier during a moment of crisis, when trust and aversion to risk take on an even greater and more relevant role in the investment allocation process.  One paragraph may then cause a splash which will soon turn to a tidal wave in the flow of investments essential to the country’s development. It would bring Brazil back in time, to the misconduct practiced by the government in the 80s and 90s, when they created problems we are sorting out to this day.

In short, it is simply not worth it.

3.    Compensation of debts owed against outstanding precatórios to be paid to those debtors

The proposed draft of Paragraph 9 of Art. 100 of the Constitution reads, “Upon payment of the precatório credits, regardless of regulation, from its value it shall be deducted, as compensation, the amounts inscribed against the original precatório holder as tax debt before the State Treasury, except debts which are suspended by reason of administrative or judicial challenge.”(g.n.)
Although the provision claims to want to “clarify the financial compensation rules in the cases where the State Treasury is both creditor and debtor to the precatório holder”, the way it is worded can be interpreted in many ways. For instance, not only can the debts of the current precatório creditor become the object of such compensation, but the debts of the former creditor can do so as well. Let us assume that holder A, who in 2009 assigns a precatório with 10 installments to assignee B, and at the time of transaction A has no outstanding debts, and in 2012 B is about to receive the 3rd installment of the precatório, when A suddenly accrues an executable tax debt. At this point B will be surprised to find that the value of his precatório will fall accordingly. This situation is absurd, but it is just what one can read in Paragraph 9.

The provision for compensation, as it currently stands, thus generates a lot of uncertainty, which compromises the ability of holders to market their precatórios, contrary to the original intent of the constitutional legislator. As Senator Kátia Abreu emphasized upon denying approval to Amendment No. 2, “the possibility of scheduling payment installments and marketing precatórios, already constitutionalized, is one of the ways the national Parliament has found to try and allow the precatório creditor to recover his judicially recognized receivables from the State Treasury, if not in whole, then at least in part.” This is exactly what will occur if the current draft of Paragraph 9 is not altered.

It would be best if the Paragraph itself were vetoed, given that it intends to establish a compensation system which has already been vetoed by the Supreme Court (due to a technicality). At the least the wording must be changed so that “original creditor” (credor original) is replaced by the term “precatório holder” (detentor do precatório), thus allowing for “financial compensation in the event that the State Treasury is both the creditor and debtor to the precatório holder”, removing the undesirable insecurity that the current draft instills.

4. Special System for Precatório Payments Under Declaratory Statute

The draft proposed for Paragraph 12 of Article 100 of the Federal Constitution foresees that: “Notwithstanding the provisions of Article 100, a declaratory statute may establish a special system for the payment of precatórios, entailing: I- earmarked net current revenue; II- charges incurred; III – payment term and methods.” [Free translation]

Including Paragraph 12 to Article 100 of the Constitution will allow an eventual declaratory statute to create a special system for the payment of precatórios, such as the one proposed in the draft written for Paragraph 97 of the ADCT, and will affect not only States, the Federal District and towns, but also the Federal Union. As already argued, this would be an illegitimate exercise.

Worst yet, Paragraph 12 as it is drafted today allows for the possibility of a declaratory statute that could completely change the payment term, payment method (whatever that may be), and the charges incurred, of all precatórios. It could, for instance, establish that all precatórios be paid in 50 years and without incurring interest. This may seem extreme or absurd, but this is the path we are headed down.

Once again we must reiterate that any changes to the Constitution which have an aim of relieving the judicial debts of Federal entities must limit themselves to seeking solutions that pertain solely to the issue of debts accrued by the States, Towns and Federal District, and must remain within the scope of the debate pertaining to the Constitution. In this case, we are referring to the provision related to Article 97, which is being proposed as an addition to the ADCT. Paragraph 12, as drafted, opens up a real Pandora’s box, with very real and comprehensive effects to the Brazilian society and the country’s image at large.

In sum, as we have made clear above, the changes proposed for Art. 100 of the Constitution must be approached warily. The issue of changing the correction criteria, as proposed by Paragraph 11, involves an economically unjust and technically inadequate change which should not be forced upon any of the pertaining entities. The only justification for approving it would be as a means of settling the debt of the federal entities; however, as the issue of debt is already being addressed (though also inadequately) through Art. 97 of the ADCT, even this justification is not acceptable. Either way, any action undertaken with the goal of optimizing the ability of the states and towns to honor their precatórios, should have its applicability limited to such. Moreover, the proposal should expressly exclude those precatórios scheduled for payment in installment pursuant to Art. 78 of the ADCT, particularly as pertains to those precatórios already issued.

The effects caused by Paragraphs 9 and 12 of Art. 100 would be no less damaging. Paragraph 9 shakes the core of judicial security inherent to property law, because the precatório holder will find himself unable to dispose of his asset by, for instance, selling it, while the potential buyer will be subject to being taxed for debts incurred by the original owner of the precatório. Paragraph 12, in turn, allows for a declaratory statute to essentially regulate every aspect of payment, from term to monetary correction to applicable interest, thus effectively having the power to completely devalue these assets.

Finally, and most importantly: all of these measures will affect not only titles yet to be issued, but also those that have already been issued. This will affect society as a whole, and Brazil’s credibility in the international arena.
Our House of Representatives holds in its hands the power to confirm that Brazil has indeed changed and can, in this day and age, fully trust their own elected officials and the international community to do what is right rather than simply approve the draft of PEC 12/06 forwarded by the Senate.
We live today through difficult times as we struggle to survive the most serious economic crisis since the Great War. These are times when every action has ample repercussion on our lives. The right path is seldom the easiest path to tread, especially now. We can only hope that our representatives have the foresight to see things in the same light.

* Luiz Felipe C. Dias de Souza holds a Master of Law and a degree in International Law from Harvard University. He is a member and Director of International Affairs of the Harvard Law School Association in Brazil and member of the Commission of Precatórios for the State of São Paulo and a member of OAB (Brazilian Bar Association).
** Daniel Gatschnigg Cardoso holds a Master of Law, with a degree in Economics and Finance Law from Universidade de São Paulo (USP) and a LLM degree in Financial and Capital Markets Law from IBMEC/SP. He is a member of Brazilian Institute of Tax Law (“Instituto Brasileiro de Direito Tributário – IBDT”) and a member of OAB (Brazilian Bar Association).

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