law and business review of the americas...pact on doing business in the americas.cover letter...

Law and Business Reviewof the Americas

VOLUME 21 WINTER 2015 NUMBER 1

TABLE OF CONTENTS

PERSPECTIVE

An Ethical Analysis of the 2014 FIFA World Cup in BrazilArjyo Mitra . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . 3

ARTICLES

Pre-Merger Analysis in Brazil: First Round (2012-2014)Carlos Emmanuel Joppert Ragazzo andMario Sergio Rocha Gordilho Jr. . . . . . . . . . . . . . . . . . . . . . . . . . . 23

Puerto Rico: America’s Tax Haven or Vacation ParadiseJason Sampas . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . 49

CASE NOTE

Past Due: An Introduction to Sovereign Debt, the OngoingDispute Between NML Capital and Argentina, and PossibleRamifications of the Dispute’s OutcomeJamison Joiner . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . 85

UPDATES

Best Business Practices: The Next Weapon of Terror inArgentinaTony Godfrey . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . 101

Trans-Pacific Partnership–Is it Really “NAFTA on Steroids?”Natalie Sears . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . 107

Succession to the Throne and the Canadian Charter of Rightsand FreedomsChristopher Cornell . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . 115

should ensure that the significance of a con-Editorial and Submission Policies:tribution would be apparent to readers

This journal is a quarterly, professional outside the specific expertise. Special termspeer-reviewed publication produced by the and abbreviations should be clearly definedSouthern Methodist University Dedman in the text or notes.School of Law’s International Law Review Accepted manuscripts will be edited, ifAssociation (and its Law Institute of the necessary, to improve the journal’s effec-Americas), as well as the Section of Interna- tiveness of communication. If editingtional Law and Practice of the American should be extensive, with a consequentialBar Association). The journal relies on the danger of altering the meaning, the manu-ongoing cooperation of the SMU School of script will be returned to the author for ap-Business, the SMU Departments of Eco- proval before type is set. Alternatively, thenomics and Political Science, and the manuscript may be returned to the authorLondon Forum of International Economic to address the deficiencies. In all events, theand Financial Law at the Centre for Com- editors reserve the right, after discussionmercial Law Studies at Queen Mary Col- with the author, to change its acceptance de-lege, University of London. cision, or to move a publication from one is-

sue to a later or earlier issue. The editorsAims and Publication Policy:will not accept unsolicited student-writtensubmissions, nor will they consider articlesThis journal addresses the legal, business,or reports that have been, or are to be, pub-economic, political and social dimensions oflished elsewhere, or materials prepared forWestern Hemispheric integration effortsone’s clients or business promotion.(e.g., NAFTA, FTAA, MERCOSUR, etc),

Manuscripts submitted for publicationtheir implementation, their future evolve-should be submitted in duplicate with ament and expansion, and their overall im-cover letter summarizing the contents to:pact on doing business in the Americas.

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ISSN 1571-9537

THE INTERNATIONAL LAW REVIEW ASSOCIATIONAn Association of The International Lawyer and Law and Business Review of the Americas

SOUTHERN METHODIST UNIVERSITY DEDMAN SCHOOL OF LAW

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Law and Business Review of the Americas

Honorable Editor-in-Chief

PROFESSOR ROBERTO MACLEAN

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LUIGI MANZETTI (POLI.SCI.)

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OFFICIAL CITATIONLAW & BUS. REV. AM. WINTER 2015

Nothing herein shall be construed as representing the opinions, views or actions of the AmericanBar Association unless the same shall have been first approved by the House of Delegates or theBoard of Governors or of the Section of International Law and Practice of the Associationunless first approved by the Section or its Council.

Southern Methodist University Dedman School of Law’sLaw Institute of the Americas

(formerly SMU Centre for NAFTA and Latin American Legal Studies)*

Established in 1952, the LAW INSTITUTE OF THE AMERICAS at SouthernMethodist University Dedman School of Law was originally designed to promotegood will and to improve relations among the people of the Americas throughthe study of comparative laws, institutions and governments respecting theAmerican Republics, and to train lawyers in handling legal matters pertaining tothe nations of the Western Hemisphere. Today, in reviving the institution, theLaw Institute of the Americas comprises meaningful academic research, teachingand programs pertaining to the “NAFTA/FTAA processes” and other WesternHemispheric integration efforts; to Latin and Central American law and judicialreform, particularly focusing on Argentina, Brazil, Chile, Guatemala, Mexico,Peru and Venezuela; and to a more limited extent, to Canadian legal issues,particularly as they interrelate to the NAFTA/FTAA. The Law Institute of theAmericas also is concerned with increasing (regional and hemispheric) legal andeconomic interconnections between the “NAFTA/FTAA processes” andEuropean and Asia-Pacific integration activities.

The officers of the Institute are as follows: the Honorable Roberto MacLean,President; Professor Joseph J. Norton, Executive Director; and Professor GeorgeMartinez, Associate Executive Director. The Institute is also supported bydistinguished group of Professorial Fellows, Senior Research Scholars,Professional Fellows, and Student Research Fellows.

As the Institute focuses primarily on issues pertaining to the North AmericanFree Trade Agreement and the pending Free Trade Area of the Americas, andthe broader economic, political, legal, and social integration processes underwayin the Western Hemisphere, Law and Business Review of the Americas is one ofthe International Law Review Association of SMU. Other parties of the journalare the Cox School of Business, the SMU Departments of Economics andPolitical Science, the London Forum, and the American Bar Association Sectionof International Law and Practice.

* From 1952 through the early 1970’s, the name was the Law Institute of the Americas: in1993, it was reactivated as the Centre for NAFTA and Latin American Legal Studies;and in 1998, it returned to its original name. For further detailed historical informationon the Law Institute of the Americas, please refer to the Law Institute of the Americas’website at http://www.law.smu.edu/lia.

Perspective

AN ETHICAL ANALYSIS OF THE 2014FIFA WORLD CUP IN BRAZIL

Arjyo Mitra*

I. INTRODUCTION

BRAZIL was officially named the host nation of the 2014 FIFAWorld Cup on October 30, 2007. This came after the country’sdelegation successfully convinced the FIFA Executive Committee

of the potential social and cultural benefits of hosting the tournament.1Although then-president, Luiz Inacio Lula da Silva, and president incum-bent, Dilma Rousseff, publicly welcomed the responsibility of hosting theevent, the Brazilian public repeatedly expressed its discontent at FIFA’sdecision.2 61 percent of the Brazilian adults who participated in a 2014survey by the Pew Research Center were against Brazil hosting theevent.3

Public protests and riots reached their climax before and during the2013 FIFA Confederations Cup, which precedes the World Cup, andregained momentum as the opening ceremony of the World Cup drewnearer.4 The protests were centered around the people’s demands forhigher expenditure on healthcare, education, and public transport.5 Butthe hosting responsibilities included an estimated expenditure of $3.6 bil-lion of taxpayer money for the construction of stadiums.6 Rampant cor-ruption and organizational inefficiency detrimentally affected the nation’spreparedness for the event. This led to further widespread public disillu-sionment. There are several ethical concerns surrounding the govern-

* Arjyo Mitra studies Economics and Finance at The University of Hong Kong. Hisresearch interests include the Great Financial Crisis of 2008, and he has writtenseveral articles on this topic. This article was first published by Seven Pillars Insti-tute for Global Finance and Ethics, www.sevenpillarsinstitute.org, and is repub-lished with the permission of the Institute.

1. Brazil Confirmed as 2014 Hosts, FIFA (Oct. 30, 2007), http://www.fifa.com/worldcup/news/y=2007/m=10/news=brazil-confirmed-2014-hosts-625695.html.

2. Zack Beauchamp, Could Brazil’s Epic World Cup Loss Cost its President her Job?,VOX (July 10, 2014, 10:40 AM), http://www.vox.com/2014/7/10/5882275/world-cup-loss-brazil-germany-dilma-rousseff-election.

3. Brazilian Discontent Ahead of World Cup, PEW RES. CENTER (June, 3 2014), http://www.pewglobal.org/2014/06/03/brazilian-discontent-ahead-of-world-cup/.

4. Id.5. Id.6. Total Costs of the FIFA World Cup 2014 in Brazil (in Millions U.S. Dollars),

STATISTA, http://www.statista.com/statistics/296493/total-costs-fifa-world-cup-2014-brazil/ (last visited Feb. 19, 2015).

3

4 LAW AND BUSINESS REVIEW OF THE AMERICAS [Vol. 21

ment’s diversion of taxpayer funds away from areas that urgentlyrequired investment and attention.

This report provides a brief overview of the present condition of Bra-zil’s economy, public service systems (healthcare and education), andbusiness environment. The description gives some context to the subse-quent discussion. The next section describes the controversies about dif-ferent aspects of the government’s overall World Cup-relatedexpenditure, specifically:

• FIFA’s tax exemption;• Construction of stadiums;• Construction costs exceeding budgets;• White elephants;• Crowding out of accompanying investments in infrastructure; and• Social costs to Brazilians.

This report summarizes the ethical concerns raised by these controver-sies. These concerns are analyzed from the perspective of whether thedecision to bid for the hosting rights for the 2014 FIFA World Cup wasethical and morally justifiable in light of the pressing need for extensivepublic investment.

Additionally, the report utilizes a consequentialist approach to answerthe question: do the ends justify the means?7 Here, the ends are the pre-dicted benefits from hosting the tournament. The means refer to theseemingly unethical use of taxpayer money for purposes other than thefacilitation of immediate public welfare.

The juxtaposition of these two contrasting perspectives on ethics shedslight on whether Brazil’s hosting of the 2014 FIFA World Cup wasethical.

II. BRAZIL: AN OVERVIEW

A. THE ECONOMY

According to the International Monetary Fund’s (IMF) World Eco-nomic Outlook Database of October 2013, Brazil is the seventh largesteconomy in the world, with an estimated Gross Domestic Product (GDP)of $2.523 trillion (corrected for purchasing-power-parity valuation of na-tional GDP) and per-capita GDP of $12,528 (the 79th largest in theworld).8 The corresponding nominal figures are $2.169 trillion (7th) and$10,773 (63rd).9

Brazil’s annual GDP growth rate reduced from 7.5 percent in 2010 to

7. See JOHN MIZZONI, ETHICS: THE BASICS 104 (2010).8. World Economic Outlook Database Oct. 2013, INT’L MONETARY FUND (IMF)

(June 22, 2014), http://www.imf.org/external/pubs/ft/weo/2013/02/weodata/weorept.aspx?pr.x=38&pr.y=5&sy=2011&ey=2018&scsm=1&ssd=1&sort=country&ds=.&br=1&c=223&s=NGDPD%2CNGDPDPC%2CPPPGDP%2CPPPPC&grp=0&a=.

9. Id.

2015] ETHICAL ANALYSIS OF THE 2014 WORLD CUP 5

0.9 percent in 2012.10 The 2014 first-quarter results showed a 1.9 percentgrowth over the past twelve months.11

B. INCOME INEQUALITY AND POVERTY

The country’s GINI Index—which measures the degree of income ine-quality—is one of the highest of the countries that form the dataset.12

The 2009 estimate was 54.7 (the 13th-highest of 150 nations in the datasetand 3rd-highest out of the 32 nations competing in the World Cup; onlyHonduras and Colombia suffer from worse income inequality)13 and the2012 estimate was 51.9.14

Sixteen percent of Brazilian citizens live below the national povertyline, and thirty-one million people live on less than $1.25 per day.15

C. HEALTHCARE

Brazil experienced dramatic improvements in public health over thelast decade. But it still lags behind most countries in the Organization forEconomic Cooperation and Development (OECD) in primary health in-dicators such as life expectancy (73.4 years versus OECD average of 80years); health spending as a percentage of GDP (8.9 percent versusOECD average of 9.4 percent); and per capita health expenditure ($1,043in 2011 versus OECD average of $3,322).16

Furthermore, the country faces significant challenges to universal ac-cess to primary healthcare. There is a deficit of primary care facilities anddoctors.17 Crucially, the recent development of the private healthcare in-dustry and the underfunding of public sector health facilities created so-cioeconomic disparities in access to quality healthcare.18 Private

10. Brazil: Overview, WORLD BANK (June 23, 2014), http://www.worldbank.org/en/country/brazil/overview.

11. Chris Wright, Will Brazil’s World Cup Pay Off For Investors?, FORBES (June 12,2014), http://www.forbes.com/sites/chriswright/2014/06/12/will-investors-in-brazil-see-a-world-cup-dividend/#.

12. Data: The GINI Index, WORLD BANK, http://data.worldbank.org/indicator/SI.POV.GINI?order=wbapi_data_value_2012+wbapi_data_value+wbapi_data_value-last&sort=asc (last visited June 22, 2014).

13. Id.; see also Patrick Rishe, 2014 World Cup: The Economic Backlash of Brazil’sPublic Relations Black Eye, FORBES (June 10, 2014), http://www.forbes.com/sites/prishe/2014/06/10/2014-world-cup-the-economic-backlash-of-brazils-public-rela-tions-black-eye/#.

14. The World Factbook, CIA, https://www.cia.gov/library/publications/the-world-factbook/fields/2172.html (last visited June 22, 2014).

15. Amy McDonald, Brazil Is Spending Billions On The World Cup, But How Are TheCountry’s Poor Managing?, DESERET NEWS (May 24, 2014), http://www.deser-etnews.com/article/865603847/Brazil-is-spending-billions-on-the-World-Cup-but-how-are-the-countrys-poor-managing.html.

16. Brazil, OECD BETTER LIFE INDEX, http://www.oecdbetterlifeindex.org/countries/brazil/ (last visited June 22, 2014).

17. Martin Bortz, Analyzing Public Health in Brazil, RIO ON WATCH (Sept. 23, 2013),http://www.rioonwatch.org/?p=9941.

18. Id.


hospitals have increased prices by 20 or 30 percent since 2009,19 makingBrazilian healthcare the most expensive in Latin America. Some opera-tions cost within 10 percent of equivalent operations in the UnitedStates.20

D. EDUCATION

The improvement in Brazil’s education has been markedly slower thanits healthcare. Only 57 percent of 25 to 34 year-olds have earned theequivalent of a high school degree, causing Brazil to lag behind mostOECD countries (the corresponding figure is 82 percent for OECD coun-tries).21 The OECD Programme for International Student Assessmentevaluated the general level of ability acquired by students in crucial sub-jects.22 Empirical results show the average Brazilian student ranked farbelow the average OECD student in reading literacy, math ability, andknowledge of science.23

Brazil’s public education system lacks the necessary facilities and fund-ing to improve these basic standards. Consequently, illiteracy levels arehigh.24

E. CORRUPTION IN THE PUBLIC SECTOR

Based on eight different studies composited into the Corruption Per-ceptions Index (2012), Brazil’s public sector is the 69th least corrupt of178 countries for which data was available.25 According to TransparencyInternational, which compiled and published the report, some of theharmful effects of corruption include “human suffering, . . . failure in thedelivery of basic services like education or healthcare[,]” and the derail-ing of “the building of essential infrastructure . . . .”26 Corruption alsounfairly imposes a “dirty tax” on the poor and vulnerable.27

High taxes, bureaucratic corruption, and high borrowing costs form the“Brazil Cost” of doing business in the country.28 This significantly hin-ders the initiation of projects. In fact, Brazil is ranked 116th out of 189countries in the ease of doing business.29

19. Peter Pallot, Expat Guide To Brazil: Health Care, TELEGRAPH (Sept. 6, 2011),http://www.telegraph.co.uk/health/expathealth/8737945/Expat-guide-to-Brazil-health-care.html.

20. Id.21. OECD BETTER LIFE INDEX, supra note 16.22. Id.23. Id.24. See id.25. The Corruption Perceptions Index, TRANSPARENCY INT’L 2012, http://www.trans-

parency.org/cpi2012/results (last visited June 22, 2014).26. Id.27. Id.28. Alexander Ragir, Rousseff Crisis Spurred By Lula Debts As Brazil Boom Dimin-

ishes, BLOOMBERG (Sept. 27, 2011), http://mobile.bloomberg.com/news/2011-09-27/rousseff-crisis-spurred-by-lula-debts-as-brazil-boom-diminishes.

29. Ease of Doing Business in Brazil, DOING BUS. 2014 http://www.doingbusiness.org/data/exploreeconomies/brazil/# (last visited June 22, 2014).


III. WORLD CUP CONTROVERSIES

A. FIFA’S TAX EXEMPTION

Any direct or indirect expenses incurred by FIFA for the 2014 WorldCup were granted full federal tax exemptions by Law Project 7422/2010,which was submitted to the Brazilian National Congress on May 31,2010.30 These expenses include “imports carried out by FIFA itself,FIFA’s Brazilian subsidiaries,” or any third-party organizations hired byor associated with FIFA to help organize the event.31 Provisional Mea-sure 497/2010 described a special tax regime for the construction of stadi-ums for the 2014 tournament and the FIFA Confederations Cup 2013.32

The exemptions detailed in Law Project 7422/2010 included, but werenot restricted to “[F]ederal excise taxes (IPI) due on customs clearance;[I]mport tax[es]; . . . Contributions for the Financing of Social Security(COFINS); [F]reight taxes (AFRMM); [and F]ee[s] for the use of theForeign Trade System (SISCOMEX) . . . .”33 Furthermore, they appliedto the imports of a wide range of durable goods and consumables thatwould be used exclusively during the tournament.34

Law Project 7422/2010 is also discriminatory in assigning the burden oftax payments to suppliers involved in the organization of the tournament.Again, it favors FIFA and its interests. Being a non-resident entity, FIFAreceives exemptions from taxes levied on its own activities in connectionwith the World Cup, whereas its businesses that are registered in Brazildo not receive such benefits.35 Crucially, the law highlights that Braziliansuppliers, both individual and corporate, who receive payments fromFIFA and its affiliates will not be exempt from taxation on income andcapital gains. But FIFA’s Brazilian subsidiaries are granted the same ex-emptions from corporate income taxes.36

This indicates the shifting of the burden of income tax payments fromFIFA to Brazilian companies not permanently associated with the foot-balling institution. Most of FIFA’s other operating and organizational ex-penses, such as compensation and prizes, also escape taxation, whereasincome of Brazil-based sources continues to face taxation.37

30. David Roberto R. Soares da Silva, Brazil Considering Full Tax Exemptions for2013, 2014 Soccer Cups, AZEVEDO SETTE (June 8, 2010), http://www.azevedosette.com.br/en/noticias/brazil_considering_full_tax_exemptions_for_2013_2014_soccer_cups/2409.

31. Id.32. Memorandum from Souza, Schneider, Pugliese e Sztokfisz Advogados to Clients:

Provisional Measure to No. 497/2010—Amendments to Tax and Customs Legisla-tion 1 (Aug. 4, 2010), available at http://souzaschneider.com.br/pdf/pt/memo/Memo%20%20MP%20497%20ENG.pdf.

33. Id.34. Id.35. Soares da Silva, supra note 30.36. Kelly Phillips Erb, World Cup Mania: Figuring Out FIFIA, Soccer & Tax, FORBES

(June 16, 2014, 12:23 PM), http://www.forbes.com/sites/kellyphillipserb/2014/06/16/world-cup-mania-figuring-out-fifa-soccer-tax/.

37. Id.


According to Brazil’s Federal Revenue Department (FRD) 2010 esti-mates, the tax breaks associated with the 2014 FIFA World Cup and the2013 FIFA Confederations Cup total around R$800 million ($475 million)between 2011 and 2015.38 It seems that while the temporary tax breakslimit costs for FIFA and its private suppliers, they also serve to limit po-tential tax revenue for the Brazilian government. This shortfall in taxrevenue most likely translates to an increase in the burden of future taxa-tion for the country’s citizens.

B. CONSTRUCTION OF STADIUMS

Estimates of the expenditure incurred by the Brazilian government inpreparing the nation for the tournament vary from $11 billion39 to $14billion,40 with some sources reporting estimates of $15 billion.41 Butthere is a broad consensus that the government has spent $3.6 billion(R$8 billion) on the infrastructural modernization of stadium facilities.42

This enabled the hosts to bring the total number of stadiums in use totwelve, a record for the tournament.43 Five cities built stadiums fromscratch, one stadium was demolished and rebuilt to suit FIFA’s specifica-tions, and the other six underwent extensive renovations.44

1. Construction Costs Exceeding Budgets

In FIFA’s original inspection report of Brazil’s candidacy for hostingthe 2014 FIFA World Cup, required investments for construction or reno-vation of the stadiums were estimated to be $1.1 billion.45 But costs had

38. Id.39. Simon Romero, Soccer and Internal Discord, on Display for World to See, N.Y.

TIMES, June 12, 2014, at A4, available at http://www.nytimes.com/2014/06/13/world/americas/hundreds-of-brazilians-protest-outside-world-cup-stadiumin-sao-paulo.html?_r=1; see Rishe, supra note 13; see also Wright, supra note 11.

40. Associated Press, World Cup Set to be Most Lucrative Ever, ESPN FC (May 23,2014), http://www.espnfc.com/fifa-world-cup/story/1830732/2014-world-cup-set-to-be-most-lucrative-ever.

41. Northern Trust, The World Cup Begins Amid a Series of Financial Controversies,FXSTREET (June 15, 2014, 23:48 PM), http://www.fxstreet.com/analysis/weekly-ec-onomic-commentary/2014/06/15/.

42. Vincent Bevins, Beyond the World Cup Stadiums, Architecture in Brazil Returns toGlory, L.A. TIMES (June 15, 2014), http://touch.latimes.com/#section/-1/article/p2p-80478313/; see also Tariq Panja, Soccer World Cup Stadium Costs Soar by $435Million in Brazil, BLOOMBERG (Nov. 27, 2013), http://www.bloomberg.com/news/articles/2013-11-26/soccer-world-cup-stadium-costs-soar-by-435-million-in-brazil;Rishe, supra note 13.

43. See Mark Koba, World Cup by the Numbers: Most Expensive Ever!, CNBC (June12, 2014, 8:00 AM), http://www.cnbc.com/id/101750395#.

44. 2014 FIFA World Cup: Where Are the 12 Host Stadiums in Brazil?, BBC SPORT

(last updated June 6, 2014, 2:04 PM), http://www.bbc.com/sport/0/football/24897388.

45. FIFA, BRAZIL BID INSPECTION REPORT FOR THE 2014 FIFA WORLD CUP 38 (Oct.30, 2007), available at http://img.fifa.com/mm/document/affederation/mission/62/24/78/inspectionreport_e_24841.pdf.


run three times over budget by 2012.46

a. Arena Corinthians, Sao Paulo

Sao Paulo’s Arena Corinthians, also known as the Itaquerao Stadium,was originally estimated to require R$335 million in investments.47 Butthe final estimates increased to R$820 million to account for expensesrequired to enable the stadium to fulfill FIFA’s general requirements,with R$420 million of the costs funded by tax credits granted by thecity.48 The stadium eventually cost R$965 million, 15 percent above itsplanned budget.49 This figure does not take into account the additionalexpenses that will be required to remove 20,000 seats after the WorldCup.50

The Itaquerao Stadium was built in a city that already had a fully func-tional stadium, the Morumbi Stadium.51 The Morumbi was originallyslated to be Sao Paulo’s only World Cup stadium.52 But the city’s or-ganizing committee failed to provide FIFA with financial guarantees forthe required $135 million renovation that was required to update thestructure and it was removed from the list of stadiums.53 This allowedSao Paulo to accommodate plans for the Itaquerao Stadium, but at amuch higher cost to the government and taxpayer.54 The necessity ofbuilding a second stadium at such high costs, especially when the firstwould have sufficed, is questionable.

b. Estadio Nacional Mane Garrincha, Brasilia

The demolition and subsequent rebuilding of Brasilia’s Estadio Na-cional Mane Garrincha in 2010 was originally supposed to cost $300 mil-lion.55 But government auditors revealed this cost tripled to $900 million,making the stadium the most expensive in Brazil and the second-mostexpensive football stadium in the world.56

46. Andrew Downie, Soccer-Brazil World Cup Stadiums on Track, but Costs Soar,REUTERS (Apr. 3, 2012, 9:49 AM), http://www.reuters.com/article/2012/04/03/soc-cer-world-brazil-idUSL2E8F2GG820120403.

47. Id.48. Id.49. Bernie Roseke, Project Management Disaster: The Arena de Sao Paulo,

PROJECTENGINEER (June 7, 2014), http://www.projectengineer.net/project-man-agement-disaster-the-arena-de-sao-paulo.

50. Downie, supra note 49.51. Sao Paulo Dropped for 2014, SBS, http://theworldgame.sbs.com.au/article/2010/06/

17/sao-paulo-dropped-2014 (last updated Nov. 12, 2012, 8:07 PM).52. Id.53. Id.54. See Downie, supra note 49.55. Marissa Payne, Five Sad and Shocking Facts About World Cup Corruption in Bra-

zil, WASH. POST (May 12, 2014), http://www.washingtonpost.com/blogs/early-lead/wp/2014/05/12/five-sad-and-shocking-facts-about-world-cup-corruption-in-brazil.

56. Id.


i. Price Gouging and Fraudulent Billing

Allegedly fraudulent billing of expenses and the existence of wide-spread corruption at the bureaucratic level are blamed for the massiveincrease in prices.57 A team of auditors from the Audit Court in Brasiliafound that as much as one-third of the stadium’s cost was attributed tooverpricing.58 Their investigation of 75 percent of the project’s costs re-vealed $275 million in alleged price gouging.59

For instance, the auditors’ report indicates that the government wasbilled $1.5 million by the construction consortium formed by AndradeGutierrez, a construction conglomerate, and Via Engenharia, an engi-neering firm, for the transportation of prefabricated grandstands thatshould have only cost $4,700.60 The auditors also uncovered additionalexpenses of $46.3 million incurred due to poor planning, delays in con-struction, and fraudulent accounting practices.61

ii. Corporate Corruption

The extent of corporate corruption prevalent in Brazil is indicated bythe discovery that Andrade Gutierrez, the company that won bids tobuild or renovate four stadiums in 2010, increased its corporate electioncampaign contributions from $73,180 in 2008 to $37.1 million in 2012.62

Odebrecht, Brazil’s top builder, also increased its political contributionsfrom $90,909 in 2008 to $11.6 million in 2012, a 127-fold increase.63 Dur-ing that period of time, Odebrecht won four stadium contracts and theoperational ownership of Rio de Janeiro’s Maracana Stadium for thirty-five years.64

“There must be some corruption,” Sergio Nogueira Seabra, Secretaryfor Transparency and Prevention of Corruption in Brazil’s ComptrollerGeneral’s Office, was quoted as saying in May 2014.65

1. White Elephants

In addition to the enormous expenses incurred by the government forthe preparation of the twelve venues, there have been significant fearsthat at least four, and as many as eight, of the twelve stadiums will fail to

57. See id.58. Bradley Brooks, High Cost, Corruption Claims Mar Brazil World Cup, ASSOCI-

ATED PRESS (May 12, 2014, 9:52AM), available at http://bigstory.ap.org/article/high-cost-corruption-claims-mar-brazil-world-cup.

59. Id.60. Brazil audit: ‘Corrupt World Cup Costs’, AL JAZEERA (June 23, 2014, 1:55 PM),

http://www.aljazeera.com/news/americas/2014/05/brazil-audit-shows-corrupt-world-cup-costs-201451263240585772.html.

61. Brooks, supra note 61.62. Payne, supra note 58.63. Brooks, supra note 61.64. Id.65. Tariq Panja, Corruption to Blame for Some Brazil World Cup Cost Rises, BLOOM-

BERG (May 23, 2014, 10:54 AM), http://www.bloomberg.com/news/articles/2014-05-22/corruption-to-blame-for-some-brazil-world-cup-cost-rises.


generate revenues beyond their use during the tournament.66

a. Estadio Nacional Mane Garrincha, Brasilia

For instance, the stadium in Brasilia hosted a few games in the 2014FIFA World Cup and is slated to host the 2016 Summer Olympics in Riode Janeiro. After that, the publicly funded stadium may be left unoccu-pied because there are no major football teams in Brasilia.67 The city’sclubs play in the third and fourth divisions of the national league andcannot attract sufficiently large crowds.68 High maintenance costs andlimited inflow of revenues mean the stadium may never generate profitsto justify the massive outlay on its construction.

b. Amazonia Arena, Manaus

The newly constructed Amazonia Arena in Manaus cost $294 million,25 percent over its planned budget,69 and finds itself in a similar situation.Manaus is a two million-strong metropolitan city located in the Amazonrainforest, and its best professional football team plays in the fourth divi-sion of the national league.70 Thus, the stadium is expected to remainvacant while racking up maintenance costs. The construction of thebrand new 44,500-seat Arena Amazonia in Manaus has been described as“shameful.”71

Similarly, the Arena das Dunas in Natal and the Arena Pantanal inCuiaba together cost R$820 million, but do not have sufficiently qualifiedclub teams to occupy them.72

1. Crowding out of Accompanying Investments in Infrastructure

The excessively large number of stadiums constructed for the WorldCup and the associated infrastructural investments on airport, transporta-tion, and accommodation greatly divided the attention of the Braziliangovernment.73 The organizational capabilities of the responsible compa-nies were also stretched to the limit by the vast number of differentprojects. Huge delays and constantly increasing costs caused by bureau-cratic and operational inefficiency hampered the achievement of the

66. Downie, supra note 49.67. Panja, supra note 45.68. See Brian Homewood, Not Much Football to Look Forward to in Brasilia,

REUTERS (July 7, 2014), http://articles.chicagotribune.com/2014-07-07/sports/sns-rt-uk-soccer-world-brasilia-20140707_1_championship-stadium-mane-garrincha.

69. Jenny Barchfield, Costly Stadium No Answer to Manaus’ Traffic Woes, ASSOCI-

ATED PRESS (June 13, 2014, 1:05 AM), available at http://news.yahoo.com/costly-stadium-no-answer-manaus-traffic-woes-040720937.html.

70. Sam Borden, Building a World Cup Stadium in the Amazon, N.Y. TIMES (Sept. 24,2013), http://www.nytimes.com/2013/09/25/sports/soccer/in-building-world-cup-sta-dium-in-amazon-rain-is-just-one-challenge.html?pagewanted=all&_r=0.

71. Barchfield, supra note 72.72. Report: How Much Did Brazil Spend on World Cup Stadiums?, STADIUMDB (Oct.

7, 2014, 9:58 PM), http://stadiumdb.com/news/2014/07/report_how_much_did_bra-zil_spend_on_world_cup_stadiums.

73. Rishe, supra note 13.


planned infrastructural goals.74 They also compromised the quality of thefacilities built. This caused the construction of many planned facilities tobe abandoned or extensively delayed.75

Approximately half of the infrastructure projects originally promisedwere not delivered or completed.76 Approximately one-fifth of allprojects were dropped due to delays.77 Attempts to improve urban trans-portation were largely unsuccessful.78 Rail projects and bus corridorswere dropped in up to six cities.79 Airports also suffered delays in con-struction, and many planned updates to design and technology wereabandoned or postponed until after the World Cup.80

For example, the construction of the Amazonia Arena in Manaus suf-fered from numerous delays and additional expenses beyond the plannedbudget.81 This had a detrimental indirect effect on important infrastruc-tural investments in the city, such as the expected $810 million investmentin Manaus’ public transportation system.82 Despite being intended tocombat the city’s traffic congestion problems, the plan was crowded outand eventually cut from the Sports Ministry’s official list of World Cup-related expenditures.83

The Guardian recently reported that Gianna, a resident of Copa doPovo (People’s Cup), a flash camp near Sao Paulo’s newly constructedItaquerao Stadium, said, “We don’t have hospitals, we don’t have schools.But we have stadiums. Lots of stadiums.”84 This accurately captures thesocial injustice of Brazil’s expenditure on stadiums at a time when itspublic education and healthcare industries have been calling for extensiveinvestments.

C. SOCIAL COSTS TO BRAZILIANS

The construction of stadiums, the upgrading of accommodation facili-ties for tourists and national delegations and the creation of urban trans-portation facilities came at immense social costs to Brazilian citizens.Those suffering from poverty were most affected by the social displace-ment caused by the evacuation of favelas and other public housing

74. See id.75. See id.76. Anthony Boadle, World Cup Leaves Brazil Costly Stadiums, Poor Public Trans-

port, REUTERS (June 5, 2014, 12:26 PM), http://www.reuters.com/article/2014/06/05/us-brazil-worldcup-infrastructure-idUSKBN0EG23H20140605.

77. Id.78. Id.79. Id.80. Id.81. Barchfield, supra note 72.82. Id.83. Id.84. Owen Gibson, The World Cup is Really Just for the People in Helicopters, GUARD-

IAN (June 11, 2014, 2:41 PM), http://www.theguardian.com/world/2014/jun/11/world-cup-helicopters-streets-sao-paulo#.


facilities.85

Estimates suggest that between 250,000 and 1.5 million people havebeen forced to abandon their residences or evicted, with very few receiv-ing adequate relocation assistance or monetary compensation.86 Somecitizens received only 20 to 40 percent of the value of their houses incompensation in what has been termed “a programme of mass eviction ofthe lower classes set out in order to put on a glossy show for the rest ofthe world.”87

IV. SUMMARY

The broad ethical concerns raised by the topics covered in these sec-tions are summarized below.

The Brazilian government decided to host the 2014 FIFA World Cupdespite the country’s clearly apparent lack of infrastructural capacity,poor operational management capabilities, and ill-suited private and cor-porate business environment.

The government has repeatedly neglected the requirements of societyand its demands for improved healthcare, education, and public infra-structure. Instead, it has served to benefit FIFA, a private foreign institu-tion, at its own cost and the cost of its citizens.

Relaxed tax requirements and numerous exemptions offered to FIFAhave robbed the government of tax revenues and increased the future taxburden on the Brazilian public.

The government has not delivered on several secondary infrastructureprojects that it promised, such as modernization of airports and urbanand interstate transportation facilities. These projects would havebrought real value to society by directly benefiting the Brazilian public.But the government sanctioned and financed the construction of expen-sive stadiums that will most likely not deliver returns on investment.

The organization of the tournament came at the direct expense of thewelfare of Brazilian citizens. Local housing facilities such as favelas wereevacuated, and appropriate relocation measures were not enacted acrossthe board.

The acknowledgement of these ethical concerns lays the foundation forthe subsequent theoretical analysis of the same from two uniqueperspectives.

85. Brazil’s Maracana Evacuation Spark Anger, ENCA.COM (Jan. 9, 2014), http://www.enca.com/world/brazils-maracana-evacuations-sparks-anger.

86. Compare Paula Daibert, Brazil’s Evicted ‘Won’t Celebrate World Cup’, AL

JAZEERA (May 26,2014, 10:17 AM) http://www.aljazeera.com/indepth/features/2014/05/brazil-evicted-won-celebrate-world-cup-201452012437552695.html withAnti-World Cup Protests Rock Streets of Brazil, COUNCIL ON HEMISPHERIC AFF.(May 21, 2014), http://www.coha.org/anti-world-cup-protests-rock-streets-of-brazil/.

87. John Burn-Murdoch, The 2014 World Cup and its Price on Brazil, OVAL LOG

(Aug. 15, 2011), https://theovallog.wordpress.com/2011/08/15/the-world-cup-its-price-on-brazil/.


V. AN ETHICAL ANALYSIS

A. A DEONTOLOGICAL APPROACH

Theories of deontological ethics broadly state that the ethical judgmentof an action must depend solely on its adherence to basic moral duties orcodes of conduct.88 Different versions of deontological theories focus onthe roles played by agents and patients within the ethical frameworksthey occupy.89

1. Agent-Relative Obligations

The fundamental duty of any government body is to ensure an ade-quate standard of living and satisfaction for its citizens. This can be doneby continuously targeting improvements in levels of education, primaryhealth, employability, security and public infrastructure. Only once thesegoals have been achieved at sustainable levels should governments em-bark on secondary projects, such as hosting international events. Theseobligations are agent-relative, in that each government is obligated to at-tend to the needs of its citizens in particular.90

The discussion of Brazil’s poverty, income inequality, illiteracy, andpoor health shows the government has not devoted enough attention toits citizens’ needs and demands. It has not fulfilled all its obligations to itscitizens and therefore should not have undertaken the responsibility ofhosting the World Cup. The taxpayer funds spent on tournament-relatedinvestments should have been used for improving existing public health-care and education facilities, both of which are sorely lagging behind theirprivate counterparts. Enabling regular access to quality education andprimary healthcare has enormously beneficial impacts on the socioeco-nomic elevation of the impoverished.91 It can also result in several posi-tive effects, such as a reduction in crime, violence, and substance abuse,all of which Brazil suffers from.92

In short, hosting the tournament represented a violation of the govern-ment’s duty and obligation towards its citizens and is unethical from apurely agent-relative deontological perspective.

88. ROSALIND HURSTHOUSE, VIRTUE ETHICS, IN THE STANFORD ENCYCLOPEDIA OF

PHILOSOPHY (Edward N. Zalta ed, Fall 2013 ed. 2013), available at http://plato.stanford.edu/archives/fall2013/entries/ethics-virtue.

89. See generally id.90. See LARRY ALEXANDER & MICHAEL MOORE, DEONTOLOGICAL ETHICS, THE

STANFORD ENCYCLOPEDIA OF PHILOSOPHY (Edward N Zalta ed., Winter 2012 ed.2012) available at http://plato.stanford.edu/archives/win2012/entries/ethics-deontological.

91. See, e.g., Bridging the Gaps: Reducing Inequality and Poverty Through Social Re-form, OXFORD BUS. GROUP, http://www.oxfordbusinessgroup.com/analysis/bridg-ing-gaps-reducing-inequality-and-poverty-through-social-reform (last visited Feb.24, 2015).

92. See Lance Lochner, Non-Production Benefits of Education: Crime, Health, andGood Citizenship 9, 49 (Nat’l Bureau of Econ. Research, Working Paper No.16722, 2011).


2. Patient-Centered Perspective

Patient-centered deontological theories dictate that people have theright against being used by another entity for the user’s benefit withouttheir prior approval.93

This definition becomes relevant when one considers the Brazilian pub-lic was largely against the organization of the World Cup. Brazilian citi-zens regularly organized riots and engaged in public displays of theirdisapproval of the huge investments on stadiums and the mass evacuationof housing facilities.94

It was abundantly clear the public was opposed to hosting the tourna-ment and the manner in which the organization took place. Thus thepatient-centered deontological theories reveal hosting the event violatedthe basic ethical rights of Brazilian citizens.

B. A CONSEQUENTIALIST APPROACH

Consequentialism entails the weighing of the potential positive andnegative impacts of a decision before rendering an ethical judgment.Thus, an action or decision can only be judged based on its conse-quences.95 An extension of this argument allows any foreseeable courseof action to be undertaken if it produces desirable results.96 Consequen-tialism, therefore, considers Brazil hosting the 2014 FIFA World Cup tobe ethical if it brings about positive consequences. Conversely, if the con-sequences prove to be negative or insufficiently positive, the act isunethical.97

1. Tourism

It is estimated that the 2014 FIFA World Cup brought approximately3.7 million people to the country from around the world.98 Tourists wereexpected to inject approximately $3.03 billion into the Brazilian economythrough expenditure on accommodation, food, transportation and en-tertainment.99 Of course, expenditure on match tickets could not be con-sidered because FIFA receives all revenue from ticket sales.100 Inaddition to these direct effects on the Brazilian economy, this money

93. ALEXANDER & MOORE, supra note 93.94. See, e.g., Brazil World Cup: Clashes at Sao Paulo and Rio Protests, BBC, http://

www.bbc.com/news/world-latin-america-27811657 (last updated June 12, 2014, 7:36PM).

95. ALEXANDER & MOORE, supra note 93.96. Id.97. Id.98. Darren Heitner, 2014 FIFA World Cup Expected to Add $3.03 Billion to Brazil’s

Economy, FORBES (May 14, 2014, 8:23 AM), http://www.forbes.com/sites/dar-renheitner/2014/05/14/2014-fifa-world-cup-expected-to-add-3-03-billion-to-brazils-economy/.

99. Id.100. Michelle Sulahian, A Week from the World Cup, FIFA is Already the Big Winner in

Brazil, FIELDS GREEN (June 5, 2014), http://thefieldsofgreen.com/2014/06/05/fifa-already-the-big-winner-in-brazil/.


could also have indirect impacts through the phenomenon of multipliereffects (i.e., the recirculation of the foreign money within the Brazilianeconomy in the form of local consumption).

But these ex-ante estimates are not always reliable. It is difficult tostatistically describe the net effects of the influx of foreigners during aWorld Cup or international event. This is partially due to the crowdingout of certain foreigners who would have attended but for increasedcrowds and prices.101 For example, the tourist inflow statistics for At-lanta were identical during the summer months of 1995, 1996, and 1997,indicating that the 1996 Summer Olympics crowded out quite a few po-tential foreign visitors.102 As another example, tourism figures for Syd-ney declined for three successive years after the 2000 Summer Olympics,revealing that the purported ex-ante benefits of tourism may often beoverestimated.103

The 2014 World Cup’s effects on tourism also depended on how thecountry’s reputation as a world-class tourist destination was affected bythe international media coverage of the tournament. Positive events,such as superb organization, civil peace, and a flawlessly executed tourna-ment, would have undoubtedly attracted foreigners. But this tournamentwas marred by controversies, intense public riots, and violent protests.104

Many foreigners will be tempted to avoid the civil unrest in Brazil. It islikely that ex-post estimates of the benefits to tourism will beunderwhelming.105

2. Reputation of Brazil

The intention behind hosting the World Cup was to portray Brazil as a“vibrant, rich, diverse and sophisticated country” on the global stage.106

Hosting a successful tournament would have generated internationalawareness of Brazil’s economic development. It would also have indi-cated world-class management and organizational capabilities and athriving business sector. In other words, the brand image of the countrywould have been significantly bolstered.

But numerous instances of delays in stadium construction, allegationsof corruption, and increases in construction costs tarnished the reputationof the country’s bureaucracy and infrastructural capabilities.

Thus, the intended consequence of “putting Brazil on the map” was notachieved to the desired extent.

101. Andrew Zimbalist, Brazil’s Long To-Do List, AM. Q., Summer 2011, at 57, availa-ble at http://www.americasquarterly.org/zimbalist (last visited Feb. 19, 2015).

102. Id.103. Id.104. See Brazil World Cup: Clashes as Sao Paulo and Rio Riots, supra note 97.105. Raymond Colitt, World Cup Didn’t Help Brazil’s Economy and Olympics Won’t

Either, NEWSCRED (Jan. 18, 2015, 11:00 AM), http://skift.com/2015/01/18/world-cup-didnt-help-brazils-economy-and-the-olympics-wont-either/.

106. Zimbalist, supra note 104.


4. Accompanying Infrastructural Investments

The preparations for the tournament involved updating, beautifying,and modifying various public infrastructural facilities, such as urbantransportation and accommodation. While these will undoubtedly havelasting legacies, one can justifiably question whether investments couldhave been made independently of the tournament.

The FIFA World Cup is often used as a driving factor for extensiveplans for the urbanization of the host country’s facilities. But such invest-ments could have been made even if Brazil did not host the tournament.The country was desperately in need of advanced highways, airports,schools, and hospitals; investments should have been made in these areasinstead of fiscal expenditures on football stadiums. The expenditure of$3.6 billion on stadiums undoubtedly crowded out some necessary invest-ments in much needed public infrastructure. This is another negative ef-fect of the preparations for hosting the tournament.

The observed investments in public infrastructure should not be consid-ered a direct consequence of the FIFA World Cup. In fact, they are vic-tims of the tournament because many planned public infrastructuralfacilities were not completed by their deadlines or were abandoned dueto the government’s focus on the tournament.

5. Harbinger of Structural Reform

The buildup to the World Cup exposed the deficiencies in Brazil’s busi-ness environment and public service sector and signaled the immediateneed for extensive structural reform. It is abundantly apparent the gov-ernment will need to meet the demands of the public in order to reducesocial unhappiness in the country. The World Cup directly contributed tothis realization by pushing social unrest firmly into the spotlight and has,therefore, been a necessary evil. If the government undertakes mass in-vestments that push Brazil onto the path of social prosperity and satisfac-tion, they will be a direct consequence of the glaring inefficiency of theWorld Cup’s organization.107

In purely theoretical terms, one can justifiably condone the Braziliangovernment’s decision to organize the tournament due to its exposure ofdeep-seated social disharmony. But this does not justify the decision tohost the tournament. Had the hosting rights not been awarded to Brazilin the first place, the government would have been able to address theunrest and target structural reform much earlier. Perhaps the unrestwould never have reached the levels observed. Targeting structural re-form and socioeconomic prosperity should be the foremost prerogative ofthe government; it should not require a debacle on the scale of the WorldCup’s organization for the government to become attuned to the needs ofits citizens.

107. Wright, supra note 11.


Thus, it appears most of the intended positive consequences of hostingthe tournament, such as improved international status and brand image,increased tourism, and advanced public infrastructure, may not beachieved as a result of the tournament. In fact, the tournament may notbring about any extraordinary consequences that would not have beenachieved without the tournament. This indicates that the government’sdecision to host the tournament is not one that survives the judgment ofconsequentialist theories of ethics.

6. Influence on National Team’s Performance

A technical analysis of the performance of the Brazilian national teamin competitive fixtures since 1960 suggests the national team performsdramatically better when playing at home.108 In fact, its chances of win-ning the World Cup increase from approximately 30 percent to 48 percentwhen home advantage is factored into the statistical model.109

Brazil was heavily considered to be a favorite to win the trophy, anddoing so at home would have rid the population of the traumatic memo-ries from the 1950 World Cup final. Brazil lost that final on home soildespite being heavy favorites. Given that Brazil is known as a football-crazed nation, winning the 2014 edition in front of a home crowd wouldpossibly have changed the public sentiment from one of brooding frustra-tion to one of jubilant ecstasy. This would most certainly have been apositive consequence of hosting the tournament.

Unfortunately, Brazil exited the tournament at the semi-final stage af-ter a humiliating 1-7 loss to Germany. This result was arguably the worstin the history of Brazilian football. Thus, the possible positive conse-quence generated by hosting the tournament was certainly not achieved.In the weeks following the World Cup there were further exhibitions ofthe dissatisfaction and frustration due to the poor performance of thenational team at home.110 This is clearly a negative consequence.

VI. SUMMARY

From a football perspective, the 2014 FIFA World Cup proved to beone of the best in recent memory. The quality of football was outstand-ing, and Brazil’s football fans lived up to their reputation as welcoming,football-loving people. Happily, the tournament was staged without anysignificant operational glitches. But this does not spare the tournament’sorganizers from intense scrutiny of the ethics of awarding the hostingrights to a country that clearly needed urgent public investment in various

108. See THE WORLD CUP AND ECONOMICS 2014, GOLDMAN SACHS 3-7 (2014), availa-ble at http://www.goldmansachs.com/our-thinking/archive/world-cup-and-econom-ics-2014-folder/world-cup-economics-report.pdf.

109. Id. at 5.110. See, e.g., Jeff Fick, Brazil Fans Turn on President Amid World Cup Failure, Give

Rousseff 2nd Bronx Cheer, FORBES (July 8, 2014, 6:07 PM), http://www.forbes.com/sites/jefffick/2014/07/08/brazil-fans-turn-on-president-amid-world-cup-failure.


infrastructural projects when the decision was made. Brazil’s governmentshould have put the needs of its citizens before the allure of hosting aninternational event such as the World Cup.

The hosting of the tournament can be deemed unethical because of itsdiversion of government funds and attention away from the immediateneeds of the Brazilian public. This conclusion is supported by deontologi-cal and consequentialist theories of analysis. The manner in which theorganization of the tournament took place—with the country’s organiza-tional inefficiency, bureaucratic corruption, and the marginalization ofthe public occupying the spotlight—left the government faced with anuphill task to restore faith in its commitment to ensuring the satisfactionof society’s basic needs.

Articles

PRE-MERGER ANALYSIS IN BRAZIL:FIRST ROUND (2012-2014)

Carlos Emmanuel Joppert Ragazzo* andMario Sergio Rocha Gordilho Junior**

ABSTRACT

In spite of the initial skepticism shown by national and international me-dia, Brazil’s new antitrust law (Law 12.529/11), which replaced Law 8.884/94, since coming into force, has brought several improvements for the Bra-zilian competition protection policy. Among the substantial structuralchanges made, one must note that the main change was, undoubtedly, theinstitution of the pre-merger analysis. The referred alterations, however,have proved to be insufficient in regards to the numerous challenges gener-ated by the new system, creating the additional need for innovations also inthe managerial field. Therefore, the present work aims to present and ana-lyze such managerial innovations created by CADE’s General-Superinten-dence team, which have enabled the implementation of the new pre-mergeranalysis system established by Law 12.259/11.

KEYWORDS: Pre-merger Analysis–CADE’s General-Superintendence–Managerial Innovations–Law 12.259/11–CADE.

I. INTRODUCTION

IN August 2012, The Economist magazine, using a free translation,called the a posteriori control of mergers a “Brazilian oddity.”1 Thisevaluation reflected the reaction to an outdated system for the man-

agement of transactions, which resulted in terms and analyses that werelonger than the ones observed in developed countries. Only a few less

* Carlos Emmanuel Joppert Ragazzo is Adjunct Professor at Fundacao Getulio Var-gas Law School. He has a Master of Laws (LL.M.) in Private Law and Doctor ofJuridical Science (J.S.D.) in Regulations of Public Utilities at the University of theState of Rio de Janeiro-UERJ, and a Master of Laws (LL.M.) in Trade Regulationand Competition Policy at the New York University–NYU. CADE’s Former Gen-eral-Superintendent. Email: [email protected].

** Mario Sergio Rocha Gordilho Junior is CADE’s General Coordinator of AntitrustAnalysis (Triage Unit). He has a MBA in Public Administration at Ebape/FGVBrasılia and in Competition Protection at GV Law Sao Paulo and an Economist.Email: [email protected].

1. “[This] year has seen the demise of a Brazilian oddity: an antitrust regime thatallowed companies to merge first and the regulator to ask questions only later.” AChampion for Choice?, ECONOMIST (Aug. 25, 2012), available at http://www.econo-mist.com/node/21560892.

23


influential economies adopted a system similar to ours, allowing thetransaction to be completed before the approval by the competitionauthority.

Despite the fact that Brazil’s competition policy has evolved ever sinceLaw 8.884/94 came into force, from the beginning of 2000, there had beenthe feeling that something needed to be done.2 Despite the extensivemanagerial work purported by the three previous bodies of the BrazilianSystem for Competition Protection (SBDC) under Law 8.884/94,3 withoutdrastic structural changes, there was little room for evolution. The expost analysis system was antagonistic to the best international practices,and it was aggravated by the heavy bureaucratic structure composed ofthree analytic bodies, known as the “three counters.”4 The result was aninefficient system, with approval deadlines which were incompatible withthe dynamics of global economy, as well as the ineffective policy.5

The government, aware of the relevance of the competition protectionpolicy for the country’s economic development and after years of discus-sion within the legislative and executive powers, granted maximum prior-ity to the pending bill in the National Congress, including it in the growthacceleration programme (PAC).6 Thus, by the end of 2011, the Congressenacted Law 12.259, which would eventually solve a good portion of the

2. One of the conclusions of Organisation for Economic Co-operation and Develop-ment’s (OECD) last Peer Review of the Brazilian competition policy was that thenew antitrust law should adopt a pre-merger review system. See generally OECD,COMPETITION LAW AND POLICY IN BRAZIL: A PEER REVIEW 2010, (2010), availa-ble at http://www.oecd.org/daf/competition/45154362.pdf.

3. Under Law 8.884/1994 there were three antitrust bodies in Brazil: (i) the Secreta-riat for Economic Monitoring (Seae) from the Ministry of Finance; (ii) the Secreta-riat for Economic Law (SDE) from the Ministry of Justice; and (iii) theAdministrative Council for Economic Defense (CADE) an independent agency.The first two secretariats were responsible for rendering opinion on mergers andfor conducting investigation on anticompetitive practices. CADE, in its turn, wasthe tribunal responsible for judging these cases on the administrative level. Seegenerally Lei No. 8.884/94, de 11 de Junho de 1994, DIARIO OFICIAL DA UNIAO

[D.O.U.] de 13.6.1994 (Braz.), available at http://www.planalto.gov.br/ccivil_03/leis/l8884.htm.

4. OECD, supra note 2, at 11. 5. See id.6. Created in 2007, during President Lula’s second mandate, the PAC promoted the

recovery of the planning and execution of major infrastructure projects of social,urban, logistics and energetic relevance for the country, contributing to its rapidand sustainable development. The economic measures for growth acceleration en-compassed the following: (i) Credit Stimulus and Financing; (ii) Improvement ofthe Investment Environment; (iii) Tax Relief and Management; (iv) Long-termFiscal Measures; and (v) Fiscal Consistency. The reform of Brazil’s antitrust policywas included as one of the most important measures to be taken in order to attractinvestments. TRIBUNAL DE CONTAS DE UNIAO [COURT OF UNION ACCOUNTS], RE-

LATORIO E PARECER PREVIO SOBRE AS CONTAS DO GOVERNO DA REPUBLICA

EXERCICIO DE 2009 [PRELIMINARY REPORT AND OPINION ON GOVERNMENT AC-

COUNTS OF THE REPUBLIC YEAR 2009] 169 (2009), available at http://portal2.tcu.gov.br/portal/page/portal/TCU/comunidades/contas/contas_governo/contas_09/Textos/CG%202009%20Relat%C3%B3rio.pdf; see also Melhoria do Ambiente deInvestimento [Improvement of the Investment Environment], MINISTERIO DO PLA

NEJAMENTO, http://www.pac.gov.br/sobre-o-pac/medidas/melhoria-do-ambiente-de-investimento (last visited Apr. 7, 2015).

2015] PRE-MERGER ANALYSIS IN BRAZIL 25

structural problems known to all agents. Nevertheless, great challengesremained, because the new law clearly lacked managerial solutions forthe implementation of the new system of prior analysis of mergers andacquisitions. These solutions were created by employees in the SBDC’sthree bodies, while handling their increasingly demanding workloads.

A few months before Law 12.259/11 came into force, several agentswent to the press willing to express their concerns regarding the new sys-tem. Various pieces, political in nature, were published in a number ofmagazines and newspapers despite not devoted to specializing in reportson the economy. For example, the newspaper O Globo published a pieceon April 22, 2012, emphasizing the concern regarding the lack of person-nel for the functioning of the new CADE.7 Exame magazine was evenmore emphatic. In a long piece, published on June 13, 2012, it highlightedthe excessive bureaucracy of the new body, affirming that with the newcompetition law, “[i]f an iron and steel mill buys a supermarket, it willhave to present 58 documents [to the ‘Supercade’].”8 In Germany, itwould suffice to send a letter.9 The criticism harshened in the rest of thepiece—stating with regard to complex transactions, the old system re-quired thirty-five documents, while the new one required 140.10 Themagazine then continued criticizing the excess of bureaucracy of the newmodel, pointing out that there would be an overdose of papers even intransactions under the fast track procedure.11 Lastly, it estimated that anopinion would take up to forty-five days to be issued and that Supercadecould stay inert for months.12

The diagnosis reflected in the national press showed that there was agreat chance that the new competition protection system would actuallydeteriorate the conditions for companies dealing with CADE. Part ofthis diagnosis resulted from the low expectations created by a negativerecord regarding the managerial results of the competition protectionbodies. These results showed that analysis took an excessive amount oftime—sometimes longer than two years.13 The other part of the diagno-sis came from the staffing problems of the new body.14

SBDC’s incapacity to deal with the ever-growing stock of mergers wasnotorious on top of its mission to fight off cartels and unilateral activi-

7. Falta de pessoal ameaca inıcio de funcionamento do Supercade [Lack of PersonnelThreat Early Preparation of the Super-CADE], O GLOBO (Apr. 22, 2012), http://oglobo.globo.com/economia/falta-de-pessoal-ameaca-inicio-de-funcionamento-do-super-cade-4711776.

8. Patrick Cruz, Lei da concorrencia veio para facilitar e complicou [Competition lawcame to help and complicated], EXAMEN (June 13, 2012), http://exame.abril.com.br/revista-exame/edicoes/1018/noticias/lei-da-concorrencia-veio-para-facilitar-e-complicou?page=3.

9. Id.10. Id.11. Id.12. Id.13. OECD, supra note 2, at 41.14. OECD, supra note 2, at 47.


ties.15 In regards to the mergers, there lacked a clear policy in order todeal with the ordering of the mergers that were presented due to thegrowing stock and the reduced number of technicians.16 Even after theadoption of the fast track procedure in 2000, which provided an addi-tional life span to the old system with considerable gains in productivity,the stock or mergers would not stop growing17 Therefore, the logic wasbasically to administer the increasing volume of stock, rather than theincome and outcome flow of mergers.18

This paper aims to detail the creation process of managerial solutions,which culminated in new CADE’s positive performance during its firsttwo years. We will demonstrate the path designed by its employees, start-ing with the approval procedure of Law 12.259/2011, including thedescription of structural changes and the transition work. Then, we willdescribe the managerial solutions developed, in order to ultimatelyachieve the results that were obtained.

II. THE TRANSITION TO THE NEW COMPETITION LAW

In 2005, the Brazilian Government forwarded to the National CongressBill 5.877, which intended to restructure the Brazilian Competition Pro-tection System. Generally speaking, it established the unification of thebodies of the system and the adoption of the pre-merger thresholds.19 In2007, the bill regarding the restructuring of the competition protectionpolicy was included as one of the priorities of the January 22nd GrowthAcceleration Program (PAC), instituted by Decree 6.025.20 After that in-clusion, the restructuring of SBDC became a priority.

Two years after its inclusion in the PAC, the project of restructuring ofthe Brazilian competition protection policy was approved by the Houseof Representatives.21 A year later, it was approved by the Senate.22 Fi-nally it was definitively approved by the House of Representatives onOctober 5, 2011.23 Law 12.529/11 was enacted by the president a little

15. The management changes related to this point are based on Chapter 1—StrategicPlanning and Prioritisation—of the International Competition Network (ICN)’sCompetition Agency Practice Manual. See INT’L COMPETITION NETWORK,AGENCY EFFECTIVENESS: COMPETITION AGENCY PRACTICE MANUAL, 25 (2010),available at http://www.internationalcompetitionnetwork.org/uploads/library/doc744.pdf.

16. See OECD, supra note 2, at 77.17. Id. at 78.18. Id.19. Lei No. 5.877/05, de 12 de Setembro de 2005, CAMARA DOS DEPUTADOS de

9.12.2005 (Braz.).20. See Decreto No. 6.025, de 22 de Janeiro de 2007, D.O.U. de 22.1.2007 (Braz), avail-

able at http://www.planalto.gov.br/ccivil_03/_Ato2007-2010/2007/Decreto/D6025.htm.

21. See generally Lei No. 12.529/11, de 30 de Novembro de 2011 D.O.U. de 30.11.2011(Braz.).

22. See id.23. See id.


less than two months after, on November 30, 2011.24 During this timeperiod, there was much debate, many agents were involved, and variousmodifications were made to Bill 5.877/2005.25 But the basic backbonewas kept intact; namely, the institution of the system of ex ante analysisof mergers and the joinder of the tasks of the three bodies of the SBDCinto a single body, which would keep the former name CADE but wouldpresent a structure more compatible to current challenges.26 Below is abrief discussion of the changes that had a significant impact on the newantitrust model.

A. STRUCTURAL CHANGES IN THE COMPETITION PROTECTION MODEL

As previously mentioned, one of the main changes was the transforma-tion of the a posteriori control of the mergers to a prior control, which isone that prevents companies from closing their transactions beforeCADE’s approval.27 With this change, the imposition of measures thatrestrict competition were more easily implemented and less traumatic tothe economy as a whole. Further, it placed the competition protectionpolicy in a more equalitarian position with the main jurisdictions of theworld, which also facilitated the cooperation in the handling of interna-tional transactions.28

The model’s other fundamental change was the joinder of tasks of thethree Brazilian antitrust bodies in the new CADE. SDE was terminatedand replaced within the structure of the Ministry of Justice by the Na-

24. CONSELHO ADMINISTRATIVO DE DEFENSE ECONOMICA [ADMIN. COUNCIL FOR

ECON. DEF.] (CADE), DEFENSE DE CONCORRENCIE NO BRASIL: 50 ANOS [COMPE-

TITION POLICY IN BRAZIL: 50 YEARS] 139 (2013), available at http://www.cade.gov.br/publicacoes/livro/CADE_-_DEFESA_DA_CONCORRENCIA_NO_BRASIL_50_ANOS.pdf; see generally Lei No. 12.529/11, de 30 de Novembro de 2011D.O.U. de 30.11.2011 (Braz.), available at http://www.planalto.gov.br/ccivil_03/_ato2011-2014/2011/Lei/L12529.htm.

25. CONSELHO ADMINISTRATIVO DE DEFESA ECONOMICA [ADMIN. COUNCIL FOR

ECON. DEF.] (CADE), DEFESA DA CONCORRENCIA NO BRASIL: 50 ANOS [COMPE-

TITION POLICY IN BRAZIL: 50 YEARS] (2013), available at http://www.cade.gov.br/publicacoes/livro/CADE_-_DEFESA_DA_CONCORRENCIA_NO_BRASIL_50_ANOS.pdf.

26. See generally Lei No. 12.529/11, de 30 de Novembro de 2011 D.O.U. de 30.11.2011(Braz.).

27. OECD, supra note 2, at 78.28. After Law 12.529/11 came into force, CADE considerably increased its interaction

with the world’s most important antitrust agencies. Some international merger re-views were carried out together with foreign agencies, which led to a significantexchange of information and ideas including discussions on the necessary remediesto be adopted in order to reduce the potential negative impact of the mergers oncompetition. Some examples of this new phase were the following cases: MergerReview No. 08700.006437/2012-13 (Syniverse Holdings e WP Roaming III) andMerger Review No. 08700.009882/2012-35 (Munksjo AB and Ahlstrom Corpora-tion). Both cases were approved by CADE’s Tribunal following the parties’ sign-ing of commitments (ACC), and after extensive information exchange betweenCADE and the European Commission. For copies of these decisions, see Sei,CADE, http://sei.cade.gov.br/sei/institucional/pesquisa/processo_pesquisar.php?acao_externa=protocolo_pesquisar&acao_origem_externa=protocolo_pesquisar&id_orgao_acesso_externo=0 (last visited May 8, 2015).


tional Consumer Secretariat, which could also be considered a positiveaspect of the new law because it strengthens a very relevant policy forsociety.29 Seae remained as a part of SBDC, but with a role devoted onlyto competition advocacy due to its performance over the last few years.30

This change aimed mostly at extinguishing what was formerly known asthe “three counters” of SBDC.31 In order to clear a merger in Brazil, thecompanies had to wait for the approval by three distinct bodies, whichwere physically separated and had frequent communication problems, re-quiring double efforts.32

After Law 12.529/11, the tasks performed by the former Seae (exceptfor the competition advocacy) were incorporated to a new body calledCADE’s General-Superintendence (GS).33 This body, which will be thefocus of the present work, also gained an attribution that plays a veryrelevant role in the new model adopted by the new Brazilian antitrustlegislation—the power to review and decide on the transactions wherethere is no need for the application of competitive restrictions (i.e., onesthat have no chance of having negative impacts on prices and/or qualityin Brazil).34 On the other hand, all the mergers that have some kind ofrestriction suggested by the GS must be ruled on by CADE’s tribunal35

and the administrative tribunal, which investigates breaches in the eco-nomic order and offer recommendations for filing or conviction.36

Hence, the more relevant cases, which in a way contribute to the defi-nition of the competition protection policy, are defined in the ruling ses-sions of the administrative tribunal. The Tribunal then becomesessentially a judicial body, which determines CADE’s case law and thecountry’s competition protection policy, leaving the reproduction of in-structions behind.37

Another legal innovation created by the new Brazilian competitionlaw—a requirement which makes the submission to CADE of a givenmerger mandatory—also deserves attention in this paper. Under Law

29. Jose Gabriel Navarro, Governo federal cria a Senacon [Federal government createsSenacon], JORNAL DA TARDE (May 31, 2012, 6:59 AM), http://blogs.estadao.com.br/advogado-de-defesa/governo-federal-cria-a-senacon/.

30. OECD, supra note 2, at 79.31. See Lei No. 12.529/11, de 30 de Novembro de 2011 D.O.U. de 30.11.2011, art. 4

(Braz.).32. Cruz, supra note 8.33. OECD, supra note 2 at 57.34. Lei No. 12.529/11, de 30 de Novembro de 2011 D.O.U. de 30.11.2011, art. 13 XII,

art. 54 I, art. 57, I (Braz.).35. Lei No. 12.529/11, de 30 de Novembro de 2011 D.O.U. de 30.11.2011, art. 13 XII

and art. 57 II (Braz.).36. Lei No. 12.529/11, de 30 de Novembro de 2011 D.O.U. de 30.11.2011, art. 13 VII-

VIII (Braz.).37. CADE’s Tribunal is active in all the administrative proceedings opened to investi-

gate anticompetitive conducts and all mergers contested by the GS. But the Tribu-nal has the power to arrogate any merger approved by the GS. See Lei No. 12.529/11, de 30 de Novembro de 2011 D.O.U. de 30.11.2011, art 65 II (Braz.); ResolucaoNo. 1, de 29 de Maio de 2012 D.O.U. de 31.5.2012, art. 122 II (Braz.), available athttp://cade.gov.br/upload/Resolucao%201_2012%20-%20RICADE%20(2).pdf.


8.884/94, the submission of any transaction which involved an economicgroup with gross revenues of more than R$400 million in the year prior tothe transaction, with rare exceptions, was considered to be mandatory.38

This resulted in the overcrowding of SBDC with transactions that weremostly fairly simple from a competition standpoint. Needless to say, themandatory character represented a considerable waste of both public andprivate resources, which resulted in inefficiency.39 After Law 12.529/11was enacted, only the submission of transactions that involve an eco-nomic group with gross revenues greater than BRL 750 million and atleast one more group with a gross revenues over BRL 75 million are con-sidered to be mandatory.40

Along with this innovation, which helped to drastically reduce thenumber of mergers presented to CADE, came another equally importantcreation, namely the possibility of regulating the mandatory notificationthresholds upon indication by the CADE’s tribunal, followed by a jointordinance from the Ministries of Economy and Justice. This measure wasadopted after the first day of effectiveness of Law 12.529/11 (May 30,2012) with Interministerial Ordinance MF/MJ 994/12, elevating thefigures of its mandatory filing thresholds (established in its article 88) toR$750 million and R$75 million.41

Finally, one has yet to emphasize the rules brought by the new law inregards to the rejection of notifications, via amendment. This point is ofgreat relevance because it encourages the parties in a transaction to pre-sent all the information referring to it at the first opportunity, under pen-alty of rejection and amendment (which can only happen once) by theGeneral-Superintendence. The amendment is the only time in the reviewprocedure of a merger when its review term is interrupted and reinitiatedbecause the information initially presented was considered to be insuffi-cient for a decision by the General-Superintendence.42 Therefore, onlywhen the parties notify CADE about the answer to such an amendment,does the review term begin again.43 Furthermore, in the event the answerto the amendment is not accepted by the General-Superintendence be-cause it still contains defects and irregularities capable of hindering thejudgment of the merits, the penalty will be the filing of the proceedingswithout the analysis of the merits.44

38. Lei No. 8.884/94, de 11 de Junho de 1994, D.O.U. de 13.6.1994, art. 54, ¶ 3 (Braz.)(which was overhauled by Lei No. 12.529/11).

39. See OECD, supra note 2, at 7.40. Id.41. See Portaria Interministerial No. 994, de 30 de Maio de 2012, GABINETE DO MINIS-

TRO de 30.5.2012 (Braz.), available at http://www.cade.gov.br/upload/Portaria%20994.pdf.

42. Id.43. Id.44. Lei No. 12.529/11, de 30 de Novembro de 2011 D.O.U. de 30.11.2011, art. 53, ¶ 1

(Braz.); see also Resolucao No. 1, de 29 de Maio de 2012, D.O.U. de 31.5.2012, art.111 (Braz.).


Before proceeding to the next topic of this paper, it is important tomention that the mistrust in the new CADE was clearly demonstrated bythe market’s level of tension soon after the enactment of Law 12.529/11.And this level of tension was externalized by the media, as shown in someexamples already discussed.45 The most interesting part is that all of thisnegative news was published not only after the promulgation of Law12.529/11 (some even after its coming into force), but also after the publi-cation of all of CADE’s main infralegal regulations.46 This signals thatthe market had a great mistrust of the new CADE’s management ability.After all, even though the structural improvements were evident, theycould be deemed innocuous without adequate management. Neverthe-less, as will be demonstrated, the work was already being developed waybefore these critics, trying to anticipate the main challenges to come.

B. TRANSITION WORKS FOR LAW NO. 12.529/2011

Soon after the approval of SBDC’s restructuring project by the Senate,and its forwarding to the House of Representatives for the final delibera-tion, President Dilma Roussef took office.47 After the initial concernover the degree of priority that would be given to this project by the newpresident, the Minister of Justice, Jose Eduardo Cardozo, confirmed thenew government’s support of the project’s approval.48 Therefore, theleadership of the SBDC (in particular SDE and CADE) decided to initi-ate the preparation for the changes at the beginning of 2011. There wasmuch that needed to be discussed, from the infralegal framework thatwould have to be created, to the budget and personnel issues, the newphysical structure, organizational charts, the compatibilization of differ-ent organizational cultures in a single body and, perhaps one of the mainpoints, how to make the new system of prior analysis of mergers work insuch a way so as to not frustrate the expectations surrounding the newBrazilian competition protection system.

The preparation for the transition process was then initiated. It wasthought that the process could unravel at any time because the six monthperiod of vacatio legis would hardly be enough to solve all the issues in asatisfactory manner. Hence, CADE’s commissioners and employees, be-sides SDE’s and Seae’s employees––which would be incorporated to the

45. See A Champion for Choice?, supra note 1.46. See generally Cruz, supra note 8; see also Molan Gaban & Juliana Oliveira Dom-

ingues, Nova Lei permitira a criacao de monopolios [New law will allow the crea-tion of monopolies], FOLHA DE SAO PAULO (July 8, 2012), http://www1.folha.uol.com.br/fsp/opiniao/53304-nova-lei-permitira-a-criacao-de-monopolios.shtml (anexample of this negative news).

47. Dilma Rousseff sworn in as Brazil’s new president, BBC NEWS (Jan. 1, 2011, 10:17PM), http://www.bbc.com/news/world-latin-america-12103312 (providing PresidentDilma Rousseff was sworn into office on January 1, 2011, succeeding Luıs InacioLula da Silva).

48. Gilberto Costa, Para Ministro da Justica novo CADE deve acelerar tramitacao deprocessos de defesa concorrencial, AGENCIA BRASIL (Oct. 6, 2011, 1:35 PM), http://memoria.ebc.com.br/agenciabrasil/noticia/2011-10-06/para-ministro-da-justica-novo-cade-deve-acelerar-tramitacao-de-processos-de-defesa-concorrencial.


new antitrust body, according to the provisions in the bill––were distrib-uted in six groups, supervised by CADE’s commissioners. These sixgroups were entrusted with the task of discussing, analyzing, and propos-ing actions to facilitate the transition. Therefore, in the first semester of2011, the transition groups for the preparation of the “New CADE” wereformed.

The six groups were (a) the New Headquarters, responsible for evalu-ating the demand for a physical space that would accommodate the in-crease in the number of staff members and the peculiarities of theactivities to be conducted; (b) Structure and Organizational Chart, whichstudied the structure of the positions, offices, and people that would benecessary in order to fulfill the new competences, including the function-ing of the General-Superintendence, the Economic Study Department,and the Federal Attorney’s Office, together with CADE’s Tribunal; (c)Information Technology, created to identify technologic solutions that aremore efficient and more adequate to new CADE; (d) Infralegal Rules,responsible for reviewing the existing rules, including new ones and edit-ing the Internal Regulations; and (e) Mobilization and Alignment, en-trusted with the task of motivating and boosting the participation of allemployees in the transition work, as well as providing the exchange ofinformation between the groups by means of newsletters.49

Besides the ones mentioned above, the pre-merger review group wasalso created and tasked with identifying the best competition protectionpractices at an international level. This group can be considered as themost important for the implementation of the new model, and it will beexplained in detail below. Its main results were (i) the structuring of theGeneral-Superintendence; (ii) the new information forms for the notifica-tion of mergers, creating specific forms for fast track and ordinary pro-

49. The main results of each transition group were the following: (a) New Headquar-ters: renting of headquarters in the end of Asa Norte, in Brasılia, which couldaccommodate the new employees incorporated from SDE and Seae; (b) Structureand Organizational chart—the task of this group was to study the necessary struc-ture for the new CADE, which would receive the tasks previously performed bySDE and Seae, and create an organizational chart of the whole organization whichhad to reflect both the new tasks and the new procedural flows. This group had astrong interaction with the pre-merger analysis group, aiming at reflecting the newflows created in the institutional design of the new CADE; (c) Information Tech-nology: the primary task of this group was to study several possibilities of newsystems presented, aiming at providing the new CADE with an informational sys-tem capable of satisfying both the internal public and the external one. This sys-tem is currently under development, but it is partly functioning; (d) InfralegalRules: this group delivered as a main product CADE’s new Internal Regulations,performing great revision work of both the old Regulations and the infralegal rulesof the former SBDC’s two Secretariats, which needed to be adapted to the newsystem; and (e) Mobilization and Alignment: this groups played a fundamentalstrategic role in the formation of the new CADE, in the sense that it sought toalign all the expectations of employees from the three bodies with what was beingdone by the six transition groups. The open communication between the managersand the employees, with regular presentations in CADE’s Plenary, directed to eve-ryone, was crucial for the motivation process of SBDC’s employees, reducing theresistance to change, common in these scenarios.


ceedings; (iii) a Resolution by CADE (Resolution 02/2012) aimed atregulating the new procedure of prior analysis of mergers, also specifyingnew criteria for submission; and (iv) the definition of the new proceduralworkflow within the General-Superintendence.50

C. THE WORK PLAN OF THE PRE-MERGER REVIEW

TRANSITION GROUP

In the first semester of 2011, several meetings with Brazilian and for-eign lawyers that worked along with CADE were conducted.51 Theytried to identify the main deficiencies present and confirmed CADE’s di-agnosis. Along with these meetings with the main agents of Brazil’s anti-trust policy, the pre-merger group initiated benchmarking studies withthe best international practices related to the system of ex ante analysis ofmergers.52 First, twenty questionnaires were sent to foreign authorities,with questions related to the functioning of their respective pre-mergersystems, such as regulations adopted, organizational structures, informa-tion level required in notification forms, deadlines, procedural flows,etc.53 Some of the twenty consulted agencies responded to the inquiryperformed by CADE.54

After these initial consultations, part of the pre-merger group set inloco interviews with authorities from some agencies that were chosen fortechnical reasons (i.e., their notorious expertise in competition protec-tion) and also for strategic reasons because some of the chosen agencieshad recently undergone similar transition procedures.55 It was not possi-ble to import a ready-made model, without adaptations to the Brazilianreality, in particular because of the inequality between the number oftechnicians available at these agencies and the number of analyses ofmergers performed each year.

After the pre-merger transition team concluded that all of the productsthey had envisaged in their initial project, which was delivered on January31, 2012 (almost four months before the new law would come into force),they were presented for validation and adjustments to all other teams, aswell as to the leaderships in both CADE and SDE.56 The products and

50. ESCOLA NACIONAL DE ADMINISTRACAO PUBLICA [NATIONAL SCHOOL OF PUBLIC

ADMINISTRATION], ACOES PREMIADAS NO 18O CONCURSO INOVACAO NA GESTAO

PUBLICA FEDERAL-2013 [AWARDED SHARES THE 18TH CONTEST INNOVATION IN

MANAGEMENT FEDERAL PUBLIC-2013] 179 (Pedro Luis Costa Cavalcante, et al.eds., 2013), available at http://www.enap.gov.br/images//livro_acoes_premiadas_18_concurso.pdf [hereinafter ESCOLA NACIONAL DE ADMINISTRACAO PUBLICA].

51. Id. at 189.52. Id.53. Id.54. For instance, Australia, Canada, Denmark, Spain, France and United States of

America. See id.55. Lauro Jardim, O CADE vai a Europa [CADE going to Europe], VEJA (Jan. 6,

2012, 5:54 PM), http://veja.abril.com.br/blog/radar-on-line/governo/o-cade-vai-a-europa/.

56. Dirigentes do SBDC elaboram proposta de novo Regimento Interno [SBDC Lead-ers Prepare Proposed New Bylaws], CONSELHO ADMINISTRATIVO DE DEFESA


main results of each team were presented at seminars organized in placesoutside the headquarters of the referred bodies in two phases.57 Duringthe seminars, each point of the products was discussed, through individ-ual presentations, followed by a debate. The key objective of these en-counters was to validate the main products developed during thetransition phase, in order to present them to the Brazilian society bymeans of public inquiries.58

The main product developed by the pre-merger team which was sub-jected to a public consultation was the Resolution that would regulate themergers, including the two notification forms (fast track and ordinaryproceedings), as well as its annexes.59 Hundreds of contributions werereceived during the public consultation process—many of them havebeen incorporated into the final versions of the texts—and were all dulyanswered. The participation of the major national agents and even ofsome international ones, such as the American Bar Association, was ofgreat value to the development of the regulation which gave rise toCADE’s Resolution 02/2012, as soon as Law 12.529/11 first came intoeffect.

III. THE MANAGERIAL INNOVATIONS INSERTED BY CADE

After all the above mentioned, the structural changes promoted by thenew Brazilian antitrust law would not be enough to guarantee, on theirown, the good functioning of the new pre-merger system.60 With time, itbecame clear to the transition group responsible for thinking up the newpre-merger model, that a procedural flow focused on a model of prioritiz-ing the proceedings needed to be adopted. This was the only way the newbody would be able to overcome the challenge of rendering higher qual-ity analyses of mergers faster and more efficiently.

Moreover, all the inefficiency of the old a posteriori control of mergersregime should be completely reversed. This is because a prior controlwould demand that the decisions of the mergers by the new CADE beconducted quickly enough in order to avoid preventing hundreds oftransactions of mergers and acquisitions between companies that occur

ECONOMICA (CADE), http://www.cade.gov.br/Default.aspx?c97d8d9c74a97e8591be8ed969ee (last visited Nov. 7, 2014).

57. The first seminar was held on February 1, 2012, and the second between February27 and March 2, 2012, both at the Israel Pinheiro Convention Center, in Brasılia.See id.

58. See id.59. These two filing forms were published for public consultation by CADE on March

2012. See Consultas Publicas Concluıdas, CADE, http://www.cade.gov.br/Default.aspx?62d524f50f04181bef5def471f21 (last visited Nov. 7, 2014).

60. As previously said in item 2.1 of this paper, the new Brazilian antitrust law solvedpart of the structural problems, for example, reducing the inefficiency generatedby the “three counters” by transforming them into one single body and all thecosts derived from this system, and also creating one more threshold to be consid-ered for the prior notice of mergers.


annually in Brazil.61 Therefore, the success of the new CADE dependedon innovative managerial solutions in order to overcome the operationaldifficulties of a pre-merger system.

The managerial problem was diagnosed based on the whole work planof the pre-merger group. The administration of mergers is difficult be-cause it requires the organization of procedures with different complexitylevels that consequently require different levels of work within an admin-istrative body such as CADE. This difficulty derives not only fromCADE, but also from the companies’ representatives who submit theirmergers, leading to a volume of necessary information varying accordingto the complexity level of the transaction. In the previous model, thecases were essentially analyzed based on a “first come, first serve” ap-proach, causing more complex cases to block the analysis of the majorityof simpler ones.62

The central theme of the managerial innovations developed by the pre-merger group was and continues to be to transform the system into acontinuous flow of analysis to avoid any interruptions in one of the unitsof the General-Superintendence.63 In order to transform the administra-tion of the proceedings, it would first be necessary to organize the entryof these proceedings into the General-Superintendence. This led to thefollowing managerial innovations introduced into CADE’s General-Superintendence.

A. CREATION OF A SPECIFIC SECTOR FOR THE TRIAGE OF MERGERS

Initially, the pre-merger transition group had to plan the new procedu-ral flow within the General-Superintendence and decide the ideal organi-zational structure in order for this flow to work in an efficient manner,despite the scarce resources and slim chances of solution until the start ofthe body.

A key element adopted by the General-Superintendence was the crea-tion of the Triage sector, which continues to be tasked with identifying allcases that clearly do not raise competition concerns and deciding those

61. See Statistics, INST. OF MERGERS, ACQUISITIONS AND ALLIANCES, http://www.imaa-institute.org/statistics-mergers-acquisitions.html#MergersAcquisitions_Brazil (lastvisited Nov. 7, 2014).

62. See Laura Naime & Ligia Guimaraes, Conheca os passos para aprovar ou rejeitar afusao Sadia-Perdigao [Learn the steps to approve or reject the merger Sadia, Perdi-gao], GLOBO—SAO PAULO (May 20, 2009), at G1, available at http://g1.globo.com/Noticias/Economia_Negocios/0,,MUL1161471-9356,00-CONHECA+OS+PASSOS+DO+CADE+PARA+APROVAR+OU+REJEITAR+A+FUSAO+SADIAPERDIGAO.html; see also Daniela Barbosa, Caso Sadia-Perdigao pode acelerarmudanca na lei das fusoes e aquisicoes [Sadia, Perdigao case can accelerate changein the law of mergers and acquisitions], EXAME (June 9, 2011, 6:00 AM), http://exame.abril.com.br/negocios/noticias/caso-sadia-perdigao-pode-acelerar-mudanca-na-lei-das-fusoes-e-aquisicoes; see also Bruno Boris, CADE–decisao que reprovacompra da Garoto pela Nestle [CADE-decision disapproves purchase of Garoto byNestle], MIGALHAS (Feb. 13, 2004), http://www.migalhas.com.br/dePeso/16,MI3649,71043-CADE+decisao+que+reprova+compra+da+Garoto+pela+Nestle.

63. ESCOLA NACIONAL DE ADMINISTRACAO PUBLICA, supra note 50, at 191.


cases within thirty days.64 This deadline was created by the leaderships ofthe new CADE. Because more than 600 approvals using the fast trackprocedure were made within thirty days, it is highly probable that this isgoing to be incorporated into the body’s Internal Regulations followingCADE’s last regulation review.

The creation of a general department was a result of the fact that theratio of proceedings per technician is higher in Brazil than in many othermain foreign authorities.65 This department was designed to “separatethe wheat from the chaff” or, more specifically, to separate the cases withless potentially offensive effects on competition (a procedure called fasttracking) from the cases that could negatively impact the competitive en-vironment.66 This new institutional design broke up the structureadopted in the previous model of a posteriori review. Even though thefast track procedure has existed since the mid-2000s, none of three bodiesof the former SBDC had a specific sector for such an activity.

The use of two notification forms (one for fast track procedures andthe other for all other cases) helped the congestion of the Triage sector.It comes down to a self-identification mechanism, which is one of the

64. See id.65. According to the information found in the annual reports of some of the world’s

most important antitrust agencies, in 2012, while CADE reviewed 660 cases withthe assistance of eighty-seven public servants (average of 7.58 cases per public ser-vant), France reviewed 2013 with the assistance of ninety-nine public servants (av-erage of 2.15 cases per public servant), Spain reviewed 113 cases with 106 publicservants (average of 1.06 public servants per case), Canada reviewed 232 caseswith 282 public servants (average of 0,82 cases per public servant), and the UnitedStates of America reviewed 1.166 cases with the assistance of 722 public servants(average of 1.61 cases per public servant). See MINISTERIO DA JUSTICA [MINISTRY

OF JUSTICE], PRESTACAO DE CONTAS ORDINARIA ANUAL: RELATORIO DE GESTAO

DO EXERCICIO DE 2012 [PROVISION OF REGULAR ANNUAL ACCOUNTS, ANNUAL RE-

PORT FOR THE YEAR 2012], available at http://www.cade.gov.br/upload/Relat%C3%B3rio%20de%20Gest%C3%A3o%20de%202012_CADE_vers%C3%A3o%20final.pdf; see also AUTORITEE DE LA CONCURRENCE, PUSHING THE BOUNDARIES

FOR A STRONG AND FAIRER ECONOMY: ANNUAL REPORT SUMMARY 2012, availa-ble at http://www.autoritedelaconcurrence.fr/doc/synthese_2012_en.pdf (providingFrance reviewed 2013 with the assistance of ninety-nine public servants); see alsoCOMISION NACIONAL DE LA COMPETENCIA, ANNUAL REPORT: 2011-2012, availa-ble at http://www.cncompetencia.es/Inicio/GestionDocumental/tabid/76/Default.aspx?EntryId=186694&Command=Core_Download&Method=attachment (pro-viding Spain reviewed 113 cases with 106 public servants); see also COMPETITION

BUREAU CANADA, ANNUAL REPORT OF THE COMMISSIONER OF COMPETITION

FOR THE YEAR ENDING MARCH 31, 2012, http://www.competitionbureau.gc.ca/eic/site/cb-bc.nsf/vwapj/cb-doc-ar-2011-12-e.pdf/$file/cb-doc-ar-2011-12-e.pdf; see alsoFEDERAL TRADE COMMISSION, THE FTC IN 2012, http://www.ftc.gov/sites/default/files/documents/reports_annual/ftc-2012/ftc-highlights-2012.pdf (last visited Apr.25, 2015).

66. The first time that the triage system was discussed with the international legal com-munity was in the Merger Enforcement in The Americas Conference, which washeld on by the New York State Bar Association Antitrust Law Section, in conjunc-tion with the International Section of the NYSBA, the Brazilian Institute on Com-petition, Consumer Affairs, International Trade (Ibrac) and the Canadian BarAssociation, in New York on July 17, 2012. See Remarks by Melanie L. Aitken,Commissioner of Competition, COMPETITION BUREAU, July 17, 2012, http://www.competitionbureau.gc.ca/eic/site/cb-bc.nsf/eng/03494.html.


ways to organize the queue (commonly used in customer service sys-tems). In case the company presents an ordinary case as a case for thefast track procedure, it bears the risk of having its case amended andultimately rejected if there is a lack of necessary information.67 This pos-sibility of amendment and rejection discourages companies from supply-ing misleading or incomplete information, leading to a more efficientTriage sector.68

The Triage department is the core of the General-Superintendence’sintelligence and its role is to create and foster new management tech-niques and substantive reviews of the mergers that are filed with CADE.Because it receives all the mergers submitted to CADE, monitors trans-actions that are occasionally not presented (whether mandatory), andcentralizes all the questions citizens may have regarding legal and infrale-gal rules that regulate CADE’s performance, the Triage department iscentral to the pre-merger review. Furthermore, because it possesses abroader vision of all the cases presented and of all the doubts alreadyanswered, the Triage department serves as a communication bridge be-tween the Brazilian antitrust community and the General-Superintendence.69

B. CREATION OF CGS, SPECIALIZED IN GROUPS OF SECTORS

BASED ON A “SCALE/SCOPE” LOGIC

The creation of a Triage sector was not the only managerial innovationin terms of institutional design. The whole structure of the General-Su-perintendence was developed to function organically, favoring scale andscope gains with specialized departments (or “coordinations”) in differ-ent sectors of the economy. It also benefits not only from the accumu-lated expertise both in regard to the review of mergers and to abuse ofdominance cases (another break from the previous system’s structure),

67. Lei No. 12.529/11, de 30 de Novembro de 2011 D.O.U. de 30.11.20113, art. 53(Braz.).

68. The companies, motivated by a system of a posteriori analysis, which did not pre-vent the conclusion of the intended transaction, made little efforts to present theirmerger in a complete form with all necessary information for a correct analysis. Tothe contrary, in cases that were notably more complex, it was obvious that theparties intended to initially present the minimum amount of information possible,submitting additional information as it was required by SBDC’s bodies, throughinformation requests, which suspended the legal term imposed by Law 8.884 (30days for each Secretariat and 60 days for CADE, with the possibility of interrup-tion upon any request for supplementary information, both to the parties and tothird parties). After all, the longer the analysis, the more difficult it would be toimplement conditions for its approval, or even failure. This negative incentivegenerated by the a posteriori analysis system also existed for the SBDC’s employ-ees who, pressured by the huge amount of transactions submitted and by the ex-tremely short legal term, did not evade from sending requests for information,which were sometimes, unnecessary to the analysis.

69. Since the enactment of the new competition law, the Triage has been mainly at theservice of antitrust law, basically answering questions on whether a given transac-tion is of mandatory filing with CADE, as well as questions on whether a giventransaction can benefit from the fast-track proceeding.


but also from the constant exchange of information between thedepartments.

The creation of those specialized departments was based on empiricalwork (CGAA 1 to 4).70 Indexes with some variables71 were created basedon all the mergers (not fast tracked) reviewed by the Seae/MF between2007 and 2011, as well as, on the stock of administrative proceedings (ex-cept for cartels) from SDE/MJ in the beginning of 2012. These indexeswere aimed at evaluating the “good stock” for each of the new depart-ments of the GS by analyzing this stock both according to the amount ofacts expected for each sector allocated in the departments and their de-gree of difficulty. The indexes also consider the possible scale and scopegains resulting from these divisions; analyzed both in terms of analysis ofmergers and of unilateral behaviors.

Because all of the general departments have the same legal compe-tence, there is a constant exchange of technicians between them when-ever there is the necessity for a task force in a certain case, or even for atemporary reinforcement in a certain sector. This flexibility in the institu-tional design also allows the structure of the General-Superintendence tomore easily adapt to the changing economy, enabling the technicians toalso adapt to the demand. It is important to highlight that the “scale/scope” logic in the formatting of general departments of the General-Superintendence is aligned with the organization of the line of mergers torender the flow of analysis more efficient.72

C. CREATION OF WORK FLOWS BASED ON DIFFERENT

DEGREES OF COMPLEXITY

The two previous innovations relate to the Triage department’s struc-ture, as well as the creation of the sectorial departments (with the help ofthe two form models) and the goal of transforming stock into continuousflow of analysis is summarized in Image 1 (below). It also reflects thedifferent treatment given to different degrees of complexity of the trans-actions presented to CADE.

70. ESCOLA NACIONAL DE ADMINISTRACAO PUBLICA, supra note 48, at 192–93.71. For instance, average analysis time, average analysis time by sector, amount of

cases analyzed by sector, amount of restrictions suggested by Seae per sector etc.Id.

72. Id.


Image 1–Mergers flow in the CADE’s General-Superintendence

The Triage department receives all the mergers and makes a first as-sessment, in order to verify if all the information and documentspresented are enough for the start of the actual proceeding analysis.73

After this, the transaction’s notice is published in the Official Federal Ga-zette, as well as on the CADE’s website to give publicity of the transac-tion to third parties.74 But if the merger is ordinary (not subject to thefast track procedure), then the Triage department forwards the proceed-ing directly to the general department responsible for its review. Initially,this department will verify if all the information submitted is enough;

73. Id. at 193.74. See Lei No. 12.529/11, de 30 de Novembro de 2011 D.O.U. de 30.11.20113, art. 53

(Braz.).


then it will go through all the stages of an act submitted under the fasttrack procedure, as described Image 1. Afterwards, the department per-forms all necessary market tests, and, as the review progresses, it can re-quest more information from the parties. Regarding the mergerssubmitted under the fast track procedure, if the Triage department be-lieves that there is a lack of information for the start of the merger re-view, then it can try to clarify through direct questions to the parties vialetters or phone calls. If the lack of information is essential for the con-tinuation of the case, then the Triage department can opt for anamendment.

After clarifying the questions during the initial proceeding of the analy-sis,75 the Triage department decides, together with the specialized coordi-nator responsible for the review in the specific sector of the transactionsubmitted and the Adjunct Superintendent, whether to proceed with thereview under the fast track procedure or to forward the transaction forreview under the ordinary procedure by the respective specialized depart-ment. In the latter case, the decision by the GS to not grant the fast trackprocedure to a transaction is discretionary.76 This only means that theGS was not convinced, even after clarifications provided by the partiesand third parties, that the transaction potentially has a less severe impacton competition; therefore, it requires a greater scrutiny by its team. Insome specific cases, even before the publishing of its notice, the Triagedepartment may request a waiver from the parties,77 which allows the GSto ask for information from third parties or other international antitrustauthorities upon authorization by the parties. The waiver, also used bythe other departments responsible for the ordinary acts, aims to speed upthe review before it is published via notice, especially in cases that raiserelevant questions, even if submitted under the fast track procedure.

These procedures aim to speed up the review term in one of two ways:(1) through fast track procedure, which adheres to the thirty day dead-

75. This initial process does not necessarily refer to the procedures performed beforethe publication of the notice. In some cases, the Triage may publish the notice, if itunderstands that the parties have presented all the information available to themto enable the start of the analysis of the transaction in the GS after diligences withthird parties (competitors, clients, suppliers etc.), it may decide, together with thespecialized coordination and the Adjunct Superintendent, not to continue theanalysis of this transaction under the fast track procedure in case the diligencesperformed have not made clear the irrelevance of the transaction in competitionterms or even if these diligences have brought new doubts about the transaction.In these cases, which are an exception to the rule, the GS determines, through anorder, that the transaction be changed to the ordinary procedure, and that newinformation to be requested.

76. Resolucao No. 2, de 29 de Maio de 2012, D.O.U. de 5.31.2012, art.7 (Braz.), availa-ble at http://www.cade.gov.br/upload/Resolu%C3%A7%C3%A3o%202_2012%20%20An%C3%A1lise%20Atos%20Concentra%C3%A7%C3%A3o.pdf.

77. Although CADE has not specifically regulated this issue, the waivers wereadopted based on the best practices of the world’s top antitrust agencies. Thisinstrument has been used in several cases with international repercussions. SeeNo. 08700.006437/2012-1 Ato de Concentracao, supra note 26; No. 08700.009882/2012-35 Ato de Concentracao, supra note 26.


line, starting from the day of submission of the act to CADE; or (2) underordinary procedure, under which the deadline depends on its level ofcomplexity, even though it is legally limited to 240 days with restrictedpossibilities of extension.78

D. INSTITUTION OF THE “PRE-SUBMISSION” PHASE

Inspired by successful experiences in international antitrust authorities,the transition team of the pre-merger group suggested the inclusion of aprovision in CADE’s Internal Regulations79 aiming at establishing priormeetings for the mergers that are not eligible for the fast track procedure.These meetings allow the parties to present to the GS the general aspectsof the intended transaction, as well as their view of the possible impactson certain markets. This whole process is conducted in a secretive man-ner, but in some cases the parties can waive secrecy to allow the authorityto access other international authorities or to allow the market to answerquestions raised.

Until now, this “pre-submission” phase has been generating positivefeedback within the scope of the General-Superintendence. The GS cananticipate its first impressions of the transaction and informationpresented up to that moment, avoiding, in the majority of cases, delays bylack of information at the time of notice of the transaction to CADEbecause it is in possession of the main aspects of the transaction, or inmany cases of a draft of the Annex 1 form of CADE’s Resolution n. 02/12. The main purpose of this stage is precisely to guarantee that thetransaction be presented in the most complete manner as possible, con-siderably reducing the possibility of an amendment. This gain in qualityregarding the information of the transactions submitted, resulting fromthe discussions during the pre-submission phase, have greatly contributedto faster review terms in these cases.

E. SYSTEM OF “CHECKS & BALANCES”

In order to supplement the flow described above, a system of “checks& balances” was created for all mergers reviewed under the fast trackprocedure, which currently represent 90 percent of all the analyses everconducted by the Superintendence. The central idea resides in using theexpertise accumulated in the four general departments that deal with or-dinary mergers for a counter-check of the analyses undertaken by the

78. In May 2014, the average term of analysis of a merger in the GS was sixty-sevendays. In sixty-three cases already examined under the ordinary procedure in theGS, ever since the new law has come into force, the biggest term was 184 days,related to a transaction challenged in the Tribunal (CA n. 08700.006437/2012-13),and that was decided through a commitment (ACC-Concentrations ControlAgreement). See ESCOLA NACIONAL DE ADMINISTRACAO PUBLICA, supra note50.

79. See Regimento Interno Do Conselho Administrativo de Defesa Economica [TheInternal Rules of the Board Economic Defense] de 07 de outubro de 2014, art. 114(Braz.).


Triage’s department under the fast track procedure. Additionally, thisflow allows these departments to constantly exchange experiences oftheir analyses, facilitate the internal communication, and grant morequality and legal certainty to the GS’s decisions.

This system works in the following way: after the development of theopinion on a transaction under the fast track procedure by a technician inthe Triage’s department, the opinion is evaluated by its general coordina-tor. Then, the Triage’s general coordinator submits its fast track opinionfor a revision by the general coordinator responsible for the analyses inthe economic sector affected by that opinion. When revising the opinionissued by the Triage department, the general coordinator may suggest al-terations or supplementations, may give its approval without alterations,and even request new diligences. The coordinator may also determinethat the merger is not eligible for the fast track procedure, causing thetransaction examined by the Triage department to be more accuratelyscrutinized for its coordination.80 But in case this general revising coordi-nator gives its approval to the opinion issued by the Triage department, itis then forwarded to the Adjunct Superintendent responsible for monitor-ing the mergers, who will proceed in a similar fashion as this revisingcoordinator. Only after the approval of the expedited opinion by the Ad-junct Superintendent, is the merger submitted for final approval by theGeneral-Superintendent.81

IV. RESULTS

The critics were wrong. Past the initial works phase, with the first andvery satisfactory results, there was no shortage of compliments to the newCADE’s performance. Various national and international publicationshighlighted the promising start of the new system. The very Exame mag-azine, about three months after its piece that carried heavy criticism,completely reversed the setting, with a long piece praising the start of thenew CADE. This piece was titled, “A promising start for the Supercade,”with the subtitle “in a little over two months, Supercade has prevailedover the skepticism and makes its debut approving the acquisition ofcompanies in record time. The Brazilian economy says thanks.”82 Butthere were also many other pieces complimenting this “promising start”highlighted by Exame, with several positive statements by lawyers who

80. See ESCOLA NACIONAL DE ADMINISTRACAO PUBLICA, supra note 50, at 187.81. It is worth noting that although this internal checks & balances system is not pro-

vided for in any specific rule, it was adopted internally by the GS with the purposeof guaranteeing both speed and quality in merger reviews, while encouraging in-formation spill-overs between the departments. This process was based on Chap-ter 3: Knowledge Management of the Agency Effectiveness Handbook. Seegenerally INTERNATIONAL COMPETITION NETWORK, AGENCY EFFECTIVE HAND-

BOOK (2013) available at http://www.internationalcompetitionnetwork.org/uploads/library/doc894.pdf.

82. See Patrick Cruz, Um comeco promissor para o Supercade [A promising start to theSupercade], EXAME (Aug. 9, 2012, 05:55 AM), http://exame.abril.com.br/revista-exame/noticias/um-comeco-promissor-para-o-supercade.


work in the field: The Economist, Carta Capital, Reuters, Valor Econom-ico, among others.83 But which results motivated this change?

A. RESULTS DURING THE TRANSITION TO THE PRE-MERGER MODEL

Before beginning its journey under new legislation and under a newmodel of pre-merger analysis, as a reflection of all the tension createdbefore Law 12.529/11 and during the final period of submission of casesunder the old model (a posteriori review, where the parties could con-clude the transaction before the approval by CADE), fifteen work daysafter May 28, 2012, which marked the last day of effectiveness of Law8.884/94, 141 mergers were presented.84 Besides these 141 transactionssubmitted over a period of less than one month, more than 100 mergerswere inherited from Seae without the conclusion of its opinion becausethis body was no longer in charge of reviewing mergers after the new lawcame into force.85

But the difficulties did not stop there. During this transition periodbetween the two laws, headquarters changed and the adaptation reformswere delayed for about three weeks, leaving the whole body practicallywithout the minimal structural conditions for work. Nevertheless, noneof these cases were delayed because the legal term for their analysisstarted counting from the day of notice, as established in Law 8.884/94,and the deadline would have to be met, with or without the structure.86

Right from the beginning, the Triage’s department started working,separating all transactions eligible for a fast track treatment from theones that deserved greater scrutiny. This activity was conducted in abouttwo weeks. With the collaboration of all teams responsible for the reviewof mergers at CADE, the result could not have been better. All thetransactions that benefitted from the fast track procedure (approximately70 percent) were reviewed by the GS in less than thirty days; until the endof 2012, almost all of the 141 cases submitted had already been examinedby the CADE’s GS.87 In April 2013, the GS’s stock of mergers presentedunder Law 8.884/94 had ended. In May 2014, there were only threemergers, submitted under Law 8.884/94 left for the tribunal’s analysis.88

In June 2012, mergers started to be filed already under the new pre-merger analysis model. This marked the beginning of the test of the inno-vations of the new CADE. The results were extremely positive. The first

83. See id.; see also A Champion for Choice?, supra note 1; Por Leonardo Goy, Cadejulga mais de 800 casos de fusao e aquisicao em 2012 [Cade thinks more than 800cases of mergers and acquisitions in 2012], REUTERS BRASIL (Dec. 12, 2012, 11:26AM), http://br.reuters.com/article/idBRSPE8BB03F20121212; Cade julga maiornumero de casos em um ano [Cade believes more cases in a year], VALOR ECONOM-

ICO (Dec.12, 2012, 7:19 PM), http://www.valor.com.br/empresas/2938174/cade-julga-maior-numero-de-casos-em-um-ano.

84. See generally ESCOLA NACIONAL DE ADMINISTRACAO PUBLICA, supra note 48.85. See id.86. See Lei No. 8.884/94, supra note 3, art. 54, paras. 6, 7 (repealed 2012).87. See ESCOLA NACIONAL DE ADMINISTRACAO PUBLICA, supra note 50.88. See id.


case approved under the fast track procedure took twenty-seven days.89

Right after that, another three cases took less than fifteen days each.90 Inthe first three months of the new CADE, the average term for the analy-sis of the fast track cases was approximately twenty days.91 As to theordinary ones, the success was also immediate. The first one was ap-proved in forty-eight days,92 and the second within fifty days.93 In thefirst six months that Law 12.529/11 became effective, the average term forthe review of ordinary mergers was forty-one days.

B. RESULTS AFTER THE TRANSITION FOR THE PRE-MERGER MODEL

Since the new law, the average terms for the fast track cases have con-tinued to stay close to the initial average, even with the significant in-crease of cases submitted in 2013. But the average terms for the ordinarycases slightly increased mostly due to the degree of difficulty of some ofthem. Ten of those cases were sent to the Tribunal with a challenge bythe GS.94 The average term for the ordinary cases between 2012 andMay 2014 was approximately sixty-seven days in the GS (eighty-sevendays total including review terms of the transactions decided by the Tri-bunal),95 complying with the international standards of leading antitrustagencies in the world.96

Below, we show the main statistics from CADE after Law 12.529 cameinto force, up until May 2014.

89. See Ato de Concentracao No. 08700.003962/2012-87 de 09 de julho de 2012 CADE(Braz.), available at http://www.cade.gov.br/temp/D_D000000675581971.pdf.

90. See Barbara Rosenberg, Brazil: The Enactment of the New Brazilian CompetitionLaw: An Important Shift, MONDAQ, http://www.mondaq.com/x/253956/Antitrust+Competition/The+Enactment+Of+The+New+Brazilian+Competition+Law+An+Important (last updated Aug. 26, 2013). This indicates that the fast track reviewtakes less than thirty days for approval by the CADE.

91. See CA ESCOLA NACIONAL DE ADMINISTRACAO PUBLICA, supra note 50, at 197.92. See Ato de Concentracao No. 08700.006962/2012-39, de 16 outobro de 2012 CON-

SELHO ADMINISTRATIVO DE DEFESA ECONOMICA (Braz.), available at http://www.cade.gov.br/temp/D_D000000704881564.pdf.

93. See Ato de Concentracao No. 08700.005310/2012-87, de 01 de Novembro de 2012CONSELHO ADMINISTRATIVO DE DEFESA ECONOMICA (Braz.), available at http://www.cade.gov.br/temp/D_D000000708581248.pdf.

94. This figure takes into account the time elapsed between the coming into force ofLaw 12.529/11 and May 2014.

95. See Lei No. 12.529/11, de 30 de Novembro de 2011 D.O.U. de 30.11.2011, art. 53(Braz.); See also Resolucao No. 1, de 29 de Maio de 2012, D.O.U. de 31.5.2012, art.111 (Braz.).

96. See generally Howard W. Fogt, et al, Timely Merger Clearance Becomes Increas-ingly Problematic As Complex Rules and Procedures for Required ApprovalsSpread Around the World, BLOOMBERG BNA (Aug. 23, 2013), http://antitrust.bna.com/atrc/7033/split_display.adp?fedfid=35698743&vname=atrcnotallissues&wsn=499968000&searchid=23793196&doctypeid=1&type=oascore4news&mode=doc&split=0&scm=7033&pg=0.


Graphic 1–Comparison between the average merger review terms (Law8.884/94–2009 to 2011–and Law 12,529/11–2012 and 2013)

21 26

182

156 154

0

20

40

60

80

100

120

140

160

180

200

2009 2010 2011 2012 2013

GENERAL AVERAGETIME FOR ANALYSIS OFMERGERS UNDER LAW12.529

GENERAL AVERAGETIME FOR ANALYSIS OFMERGERS UNDER LAW8.884

Source: CADE

Table 1–Statistics from CADE’s General-Superintendence(2012 to 2014)

No. Fast No. No. Average No. AverageTrack Ordinary Summary Time – Ordinary Time -

Year (Entry)* (Entry)* Opinions Fast Track Opinions Ordinary Total

2012 121 17 106 18,7 8 41,3 138

2013 334 41 319 19,4 32 65,1 375

2014** 124 21 131 21,1 23 78,3 145

*including cases withdrawn**data updated up to 20 May2014 658

Source: CADE-Data updated up to May 20, 2014.

Table 2–Average terms of the General-Superintendence only regardingordinary cases (distributed by brackets of terms of discovery)

RepresentativenessBrackets Number of Cases Average (days) (%)

Considering all cases 63 67 100

taking out only the ones 56 58 89challenged by the GS (07)

taking out only the ones above 53 51 84100 days (10)

taking out only the ones above67 days (general average term) 42 44 67

(21)

taking out only the ones above 29 39 4650 days (34)

Source: CADE -Data updated up to 20 May 2014.


As easily noticable from the data presented above, the efficiency gainin the new prior analysis of mergers in comparison to the former system isundeniable. In as early as the first year, the decrease was drastic, goingfrom an average term of 154 days in 2011 to twenty-one days in 2012(representing approximately an 86 percent decrease in terms). Equallyimportant, the average review period remained steady from 2012 on-wards, but the number of transactions considerably increased in 2013 anduntil May 2014. Currently, this average term is twenty-six days. It mustbe stressed that this term counts in all the procedures (fast track and ordi-nary) and also encompasses the discovery period carried out by the GS,as well as the ruling period by the Tribunal. In regards to ordinary cases,the term includes the period carried out by the GS and the Tribunal,which accounts for an average review term in April 2014 of eighty-onedays—still below the maximum term (240 days, which can be extendedfor 90 more days) established by law. It should be noted that only onemerger97 decision surpassed the 240 day deadline among the 619 currentdecisions.98

In relation to the ordinary cases, Table 2 clearly shows that the vastmajority of the sixty-three cases already instructed by the GS had ananalysis review term shorter than 100 days and also shorter than the gen-eral average (sixty-seven days in the GS). In the first case, only ten anal-yses surpassed 100 days, which means that over 84 percent of the caseswere solved in a shorter time frame. In the second case, only twenty-oneanalyses surpassed sixty-seven days, which is the current average term forordinary cases in the GS and means that almost 70 percent of the caseswere solved in a term shorter than the average. Further, almost half (46percent) of the total amount of ordinary cases already examined by theSuperintendence was below fifty days.

There are also five ordinary cases that were approved in a shorter termthan the maximum term determined for the fast track procedure, which isthirty days. Finally, of the ten cases that surpassed 100 days of review, the“outliers” in the universe of ordinary cases already examined by the GS,six were challenged by the Tribunal (five of which with a declaration ofcomplexity)99 and the other four had problems in the presentation of in-

97. This was the case of the merger between the higher education institutions,Anhanguera and Kroton, which had its term extended upon request by the Tribu-nal, having used 301 days until its final decision, for the approval conditional uponthe fulfillment of a number of measures provided for in a Concentrations ControlAgreement (CCA), entered into by CADE and the claimants. See Ato de Concen-tracao No. 08700.005447/2013-12, de 06 de maio de 2014 CONSELHO ADMINISTRA-

TIVO DE DEFESA ECONOMICA (Braz.), available at http://www.cade.gov.br/temp/D_D000000776091737.pdf.

98. Data updated to 20 May 2014. See generally ESCOLA NACIONAL DE ADMINISTRA-

CAO PUBLICA, supra note 50.99. Article 120 of CADE’s Internal Regulations, which creates the “declaration of

complexity,” as to regulate the GS’ request for an extension of term provided forin §2 of Article 88 of Law 12.529/11. Article 120 establishes in its main section that“The General-Superintendence may, through a duly reasoned decision, declare thetransaction as a complex one and determine the realization of a new supplemen-


formation by the parties (some of those were even initially submitted asfast track). It should also be stressed that, even if we add up the termsused by the Tribunal to judge the cases that were challenged by the GSuntil May 2014 (ten in total) or that were arrogated by them (three),these averages would not be significantly altered.

Lastly, it is worth mentioning that the good performance by CADE inthe analysis of mergers generated a positive impact on its repressive mis-sion concerning the fight against anticompetitive behaviors, especiallycartels. In 2013, CADE judged the greatest number of proceedings refer-ring to anti-competitive behaviors registered in the last years—thirty-eight cases (as per Graphic 2 below). Of these, twenty-two were con-victed, including thirteen cartel cases. In total, the penalties applied byCADE add up to R$4916 million.100 These values are sent to the Collec-tive Rights Protection Fund and they may return to society under theform of financing of projects regarding the protection of consumer rights,the environment, historical and cultural heritage, among others.

Ever since the creation of the new law, the GS concluded the analysisof 271 behavioral cases, filing them or forwarding them for ruling by theTribunal.101 The stock of behaviors inherited from SDE by the newCADE, which was 444 proceedings on May 29, 2012, has been reduced to296 in May 2014, also including the ones initiated during this period.102

Graphic 2–Anticompetitive behaviors cases judged by CADEfrom 2010 to 2014

14 1512

16

7

18 16 14 38 16

41

2

22

9

0

5

10

15

20

25

30

35

40

2010 2011 2012 2013 2014*

Convicted

Filed

Source: CADE

tary investigation, specifying the diligences to be performed.” See Lei No. 12.529/11, de 30 de Novembro de 2011 D.O.U. de 30.11.2011, art. 88, § 2 (Braz.); see alsoResolucao No. 1, de 29 de Maio de 2012, D.O.U. de 31.5.2012, art. 120 (Braz.).

100. CADE, BALANCE 2013 14 (2014), available at http://www.cade.gov.br/upload/Balan%C3%A7o%202013%20.pdf.

101. See ESCOLA NACIONAL DE ADMINISTRACAO PUBLICA, supra note 50, at 199.102. See id.


V. CONCLUSION

As explained throughout this paper, the legal revision of the BrazilianCompetition Protection System addressed the structural “bottlenecks”that hindered the execution of the Brazilian antitrust policy in a satisfac-tory manner. The data presented speaks for itself. In only one year, theaverage term of analysis of mergers was reduced by over 80 percent, com-pared to the best average reached during the effectiveness of Law 8.884/94 and not to its historical average. Further, the productivity gains in theanalysis of mergers reached by CADE in these two first years also re-flected directly on its repressive role with considerable gains in the num-bers related to the fight against cartels and other unilateral behaviors.These results motivated a series of recognition acts concerning CADE’smanagerial innovations.

After the internal public and, mainly, the agents in the Brazilian anti-trust policy demonstrated their recognition of the new bodies’ good start,the international antitrust community also took notice of the improve-ments. The “Global Competition Review” (GCR), an important interna-tional newspaper on competition protection in their annual ranking ofantitrust agencies, granted in 2013 another half star to the new CADE,which already had 3.5 stars in the previous year, hoisting it to the top tenof the competition authorities in the world.103 Brazil went from the 13thposition to the 8th position, going from the “good” category to the “verygood” category, only behind renowned agencies such as the United States(FTC and DOJ), the European Commission, England (UK’s CompetitionCommission), Germany, France, and Japan. It boosted Brazil to the samelevel as Australia, the Netherlands, Spain, and England (UK’s Office ofFair Trade), and ahead of Canada, Korea, Italy, and New Zealand. Outof developing countries, Brazil appears in the first place.104 CADE’smain highlights in the evaluation made by GCR were (i) success in thetransition to Law 12.529/11; (ii) prior analysis of mergers; (iii) new notifi-cation criteria; (iv) analysis of fast track mergers in an average term of 19days––one of the fastest in the world; and (v) the refining of the fightagainst cartels.105

Towards the end of November 2013, the project, referring to the newprocess of analysis of mergers, was ranked within the ten first places(among 102 registered) in the 18th competition of innovation in the pub-lic service, promoted by the National School of Public Administration(ENAP) in partnership with the Ministry of Planning, Budget and Man-agement (MPOG), which was unprecedented for CADE.106 The purposeof the competition, which has been promoted for seventeen years, is to

103. See Rating Enforcement 2013, GLOBAL COMPETITION REV., http://www.autoritede-laconcurrence.fr/doc/gcr_rating13.pdf (last visited Nov. 7, 2014).

104. Id.105. Id.106. Information on this partnership was released by TVNBR, a Brazilian TV news

agency, on April 10, 2014. See Iniciativa reduz tempo de analise de processos naarea de defesa economica [Initiative reduces analysis time of economic processes in


stimulate the dissemination of innovative solutions in organizations of theFederal Government. On April 8, 2014, at an event taking place inENAP’s headquarters, CADE was ranked 7th and obtained the innova-tion stamp, an already renowned brand in the Brazilian federal publicservice for the recognition of managerial practices, which have promotedinnovations of proven efficiency in their fields of action.107

In conclusion, the managerial innovations refined the use of the institu-tion’s human capital (always very scarce in the public sector), privilegedthe internal communication and the information flow—splitting responsi-bilities among all involved in an empowerment process, which generatesthe feeling of belonging to the organization for the whole group and, con-sequently, creates greater motivation and a good organizational atmos-phere.108 The costs involved in its development were low109 because itdid not rely on complex information technology systems and completelyfocused on the human material available, which may very well be repro-duced in other bodies that have great volumes of demands with differentcomplexity levels that are above the team’s production capacity.110

the area of defense], YOUTUBE (Apr. 10, 2014), https://www.youtube.com/watch?v=wiQv5doYxQ4.

107. The complete video of the award ceremony, which includes presentations on allthe projects that were awarded that year, was released by TVNBR on April 9,2014. See Premio reconhece iniciativas inovadoras implantadas na AdministracaoFederal [Award recognizes innovative initiatives implemented in the Federal Ad-ministration], YOUTUBE (Apr. 9, 2014), https://www.youtube.com/watch?v=rbF_ynOxONM.

108. See ESCOLA NACIONAL DE ADMINISTRACAO PUBLICA, supra note 50, at 204.109. See id. at 195.110. See id. at 194–95, 203–04.

PUERTO RICO: AMERICA’S TAX HAVEN

OR VACATION PARADISE

Jason Sampas, C.P.A., Esq.*

I. INTRODUCTION

“IN this world nothing can be said to be certain, except death andtaxes.”1 Puerto Rico passed some aggressive tax legislation dur-ing 2012 to entice affluent investors to relocate. The Puerto Ri-

can government believes it will help boost their economy and the island’sgeneral welfare,2 and might enhance its reputation as a vacation paradise.Puerto Rico has passed these types of laws in the past. A few examplesof such legislation include: the Puerto Rico Industrial Incentives Act of1954, the Puerto Rico Industrial Incentives Act of 1963, and the PuertoRico Tax Incentives Act of 1987.3 Incentives included exempting incomefor up to ten years4 or excluding up to 90 percent of income from tax.5As these tax incentives expired, Puerto Rico needed to pass new legisla-tion to continue to attract wealthy investors and businesses.

Plans to reduce tax and maintain wealth are not new concepts and areoften powerful motivators to cause people to relocate.6 A tax haven is“[a] country, that imposes little or no tax on the profits from transactionscarried on there or on persons residence there.”7 While the avoidanceand reduction of tax is legal, tax evasion is illegal.8 This article will evalu-ate the financial decisions affecting an individual’s choice to relocate to apotential tax haven.

* LL.M. in Taxation candidate, University of San Diego School of Law, May 2015.He would like to express his gratitude to Jonathan Sampas, Nichole Sampas, ChrisSalcedo, and Jennifer Jackson for providing him with creative naming assistance.He would like to thank Professor James Cooper and Mr. Howard Schweitzer fortheir feedback, the LAW & BUSINESS REVIEW OF THE AMERICAS staff for theirassistance, his family for always being there, and Jennifer Jackson for her unwaver-ing encouragement, support, and assistance throughout this project.

1. The meaning and origin of the expression: Nothing is certain but death and taxes,PHRASE FINDER, http://phrases.org.uk/meanings/death-and-taxes.html (last visitedDec. 27, 2013).

2. 2012 P.R. LAWS no. 22, p. 2 available at http://www.lexjuris.com/lexlex/Leyes2012/lexl2012022.htm.

3. P.R. LAWS ANN. tit. 13, §§ 10001, 10012, 10040 (2013).4. Id. § 10001.5. P.R. LAWS ANN. tit. 13, § 10040 (2013).6. Katherine Burton et al., Puerto Rico’s no capital gains tax luring wealthy Ameri-

cans, BLOOMBERG NEWS (Mar. 11, 2013), available at http://business.financialpost.com/2013/03/11/puerto-ricos-no-capital-gains-tax-luring-wealthy-americans/.

7. BLACK’S LAW DICTIONARY, 1502 (8th ed. 2004).8. I.R.C. § 7201 (2014).

49


This article will discuss how the following three Puerto Rican incen-tives: (1) Act 20; (2) Act 22; and (3) Act 273, could affect three distinctgroups of individuals who are considering moving from the United Statesto Puerto Rico. After explaining the rules, the section will apply thoserules to our groups, and the article will demonstrate whether the rule/code is favorable to the individual group.

The United States and Puerto Rico both have vast and complex Inter-nal Revenue Codes (IRC). Therefore, this article is written within a vac-uum, ignoring certain items such as the following: deductions, expenses,credits, subpart F income, certain FDAP income, withholding issues, en-tity-formation issues, entity-relocation issues, entity-dissolution issues,fund-relocation tax issues, RICs, dividend received deduction, employ-ment taxes, and the alternative minimum tax under both codes. Section Isummarizes the three Puerto Rican legislative acts. Section II addressesthe geographical definitions of the United States and Puerto Rico and itsapplication to residency. Section III explains the similarities and differ-ences between the United States’ Internal Revenue Code (IRC) and Pu-erto Rico’s Internal Revenue Code (IRC) regarding the definitions ofinterest, dividends, and capital gains. Section IV discusses the matter inwhich both IRC’s treat income sourcing related to retirement income,interest, dividends, and capital gains. Section V, the final section, com-pares the tax rates of both locations related to corporations, partnerships,and individuals. This article concludes by highlighting the tax advantagesand disadvantages of the Puerto Rican incentives to each group, and thenmakes a recommendation for each group. The three groups are describedbelow. The groups use fictitious scenarios to highlight the potential taxtreatment that the Puerto Rican incentives offer based on his or her spe-cific situations.

A. JASON AND JEN—THE RETIRED COUPLE

Jason is a married, seventy-year-old retired, blue-collar worker. Heand his wife Jen, also retired, survive solely on their retirement incomethat includes social security benefits and some investments income, in-cluding interest, dividends, and capital gains. Jen constantly nags Jasonabout the outrageously high United States tax rates. The tax rates are sohigh that both of them might have to go back to work to make ends meet.They both yearn for the “sweet life” and want to spend their final years ina sandy-beached paradise. Unfortunately, they cannot afford southernCalifornia or Hawaii, and despise the elderly stereotypes of Florida.

B. JON AND NICHOLE—THE ATTORNEY AND HEDGE FUND MANGER

Jon is a married, world-renowned international law attorney whoteaches at a prominent law school. His brilliant wife Nichole is an afflu-ent investor who manages a hedge fund. The two are happily marriedwith two children. Nichole made millions during the dot-com bubble, andstarted her own company that now manages a hedge fund. With Jon’s

2015] PUERTO RICO 51

continued support, Nichole continued to manage her hedge fund, whichshe primarily does from home despite their substantial wealth. Jon’samazing success, combined with Nichole’s intuitive investment abilitiesmade them a fortune, which they tucked away in a multitude of diversi-fied investments. Thus, a substantial portion of their income is from in-terest, dividends, and capital gains. They both worry the United Statestax rates could jump back up to 80 or 90 percent in the near future. Theyboth crave reduced workloads and retirement to a sandy-beached para-dise to spend more time with each other and their wonderful children.

C. MIKEY—THE ENTREPRENEUR

Mikey is a genius, hardworking, single entrepreneur. He has workedone year and a day on his current and third startup. His previous compa-nies were amazingly successful. While his company is in the early devel-opment stages, he is confident it will be incredibly successful and sell for alarge sum of money. He believes he paid too much tax when he sold hisprevious companies, and does not want to pay the same high tax rateswhen he sells his current company. He suspects the already high UnitedStates tax rates will significantly increase in the near future because theUnited States is facing so many budget problems. In addition to hisUnited States concerns, the high California tax rates also concern him. Ifthe tax incentives are significant enough, he is willing to relocate his com-pany to a suitable alternative location.

II. SPECIFIC PUERTO RICAN LEGISLATIVEINCENTIVE ACTS

As mentioned above, Puerto Rico has a long history of passing tax andbusiness incentives to attract foreign investment.9 The new incentive actsacknowledge that while Puerto Rico is granting significant tax exemp-tions, the presence of these high net worth investors within the island willpositively support its economy.10 Puerto Rico recently passed numerousincentive laws to entice businesses and individuals to relocate. This arti-cle focuses on three more recent and aggressive pieces of legislation: Act20—The Export Services Incentives Act, Act 22—The Individual Inves-tor Act (both passed January 17, 2012),11 and Act 273—The InternationalFinancial Center Incentives Act (passed September 25, 2012).12

A. ACT 20—THE EXPORT SERVICES INCENTIVE ACT

Act 20 incentivizes businesses to relocate its operation to Puerto

9. See generally P.R. LAWS ANN. Tit. 13, §§ 10001, 10012, 10040 (2013).10. 2012 P.R. LAWS no. 22 p. 1, available at http://www.lexjuris.com/lexlex/Leyes2012/

lexl2012022.htm.11. Id.; 2012 P.R. LAWS no. 20 p. 1, available at http://www.lexjuris.com/lexlex/Leyes

2012/lexl2012022.htm.12. 2012 P.R. LAWS no. 273 p. 1, available at http://www.lexjuris.com/lexlex/Leyes2012/

lexl2012273.htm.


Rico.13 The act lists an abundance of approved business activities, butthe most notable activities are as follows: research and development; con-sulting services for any trade or business; professional services such aslegal, tax, and accounting; centralized management services; services per-formed by electronic data processing centers; shared service centers; callcenters; investment banking and other financial services; and anythingelse allowed by the Secretary.14 If an individual relocates their businessto Puerto Rico, their business could be exempt from the normal PuertoRican IRC tax rates and subject to a flat 4 percent tax, which could be-come a 3 percent tax if the business is considered “strategic.”15 The ex-emption applies for twenty years with a ten year renewal.16 Thebusiness’s personal and real property are completely exempt from PuertoRican state and municipal taxes for the first five years, and subject to a 90percent exemption thereafter.17 Additionally, company benefits or divi-dends distributed to the shareholders, members, or partners could be ex-empt from Puerto Rican tax.18 To receive this exemption, the companymust file the necessary application and sign a contract with the PuertoRican government.19 The benefits granted under the exemption remainvalid during the exemption period even if subsequent Puerto Rican lawsinvalidate the exemption.20

B. ACT 22—THE INDIVIDUAL INVESTORS INCENTIVES ACT

Act 22 incentivizes individuals to move to Puerto Rico.21 The incen-tives are only available to individuals who are not a bona fide PuertoRican resident within the last fifteen years,22 and meet the residency re-quirements discussed below.23 The Act exempts all passive income ob-tained from investments from Puerto Rican taxes.24 Investment incomeincludes interest, dividends, and capital gains.25 If the individual movesto Puerto Rico with built-in capital gains, those capitals gains are subjectto a 5 percent tax on the pre-move appreciation if the individual resides

13. 2012 P.R. LAWS no. 20 p. 1.14. Id. at 7–8; P.R. LAWS ANN. tit. 13, § 30041(a)(12) (2013)(defining “the Secretary”

as the Secretary of the Treasury of Puerto Rico).15. 2012 P.R. LAWS no. 20 p. 10, available at http://www.oslpr.org/download/en/2012/

A-0020-2012.pdf (explaining how export services rendered are considered“strategic”).

16. Id. at 16–17.17. Id. at 13.18. Id.19. See id. at 25; see generally DEPARTMENT OF ECONO. DEV. & COMM., TAX INCEN-

TIVES APPLICATION, available at http://www2.pr.gov/agencias/oeci/Documents/So-licitudes/Solicitudes/Application%20for%20Act%2020%20Fillable.pdf (lastrevised Jul. 17, 2013).

20. 2012 P.R. LAWS no. 20 p. 34.21. 2012 P.R. LAWS no. 22 p.1, available at http://www.lexjuris.com/lexlex/Leyes2012/

lexl2012022.htm.22. Id. at 2.23. Treas. Reg. § 1.937-1(e) (2013); P.R. LAWS ANN. tit. 13, § 30041(a)(30) (2013),24. 2012 P.R. LAWS no. 22. p. 1.25. Id. at 2–3.


in Puerto Rico for at least ten years.26 To obtain this incentive, the indi-vidual must notify the Puerto Rican Secretary of his or her intent to ob-tain residency, file the necessary application with the Puerto Ricangovernment, and sign a contract with the Puerto Rican government,which is then valid until December 31, 2035.27

C. ACT 273—THE INTERNATIONAL FINANCIAL

CENTER INCENTIVES ACT

Act 273 focuses on setting up and relocating international banks to Pu-erto Rico.28 An individual can either move or incorporate his or her cor-porate bank in Puerto Rico. The move allows the investor to obtainsignificant financial incentives by signing a contract with the Puerto Ricangovernment.29 The corporation must pay an initial $5,000 filing fee alongwith providing the necessary ownership information.30 If approved, theentity must pay a $250,000 license fee.31 There is also an annual $5,000renewal fee.32 After securing the license, the entity is exempt from taxunder Puerto Rico’s IRC and subject only to a flat 4 percent tax.33 Theentity is also exempt from paying Puerto Rican municipal taxes, real orpersonal property taxes, or tangible or intangible property taxes.34 Theexemption is valid for fifteen years.35 The entity can renew its exemptionfor another fifteen years by filing a renewal notice no more than sixmonths before the initial fifteen-year exemption expires.36 Within sixmonths of the thirty-year renewal’s expiration, the entity can apply foranother fifteen-year exemption, for a total of forty-five years.37 Duringthe last fifteen years, the Secretary has the option to either leave the en-tity’s tax rate at 4 percent or increase the entity’s tax rate up to 10 per-cent.38 If other Puerto Rican laws are inconsistent with this law, this lawshall prevail.39 But the entity must employ at least four Puerto Rico re-

26. Id. at 3.27. See id. at 1; see APPLICATION TO NOTIFY THE PUERTO RICO SECRETARY TO OB-

TAIN RESIDENCY, available at http://www2.pr.gov/agencias/oeci/Documents/Solici-tudes/Solicitudes/Notification%20of%20Residency%20under%20Act%2022-2012.pdf (last visited Apr. 13, 2015); see DEPARTMENT OF ECONO. DEV. & COMM., TAX

INCENTIVES APPLICATION TAX INCENTIVES APPLICATION: ACT TO PROMOTE THE

INTERNATIONAL FINANCIAL CENTER INCENTIVES ACT TRANSFER, http://www2.pr.gov/agencias/oeci/Documents/Solicitudes/Solicitudes/Application%20for%20Act%20273%20Incentives%2007_02_13.pdf (last revised Jul. 2, 2013).

28. 2012 P.R. LAWS no. 273 p. 1, available at http://www.lexjuris.com/lexlex/Leyes2012/lexl2012273.htm.

29. Id. at 12.30. Id. at 9.31. Id. at 6.32. Id. at 11.33. Id. at 8.34. P.R. LAWS. ANN. tit. 7 § 3101 (2013).35. Id. § 3807 (a)(8)(e).36. Id.37. Id.38. Id.39. Id. § 3103.


sidents as full-time employees.40 Fortunately, a valid Act 22 exemptioncan waive this requirement.41

Some have criticized these aggressive incentives as making Puerto Ricoa tax haven.42 While the United States has tax credits and incentives toencourage businesses and individuals to relocate and start business withinthe United States,43 Puerto Rico’s recent tax incentives are far more ag-gressive than any United States incentives.

III. GEOGRAPHICAL DEFINITION OF PUERTO RICO ANDTHE UNITED STATES APPLIED TO RESIDENCY

The United States IRC’s geographical definition of the United Statessignificantly affects income sourcing for Puerto Rico and the UnitedStates. Puerto Rico and the United States have their own independentIRCs, but the Puerto Rican IRC is modeled after the United States IRC,where both systems have exclusive authority to tax their own residents.44

Although, Puerto Rico and the United States have a tax coordinationagreement, as opposed to a treaty, to help define how the two systemscoexist.45

“The term ‘United States’ when used in a geographical sense includesonly the States and the District of Columbia.”46 “The term ‘State’ shallbe construed to include the District of Columbia, where such constructionis necessary to carry out provisions of this title,” and includes the fiftyrecognized states.47 The United States and State geographical definitionsexclude the United States possessions, which are Puerto Rico, Guam,American Somoa, and the Northern Mariana Islands (Possessions).48

Unless explicitly mentioned to the contrary, any reference to a Possessionshall include Puerto Rico.49 To add some additional confusion to the al-ready complex United States IRC, some United States IRC sections treatPuerto Rico as a foreign country,50 while others sections treat Puerto

40. Id. § 3092(a).41. 2012 P.R. LAWS no. 22, art 5 available at http://www.oslpr.org/2009-2012/leyes/pdf/

ley-22-17-Ene-2012.pdf.42. John Marino, Congressional chairman rejects Puerto Rico Exemption Proposal,

CARIBBEAN BUS. PR, (Sept. 19, 2013), http://www.caribbeanbusinesspr.com/prnt_ed/congressional-chairman-rejects-puerto-rico-exemption-proposal-8996.html.

43. See, e.g., I.R.C. § 179(b)(1) (2014).44. JOEL D. KUNTZ & ROBERT J. PERONI, KUNTZ & PERONI: U. S. INTERNATIONAL

TAX (WG&L) ¶ D 1.02 (2015), 2000 WL 530248, available at https://a.next.westlaw.com/Document/Ifb5416a1c01111da8725eac5fdcb2c2d/View/FullText.html?originationContext=documenttoc&transitionType=CategoryPageItem&contextData=(sc.Default).

45. See generally Tax Coordination Agreement Between the United States of Americaand the Commonwealth of Puerto Rico, US-PR, May 26, 1989, 1990-1 C.B. 199(IRS FIA), 1989 WL 253534.

46. I.R.C. § 7701(a)(9) (2014).47. Id. § 7701(a)(10).48. Id. §§ 7701(a)(9)–(a)(10),7701(d).49. Id. § 7701(d).50. Id. §§ 7701(a)(9), 872(b)(8).


Rico as part of the geographical United States,51 which complicates howPuerto Rican income and residents are classified. If Puerto Rico is notpart of the United States by definition, logically, it should be a foreigncountry, its residents’ foreign individuals, its corporations’ foreign corpo-rations, and income from Puerto Rico sourced to a foreign country.52

When determining if an individual is part the United States or a foreigncountry, the individual is classified as a United States citizen/person(United States resident), a resident alien, or a nonresident alien.53 AUnited States citizen is a person that applies for a “[U]nited States pass-port (or renewal thereof), or applies to be lawfully accorded the privi-leges of residing permanently in the United States as an immigrant inaccordance with the immigration law.”54 A United States person means“a citizen or resident of the United States, a domestic partnership, [and] adomestic corporation.”55 The United States IRC treats an alien individ-ual as a United States resident (which is referred to as a resident alien)for any year the alien individual is a lawful permanent resident within theUnited States for a calendar year, meets the substantial presence test (dis-cussed below), or makes the proper first year election in accordance withthe statute.56 “A nonresident alien individual is an individual who isneither a citizen of the United States nor a resident of the UnitedStates.”57 Some United States IRC sections define a nonresident alienindividual to include a United States citizen living in Puerto Rico,58 whileother sections do not.59 According to the Puerto Rican IRC, a nonresi-dent alien “[m]eans an individual who is not a United States citizen and isnot a resident of Puerto Rico.”60

If an individual is a United States citizen or resident alien, the UnitedStates will tax his or her worldwide income, regardless of location,61 sub-ject to some exceptions.62 The United States also taxes nonresident alienindividual income to the extent his or her income is from sources withinthe United States,63 subject to certain investment exemptions,64 or in-come “effectively connected” to a United States “trade or business.”65

While these provisions cast a large taxation blanket on United Statesbased income, the United States IRC exempts a United States citizen’s

51. Id. § 881(b)(3)(A).52. Rev. Rul. 56-616 (1956), 1956-2 C.B.589, 1956 WL 11256.53. I.R.C. §§ 7701(a)(30), 7701(b)(1)(A)–(B) (2014).54. Id. § 6039E(a).55. Id. §§ 7701(a)(30)(A)–(C).56. Id. §§ 7701(b)(1)(A)(i)–(iii).57. Id. § 7701(b)(1)(B).58. See Treas. Reg. § 1.861-2(a)(2) (2014).59. See I.R.C. § 7701(b)(1)(B).60. P.R. LAWS ANN. tit. 13 § 30041(a)(21) (2013).61. I.R.C. § 1 (2014); Treas. Reg. § 1.1-1 (2008); see, e.g., Specking v. Comm’r., 117

T.C. 95, 101-02 (2001), aff’d sub nom Haessly v. Comm’r., 68 F.App’x 44 (9th Cir.2003) and aff’d sub nom Umbach v. Comm’r., 357 F.3d 1108 (10th Cir. 2003).

62. I.R.C. § 911(a) (2014).63. Id. § 871(b)(1).64. Id. § 871(k)(1)(A).65. Id. § 872(a).


foreign earned income if the United States citizen earns the income whileresiding in the foreign country, up to a certain amount adjusted annuallyfor inflation.66

A United States citizen or resident alien is subject to United States taxon his or her worldwide income unless that income is Puerto Ricansourced.67 A United States citizen living in Puerto Rico is exempt fromUnited States tax and subject only to Puerto Rico tax on his or her PuertoRican based income.68 Additionally, an alien individual residing in a Pos-session is subject to United States taxation in the same manner as aUnited States alien resident.69

Although excluded from the United States and State geographical defi-nition, Puerto Rico is part of the United States, and its residents areUnited States citizens.70 While the United States enters into treaties tobridge relations with foreign countries, Puerto Rico and the United Statesentered into an implementation agreement and not a treaty.71 The imple-mentation agreement states the United States IRC, and not the PuertoRican IRC, establishes the requirements to become a Puerto Rican resi-dent.72 To become a Puerto Rican resident the United States IRC usesthree tests: (1) the presence test;73 (2) the tax home test;74 and (3) thecloser connection test.75 According to the United States IRC, a “[b]onafide Puerto Rican resident means a person who is present for at least 183days during the taxable year,” was present “for at least 549 days duringthe three-year period consisting of the taxable year and the two (2) im-mediately preceding taxable years,” provided that the individual was pre-sent in Puerto Rico for at least sixty days each year76 and does not have acloser tax home77 or a closer connection to the United States or a foreigncountry.78

An individual is present in the United States on any day in which he orshe is physically present in the United States.79 Multiple factors deter-mine a significant connection, like “a permanent home in the UnitedStates,” current United States voter registration, or a child in the United

66. Id. § 911(b)(2).67. Id. § 933(1).68. Id. § 933(2).69. Treas. Reg. § 1.876-1 (b) (2014).70. P.R. LAWS ANN. tit. 1, § 7 (2014).71. See RUFUS RHOADES & MARSHALL LANGER, RHOADES & LANGER, UNITED

STATES INTERNATIONAL TAXATION AND TAX TREATIES PUER § 8.07 (2014).72. I.R.C. § 937 (2014); RHOADES & LANGER, supra note 71.73. Treas. Reg. § 1.937-1(c)(1); see also, IRS, I.R.S. FORM 8898: STATEMENT FOR INDI-

VIDUALS WHO BEGIN OR END BONA FIDE RESIDENCE IN A UNITED STATES POS-

SESSION (2007), available at http://www.irs.gov/pub/irs-pdf/f8898.pdf (this formprovides a non-exhaustive, but comprehensive list of what is a closer connection)[hereinafter I.R.S. FORM 8898].

74. Treas. Reg. § 1.937-1(d)(1) (2014); see also, I.R.S. FORM 8898, supra note 73.75. Treas. Reg. § 1.937-1(e)(1) (2014); see also, I.R.S. FORM 8898, supra note 73.76. I.R.C. § 937(a); Treas. Reg. §1 .937-1(c).77. Treas. Reg. § 1.937-1(d) (2014).78. Id. § 1.937-1(e).79. I.R.C. § 7701(b)(7).


States who is not there as a student or based on a custodial decree.80 Thetax home test ensures that an individual does not have a tax home closerthan his or her tax home in Puerto Rico.81 Alternatively, the Puerto Ri-can IRC defines a resident individual as an individual domiciled in PuertoRico, and presumes he or she is a resident if they are present within Pu-erto Rico for 183 days82

An individual must file I.R.S. Form 8898 to demonstrate that he or shemet the above three tests.83 This form notifies the United States Secre-tary of Treasury of the individual’s intent to become a Puerto Rican resi-dent.84 Additionally, the individual must file a form with the PuertoRican Secretary85 stating his or her intent to become a Puerto Rican resi-dent.86 An individual does not become a Puerto Rican resident until heor she meets the three tests above for an entire year—only then can he orshe exclude Puerto Rican sourced income from United States tax.87

These rules ensure that a person actually resides in Puerto Rico anddoes not merely rent a mailbox or residence in Puerto Rico to make thataddress his or her residence for documentation purposes. For the pastfifty years, when the government challenges a residency claim the courtsexamine eleven factors to determine if there is substance to an individ-ual’s move.88 Those factors are as follows:

1. Intention of the taxpayer;2. Establishment of his home temporarily in the foreign country for

an indefinite period;3. Participation in the activities of his chosen community on social

and cultural levels, identification with the daily lives of the peo-ple and, in general, assimilation into the foreign environment;

4. Physical presence in the foreign country consistent with hisemployment;

5. Nature, extent and reasons for temporary absences from his tem-porary foreign country;

6. Assumption of economic burdens and payment of taxes to theforeign country;

7. Status of resident contrasted to that of transient or sojourner;8. Treatment accorded his income tax status by his employer;9. Marital status and residence of his family;

80. Treas. Reg. § 1.937-1(c)(5) (2014); see also, I.R.S. FORM 8898, supra note 73.81. Treas. Reg. § 1.937-1(d).82. P.R. LAWS ANN. tit. 13 § 30041(a)(30) (2011).83. I.R.C. § 937(c)(1); I.R.S. FORM 8898, supra note 73.84. Id.85. P.R. LAWS ANN. tit. 13 § 30041(a)(12) (2011) (the secretary “[m]eans the Secretary

of the Treasury of [Puerto Rico]”).86. See APPLICATION TO NOTIFY THE PUERTO RICO SECRETARY TO OBTAIN RESI-

DENCY, supra note 27.87. I.R.C. § 933(1) (2014); Treas. Reg. § 1.937-1(f) (2014).88. Vento v. Dir. Of V.I. Bureau of Internal Revenue, 715 F.3d 455, 466–67 (3rd Cir.

2013) (citing Sochurek v. Comm’r, 300 F.2d 34, 38 (7th Cir. 1962)); see also, I.R.S.FORM 8898, supra note 73 (listing many factors that the Secretary of Treasury willuse to evaluate if the move to the possession is valid).


10. Nature and duration of his employment; whether his assignmentabroad could be promptly accomplished within a definite orspecified time;

11. Good faith in making his trip abroad; whether for purpose or taxevasion.89

While no one factor is determinative, nor is a lack of any particularfactor an immediate failure, they are evaluated in four groups.90 The fourgroups are (1) intent (factors one, two, seven, ten, and eleven); (2) physi-cal presence (factors two, four, five, and seven); (3) a taxpayer’s social,family, and professional relationships (factors three and nine); and (4) thetaxpayer’s own representations (factors six and eight).91

To determine the location of a corporation or partnership under theUnited States IRC, the term “domestic” as applied to a “[c]orporation orpartnership means created or organized in the United States or under thelaw of the United States or of any State, unless in case of a partnership,the Secretary provides otherwise by regulations.”92 The United StatesIRC defines a “foreign corporation” or “partnership” as “a corporationor partnership which is not domestic.”93 A Puerto Rican domestic corpo-ration or partnership “[m]eans created or organized in Puerto Rico orunder the laws of Puerto Rico.”94 A foreign Puerto Rican corporation orpartnership “[m]eans a corporation or partnership which is notdomestic.”95

How do these residency tests affect our groups? These requirementsmean that each group of individuals must move themselves, their busi-nesses, and their families to Puerto Rico.

Jason and Jen should not encounter transitional problems. As a retiredblue-collar couple, they are unlikely to have significant business connec-tions that would hinder their move. Their assets likely consist of a homethat they would sell, a car that they could ship, personal belongings, andintangible assets like a bank or stock account. Retirement income andsocial security benefits should easily transfer too if they provide the nec-essary paperwork. To meet the presence test they can buy a new home inPuerto Rico which will become their new principal residence.96 They willmeet the tax home test because they will give up their tax home in theUnited States when they establish a Puerto Rican tax home.97 They canmeet the closer connection test by establishing a bank account to receivetheir retirement income, forming social and professional relationships inPuerto Rico, registering to vote in Puerto Rico, registering their car in

89. Vento, 715 F.3d at 466–67 (3rd Cir. 2013) (citing Sochurek, 300 F.2d at 38).90. Id.91. Id. at 467.92. I.R.C. § 7701(a)(4) (2014).93. Id. § 7701(a)(5).94. P.R. LAWS ANN. tit. 13 § 30041(a)(6) (2011).95. Id. § 30041(a)(7) (2011).96. Treas. Reg. § 1.937-1(c) (2014); see also, I.R.S. FORM 8898, supra note 73.97. Treas. Reg. § 1.937-1(d) (2014); see also, I.R.S. FORM 8898, supra note 73.


Puerto Rico, and obtaining a Puerto Rican driver’s license, among otherthings.98 Their biggest challenge is leaving their social and family rela-tionships. Additionally, Jason and Jen must file the necessary paperworkand sign a contract with the Puerto Rican government to take advantageof the Puerto Rican incentives.99

Jon and Nichole’s situation is more complex. Jon will have to quit histeaching job because flying back and forth from Puerto Rico to theUnited States means he might not meet the presence test and he will havea closer connection to the United States than Puerto Rico due to hiswork.100 Jon might be able to circumvent this requirement if he couldlecture via a podcast or video conference, but that is beyond the scope ofthis article. Nichole will have significant difficulty because she has anactive home business. She must either move the entire entity to PuertoRico or close this entity and start a new one in Puerto Rico to satisfy thecloser connection test.101 The couple will also have to file the necessarypaperwork depending on what exemptions they seek.

Mikey may have more issues than the entire group combined. Not onlymust he uproot his entire life, but he must also relocate his business. Totake advantage of Puerto Rico’s favorable tax incentives, he must seekapproval from the Puerto Rican government, sign a contract with them,and actually conduct business.102 If approved, he must transfer his busi-ness, find a suitable location, move all his assets, and hire employees. Themoving process might impose some barriers to entry because Mikeyneeds employees and machines, whereas Jon and Nichole require onlycomputers and communication connections.

While the United States and Puerto Rican systems share some similari-ties, they also have some differences. Puerto Rico and the United Stateshave their own exclusive tax systems and exclusive Treasury systems.103

Additionally, Puerto Rican courts can enforce the tax laws of otherStates,104 so long as the State would enforce the Puerto Rican IRC in itscourts.105 United States citizens who are Puerto Rican residents are notsubject to United States tax on his or her Puerto Rican sourced income

98. Id.99. 2012 P.R. LAWS no. 22 p. 1, available at http://www.oslpr.org/2009-2012/leyes/pdf/

ley-22-17-Ene-2012.pdf; see DEPARTMENT OF ECONO. DEV. & COMM., supra note27.

100. See Bergersen v. Secretary, 109 F.3d 56 (1st Cir. 1997) (holding that a dentist didnot meet the closer connection test to Puerto Rico, and his income was taxable bythe United States where the dentist continued to maintain his dental practice anddental supply distribution company in Illinois, stayed at his parent’s house when hewas back to service patients, continued to receive business mail for his practice andhis dental supply company in Illinois despite the fact that he moved his family toPuerto Rico and re-headquartered his dental supply business to Puerto Rico).

101. Treas. Reg. § 1.937-1(e) (2014); see also, I.R.S. FORM 8898, supra note 73.102. 2012 P.R. LAWS 20 p. 25, http://businessinpuertorico.com/documents/ACT-20-PG

.pdf; see DEPARTMENT OF ECONO. DEV. & COMM., supra note 27.103. I.R.C. § 2 (2014); P.R. LAWS ANN. tit. 13 § 30001 (2011).104. P.R. LAWS ANN. tit. 13 § 343 (“[s]tate—Means any state, territory or possession of

the United States of America”).105. Id. §§ 342, 341.


even though the United States taxes the worldwide income of their citi-zens.106 Furthermore, many United States tax incentives require only fil-ing a form with the tax return, rather than signing contract(s) with thegovernment.107 In Puerto Rico, a taxpayer’s tax return is considered apublic document available to inspection upon a validly approved re-quest.108 In the United States, tax returns are confidential.109

IV. UNITED STATES INTERNAL REVENUE CODE ANDPUERTO RICAN INTERNAL REVENUE CODE DEFINITIONS

AND APPLICABLE TAX RATES FOR INTEREST,DIVIDENDS, AND CAPITAL GAINS

A. INTEREST

Black’s Law Dictionary defines interest as “[t]he compensation fixedby agreement or allowed by law for the use or detention of money, or forthe loss of money by one who is entitled to its use.”110 The United StatesIRC does not explicitly define interest, but some sections define varioustypes of interest.111 Investment interest is any amount “paid or accruedon indebtedness properly allocable to property held for investment.”112

Puerto Rico offers definitional guidance by stating interest is “[a]ny inter-est on bonds, notes and other obligations issued by a domestic corpora-tion or partnership, or by a foreign corporation of partnership.”113

Puerto Rico and the United States tax interest from income differently.Interest in the United States could be subject to the top United Statesindividual ordinary income tax rate of 39.6 percent.114 Puerto Rico couldtax interest income at the top Puerto Rican individual ordinary incometax rate, which depending on the year, ranges from 30 to 33 percent.115

However, a Puerto Rican resident’s interest income could be eligible fora special preferred tax rate of 10 percent, if the interest meets certainstatutory requirements and the taxpayer makes the election.116 PuertoRico’s Act 22 exemption eliminates the taxpayer’s liability for interest

106. I.R.C. § 933(1) (2014).107. 2012 P.R. LAWS 20 p. 25 http://businessinpuertorico.com/documents/ACT-20-PG

.pdf.108. P.R. LAWS ANN. tit. 13 § 33213.109. I.R.C. § 6103(a) (2014).110. BLACK’S LAW DICTIONARY, 886 (9th ed. 2009).111. RHOADES & LANGER, UNITED STATES INT’L TAX’N & TAX TREATIES § 25.02

(2014), available at https://advance.lexis.com/GoToFullDocumentFromHistory?vrequestid=f136363-25e8-c93e-e762-7075e02699f5,e5fd3b2e-e1ca-df-de50-f700deb07903,f377f25e-e85f-20db-ab64-3f3f3b9fafa,d3111e2e-4a75-990-eb63-911c27858cd8,f6fd9fb8-4cd6-33fb-99a1-39b74368461a&crid=3f4c43b9-f413-30b7-cad9-5705e4ea60d3.

112. I.R.C. § 163(d)(3)(A) (2014).113. P.R. LAWS ANN. tit. 13 § 30085 (b)(1) (2011).114. I.R.C. § 1(a) (2014).115. P.R. LAWS ANN. tit. 13 § 30061 (2011).116. Id. §§ 30111(a)(4), 30085(b), 30084(1).


income,117 subject to sourcing issues discussed below. The United Stateshas no such exemption, unless the interest is from municipal bonds.118

B. DIVIDENDS

Both the United States and Puerto Rico IRC define a dividend verysimilarly, as

“[a]ny distribution of property made by a corporation to its share-holders [whether it is money or property] out of its earning and prof-its accumulated after February 28, 1913, or out of its earnings andprofits of the taxable year . . . without regard to the amount of theearnings and profits at the time the distribution was made.”119

For length and simplicity purposes, this article disregards specially taxedqualified dividends and preferred stock dividends.120 This means PuertoRico and the United States will tax dividends as ordinary income.121

Therefore, they could be subject to tax at the top United States individualordinary income tax rate of 39.6 percent.122 Puerto Rico could tax divi-dends at the top Puerto Rico individual ordinary income tax rate, which,depending on the year, could range from 30 to 33 percent.123 Although, aPuerto Rican resident’s dividend income could be eligible for a specialpreferred tax rate of 10 percent if the dividends meet certain statutoryrequirements and the taxpayer makes the election.124 Thus, if a signifi-cant portion of any of our group’s income is from dividends, PuertoRico’s Act 22 exemption eliminates the Puerto Rican resident’s tax liabil-ity,125 subject to sourcing issues discussed below. The United States hasno such exemption for dividends.

C. CAPITAL GAINS

The United States and Puerto Rican IRC define a capital asset in thenegative, which means that they define what a capital asset is not.126

Therefore, anything not specifically enumerated is a capital asset.127 InPuerto Rico, a capital asset is not inventory, depreciable property used ina trade or business, accounts receivable, energy credits, literary rights,musical rights, artistic rights, or any similarly created rights by the tax-payer.128 The United States definition is similar but leaves out the energy

117. 2012 P.R. LAWS no. 22 p. 3, available at http://www.oslpr.org/2009-2012/leyes/pdf/ley-22-17-Ene-2012.pdf.

118. I.R.C. § 103(a) (2014).119. Id. § 316(a) (2014); P.R. LAWS ANN. tit. 13 § 30149(a) (2011).120. Id. §§ 245, 244, 243, 1(h)(11) (2014).121. Id. § 1(a) (2014); P.R. LAWS ANN. tit. 13 § 30061(2011).122. Id. § 1(a) (2104).123. P.R. LAWS ANN. tit. 13 § 30061 (2011).124. Id. § 30111(a)(6); P.R. LAWS ANN. tit. 13 § 30086 (2011).125. 2012 P.R. LAWS No. 22 p. 3, available at http://www.oslpr.org/2009-2012/leyes/pdf/

ley-22-17-Ene-2012.pdf.126. I.R.C. § 1221(a) (2014); P.R. LAWS ANN. tit. 13 § 30141(a)(1) (2011).127. Id. § 1221(a); P.R. LAWS ANN. tit. 13 § 30141(a)(1).128. P.R. LAWS ANN. tit. 13 § 30141(a)(1).


credits and adds “any commodities derivative financial instrument heldby a commodities dealer,” any hedging transaction that is clearly identifi-able as a hedging transaction, and supplies “regularly used or consumedby the taxpayer in the ordinary course of a trade or business.”129 TheUnited States additions could affect stock traders. Stock traders are atarget group Puerto Rico hopes to attract and probably the reason why itwas not included.

The codes differ in how they define a long-term and short-term capitalasset. In Puerto Rico, a capital asset sale is long-term if the taxpayer heldthe asset for more than six months, and short-term if held less than sixmonths.130 In the United States, a capital asset sale is long-term if thetaxpayer held the asset for more than one year, and short-term if held forone year or less.131 The long-term and short-term differences matter be-cause both codes tax long-term assets at a lower rate.132

Puerto Rico taxes net long-term capital gains at a flat 10 percent.133 Ataxpayer who moves to Puerto Rico with pre-move capital asset apprecia-tion is subject to a 10 percent tax on the pre-move appreciation.134 If theindividual is a Puerto Rican resident for more than ten years, this lowersthe tax rate to 5 percent and excludes that pre-move gain from UnitedStates tax entirely.135 Act 22 exempts an individual’s passive investmentincome, which means long-term and short-term capital gains are exemptfrom Puerto Rican income tax.136 The exemption only applies to assetsacquired after establishing his or her Puerto Rican residency.137 This is asignificant advantage over the United States IRC because stock traders,whose business activities are typically all capital transactions, could ex-empt all of his or her income from tax. Furthermore, a Puerto Ricantaxpayer may elect to treat his or her long-term capital gains as ordinaryincome and pay taxes according to his or her ordinary income tax rate.138

The taxpayer makes this decision after determining whatever scenario ismore beneficial.139 A taxpayer is likely to make this election only if he orshe is in the lower tax brackets. The United States automatically exemptsa taxpayer’s long-term capital gains if the taxpayer is in the lowest two taxbrackets.140

The United States taxes long-term capital gains on a progressivescale.141 United States long-term capital gains do receive a lower tax

129. I.R.C. § 1221(a).130. P.R. LAWS ANN. tit. 13 § 30141(a)(2)–(9).131. I.R.C. § 1222(a)(1)–(4).132. I.R.C. § 1(h) (2014); P.R. LAWS ANN. tit. 13 §§ 30111(a)(2), 30082(a) (2011).133. P.R. LAWS ANN. tit. 13 § 30082(a).134. 2012 P.R. LAWS no. 22 p. 3, available at http://www.oslpr.org/2009-2012/leyes/pdf/

ley-22-17-Ene-2012.pdf.135. Id.136. 2012 P.R. LAWS no.22 p. 3–4.137. Id. at 3.138. P.R. LAWS ANN. tit. 13 §§ 30111(a)(2), 30082(a).139. Id.140. I.R.C. § 1(h) (2014).141. Id. § 1.


rate, but it depends upon the taxpayer’s ordinary income tax bracket.142

The long-term capital gain tax rate can range from 0 percent in the lowesttwo tax brackets, to 20 percent if you are in the highest tax bracket.143

Moreover, the Affordable Care Act added an additional 3.8 percent taxto long-term capital gains in the highest bracket,144 raising the top long-term capital gain rate to 23.8 percent.145 Of course, the United States taxrates mentioned include solely federal tax, and do not include state taxes.By adding state taxes, which could be up to 13.3 percent,146 an individ-ual’s long-term capital gain could be subject to tax at over 30 percent.When compared to Puerto Rico’s 10 percent tax147 or Puerto Rico’s Act22 complete exemption,148 an individual choosing to remain in the UnitedStates could pay between 20 to 40 percent more, despite the favorablylower tax treatment.

While this article compares the Puerto Rican and United States IRCs,it should be noted that a United States resident and his or her companycould also be subject to state taxes in addition to federal taxes, subject tosourcing issues discussed below. A Puerto Rican resident and his or hercompany are only subject to Puerto Rico tax subject to sourcing issuesdiscussed below. Thus, the move could save the individual or companythe applicable state tax on that income.

V. INCOME SOURCING

Puerto Rico’s incentives only apply to income subject to taxation underPuerto Rico’s IRC because income not subject to Puerto Rico tax doesnot need Puerto Rico incentives, which is why sourcing is very important.The sourcing treatment can differ depending upon the type of income,the business’s location(s), the owners’ location(s), where he or she is con-ducting business, and the type of business, among many other factors.149

This article addresses only four income types: (1) retirement; (2) interest;(3) dividends; and (4) capital gains. Each scenario assumes that the indi-viduals, the business, and its owners, are located solely within PuertoRico or solely within the United States. Each group of individuals is stillconsidered United States citizens subject to United States tax on theirworldwide income.150 Fortunately, any United States citizen, who be-comes a Puerto Rican resident and earns income within or has incomesourced to Puerto Rico, is exempt from United States tax.151 Therefore,this article will not analyze the United States taxation of a United States

142. Id. § 1(h).143. Id.144. Id.145. I.R.C. §§ 1411, 1(h) (2014).146. CAL. REV. & TAX. CODE § 17041 (West 2013).147. P.R. LAWS ANN. tit. 13 §§ 30111(a)(2), 30082(a) (2011).148. 2012 P.R. LAWS no. 22 p. 3, available at http://www.oslpr.org/2009-2012/leyes/pdf/

ley-22-17-Ene-2012.pdf.149. I.R.C. §§ 861-865, 871-872, 881-882.150. Id. § 1; Treas. Reg. § 1.1-1 (2008).151. I.R.C. § 933(1).


citizen’s worldwide income where the United States citizen is now a Pu-erto Rican resident and his or her income was earned within, or sourcedto Puerto Rico. As stated earlier, certain sections explicitly treat UnitedStates citizens who are now Puerto Rican residents as nonresident alienindividuals,152 or as United States citizens.153

A. SOURCING GENERALLY

Rules similar to the rules for determining whether income is incomefrom sources within the United States or is effectively connected with theconduct of a trade or business within the United States shall apply forpurposes of determining whether income is from sources within a posses-sion. As such, any income treated as income from sources within theUnited States or as effectively connected with the conduct of a trade orbusiness within the United States shall not be treated as income fromsources within any such possession or as effectively connected with theconduct of a trade or business within any such possession.154

Puerto Rico and the United States use the United States IRC to deter-mine whether income is sourced within or outside the country, andwhether that income is effectively connected to a trade or business withinthat country.155 Recently, Puerto Rico passed its own rules regarding in-come sourcing,156 which could complicate sourcing issues. Fortunately,the Puerto Rican IRC is very similar to the United States IRC.

United States sourced personal or corporate income from a trade orbusiness is trade or business income effectively connected to a UnitedStates trade or business and subject to United States tax.157 A foreignentity’s or foreign individual’s income is subject to United States tax, andis sourced within the United States if it is effectively connected to aUnited States trade or business.158 A “‘trade or business within theUnited States includes the performance of personal services within theUnited States at any time within the taxable year.”159

Aside from performing personal services within the United States,160

an effectively connected trade or business is negatively defined in theUnited States IRC, which states two exceptions that are not a trade or

152. Treas. Reg. § 1.861-2(a)(2) (2014).153. I.R.C. § 7701(b)(1)(B).154. Id. § 937(b).155. Id.156. P.R. LAWS ANN. tit. 13 § 30114 (2011).157. I.R.C. §§ 882(b), 872(a), 861(b).158. Id. §§ 937(b), 882(a)(1), 871(b)(2).159. Id. § 864(b).160. See id. § 864(b)(1) (trade or business within the United States does not include,

“the performance of personal services for a nonresident alien individual, foreigncorporation, foreign partnership not engaged in a trade or business within the[United States] or for an office or place of business maintained in a foreign countryor in a possession of the [United States] by an individual who is a citizen or resi-dent of the [United States] . . . ” if they do not exceed ninety days and the compen-sation is less than $3,000).


business.161 These two exceptions not considered a trade or businesswithin the United States are (1) “performance of personal services for anonresident alien individual, foreign partnership, or foreign corporation,not engaged in trade or business within the United States, or for an officeor place of business maintained in a foreign country, or “ . . . possessionby a [United States] citizen, resident [alien], . . . a domestic corporation,or a domestic partnership”; or (2) trading securities on a taxpayer’s ownaccount so long as the taxpayer does not have an office or fixed place ofbusiness that conducts those transactions.162 While the United Statestaxes its citizen’s worldwide income,163 the United States only taxes non-resident aliens to the extent his or her income is sourced within theUnited States or is effectively connected to a United States trade or busi-ness.164 Puerto Rico similarly taxes nonresident alien individuals or cor-porations not engaged in a Puerto Rican trade or business to the extentthe income is sourced within Puerto Rico.165 But during the year of themove from the United States to Puerto Rico, “[a]mounts received fromsources outside Puerto Rico attributable to the period of residenceoutside of Puerto Rico” are exempt from Puerto Rico tax.166

When determining if the income is sourced to the United States or tothe foreign country, “the name of the particular foreign country shall beused instead of the term United States, and the term domestic shall beconstrued to mean created or organized in such foreign country.”167

“[T]he term ‘foreign person’ means any other person other than a UnitedStates person, or a person who would be a United States person if refer-ences to the United States in section 7701 included references to a posses-sion of the United States.”168 The rules for determining income sourcingand if a trade or business is effectively connected to the United Statesfrom foreign countries shall apply to possessions, unless otherwisestated.169

A foreign corporation or nonresident alien individual is engaged in atrade or business within the United States and has effectively connectedincome associated with that trade or business when (1) he or she gener-ates a gain or loss from selling capital assets sourced within the UnitedStates and connected to his or her trade or business within the UnitedStates; (2) all gains or losses are from sources within the United States;(3) the income is sourced outside the United States and is effectively con-nected to the United States, if that income is attributable to an office orfixed place of business within the United States; (4) the office or fixedplace of business within the United States receives interest or dividend

161. Id.162. Id.163. Id.§ 1; Treas. Reg. § 1.1-1 (2008).164. I.R.C. §§ 871(b)(1) (2014).165. P.R. LAWS ANN. tit. 13 §§ 30441, 30432, 30431 (2011).166. Id. § 30102(a)(34)(A)(ii) (2011).167. Treas Reg. § 1.863-6 (2014).168. I.R.C. § 881(b)(3)(A).169. I.R.C. § 893(b).


income from banking or similar businesses within the United States; (5)the income is “received by a corporation the principal business of whichis trading in stocks or securities for its own account”; or (6) the income isattributable to selling capital assets through an office or fixed place ofbusiness within the United States.170 Income from sources outside theUnited States is not effectively connected if it “consists of dividends, in-terest, . . . paid by a foreign corporation in which the taxpayer owns” . . .or is considered to own “more than 50 percent of the total combinedvoting power of all classes of stock entitled to vote.”171 If a Puerto Ricanresident trades securities within the United States, he or she is not effec-tively connected to a United States trade or business so long as the Pu-erto Rican resident does not have an office or fixed place of businesswithin the United States that executes the transactions.172

The broad United States source rules ensure some of our individuals’income is sourced within the United States. Jason and Jen will have verylittle trouble with sourcing issues because they do not operate a businessand do not work. Their income consists of pension payments, social se-curity, and possibly some investments. Even these limited incomesources pose some problems, which are discussed below.

Jon, Nichole, and Mikey will have significant issues because they oper-ate businesses and provide personal services within the United States.Jon can not regularly fly back and forth to teach or service clients becausehe would then fail the closer connection test173 and source that incomewithin the United States to an effectively connected United States tradeor business.174 Nichole and Mikey both operate businesses and performpersonal services for businesses that will source the income to the UnitedStates, effectively connecting that income to a United States trade or bus-iness.175 At a minimum, the salaries that Nichole and Mikey receive fromtheir companies are sourced within the United States because their enti-ties are within the United States and they perform personal services forthose companies within the United States.176

To avoid sourcing issues when Nichole and Mikey move to PuertoRico, they should move their entire business to Puerto Rico, thereforeensuring there is no office or fixed place of business within the UnitedStates.177 Removing the office or fixed place of business from the UnitedStates ensures that the business’s income is sourced within Puerto Ricoand is not effectively connected with a United States trade or business.Nichole will not have excessive sourcing issues because she primarily

170. Id. § 864(c) (2014).171. Id. § 864(c)(4)(D); see also, I.R.C. § 952 (2014) (which describes subpart F income

as it relates to controlled foreign corporations).172. Id. § 864(b)(2)(C).173. Treas. Reg. § 1.937-1(c)(5) (2014).174. I.R.C. §§ 864(b)(1), 861(a)(3).175. Id.176. Id.177. Id. § 864(b)(1); Treas. Reg. § 1.864-4(b)(5)(iii) (2013).


trades stocks. The sourcing rules carve out an applicable stock exception,provided Nichole does not have an office or fixed place of business withinthe United States.178

B. RETIREMENT INCOME

An individual’s retirement income is sourced to his or her state of dom-icile.179 Puerto Rico is a state for purposes of retirement income sourc-ing.180 A United States citizen who is now a Puerto Rican residentshould exclude his or her retirement income when he or she calculates hisor her gross income from other United States sourced income or UnitedStates effectively connected income.181 The major difference betweenPuerto Rico and the United States is that a Puerto Rican resident is sub-ject only to Puerto Rican tax on his or her retirement income, whereas aUnited States resident is subject to United States tax and state tax on thesame income.182 Additionally, Puerto Rico exempts the first $15,000 of aresident’s pension from tax if the individual is sixty years or older,183

while the United States does not.Unfortunately, social security income is sourced within the United

States no matter where the individual resides.184 A nonresident alien in-dividual receiving social security benefits of any type has income not ef-fectively connected with a United States trade or business, but sourcedwithin the United States.185 The United States taxes only 85 percent ofan individual’s social security benefits.186

Hopefully, all of our individuals will receive retirement income some-day. Currently, retirement income is only an issue for Jason and Jen. Ja-son and Jen’s pensions are sourced to their state of domicile, which couldinclude Puerto Rico.187 Even though they are not effectively connectedto a United States trade or business, 85 percent of their social securitybenefits are considered as income sourced within the United States andsubject to United States tax.188 Jason and Jen will also enjoy PuertoRico’s $15,000 exemption of their retirement income.189 Their remainingretirement income is still subject to Puerto Rican tax, which reaches a top

178. I.R.C. § 864(b).179. 4 U.S.C. § 114(a) (2014).180. Id. § 114(b)(3).181. I.R.C. § 871(f)(1); see also, 4 U.S.C. § 114(a) (“[n]o State may impose an income

tax on any retirement income of an individual who is not a resident or domiciliaryof such State (as determined under the laws of such State)”); see also, I.R.C. § 933(2014) (Puerto Rico sourced income is exempt from United States IRC taxation ifthe individual is a bona fide resident of Puerto Rico).

182. I.R.C. § 933(1).183. P.R. LAWS ANN. tit. 13 § 30102(a)(13) (2011).184. I.R.C. § 861(a)(8) (2014).185. Id. § 871(a)(3).186. Id. § 871(a)(3)(A).187. 4 U.S.C. § 114(b)(3) (2014).188. I.R.C. § 871(a)(3)(A).189. P.R. LAWS ANN. tit. 13 § 30102(a)(13).


rate of 33 percent after $50,000.190 If they received $100,000 of retire-ment income and stay in the United States, then they will pay $16,233 inUnited States taxes, versus paying $20,740 if they moved to Puerto Rico,which could change based on the amount of social security income re-ceived. The calculation changes substantially if they received $75,000. Inthat case, they would pay $10,358 in United States taxes and $17,440 inPuerto Rican taxes.

C. INTEREST

Interest income is sourced to the payor, regardless of how and wherethe interest was paid.191 Interest not sourced within the United States issourced outside the United States.192 Thus, a nonresident alien individualliving in Puerto Rico receiving interest income from a United Statessource has gross income sourced within the United States subject toUnited States tax.193 A nonresident alien individual’s taxable UnitedStates gross income does not include “interest on deposits with a foreignbranch of a domestic corporation or a domestic partnership if suchbranch is engaged in the commercial banking business”194 or interest onbusiness deposits not effectively connected with a trade or businesswithin the United States.195 Additionally, United States sourced portfo-lio interest income received by a Puerto Rican corporation or Puerto Ri-can resident is not subject to United States tax.196

“[P]ortfolio interest means any interest (including original issue dis-count) which would be subject to tax under subsection (a) but for thissubsection, and is paid on an obligation which is in registered form, andwith respect to which” a United States person is otherwise required towithhold under IRC section 1441(a) and the United States person “re-ceives a statement . . . that the beneficial owner of the obligation is not aUnited States person.”197 Portfolio interest does not include interestfrom United States obligations, interest received by a bank on a loan orextension of credit made in the ordinary course of business, interest re-ceived from a 10 percent shareholder of the company making the loan, orinterest received from a related party’s controlled foreign corporation.198

A corporation is not a controlled foreign corporation if a United Statescitizen who is now a Puerto Rican resident owns 50 percent or more ofthe foreign corporation because a Puerto Rican resident is not a UnitedStates person for this section.199

190. Id. § 30061.191. I.R.C. § 861(a)(1) (2014).192. Id. § 862(a)(1).193. I.R.C. § 861(a)(1).194. Id.195. Id. § 871(i)(2)(A) (2014).196. Id. §§ 881(c)(1), 871(h)(1) (2014).197. Id. § 871(h)(2).198. Id. §§ 871(h)(2), 881(c)(3); see also id. § 864(d)(4) (defining related controlled for-

eign corporation); see also id. § 318 (defining corporate attribution rules).199. Id. § 957(c) (2014).


A nonresident alien individual or corporation has interest incomesourced within Puerto Rico and effectively connected to Puerto Rico ifthe interest is from “bonds, notes, or other interest-bearing obligations ofresident persons, whether natural or juridical.”200 Interest is outside ofPuerto Rico if (1) paid by foreign corporations, partnerships, domesticcorporations, or partnerships engaged in business in Puerto Rico, exceptfor a banking business, where less than 20 percent of the entity’s grossincome for the three years ending when the interest was paid was fromsources within Puerto Rico; (2) it is interest from deposits from PuertoRican banks; (3) it is interest on mortgage payments secured by PuertoRican land; and (4) it is interest on bonds, notes, or other obligations thatderive or accumulate interest received by individuals that are citizens ofthe United States and are not residents of Puerto Rico.201 Interest in-come is from without Puerto Rico if it is interest other than that derivedfrom sources within Puerto Rico as provided directly above.202

While endless scenarios could exist relating to the receipt of interestincome, Jason, Jen, Jon, Nichole, Mikey, and their respective corporationsare likely to encounter the same three scenarios described below. Thefirst scenario occurs when someone has a bank account with a UnitedStates domestic bank that pays him or her interest. The interest payor isthe United States bank, and the Puerto Rico recipient is treated as a non-resident alien individual or foreign corporation because he or she is aPuerto Rican resident.203 This means the interest is from sources withinthe United States.204 Although the interest received by the nonresidentalien individual or foreign corporation is sourced within the UnitedStates, it is not effectively connected to a United States trade or business.Thus, it is exempt from United States tax.205

The second scenario occurs when a nonresident alien individual or for-eign corporation has some type of United States government-issued se-curity or bond, state-issued security or bond, or municipal bond. Thepayor is the United States government, which sources the income withinthe United States.206 If the United States sourced income is not effec-tively connected to a United States trade or business, then it is exemptfrom United States tax.207 Although, a banking corporation createdunder Puerto Rican laws operating as a bank in Puerto Rico that holdsUnited States government obligations has income effectively connectedwith a United States trade or business, whether or not the Puerto Ricanbank was operating within the United States.208

200. P.R. LAWS ANN. tit. 13 § 30151(a)(1) (2011).201. Id.202. P.R. LAWS ANN. tit. 13 § 30151(a)(1).203. I.R.C. § 1441(e).204. Id. § 861(a)(1).205. Id. §§ 881(d), 871(i)(2)(A).206. Id. § 861(a)(1).207. Id. §§ 881(d), 871(i)(2).208. Id. § 882(e).


The third scenario occurs when the nonresident alien individual or for-eign corporation invested its money in the stock market or a mutual fundand the resulting interest income meets the portfolio income require-ments.209 The interest income is sourced outside the United States, is noteffectively connected to a United States trade or business, and is exemptfrom United States tax.210

While Puerto Rican residents are exempt from United States tax on theinterest income,211 they are still subject to Puerto Rican tax on their in-terest income up to 25 percent.212 Fortunately, Act 22 exempts their in-terest income from Puerto Rican tax.213 If our group’s individuals remainin the geographical United States, their interest income is considered or-dinary income subject to the top United States tax rate of 39.6 percent,214

which does not include state taxes.If our individuals keep their corporations in the United States, the cor-

porations’ interest income is subject to corporate tax between 15 and 39percent.215 By moving the corporations to Puerto Rico and obtaining anAct 20 or Act 273 exemption, the corporations are subject to Puerto Ri-can corporate tax at 4 percent,216 as opposed to the normal Puerto Ricancorporate tax rates that could be up to 25 percent.217 If the Puerto Ricancorporations have interest income from a trade or business effectivelyconnected to the United States, then they are subject to a United Statestax of 30 percent.218

D. DIVIDENDS

The sourcing treatment for dividends differs from the interest treat-ment. The source of a dividend is the location of the corporation’s in-come responsible for paying the dividend.219 A nonresident alienindividual residing in Puerto Rico, or foreign corporation organizedunder Puerto Rican laws, has income sourced within the United States ifhe or she receives a dividend from a United States domestic corpora-tion.220 A United States domestic corporation distributing a dividend toa corporation organized under Puerto Rican laws is subject to a 10 per-cent tax, rather than 30 percent if the corporation satisfies certain statu-tory requirements.221 To qualify for the lower dividend tax rate, the

209. Id. § 881(c)(2) (stating the portfolio requirements).210. Id. §§ 881(c), 871(h)(2).211. Id.212. P.R. LAWS ANN. tit. 13 §§ 30072, 30071(b) (2011).213. 2012 P.R. LAWS no. 22 p. 3 – 4, available at http://www.oslpr.org/2009-2012/leyes/

pdf/ley-22-17-Ene-2012.pdf.214. I.R.C. § 1 (2014).215. Id. § 55(a) (2014).216. 2012 P.R. LAWS no. 20 p. 10; 2012 P.R. LAWS No. 273 p. 10, available at http://www

.lexjuris.com/lexlex/Leyes2012/lexl2012273.htm.217. P.R. LAWS ANN. tit. 13 §§ 30072, 30071(b).218. I.R.C. § 881(a).219. Id. § 861(a)(2).220. Id. §§ 881(a)(1), 871(a)(1), 861(a)(2).221. Id. § 881(b)(1).


Puerto Rican corporation must have the following elements: (1) a UnitedStates citizen or Possession resident owns at least 75 percent of the corpo-ration’s stock; (2) at least 65 percent of the company’s gross income forthe last three years ending on the close of the taxable year is from a Pos-session resident or the United States; and (3) “no substantial part of theincome of such corporation is used . . . to satisfy obligations to personswho are not bona fide residents of such a possession or the UnitedStates.”222 Nevertheless, the dividend is exempt from United States tax ifthe foreign corporation’s gross income from all sources for the three yearperiod, or the corporation’s existence if less than three years—ending onthe close of the taxable year preceding the dividend’s declaration—wasmore than 75 percent effectively connected to sources within the UnitedStates.223 Dividends received by a nonresident individual not engaged ina United States trade or business are exempt from United States tax.224

Puerto Rico defines a domestic corporation as any corporation “cre-ated or organized in Puerto Rico under the laws of Puerto Rico.”225 Adividend is from sources within Puerto Rico and effectively connected toPuerto Rico if the dividend is from a domestic corporation or partnershipthat derives more than 20 percent of its gross income from sources withinPuerto Rico for the previous three years, ending on the close of the taxa-ble year when the dividend was paid.226 “[D]ividends and benefits notderived from sources within Puerto Rico as provided” directly above arefrom outside Puerto Rico.227

Our individuals are likely to receive dividends from United States do-mestic corporations. Jason and Jen do not operate a business. Their divi-dends are unrelated to an effectively connected United States trade orbusiness, so they are exempt from United States tax.228 Any dividendsthey receive are from sources within the United States, but exempt fromUnited States tax.229 If they remain in the United States, then those divi-dends are taxed as ordinary income up to 39.6 percent,230 plus applicablestate tax. If they move to Puerto Rico and obtain an Act 22 exemption,then those dividends are exempt from Puerto Rican tax.231 If Jason andJen did not have the Act 22 exemption, then they would be subject toPuerto Rican tax up to 25 percent.232

Jon, Nichole, and Mikey might have dividends from a United Statessourced trade or business. If so, as Puerto Rican residents, then they will

222. Id. §881(a)(1)–(b)(1).223. Id. §§ 871(i)(2)(D), 861(a)(2).224. Id. §§ 871(b)(2), 871(i)(2).225. P.R. LAWS ANN. tit. 13 § 30041(a)(6) (2011).226. Id. § 30151(a)(2).227. Id. § 30152(a)(2).228. I.R.C. §§ 871(b)(2), (i)(2) (2014).229. Id. § 871(i)(2).230. Id. § 1.231. 2012 P.R. LAWS no. 22 p. 3, available at http://www.oslpr.org/2009-2012/leyes/pdf/

ley-22-17-Ene-2012.pdf.232. P.R. LAWS ANN. tit. 13 §§ 30072, 30071(b).


have income from sources within the United States effectively connectedto a United States trade or business subject to United States tax at 30percent.233 If their Puerto Rican based corporations receive a dividendfrom a United States domestic corporation, then the corporations aresubject to a United States tax of 10 percent, instead of 30 percent.234 Iftheir corporations remain in the United States and receive a dividendfrom another United States domestic corporation, then that dividend istaxed at the standard United States corporate tax rates that range be-tween 15 and 39 percent.235 If the entity moved to Puerto Rico and didnot have the exemption, the entity could pay tax up to 25 percent.236 Ifthe corporation receives an Act 20 exemption, the corporation is subjectto a 4 percent on their dividend income.237 Additionally, a valid Act 20exemption will exempt the corporate shareholder from paying tax whenthe corporation distributes the income to them as a dividend.238 The Act20 exemption from Puerto Rican tax on corporate dividends is exclusiveof an Act 22 exemption. This is very useful because the Act 20 exemptioncould last for thirty years,239 and the Act 22 exemption expires on De-cember 31, 2035.240 An Act 273 exemption allows a corporation to pay a4 percent tax on any dividend income.241 Furthermore, any dividendspaid from the corporation to the owners are taxed at 6 percent during theexemption period, which could last up to forty-five years.242 The Act 273exemption could also outlast the Act 22 exemption for individuals,243

which would provide significant benefits to the corporation’s ownerswhen they receive dividend distributions from the corporation.

E. CAPITAL ASSETS

When determining the source of a capital asset sale by a United Statescitizen who is a Puerto Rican resident, or a Puerto Rican based entity, theindividual or entity is treated like a nonresident alien individual or a for-eign corporation.244 “[T]he sale of personal property by a United Statesresident shall be sourced in the United States, or by a nonresident shallbe sourced outside the United States.”245

233. I.R.C. § 871(a)(1)(A).234. Id. § 881(b)(2).235. Id. § 55(a).236. P.R. LAWS ANN. tit. 13 §§ 30072, 30071(b).237. 2012 P.R. LAWS no. 20 p. 13, available at http://www.oslpr.org/download/en/2012/

A-0020-2012.pdf.238. Id.239. Id. at 16–17.240. 2012 P.R. LAWS no. 22 p. 1, available at http://www.oslpr.org/2009-2012/leyes/pdf/

ley-22-17-Ene-2012.pdf.241. 2012 P.R. LAWS no. 273, p. 10, available at http://www.lexjuris.com/lexlex/Leyes

2012/lexl2012273.htm.242. Id. at 11.243. Compare 2012 P.R. LAWS no. 22, p. 2; with 2012 P.R. LAWS no. 273.244. I.R.C. § 865(g)(1) (2014).245. Id. § 865(a).


A nonresident alien individual who trades stocks, securities, or com-modities, for business or for personal purposes, whether on his or herown, through an employee, a resident broker, a commission agent, a cus-todian, or other independent agents “whether or not any such” individu-als have discretionary authority to execute the transaction, is notconducting a trade or business within the United States, or performingpersonal services within the United States.246 Such actions are notsourced within the United States, provided “[t]he taxpayer does not havean office or other fixed place of business within the United States throughwhich or by the direction of” the transactions are executed.247

All of our individuals are likely to have some type of capital gains.Their capital gains will relate to the sale or exchanges of securities, invest-ments portfolios, or the sale of some personal property or real property.Provided that the sale of capital assets such as these is unrelated to anoffice or fixed place of business within the United States, a Puerto Ricanresident or corporation is exempt from United States tax on that sale.248

Jason and Jen will have the least difficulty with this issue. They are aretired couple who do not own, operate, or have a business within theUnited States or Puerto Rico. They would receive capital gains fromtheir investments, which are not subject to United States tax.249 Al-though these distributions are taxable income to Jason and Jen in PuertoRico, the Act 22 exemption eliminates the requirement to pay PuertoRican tax.250 If Jason and Jen remained in the United States, any short-term capital gains are subject to ordinary income tax treatment at ratesup to 39.6 percent.251 If their capital gains are long-term, they are subjectto a maximum tax rate of 23.8 percent.252 By contrast, if Jason and Jenwere to move to Puerto Rico, absent the Act 22 exemption, they wouldbe subject to a 10 percent tax on their long-term capital gains,253 and upto a 25 percent tax on their short-term capital gains.254 Jason and Jen willbenefit from the Act 22 exemption, but unless their income consists ofsignificant capital gains, their benefit is minimal.

Jon and Nichole might benefit the most from the lack of United Statestax on capital gains distributed from United States sources to Puerto Ri-can residents or Puerto Rican corporations.255 Jon has substantial portfo-lio income, which likely includes capital gains. Act 22 will exempt those

246. Id. § 864(b)(2).247. Id.248. Id. § 864(b)(2); I.R.S. Notice 89-40, 1989-15 I.R.B. 16.249. Id. § 864(b)(2).250. 2012 P.R. LAWS no. 22 p. 3–4, available at http://www.oslpr.org/2009-2012/leyes/

pdf/ley-22-17-Ene-2012.pdf.251. I.R.C. § 1(h)(2) (2014).252. See id.; see also id. § 1411(a)(1).253. P.R. LAWS ANN. tit. 13 § 30082(a) (2011).254. P.R. LAWS ANN. tit. 13 §§ 30072; 30071(b) (2011).255. See I.R.C. §§ 1445(b)(6), 864(b)(2) (2014); I.R.S. Notice 89-40, 1989-15 I.R.B. 16.


capital gains from Puerto Rican tax.256 Nichole’s hedge fund income willcontain substantial capital gains, which can leave the United States tax-free.257 If Nichole made $10,000,000 in capital gains from trading stocks,that amount would be subject to a 10 percent Puerto Rican tax, which is$1,000,000.258 Conveniently, Nichole’s Puerto Rican-based income is ex-empt from United States tax.259 Therefore, when Nichole combines herexemption from United States tax with her Act 22 exemption on capitalgains, she will pay no tax on her $10,000,000.260

If Nichole remained in the United States, her capital gains would bebroken into long-term capital gains and short-term capital gains. Themaximum tax on her long-term capitals gains is 23.8 percent,261 which is atax of $2,380,000. The maximum tax on her short-term capital gains is39.6 percent,262 which is a tax of $3,960,000. If Nichole were to keep hercorporation within the United States, then that corporation’s $10,000,000in gains will be subject to United States corporate tax amounting to$3,400,000.263

Comparatively, if Nichole moves to Puerto Rico and obtains an exemp-tion under either the Act 20 or Act 273, her capital gains will be subjectto Puerto Rican tax of 4 percent,264 which is $400,000. If Nichole’s corpo-ration obtains an Act 20 exemption, income distributed as dividends toNichole will be exempt from Puerto Rican tax.265 An Act 20 exemptioncould outlast an Act 22 exemption, which would allow Nichole to con-tinue to exempt significant amounts of income. If Nichole obtains an Act273 exemption for her corporation, then income distributed as dividendsto her will be subject to a Puerto Rican tax of 6 percent,266 which is$600,000. Act 22 could eliminate this 6 percent tax until the exemptionexpires on December 31, 2035.267 At that point, the 6 percent tax underAct 273 would apply.268

Mikey’s situation is very different. He probably has some capital gainincome from some investments, but that amount is likely minimal. Re-gardless, Act 22 will exempt the full amount of his capital gain income.269

256. 2012 P.R. LAWS no. 22 p. 3 – 4, available at http://www.oslpr.org/2009-2012/leyes/pdf/ley-22-17-Ene-2012.pdf.

257. I.R.C. § 864(b)(2); I.R.S. Notice 89-40 (1989) 1989-15 I.R.B. 16.258. See id. § 865(g)(2) (2014).259. See id. § 933(1) (2014).260. 2012 P.R. LAWS no. 22 p. 3–4, available at http://www.oslpr.org/2009-2012/leyes/

pdf/ley-22-17-Ene-2012.pdf.261. See I.R.C. §§ 1411, 1(h).262. See id. § 1(a).263. See id. § 11(a).264. See 2012 P.R. LAWS no. 20 p. 10, available at http://www.oslpr.org/download/en/

2012/A-0020-2012.pdf; 2012 P.R. LAWS no. 273 p. 10, available at http://www.lexjuris.com/lexlex/Leyes2012/lexl2012273.htm.

265. See 2012 P.R. LAWS no. 20 p. 13.266. See 2012 P.R. LAWS no. 273 p. 11.267. 2012 P.R. LAWS 22, no. p. 1, available at http://www.oslpr.org/2009-2012/leyes/pdf/

ley-22-17-Ene-2012.pdf.268. 2012 P.R. LAWS no. 273 p. 11.269. 2012 P.R. LAWS no. 22 p. 3–4.


Mikey’s big benefit will come when he sells his business. Even with anAct 22 exemption, he must pay Puerto Rican tax on his business’s pre-move appreciation.270 Act 22 only exempts post-move appreciation fromPuerto Rican tax.271 If he resides in Puerto Rico for more than ten years,then his pre-move appreciation is taxed at 5 percent272 rather than 10percent.273 If Mikey remains within the United States, any capital gainincome is taxed at a maximum rate of 23.8 percent.274 By moving to Pu-erto Rico, Mikey can save 23.8 percent on any post-move appreciation,and between 13.8 to 18.8 percent on any pre-move appreciation.

VI. UNITED STATES AND PUERTO RICO TAX RATECOMPARISON FOR INDIVIDUALS, CORPORATIONS,

AND PARTNERSHIPS

A. CORPORATIONS AND PARTNERSHIPS

The United States and Puerto Rico used to tax corporations and part-nerships differently from each other. In 2011, Puerto Rico enacted anentirely new IRC.275 Before the new Puerto Rican IRC, Puerto Ricotaxed corporations and partnerships with rates ranging from 20 to 30 per-cent, based on the entity’s income and number of Puerto Rican basedemployees.276 The Puerto Rican corporate tax now could reach 25 per-cent.277 This tax rate could change if the entity qualifies as a special en-tity,278 but the special entity designation is disregarded in this articlebecause they do not qualify. A partnership does not have an entity leveltax, but the partners are liable for tax on their individual tax returns.279

A nonresident alien individual who is a partner in a partnership that isengaging in trade or business in Puerto Rico “[s]hall be deemed as en-gaged in a trade or business in Puerto Rico with respect to its distributiveshare in the income . . . of the partnership.”280

United States corporations are taxed on a progressive tax scale startingat 15 percent of income not exceeding $50,000, but subject to 39 percenttax on income between $100,000 and $335,000, and topping out at 35 per-cent for amounts exceeding $18,333,333.281 Unfortunately, United Statescorporations, like Puerto Rican corporations, are subject to double taxa-tion. The corporation is initially taxed on its income at the corporatelevel.282 Later, when the corporation distributes income as dividends or

270. Id. at 3.271. Id. at 3–4.272. Id. at 3.273. P.R. LAWS ANN. tit. 13 § 30082(a) (2011).274. I.R.C. §§ 1411; 1(h) (2014).275. 2011 P.R. LAWS no. 1, http://www.oslpr.org/download/en/2011/A-0001-2011.pdf.276. P.R. LAWS ANN. tit. 13 § 8415(b) (2010).277. Id. §§ 30072, 30071(b) (2011).278. Id. § 30071(c) (2011).279. Id. § 30331(2011).280. Id.281. I.R.C. § 11(b) (2014).282. Id.


benefits, the shareholders or employees are taxed upon receipt,283 thus,double taxation results.

Like a regular Puerto Rican partnership, United States partnershipsare not taxed at the federal level at all.284 A partnership is merely a flowthrough entity, where “[p]ersons carrying on a business as partners shallbe liable for income tax only in their separate or individual capacities.”285

The character of income received at the partnership level will flowthrough to each partner maintaining its character.286 This article does notaddress any state taxes or fees on corporations or partnerships, whichcould be significant.

The entity differences will not affect Jason and Jen because they do notoperate a business. Jon, Nichole, and Mikey will benefit the most fromthe tax rate differences because a properly structured tax exemptioncould shelter significant amounts of income.

Under Puerto Rican law, Jon could face an entity level tax if he starts acorporation.287 Thus, Jon should apply for the Act 20 exemption.288 Theexemption would subject Jon’s corporation to a flat 4 percent tax, whichwould significantly reduce his corporate tax liability for up to thirtyyears.289 If Jon started a partnership, he should still apply for the Act 20exemption because Act 20 also provides an exemption to recipients ofcompany distributions and exemptions from property and municipaltaxes.290 While Jon might have some concerns about an entity level tax,the major concerns revolve around Nichole.

The tax treatment of her business depends on her entity choice. Hedgefunds typically choose a flow-through entity like a partnership becausethe partnership’s income is taxed to the partners not the entity,291 andavoids the double taxation associated with a corporation. Nichole’s mainissues revolve around income sourcing and the entity’s tax treatment. Asa hedge fund manager, Nichole will conduct tens of thousands of capitaltransactions throughout the year. To conduct her business in PuertoRico, Nichole must either associate herself with a Puerto Rican bank, aninternational bank within Puerto Rico, or, for the low price of $250,000,start her own bank!292 Starting her own bank means Nichole is not sub-ject to frustrating bank fees or servicing issues, and potentially exemptfrom some banking usury laws.293 If she decides to start her own bank,

283. Id. § 1.284. Id. § 701.285. Id.286. Id. § 702(b).287. P.R. LAWS ANN. tit. 13 §§ 30072, 30071(b) (2011).288. 2012 P.R. LAWS no. 20 p. 10, available at http://www.oslpr.org/download/en/2012/

A-0020-2012.pdf.289. Id. 16–17290. Id. 15.291. I.R.C. § 701 (2014).292. 2012 P.R. LAWS no. 273 p. 7, available at http://www.lexjuris.com/lexlex/Leyes2012/

lexl2012273.htm.293. Id. at 30.


she should apply for the Act 273 exemption that allows her entity to payflat 4 percent tax294 for up to forty-five years.295 Although, the PuertoRican Secretary has the discretion to modify the entity’s tax rate up to 10percent for the last fifteen years.296

Another potential issue for the Act 273 exemption is the four-em-ployee requirement.297 The cost and headaches associated with employ-ing four employees could outweigh the Puerto Rican law’s incentives.Fortunately, Act 22 grants Nichole’s banking entity an exception from thefour-employee requirement.298 If Nichole did not have an Act 22 exemp-tion, the Puerto Rican Secretary may waive the employee requirementupon Nichole’s request.299

If Nichole continues to reside in the United States, her primary benefitis the lack of an employee requirement if she is unable to obtain an ex-emption or waiver. Nichole’s share of partnership income will maintainits characteristics as it flows through to her personal tax return.300 Thoseamounts are then taxed at her applicable individual tax rates.301 Jon andNichole are likely subject to the top ordinary income tax rates of 39.6percent,302 and top long-term capital gain tax rates of 23.8 percent303

when they combine their income, excluding state taxes. If Nichole andJon make $10,000,000, the most tax they would owe is $3,960,000,304 andthe lowest tax they would owe is $2,380,000,305 provided they operated apartnership. If they operated a corporation, their corporation will pay anentity level tax of $3,400,000,306 meaning the most the corporation coulddistribute to them is $6,600,000. Then, whatever amounts the corporationdistributed to them is subject to tax at their respective individual rates. Ifthe corporation then distributed this entire amount to them, the most taxthey would pay is $2,613,600307 and the lowest is $1,570,800.308 Alto-gether, they could pay tax ranging from $6,013,600 to $4,970,800, which isabout 49 to 60 percent of their $10,000,000 income, excluding state taxes.

If Jon and Nichole relocated their business to Puerto Rico, and becamePuerto Rican residents with valid Act 22 and Act 273 exemptions, the

294. Id. at 10.295. Id. at 17.296. Id.297. Id. at 24.298. 2012 P.R. LAWS no. 22 p. 3, available at http://www.oslpr.org/2009-2012/leyes/pdf/

ley-22-17-Ene-2012.pdf.299. 2012 P.R. LAWS no. 273 p. 24, available at http://www.lexjuris.com/lexlex/Leyes

2012/lexl2012273.htm.300. I.R.C. §§ 1411, 702(b), 701, 1(a) (2014).301. Id. §§ 1411, 1(a), 1(h).302. Id. § 1(a).303. See id. § 1(h), 1411.304. Id. § 1(b).305. See id. § 1(h), 1411.306. Id. § 11(b).307. Id. § 1(b).308. Id. §§ 1411, 1(a), 1(h).


corporation will pay a tax of $400,000 on their $10,000,000,309 and a part-nership will pay zero.310 A Puerto Rico move with a valid exemption willsave them $3,000,000 in corporate tax. If Jon and Nichole started a Pu-erto Rican partnership, because partnership income maintains its charac-ter,311 Nichole will pay Puerto Rican income tax on anything Act 22 doesnot exempt. If the entity is a corporation or partnership and distributesinterest, dividends, or capital gains, Act 22 will exempt these amountsfrom tax.312

Mikey’s situation differs from the others. His startup company is stillnot worth any money, but it is poised for rapid growth. He should relo-cate his company to Puerto Rico to source as much post-move apprecia-tion to Puerto Rico, which is then eligible for Act 22 exemption. Thisrequires him to establish a Puerto Rican residency before his business’svalue skyrockets. The Act 20 business exemption will subject his entity toPuerto Rican tax of 4 percent313 for up to thirty years,314 rather than Pu-erto Rico’s entity level tax up to 25 percent.315 He will save up to 21percent in Puerto Rican tax annually.

If Mikey stays in the United States, the United States IRC will dictatehis business and personal tax liability.316 If Mikey’s entity is a corpora-tion instead of a partnership, he is subject to tax at the corporate levelbetween 15 and 35 percent,317 and then tax at the individual level whenthe company distributes profits through dividends or pays him a salary.318

A Puerto Rico move would save Mikey 11 to 31 percent in corporate taxannually.

B. INDIVIDUALS

As previously stated, the United States and Puerto Rico each havetheir own individual exclusive taxing systems,319 and both maintain a pro-gressive tax structure.320 The top United States individual rate is 39.6percent,321 and Puerto Rico’s top rate ranges from 30 to 33 percent, de-pending on the year.322 While the lower Puerto Rican rate looks morefavorable, it applies to all income from $61,300 to $121,500, depending on

309. 2012 P.R. LAWS no. 273 p. 10, available at http://www.lexjuris.com/lexlex/Leyes2012/lexl2012273.htm.

310. P.R. LAWS ANN. tit. 13 § 30331 (2011).311. Id.312. 2012 P.R. LAWS no. 22 p. 3–4, available at http://www.oslpr.org/2009-2012/leyes/

pdf/ley-22-17-Ene-2012.pdf.313. 2012 P.R. LAWS no. 20 p. 10, available at http://www.oslpr.org/download/en/2012/

A-0020-2012.pdf.314. Id. at 16–17.315. P.R. LAWS ANN. tit. 13 §§ 30072, 30071 (2011).316. I.R.C. § 1 (2014).317. Id. § 11.318. Id. § 1(c).319. I.R.C § 1(c); P.R. LAWS ANN. tit. 13 §§ 30061, 352 (2010).320. I.R.C § 1(c); P.R. LAWS ANN. tit. 13 § 30061(a).321. I.R.C. § 1.322. P.R. LAWS ANN. tit. 13 § 30061(a).


the year.323 This article will use the 30 percent rate that applies to incomeof $121,500 and over for all income earned after December 31, 2015.324

The top United States rate begins for single individuals at $400,000325 andfor married joint filers at $450,000.326 In the United States, a single per-son making $500,000 would pay tax of $155,764, and a married individualwould pay tax of $145,646.327 If the same person made $500,000 in Pu-erto Rico, he or she would pay tax of $133,600. The United States calcu-lations do not include state taxes, which could add between 0 and 13.3percent328 or more depending on the specific states.

All of our groups are likely have a capital transaction because eachgroup should sell its house. A house is a capital asset because it is notexplicitly defined as not a capital asset.329 Upon selling their homes, allare likely to qualify for a sale of personal residence exemption. This ex-emption excludes gains of up to $250,000 if single, and $500,000 if marriedfiling joint.330 To qualify, he or she must have lived in the house fortwenty-four of the last sixty months.331 Puerto Rico recently enacted asimilar exemption, but it only applies to individuals who are sixty yearsand older who lived in their home for thirty-six of the last sixty months,332

and exempts only $150,000.333 Any amount exceeding the exemption is along-term capital gain.334 The sale of United States real property isUnited States sourced income explicitly subject to United States tax, nomatter where the individual lives and when the home was sold,335 makingit ineligible for any Puerto Rican tax benefits.

Assuming the sale results in a gain, this excess capital gain tax mightaffect our groups differently. Jason and Jen might receive the worst orbest treatment. Assume that they bought their home many years ago.Their home likely appreciated significantly over the years, and may ex-ceed the $500,000 exemption, which will push their other income intohigher brackets (the worst treatment).336 This income increase could sub-ject them to the top capital gain rate of 23.8 percent for any excessgain.337 This excess gain could also push their ordinary income tax to-ward the 39.6 percent bracket.338 Jason and Jen have limited retirementincome and cannot work anymore. Thus, they are relying on this sale to

323. Id.324. Id. § 30061(a)(6).325. I.R.C. § 1(c).326. Id. § 1(i)(3).327. Id. § 1.328. CAL. REV. & TAX. CODE §§ 17043, 17041 (West 2014).329. I.R.C. § 1221 (2014).330. I.R.C. § 121 (2014).331. Id.332. P.R. LAWS ANN. tit. 13 § 30102(a)(16) (2011).333. Id.334. I.R.C. § 1221; P.R. LAWS ANN. tit. 13 § 30141 (2011).335. I.R.C. § 861(a)(5).336. Id. § 121.337. Id. §§ 1411 (2014), 1(h).338. Id. § 1(a).


fund their move and to purchase a new house. Conversely, the exemp-tion could shield their entire gain up to $500,000 (the best treatment).339

Jon, Nichole, and Mikey are all young and able to work. They couldwork extra hours to offset the moving costs. Both groups should qualifyfor the exemption, shielding any gain from tax. These two groups areunlikely to have owned their homes for as long as Jason and Jen, thus, theexemption is likely to cover any applicable appreciation. While the homesale is likely an isolated capital transaction, there are other capital trans-actions that warrant more concern.

Jon and Nichole are both highly successful and receive significant in-vestment income. If Jon continues to teach or practice law, his wage in-come is subject to Puerto Rican taxation at rates ranging from 30 to33percent.340 Act 22 exempts any investment income attributable to inter-est, dividends, or capital gains from taxation, but not wage or salary in-come.341 Nichole will have tens of thousands of long-term and short-termcapital transactions during the year. The United States requires Nicholeto hold a capital asset for one year and a day to become long-term.342

Puerto Rico only requires her to hold a capital asset for six-months toqualify as a long-term capital asset.343 The difference between the long-term classifications could have a significantly positive impact on her busi-ness, in addition to benefitting from the lower tax rates.344 Conveniently,Act 22 exempts capital gains whether long-term or short-term,345 an im-mense advantage to her.

If Jon and Nichole stay in the United States, the United States IRC willdictate their tax liability.346 Jon and Nichole are likely in the top 39.6percent tax bracket for ordinary income,347 which includes interest, divi-dends, and short-term capital gains.348 Long-term capital gains are taxedat a maximum of 23.8 percent.349 If they move to Puerto Rico, theirwages are subject to the top Puerto Rican tax rate ranging from 30 to 33percent depending on the year.350 Any long-term capital gains are sub-ject to a 10 percent tax,351 absent an Act 22 exemption.352 By moving toPuerto Rico, Jon and Nichole could exempt interest, dividend, and capital

339. Id. § 121.340. P.R. LAWS ANN. tit. 13 § 30061(a) (2011).341. 2012 P.R. LAWS no. 22 p. 3–4, available at http://www.oslpr.org/2009-2012/leyes/

pdf/ley-22-17-Ene-2012.pdf.342. I.R.C. § 1221(a)(3) (2014).343. P.R. LAWS ANN. tit. 13 § 30141(a)(4) (2011).344. 2012 P.R. LAWS no. 22 p. 3–4.345. Id.346. I.R.C. § 1 (2014); Treas. Reg. § 1.1-1 (2008).347. I.R.C. § 1.348. Id. § 1(a).349. Id. §§ 1411, 1(h)(1)(C).350. P.R. LAWS ANN. tit. 13 § 30061(a) (2011).351. Id. §§ 30111(a)(2), 30082(a).352. 2012 P.R. LAWS no. 22 p. 3–4, available at http://www.oslpr.org/2009-2012/leyes/

pdf/ley-22-17-Ene-2012.pdf.


gains from tax,353 which are subject to ordinary income tax rates in theUnited States up to 39.6 percent,354 a 39.6 percent. While Jon andNichole enjoy significant Act 22 exemptions on their yearly income,Mikey will enjoy that exemption during one big sale.

Mikey should hire an appraiser to value his company before he movesif his company’s value is not easily ascertainable. This will lock in thepre-move value and source any post-move appreciation to Puerto Rico.Any post-move appreciation generated while he is a Puerto Rican resi-dent is eligible for the capital gain exclusion under Act 22.355 Mikeyshould reside in Puerto Rico for more than ten years so that his pre-moveappreciation is subject to a lower 5 percent tax, rather than a 10 percenttax.356 Comparatively, if he continued to reside in the United States, thesale of his company should put him in the top long-term capital gain taxbracket of 23.8 percent,357 plus any applicable state tax. Mikey couldsave up to 18.8 percent by subjecting his pre-move appreciation to PuertoRican tax, and fully exempt any post-move appreciation, which will savehim 23.8 percent,358 plus any applicable state tax.

If Mikey stays in the United States, his best option is to sell the busi-ness as a stock sale because he could exclude between 50 and 100 percentof the gain that does “not exceed the greater of $10,000,000 or ten timesthe aggregate adjusted basis of qualified small business stock.”359 Toqualify, Mikey must meet IRC section 1202’s requirements, but becausehe started the company from the ground up, he is likely within its param-eters.360 But, a buyer of Mikey’s company is unlikely to select this optionbecause a buyer usually benefits more from an asset sale. An advantageof an asset sale is that the buyer can depreciate the company assetsagain,361 and reject company liabilities. If the parties allocated any of thepurchase price to goodwill, the buyer can amortize that amount over fif-teen years.362 If Mikey sells solely the rights to his intellectual property,which has a set expiration date, the buyer can amortize the purchase priceover the remaining life.363 Asset and intellectual property sales can besignificantly more advantageous to a buyer than a stock sale, which is whyit is unlikely.

The following illustrates the benefits of selling Mikey’s business withPuerto Rico’s incentives versus staying in the United States and payingthe United States tax. Mikey’s initial basis in his company is $500,000, hispre-move appreciation is $1,000,000, and after ten years, which is when he

353. Id.354. I.R.C. § 1(a).355. 2012 P.R. LAWS no. 22 p. 3.356. 2012 P.R. LAWS no. 22 p. 3–4.357. I.R.C. §§ 1411, 1(h).358. See id.359. Id. § 1202(b)(1)(B).360. Id. §§ 1202(c)–1202(e).361. Id. § 167.362. Id. § 197(a), 197(d)(1)(A).363. Id. § 197(d)(1)(D).


sells, the business appreciated to $40,000,000. If he stays in the UnitedStates, assuming no exclusions apply, when he sells his business for$41,500,000, he will pay a tax of $9,758,000,364 plus applicable state taxes.If he moves to Puerto Rico, the $1,000,000 pre-move appreciation istaxed at 5 percent, which is $50,000,365 and Act 22 exempts any post moveappreciation from tax.366 If Mikey moves to Puerto Rico, he will pay atotal tax of $50,000, on a business worth $41,500,000. The Puerto Ricomove could save him $9,708,000 in taxes!

VII. CONCLUSION

The Puerto Rican incentives provide very enticing financial incentivesto encourage one to seek Puerto Rican residency. For individuals likeJason and Jen, who will receive minimal benefits, these benefits are notsubstantial enough, and therefore they should not move. The residencytest, closer connection test, and tax home test ensure that an individualactually becomes a Puerto Rican resident and is not simply renting amailbox or home in Puerto Rico to enjoy the benefits. The individualmoving to Puerto Rico remains a United States citizen, even though thetax code often defines him or her as a non-resident alien individual.

The significant financial incentives provided in the three Puerto Ricanlegislative incentives discussed are powerful motivators to persuadesomeone to relocate to Puerto Rico. For financially motivated individu-als whose income consists primarily of interest, dividends, and capitalsgains, these benefits are enormous. Jon and Nichole will benefit signifi-cantly from the exemption and should move to Puerto Rico. An Act 22tax emption lasts until December 31, 2035367 and an Act 273 exemptioncan be valid up to forty-five years.368 While briefly mentioned, the Act273 also exempts the corporation from paying municipal taxes and taxeson real or personal property or tangible or intangible property, whichcould be significant.369 Jon and Nichole could quickly amass a fortuneupon which they may pay little to no tax.

Mikey had a different situation throughout this entire article. Not onlyis he moving his life and business to Puerto Rico, but also he must findqualified individuals within Puerto Rico to help grow his business. Jonand Nichole both have the intellectual knowledge to conduct their busi-ness without outside assistance. Mikey needs workers to help his com-pany grow, which Puerto Rico can provide. If Mikey desires to reap thebenefits of the various Puerto Rican incentives, he should do so beforehis business significantly appreciates so he can source as much apprecia-

364. See I.R.C. §§ 1(h), 1411.365. See 2012 P.R. LAWS no. 22 p. 3, available at http://www.oslpr.org/2009-2012/leyes/

pdf/ley-22-17-Ene-2012.pdf.366. Id. at 4.367. Id. at 1.368. 2012 P.R. LAWS no. 273 p. 17, available at http://www.lexjuris.com/lexlex/Leyes

2012/lexl2012273.htm.369. Id. at 29.


tion and income to Puerto Rico as possible. The potential tax exemptionhe receives upon selling his business is a major incentive that should per-suade him to relocate.

As stated above, this article discussed a variety of issues within a vac-uum and excluded a list of items, including, but not limited to deductions,expenses, credits, subpart F income, certain FDAP income, withholdingissues, entity-formation issues, entity-relocation issues, entity-dissolutionissues, fund-relocation tax issues, RICs, dividend-received deduction, em-ployment taxes, and the alternative minimum tax under both codes. Anindividual contemplating a move to Puerto Rico for the purpose of bene-fiting from these tax incentives should consult a knowledgeable attorneyand tax expert before he or she undertakes the journey. A tax haven is“a country, that imposes little or no tax on the profits from transactionscarried on there or on persons resident there.”370 Is Puerto RicoAmerica’s tax haven or simply a vacation paradise? Like the answer toalmost any legal question, it depends; and depending on the situation,Puerto Rico could be America’s tax haven.

370. BLACK’S LAW DICTIONARY, 1600 (9th ed. 2009).

Case Note

PAST DUE: AN INTRODUCTION TO

SOVEREIGN DEBT, THE ONGOING

DISPUTE BETWEEN NML CAPITAL

AND ARGENTINA, AND POSSIBLE

RAMIFICATIONS OF THE

DISPUTE’S OUTCOME

Jamison Joiner*

I. INTRODUCTION

IF money is borrowed on credit and not repaid, then creditors comeknocking. This is not a foreign proposition, and almost everyone hashad some experience with it, either directly or indirectly. People and

companies are not the only ones that feel the creditor’s pinch when fundsbecome scarce; countries can also default on their debt obligations.1 Ar-gentina is no stranger to this fact, and has defaulted seven times over thepast 200 years.2 Further, Argentina’s 2001 default was “the largest sover-eign default ever at the time.”3

The impacts of such an occurrence are not short-lived, and it appearsthat Argentina defaulted for an eighth time this July when it “missed acoupon payment on its restructured sovereign bonds.”4 Argentina hotly

* J.D. Candidate 2016, Dedman School of Law, Southern Methodist University;B.B.A. in Management and B.A. in Spanish, SMU 2011. The author would like tothank his family for its love and support. The author would also like to thankCourtney Floyd, the Hatton W. Sumners Foundation, and the SMU InternationalLaw Review Association.

1. While sovereign debt defaults do occur, they are not are not overly frequent andonly forty occurred between 1970 and 2010. John A. E. Pottow, Mitigating theProblem of Vulture Holdout: International Certification Boards for Sovereign-DebtRestructurings, 49 TEX. INT’L L.J. 221, 223 (2014). Moreover, there are differentstandards for what constitutes a sovereign default. “According to Moody’s, a sov-ereign default occurs whenever a country defaults on any of its bonds.” Joy Dey,Collective Action Clauses Sovereign Bondholders Cornered?, 15 L. & BUS. REV.AM. 485, 493 (2009). “Standard & Poor’s (S&P) defines default as the failure of aborrower to meet principal or interest payment of its debt obligations on the duedate.” Id.

2. Shane Roming, Argentina’s Long History of Economic Booms and Busts, WALL

ST. J. MONEYBEAT (July 30, 2014, 7:43 PM), http://blogs.wsj.com/moneybeat/2014/07/30/argentinas-long-history-of-economic-booms-and-busts/.

3. Id.4. Hugh Bronstein, Default? What Default? Argentina slams U.S. for using ‘D’ Word,

REUTERS (Sep. 16 2014, 3:14 PM), http://www.reuters.com/article/2014/09/16/us-ar-gentina-debt-idUSKBN0HB2B520140916.

85


contests that any default took place, and instead argues that it attemptedto make the payment, but could not because of rulings by U.S. courts inongoing proceedings between it and holdout creditors from the 2001 de-fault.5 In response, Argentina recently passed legislation that allows it tobypass U.S. judicial decisions and repay holders of restructured sovereigndebt without conceding to holdout creditors.6

The ongoing developments between Argentina, its creditors (boththose that agreed to restructured debt exchanges and those that heldout), and the United States will have far reaching implications.7 In Ar-gentina, the immediate effect of another default could cripple the nation’sability to obtain credit.8 On a grander scale, the precedent set in thisdispute could determine the course taken in the Eurozone’s resolution ofGreece’s 2012 default, the largest in history, and, in effect, shape the fu-ture of sovereign debt defaults and restructurings.9

II. LEGAL BACKGROUND AND DEVELOPMENT

When considering sovereign defaults, it is important to keep in mindsome key differences between the credit defaults of people and those ofcorporations. The most apparent difference is the vastly grander scope ofa sovereign default than a personal or corporate default.10 The impact ofa sovereign default affects not only that nation, but, given the intercon-nectedness of global economies, countries and people the world over.11

A less obvious, but arguably more important divergence between the twolies in the fact that sovereign debt defaults are not governed by a single,universally applicable and statutorily recorded bankruptcy code.12 In-stead of filing for bankruptcy, sovereign states “restructure their debt toprevent or resolve financial and economic crises and to achieve debt sus-tainability levels.”13

This approach presents a number of challenges, chiefly holdout credi-

5. Id.6. Julie Deisher, Argentina passes law circumventing US Court ruling limiting debt

repayments, JURIST (Sept. 12, 2014, 8:44 AM), http://jurist.org/paperchase/2014/09/argentina-passes-law-circumventing-us-court-ruling-limiting-debt-repayments.php.

7. Daniel Huang, Don’t Cry for Them: The World’s Biggest Sovereign Defaults Since2000, WALL ST. J. MONEYBEAT (July 2, 2014, 1:59 PM), http://blogs.wsj.com/moneybeat/2014/07/02/dont-cry-for-them-the-worlds-biggest-sovereign-defaults-since-2000/.

8. Id.9. Id.

10. Dey, supra note 1, at 493.11. Id.12. Id. at 495.13. In layman’s terms, this typically involves a sovereign’s creditors agreeing to new

repayment terms as part of an effort to allow the sovereign to pay off its debts (orat least a mutually agreed upon portion of them) while mitigating the negativeeffect on its economy. Rodrigo Olivares-Caminal, Understanding the Pari PassuClause in Sovereign Debt Instruments: A Complex Quest, 43 INT’L LAW. 1217, 1218(2009).

2015] PAST DUE 87

tors.14 In some cases, sovereign debt issues include a Collective ActionClause (CAC) that sets out “what percentage of a bond issue would haveto agree to a restructuring for it to be possible to force that restructuringon the” rest of the bondholders, whether they agreed to it or not.15 Whendebt issues do not include CACs, small groups of holdout creditors candelay or even prevent restructuring efforts.16 Among holdout creditors,there exists a more contentious subset: vulture funds. Vulture funds buysovereign debt at discounted rates from the original debt holder and thendemand repayment at full value while refusing efforts at restructuring.17

While vulture funds are legal and make good business sense, the ap-proach strikes many as morally reprehensible, especially those associatedwith the nation in default.18 Nevertheless, they are a part of the realitythat a country must face when it defaults on its debt obligations.19

Argentina provides a prime example of just how confounding the pros-pect of default can be for a sovereign nation. In 1991, Argentina adoptedan economic program called the “Covertabilidad” that linked the value ofthe Argentinean peso to the U.S. dollar as part of an effort to reduce debtand manage inflation.20 While the Convertabilidad was initially effective,it also made the Argentinian “economy vulnerable to foreign crisis.”21

The public was acutely aware of this fact and, in 2001, fear of a devalua-tion led to a bank run that caused Argentina’s financial system to spiralout of control. Ultimately, Argentina defaulted on over one-hundred bil-lion U.S. dollars in external bond debt to its domestic and foreigncreditors.22

In an effort to address “the $102 billion debt that the country main-tained with its domestic and foreign creditors, the government openedtwo debt exchanges in 2005 and 2010, through which it managed to get

14. There are three basic parties involved in a sovereign debt restructuring: the sover-eign, holders of original bonds, and holders of restructured bonds. The sovereignis the debtor on both types of bonds. “The old bonds are those held by the hold-outs that did not participate in the exchange offer.” Id. “The new bonds are thosethat were issues to creditors as result of the exchange offer, i.e. as result of thetender of their old bonds for new bonds.” Id. Generally, holdouts (even whenthey are small in number or proportion) can hold up an entire restructuring agree-ment if they do not agree with it unless there is a collective action clause (CAC).Id. at 486.

15. Tim Wortsall, Argentina’s Default, Vulture Funds, And The Little Secret That NotMany Understand, FORBES (Aug. 2, 2014, 10:23 AM), http://www.forbes.com/sites/timworstall/2014/08/02/argentinas-default-vulture-funds-and-the-little-secret-that-not-many-understand/.

16. Id.17. Id.18. See Cristina Fernandez Calls Vulture Funds ‘Economic Terrorists, TELESUR (Sept.

24, 2014), http://www.telesurtv.net/english/Cristina-Fernandez-Calls-the-Vulture-Funds-Economic-Terrorists-20140924-0057.html.

19. See id.20. Joanna Somoes, Sovereign Bond Disputes Before ICSID Tribunals: Lessons from

the Argentina Crisis, 17 L. & BUS. REV. AM. 683 (2011).21. Id.22. During the bank run, “approximately one billion dollars were withdrawn daily.”

Id. Although the Argentinian government placed heavy restrictions on the with-drawal and transfer of funds, such measures were ineffective. Id.


support from 93 percent of the investors by providing them with a settle-ment at a 65 percent discount on the dollar.”23 The remaining 7 percent,however, consists of vulture funds that refused the restructuring offer.24

These holdouts, led by U.S. hedge fund NML Capital, embody the vul-ture fund mantra and bought Argentinian debt when it “was on the vergeof default at a discounted price,” then sued Argentina in the SouthernDistrict of New York “for the full amount owed on the debt, plus inter-est,” when it failed to make payments.25 Almost unbelievably, it is Ar-gentina’s conflict with this small remainder of its sovereign debt holdersthat has the world on edge.

III. DEVELOPMENTS AND PROBLEMS

A. OVERVIEW OF ARGENTINA’S CONFLICT WITH NML CAPITAL

AND OTHER VULTURE FUNDS

Argentina’s conflict with NML Capital is not a one-off case, but astring of disputes—collectively referred to here as the NML v. Argentinasaga—centered on efforts at debt collection stretching across multipleyears.26 As stated above, “[t]he NML plaintiffs [collectively, NML], are acoalition of distressed debt funds and retail investors who sat out the re-structuring, sued, and then launched a largely fruitless global search forArgentine assets.”27 Although the initial cases between NML and Ar-gentina began over a decade ago, discussion for the purposes of this anal-ysis begins much more recently with a case decided in 2012 that set thesocial, political, and legal stage for how the NML v. Argentina saga willplay out.

In NML I, in addition to seeking money judgments that it worriedwould be uncollectable, NML also “held some Argentine bonds in re-serve and returned to federal court in New York to demand specific per-formance of the underlying bond covenants.”28 NML’s stance is based

23. Argentina’s Debt Battle: Why the ‘Vulture Funds’ Are Circling, Knowledge@Whar-ton, WHARTON SCH. U. PA. (July 3, 2014), http://knowledge.wharton.upenn.edu/article/argentinas-debt-battle-vulture-funds-circling/; see also Rodrigo Olivares-Caminal, To Rank Pari Passu Or Not To Pari Passu: That Is The Question InSovereign Bonds After The Latest Episode Of The Argentina Saga, 15 L. & BUS.REV. AM. 745, 747 – 49 (2009); see also NML Capital, Ltd. v. Republic of Argentina(NML I), 699 F.3d 246, 251 – 54 (2d. Cir. 2012), cert. denied. 134 S. Ct. 201 (2013).

24. Alexcia Chambers, Moment: Implications of Argentina’s Default, DIPLOMATIC

COURIER (Sep. 9, 2014), http://www.diplomaticourier.com/blog/2362-moment-im-plications-of-argentina-s-default.

25. Id.; see also The Economist Explains: Why Argentina may default on its debts,ECONOMIST (July 29, 2014, 11:50 PM), http://economist.com/blogs/economist-ex-plains/2014/07/economist-explains-22 (explaining that NML Capital, along with theother vulture funds, “scooped up cheap defaulted debt in order to chase paymentof full principal plus interest in the New York courts, under whose law the originalbonds were written.”).

26. W. Mark C. Weidemaier & Anna Gelpern, Injunctions in Sovereign Debt Litiga-tion, 31 YALE J. ON REG. 189, 190 – 91 (2014).

27. Courts and academics generally refer to the plaintiff vulture funds as a single en-tity, NML. Id.

28. Id.

2015] PAST DUE 89

upon a quirky boilerplate provision called a pari passu clause.29 The paripassu clause in Argentina’s bonds stated that Argentina would “‘rank atleast equally’ with all its other indebtedness,” which, at its core, meansthat if a debtor cannot pay all of its creditors then it must pay themequally as opposed to paying some and not others.30 Conversely, Argen-tina argued that the injunctive relief sought would violate the ForeignSovereign Immunities Act (FSIA), which provides that “the property inthe United States of a foreign state shall be immune from attachmentarrest and execution.”31 Judge Griesa of the Southern District of NewYork was not persuaded by Argentina’s argument and issued an injunc-tion in 2012, whereby “Argentina may no longer pay the holders of itsrestructured bonds . . . unless it pays NML in full, an amount now esti-mated at around $1.4 billion.”32 The Second Circuit affirmed JudgeGriesa’s ruling based on the rationale that Argentina breached a contrac-tual duty “when it prioritized paying holders of its restructured debt overthe bondholders who held its defaulted debt.”33 In other words, “when-ever Argentina pays on the bonds or other obligations that it issued in2005 or 2010 exchange . . . , the Republic must also make a ‘ratable pay-ment’ to plaintiffs who hold defaulted bonds.”34

To be sure, NML I and NML II seem like cut and dry cases: Argentinaowes the holders of its sovereign debt and should treat each of themequally.35 Argentina, however, views the outcomes in a different light.As an initial matter, there is some debate whether pari passu clauses are

29. NML I, 699 F.3d at 263 – 64.30. Id.; Felix Salmon, Hedge Fund vs. Sovereign: How U.S. Courts Are Radically Up-

ending International Finance, FOREIGN AFF. (June 24, 2014), http://www.foreignaf-fairs.com/articles/141588/felix-salmon/hedge-fund-vs-sovereign.

31. Foreign Sovereign Immunities Act, 28 U.S.C. § 1609 (2014). While the FSIA di-rectly addresses judicial “seizure and control over specific property . . . courts arealso barred from granting ‘by injunction, relief which they may not provide byattachment.’” NML I, 699 F.3d at 262, quoting S & S Machinery Co. vMasinexportimport, 706 F.2d 411, 418 (2d Cir. 1983).

32. Basically, “the injunction allows Argentina to keep stiffing NML, but only if it alsostiffs the exchange bondholders.” Weidemaier & Gelpern, supra note 26 at 191; seealso NML I, 699 F.3d at 262 – 65 (explaining that the injunctions sought are notbarred by FSIA because “[t]hey affect Argentina’s property only incidentally tothe extent that the order prohibits Argentina from transferring money to somebondholders and not others), NML Capital, Ltd. v. Republic (NML II), No. 08 Civ.6978 (TPG), 2012 WL 5895784 (S.D.N.Y. Nov. 21, 2012), aff’d, 2013 WL 4487563(2d. Cir. 23, 2013), cert. denied, 134 S. Ct. 2819 (2014).

33. Max Slater, Federal appeals court orders Argentina to pay more than $1 billion toinvestors, JURIST (Oct. 27, 2012, 11:11 AM), http://jurist.org/paperchase/2012/10/federal-appeals-court-orders-argentina-to-pay-more-than-1-billion-to-inves-tors.php; See also NML I, 699 F.3d at 264 – 65 (2nd Cr. 2012).

34. John R. Crock, Contemporary Practice of the United States Relating to InternationalLaw, Second Circuit Affirms Orders Requiring Argentina to Treat Restructured andHoldout Bond Holders Equally; Argentina Seeks Certiorari in Related Extraterrito-rial Discovery Case, 107 AM. J. INT’L L., 930, 930 – 31 (2013). In NML II, the courtclarified that the ratable payment requirements means “that whenever Argentinapays a percentage of what is due on the Exchange Bonds, it must pay plaintiffs thesame percentage of what is then due on the FAA bonds.” Id. at 931; see also NMLII, 2012 WL 5895786 at *2.

35. See generally NML I, 699 F.3d 246 (2nd Cr. 2012); NML II, 2012 WL 5895786.


at all binding during sovereign default proceedings.36 Argentina, framingthe issue within that context, views NML I and NML II as judicial mal-practice and a “counterintuitive interpretation of a boilerplate provision[that] upsets settled financial market expectations and threatens all futuresovereign debt restructurings.”37 In addition, Argentina already made ef-forts to treat all of its creditors equally “[i]n September 2013, [when] itsuspended indefinitely its Lock Law (which was designed to ensure thatholdouts would not be treated better than exchange bondholders).”38

Moreover, NML has “doggedly pursued Argentina for assets abroad”since NML I and has made attempts to repossess everything from Belgiandiplomatic accounts; to the presidential helicopter, Tango 1; to an actualArgentinian warship, the ARA Fragata Libertad.39 Taken as a whole,NML I, NML II, and their ripples “turn[ed] the natural order of debt onits head.”40 These cases did not, however, mark the last time that NMLwould prevail against Argentina in a U.S. court.

B. WHERE’S MY MONEY? ARGENTINA, NML, AND POSTJUDGMENT

DISCOVERY UNDER THE FSIA

On June 16, 2014, the U.S. Supreme Court issued its most recent opin-ion in the NML v. Argentina saga, this time dealing with post-judgmentdiscovery of extraterritorial assets.41 NML, in an effort to “accuratelyidentify the places and times when [Argentina’s] assets might be subjectto attachment and execution . . . served subpoenas on two nonpartybanks, Bank of America (BOA) and Banco de la Nacion Argentina(BNA), an Argentinian bank with a branch in New York City.”42 BothArgentina and BOA moved to quash NML’s subpoena on BOA, andNML subsequently moved to compel compliance.43 NML then narrowedits subpoenas to exclude the names of some officials during its search and“agreed to treat as confidential any documents that the bank sodesignates.”44 While “NML and BOA later negotiated additionalchanges to the BOA subpoena . . . BNA neither engaged in negotiation

36. Salmon, supra note 30; see generally, Lee C. Buchheit & Jeremiah S. Pam, The PariPassu Clause in Sovereign Debt Instruments, 53 EMORY L.J. 869 (2004).

37. 10 Reasons Why NML v. Argentina Matters to All, Embassy of Argentina, embas-syofargentina.us/embassyofargentina.us/argentinamonthly/10reason-swhynlmvargentinamatters.pdf, http://www.mecon.gov.ar/DESENDEUDAR/en/doc/reports-folleto16.pdf (lasted visited Feb. 23, 2015).

38. Id.39. Id.; Pottow, supra note 1, at 225. Argentina’s war “ship was released only after a

ruling from the International Tribunal for the Law of the Sea.” Salmon, supra note30.

40. See Salmon, supra note 30. “It used to be that having a bond was good but thathaving a judgment was much better. Now, however, it’s the other way around:judgments will get you nowhere, while bonds, if they have a pari passu clause, canmake you all-powerful.” Id.

41. See generally Republic of Argentina v. NML Capital, Ltd., 134 S. Ct. 2250 (2014).42. Id. at 2253.43. Id. at 2253.44. Id.

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nor complied with the subpoena.”45 The district court subsequentlygranted NML’s motion to compel and “reaffirmed that it would serve as a‘clearinghouse for information’ in NML’s efforts to find and attach Ar-gentina’s assets.”46 Of the three, Argentina was the only one to appealthe ruling.47

Similar to its position in NML I, Argentina argued “that the court’sorder transgressed the Foreign Sovereign Immunities Act (FISA) be-cause it permitted discovery of Argentina’s extraterritorial assets” basedon the rationale that, because the statute is silent as to post-judgmentdiscovery, the court should interpret the statute as granting “absolute ex-ecution immunity to foreign-state property.”48 The Court did not agree,and held that FSIA does not provide sovereign debtors with immunityfrom post-judgment discovery of extraterritorial assets, stating that U.S.courts lack the authority to execute against property in foreign countriesand explaining that “even if Argentina were correct that § 1609 executionimmunity implies coextensive discovery-in-aid-of-execution immunity,the latter would not shield from discovery of a foreign sovereign’s extra-territorial assets.”49 Justice Scalia went on to clarify that NML’s subpoe-nas were permissible under both the FSIA and the Federal Rules of CivilProcedures, because “[t]hey ask for information about Argentina’s world-wide assets generally, so that NML can identify where Argentina may beholding property that is subject to execution.”50 When such assets doturn up, any dispute between Argentina and NML regarding the immu-nity of specific assets will be settled by the district court.51

This much is clear—the Court’s ruling against Argentina did nothing tohelp Argentina’s struggle against NML. Arguably more important thanthe holding, however, is Scalia’s summary snippet buried in the middle ofthe opinion that states: “Thus, any sort of immunity defense made by aforeign sovereign in an American court must stand on the Act’s text. Orit must fall.”52 Said differently, under the guise of simple four cornerscontract interpretation, the Court can punt issues like “the fate of inter-national bond markets, or the sanctity of concepts such as sovereign im-munity.”53 The result has been pandemonium.54 Coupled with its denialof certiorari from NML II on the same day, the Court has put Argentinabetween a rock and a hard place.55 “Argentina wants to pay the ex-change bondholders, but it can’t. Argentina doesn’t want to pay [NML],

45. Id.46. See id. at 2254.47. Id.48. Id. at 2254, 2256 – 58.49. Id. at 2557.50. Id. at 2258.51. Id.52. Id. at 2256.53. Salmon, supra note 30.54. Id.55. See generally NML II, 134 S. Ct. 2819 (2014).


but it has to.”56 Faced with two unappealing alternatives, Argentinaopted for a third route and took matters into its own hands.

C. ARGENTINA’S COUNTER MEASURES AND THEIR RECEPTION

After the U.S. Supreme Court ruled that the FSIA did not preventpost-judgment discovery actions against sovereign debtors and deniedcertiorari for NML II, Argentina felt that it was fighting NML on unevenground, namely in an imperialist U.S. judiciary that favored the interestsof a small group of investors over its sovereignty.57 In response, Argen-tina took action on two fronts: (1) action in the International Court ofJustice and (2) passage of domestic legislation that supersedes the U.S.judiciary’s authority to prevent payment to holders of restructured debt.58

Shortly after the U.S. Supreme Court’s most recent NML v. Argentinadecision, Argentina filed suit “against the United States of America, re-garding a ‘Dispute concerning judicial decisions of the United States ofAmerica relating to the restructuring of the Argentine sovereign debt.’”59

In its submission, Argentina alleged that the United States “committedviolations of Argentine sovereignty and immunities and other related vio-lations as a result of judicial decisions adopted by U.S. tribunals concern-ing the restructuring of the Argentine public debt.”60 While a strongsymbolic gesture, proceedings in the ICJ are exceedingly unlikely to bringan end to Argentina’s woes because the United States must consent tojurisdiction for the suit to progress, something that has only occurredtwenty-two times over the past seven decades.61

Argentina, sensing that an ICJ proceeding likely would not yield thedesired result, took direct action, and on August 19, 2014, announced“that, in an effort to sidestep the U.S. Court ruling which blocked pay-ments on restructured debt . . . , the government [would] submit a bill tothe Argentine Congress that lets overseas debt holders swap into newbonds governed by Argentine law with the same terms.”62 Despite re-ceiving admonishments from Judge Griesa in the Southern District of

56. Salmon, supra note 30.57. Corinne Ball & Veerle Roovers, Eurosource-deals and debt-August 2014, LEX-

OLOGY (September 3, 2014), http://www.lexology.com/library/detail.aspx?g=f6312dfd-4c98-8ca7-c0c3ae9cff38.

58. Press Release, International Court of Justice (I.C.J.), The Argentine Republicseeks to institute proceedings against the U.S. before the International Court ofJustice. It requests US to accept the Court’s jurisdiction. (Aug. 7, 2014), availableat http://www.icj-cij.org/presscom/files/4/18354.pdf [hereinafter I.C.J. Press Re-lease]; Press Release, Embassy of Arg., A broad majority enacted into law theSovereign Payment of the Debt (Sept. 11, 2014), available at http://www.embassy-ofargentina.us/embassyofargentina.us/en/news/140911mecon.html [hereinafterArg. Embassy Press Release].

59. I.C.J. Press Release, supra note 58.60. Id.61. Sovereign Debt Update, JONES DAY (Sept./Oct. 2014), http://www.jonesday.com/

Sovereign-Debt-Update-10-01-2014/?utm_source=Mondaq&utm_medium=syndication&utm_campaign=View-Original.

62. Id.

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New York, the Argentine government continued to push the bill onto itsSenate floor.63 These efforts proved fruitful, and on September 11, 2014,the Argentine Legislature enacted the Sovereign Payment of the Restruc-tured Debt Law.64 This law addressed three main issues: replacing theexisting trustee (BNY Mellon, Corp.) with an Argentine trustee; grantingcreditors the option to voluntarily switch the governing law of their bondsto another jurisdiction; and validating the pari passu clause by making“deposits for 7.6 [percent] of the bondholders that did not participate ineither of the restructuring processes carried out by Argentina in 2005 and2010.”65 The net effect of these changes is to “encourage” investors tomove their Argentine debt from the United States to Argentina orFrance.”66

Although the Sovereign Payment of the Debt Law is a recent develop-ment, Argentina put it to work immediately by depositing $161 million ina local bank, Nacion Fedeicomisos, to act as trustee and “make good onan interest payment due Sept. 30.”67 That effort was thwarted, at leasttemporarily, when the district court foreseeably found Argentina in con-tempt of court for making an end around effort on its ruling.68 A lessapparent effect of the court’s ruling, however, could indefinitely preventthe Sovereign Payment of the Debt Law from coming into effect.69 Ar-gentina’s sovereign “bond contracts state that the [trustee] role must befulfilled by a bank that’s in good standing with U.S. federal and statelaw.”70 As such, it is unclear whether Nacion Fideicomisos would be pre-cluded from serving “as a legally valid trustee”71 due to Argentina beingheld in contempt of court. The resulting confusion has left debt holdersand banks with an unappealing decision to make: whether to be penalizedby the U.S. judiciary or by an aggressive Argentine administration.72

63. Id.64. Arg. Embassy Press Release, supra note 58.65. Id.66. Deisher, supra note 6.67. Katia Porzecanski, How to Collect Argentina Bond Payment is Unresolved Riddle,

BLOOMBERG (Oct. 2, 2014, 10:04 AM), http://www.bloomberg.com/news/2014-10-02/how-to-collect-argentina-bond-payment-is-unsolved-riddle.html.

68. Alison Sacriponte, US judge declares Argentina in contempt of court, JURIST (Sept.30, 2014, 2:18 PM), http://jurist.org/paperchase/2014/09/us-judge-declares-argen-tina-in-contempt-of-court.php.

69. See Porzecanski, supra note 67.70. Id.71. Id.72. On one hand, those that try to orchestrate payments or debt swaps could face

penalty at the hands of U.S. courts for cooperating with Argentina while it is heldin contempt. Porzecanski, supra note 67. Conversely, banks that comply with theU.S. court’s order and refuse to make payments risk Argentina revoking their“permission to operate a local representative office.” Sovereign Debt Update,supra note 61. Argentina has gone so far as to threaten banks with “severe civil,regulatory and criminal risks” if they do not comply with its demands. NicoleHong, Judge Thomas Griesa Rules Against NML Capital in Argentina Debt Case,WALL ST. J. (Sept. 10, 2014, 4:34 PM), http://www.wsj.com/articles/judge-thomas-griesa-rules-against-nml-capital-in-argentine-debt-case-1410381252 (citing Ci-tibank, N.A.’s Memorandum of Law in Opposition to Plaintiff’s Motion for Partial


Where this catch-22 leaves the situation going forward is anyone’sguess.73 As expected though, guesses are not in short supply.

IV. COUNTDOWN TO DEBT-ONATION: POSSIBLEREPERCUSSIONS OF THE NML

V. ARGENTINA SAGA

To be clear, there is little doubt that the outcome of NML v. Argentinawill impact the future of sovereign debt issues.74 How significant thatimpact will be remains a question. As in every other aspect of this dis-pute, the answer depends on which of two drastically divergent view-points one subscribes to.

From NML’s perspective, the outcome of the Argentine default will belimited to just that: Argentina’s default. Indeed, the American TaskForce in Argentina, an organization supported by Elliott Associates, L.P,NML’s parent company, portrays the entire conflict as a threat to nor-malcy in the international sovereign debt market, with Argentina dis-rupting order and casting flux into the system.75 The Second Circuit alsobelieves that its decisions will be of limited impact because of the paripassu clause’s “added provision that no creditor shall be subject to subor-dination, which the court presumed is not included in other sovereigndebt contracts,” and Argentina’s firm stance to never pay its holdoutcreditors.76 “The court’s implicit suggestion [seems to be] that a debtorwho was less brazen in its refusal to meet contractual obligations and lessvocal about its general disregard for the orders of U.S. courts might notwarrant the same treatment as Argentina.”77

In contrast, Argentina asserts that its fate will “have consequences foralmost every sovereign that has issued international debt over the past

Reconsideration of the June 27, 2014 Order, NML Capital, Ltd. v. Republic ofArgentina, No. 08 Civ. 6978, 2014 WL 3867736 (S.D.N.Y. July 17, 2014).

73. “It is too early to predict the long-term consequences of NML [b]ut it would be amistake to dismiss the case as completely sui generis.” Weidemaier & Gelpern,supra note 26, at 192.

74. “Although sovereign bond agreements drafted after Argentina’s default containmore safeguard clauses meant to protect the debtor-sovereigns, the Second Cir-cuit’s opinion will likely make restructuring more expensive, if parties attempt it atall.” Jack Jrada, Closing the Book on Argentina’s Sovereign Debt Default: TheSecond Circuit’s Decision and its Ramifications for Sovereign Debt Restructuring inthe Eurozone, 32 REV. BANKING & FIN. L. 222, 231 – 23 (2013). Even if none ofthe far-fetched predictions come to fruition, “[a]t the very least, the court injectedmore uncertainty into the sovereign debt market by giving new meaning to thepari passu clause, different from the interpretation that sovereign debtors held forso many years.” Id.

75. Robert J. Shapiro and Nam D. Pham, Discredited - The Impact of Argentina’s Sov-ereign Debt Default and Debt Restructuring on U.S. Taxpayers and Investors, AM.TASK FORCE ARGENTINA, 26, http://www.atfa.org/wp-content/uploads/2012/09/atfa_1006.pdf (last visited Feb. 20, 2015).

76. Brett M. Neve, Note and Comment, NML Capital, LTD. v. Republic of Argentina:An Alternative to the Inadequate Remedies Under the Foreign Sovereign ImmunitiesAct, 39 N.C. J. INT’L & COM. REG. 631, 657 – 58 (2014); see also NML I, 699 F.3dat 264 – 65.

77. Neve, supra note 76, at 658.

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[thirty] years” and NML v. Argentina might set dangerous precedent forremedies against sovereign debtors in the future.78 The United States hassubmitted two amicus briefs in support of this position, arguing that theSecond Circuit’s opinion runs contrary to U.S. interests and could under-mine decades of work towards stability in sovereign debt restructurings.79

Much of the international community—both sovereign nations and insti-tutions like the International Monetary Fund (IMF)—has aligned withthis stance as well.80

Despite both sides’ rancorous contentions, however, the true implica-tions of NML v. Argentina remain unclear. One factor that could miti-gate negative consequences is the growing prevalence of CACs, which“have been included in 99 [percent] of the aggregate value of New Yorklaw bonds issued since 2005.”81 This could be misleading, though, andmany commentators argue “that [CACs], when present, can only affectrestructuring where a supermajority of creditors agrees to ‘take a hair-cut.’”82 Relying on creditors to act so altruistically is a hairy propositionand many may prefer attempting “to emulate the success of Argentina’sholdouts in other courts.”83 If “[t]he copycat lawsuit brought by Taiwanto collect on Grenada’s defaulted debt less than sixth months after theSecond Circuit’s NML ruling” is any indication, following in NML’s foot-steps instead of “taking a haircut” appears to be the more likely out-come.84 Indeed, many “[p]rivate claimants also have pressed forinjunctions or similar relief against foreign sovereigns outside the debtcontext.”85

Of particular importance is NML v. Argentina’s effect on Greece’s de-fault in the Eurozone. The prevailing fear is that, even though “NewYork law does not govern the bond agreements at issue in the Eurozone’ssovereign debt crisis, and the agreements include [CACs],” if NML suc-ceeds in forcing Argentina to pay its holdout creditors, holders of othersovereign debt will have a greater impetus to act similarly, which “willseriously hamper efforts to restructure sovereign debt in the Eurozoneif . . . enough bondholders . . . take a risk and hold out.”86 “It may behasty, however, to conclude that the crises in Argentina and Greece arecomparable.”87 While there are some similarities between the two situa-tions, namely that both defaults came from inflexible monetary policiestied to a currency that neither sovereign could independently control,“the reality is that the Argentine trajectory could not have applied to

78. 10 Reasons Why NML v. Argentina Matters to All, supra note 37.79. Id.80. Id.81. Jrada, supra note 74, at 231 (quoting NML 1, 699 F.3d at 264).82. Id.83. Id.84. Weidemaier & Gelpern, supra note 26, at 192.85. Id.86. Jrada, supra note 74, at 231 – 33.87. Chambers, supra note 24.


Greece.”88 This is largely the result of one key difference—Argentina’sdebt reformation efforts are controlled by the IMF, whereas Greece’s areled by a confluence of the European Union, the European Central Bank,and the IMF.89 Although NML v. Argentina may affect future debtholder expectations and strategy, it is unlikely to have the widespreadimpact that many have feared.90

The international community is also doing its part to ensure that NMLv. Argentina does not have a systemic impact on the international sover-eign debt market.91 In particular, the International Capital Market Asso-ciation has proposed a plan meant to limit holdout creditors’ ability toprevent restructuring efforts, the IMF has promulgated “a series of newproposals” meant to address collected actions problems like those facedby Argentina, and the United Nations has passed a resolution “to beginan ‘intergovernmental negotiation process aimed at increasing the effi-ciency, stability, and predictability of the international financial sys-tem.’”92 In addition, the United Nations Human Rights Council passed aresolution condemning vulture funds like NML Capital.93 These mea-sures, however, are in the fledgling stages of their development and maynot have a direct short-term effect.94

Until international efforts prove to be effective, one recent and twopending decisions are likely to shape the outcome of the NML v. Argen-tina saga. To further complicate the matter, more creditors are joiningNML as holdouts every day.95 The recent decision, issued by a federalmagistrate judge in Nevada, compelled 123 nonparty corporations tocomply with NML’s post-judgment efforts to discover Argentine assets.96

Of the pending decisions, a relatively minor one that was filed in Dallasaddresses NML’s efforts to compel company documents from energycompanies engaged in joint ventures with Argentina.97 As of February2015, both parties were engaged in good faith negotiations regarding thescope of the subpoenas and the motions to compel, and the company doc-

88. Id.89. Id.90. Id.; cf. Jrada, supra note 74, at 231 – 33.91. Special Sovereign Debt Edition: EuroResource-Deals and Debt, JONES DAY (Oct.

2014), http://www.jonesday.com/EuroResourceDeals-and-Debt—Special-Sover-eign-Debt-Edition-10-27-2014/.

92. Id.93. Id.94. See id.95. Katia Porzecanski, Owl Creek Said to Seek Group to Accelerate Argentine Debt,

BLOOMBERG (Oct. 29, 2014, 1:28 PM), http://www.bloomberg.com/news/2014-10-29/owl-creek-said-to-seek-group-to-accelerate-argentine-debt; Sheelah Kolhatkar,A New Twist in the Argentina Debt Saga, BUSINESSWEEK (Oct. 29, 2014), http://www.businessweek.com/articles/2014-10-28/a-surpise-appearance-in-the-argentine-debt-drama.

96. See NML Capital Ltd. v. Republic of Argentina, No. 2:14-CV-492-RFB-VC, 2014WL 3898021 at *12 (D. Nev. Aug. 11, 2014).

97. Khadijah M. Britton, NML, Argentina Fight Over Energy Co. Subpoenas, LAW360(Oct. 28, 2014, 4:17 PM), http://www.law360.com/internationaltrade/articles/590733/nml-aregentina-fight-over-energy-co-subpoenas-.

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uments were stayed pending those negotiations.98 The other decision ad-dresses “whether or not Citigroup . . . can process an expected interestpayment by Argentina,” and will have direct implications on the conflictin U.S. courts and the Argentine legislature.99

V. CONCLUSION

The conflict between NML and Argentina presents a quandary. Theway out of the quandary and its larger implications, however, are un-known. While fears that Argentina’s fate could be transposed ontoGreece are largely misplaced, the precedent set by the result of the NMLv. Argentina saga could set the path for many future conflicts betweensovereign debtors and holdout creditors, especially with regard to the in-terpretation of pari passu clauses.100

98. Order Staying Action, NML Capital, Ltd. v. Republic of Argentina, No. 3:12-MC-00080, (Order Staying Action Feb. 2, 2015).

99. Nate Raymond, Citigroup to revisit U.S. Court over Argentina Bond Payments,REUTERS (Oct. 23, 2014, 1:28 PM), http://www.reuters.com/article/2014/10/23/us-argentina-debt-citigroup/idUSKNC0IC1NW20141023.

100. See Jrada, supra note 74, 231 – 33.

Updates

BEST BUSINESS PRACTICES: THE NEXT

WEAPON OF TERROR IN ARGENTINA

Tony Godfrey*

Is evil something you are? Or is it something you do?

—”Patrick Bateman,” American Psycho1

ON April 30, 2009, one of America’s “big three” automobile man-ufacturers, DaimlerChrysler, announced that it was shuttingdown its factory in Twinsburg, Ohio.2 The factory opened in the

1950s, and, at the time of its closing, employed 1,250 residents of thesmall Ohio town with a total population of 19,000.3 At one point, thefactory made up 90 percent of Twinsburg’s overall budget between com-pany payroll taxes and property taxes.4 Such a large factory closing in asmall town reliant on its business is always an earthquake to the localcommunity. At times, it is also an unavoidable business decision.5 But insome countries, for some U.S.-based businesses, these decisions may beacts of terror.

I. ARGENTINA’S ANTI-TERRORISM ACT OF 20112011

On December 27, 2011, the Argentine Congress enacted Laws No.26733 and 26734.6 The package was originally submitted in June 2011 byPresident Kirchner to address deficiencies found by the Financial ActionTask Force (FATF) in Argentina to combat money laundering and other

* Tony Godfrey is on the cusp of completing his legal studies at the SMU DedmanSchool of Law. He earned his B.A. in English Literature and Political Science,cum laude, from Abilene Christian University.

1. BRET EASTON ELLIS, AMERICAN PSYCHO 376 (1991).2. Michelle Jarboe McFee, Chryslers Plans to Close Twinsburg Plant by December

2010, Bankruptcy Documents Show, ASSOCIATED PRESS, (May 1, 2009), http://www.cleveland.com/business/index.ssf/2009/05/associated_press_filechrysler.html.

3. Id.4. Alison Grant, Twinsburg Stamping Plant: From Bright Beginning to Bleak Ending,

CLEVELAND (March 22, 2011, 2:02 PM), http://www.cleveland.com/business/in-dex.ssf/2010/07/twinsburg_stamping_plant_from.html.

5. See id. (discussing the changing landscape of the automobile manufacturing busi-ness as it related to Twinsburg specifically, and the business realities confrontingChrysler at the time that led to the factory closing).

6. Law No. 26733, Dec. 27, 2011, B.O. (Arg.), available at http://www.infoleg.gob.ar/infolegInternet/anexos/190000-194999/192139/norma.htm; Law No. 26734, Dec. 27,2011, B.O. (Arg.), available at http://www.infoleg.gob.ar/infolegInternet/anexos/190000-194999/192137/norma.htm.

101


acts that could finance terrorism.7 Passed together, these laws tightenedArgentina’s restrictions on money laundering and other financial crimes,8and provided a broad brush for combatting terrorism.9

A. TERRORIZING

Law No. 26734 specifically amended the Argentinian Penal Code, Arti-cle 41, by attaching Article 41(d).10 This section sets out:

“When any of the offenses under this Code has been committed inorder to terrorize the population or compel national authorities orforeign governments or agents of an international organization to do,or abstain from doing, any act, the minimum and maximum punish-ment will increase by twice the minimum and maximum.”

This increase shall not apply if the act or acts are done on the occasionof or in the exercise of human, social, or any other constitutional right.11

This expansive amendment has been met with criticisms. In the ab-sence of reference definitions, or any case law clarifying the statute, actsdone with the purpose of terrorizing the population has no definitive defi-nition. The vagueness of this particular clause has concerned a number ofhuman rights organizations.12 One common concern is the indeterminacyof the subject of the law, as the “act” in question is also undefined.13

Additionally, there are concerns that the law, despite its limiting secondparagraph, could limit protests and journalism that the government doesnot approve of.14 This concern is not entirely unfounded. One journalisthas already been threatened with the application of the aggravatedcharge of terrorism with the intent of terrorizing a population for filmingand publishing alleged invalid arrests.15 The Inter-American Press Asso-ciation (IAPA) openly condemned the threat of the terrorism charge and

7. See Press Release, Fin. Action Task Force (FATF), Improving Global AML/CFTCompliance: On-Going Process (Oct. 28, 2011), available at http://www.fatf-gafi.org/countries/a-c/argentina/documents/improvingglobalamlcftcomplianceon-go-ingprocess-28october2011.html (discussing the commitment of Argentina’s execu-tive branch in June 2011 to address the identified deficiencies).

8. Law No. 26733, Dec. 27, 2011, B.O. (Arg.), available at http://www.infoleg.gob.ar/infolegInternet/anexos/190000-194999/192139/norma.htm.

9. Law No. 26734, Dec. 27, 2011, B.O. (Arg.), available at http://www.infoleg.gob.ar/infolegInternet/anexos/190000-194999/192137/norma.htm.

10. Id. at art. 3.11. Id.12. Charlie Ramsey, Anti-Terrorism Law Causes Rights Concerns, THE ARGENTINA

INDEP. (Jan. 25, 2012), http://www.argentinaindependent.com/socialissues/humanrights/anti-terrorism-law-causes-rights-concerns/.

13. Id.14. Argentine Human Rights Reference Openly Criticizes the Anti-Terrorism Law,

MERCOPRESS (Dec. 27, 2011), http://en.mercopress.com/2011/12/27/argentine-human-rights-reference-openly-criticizes-the-anti-terrorism-law.

15. Newspaper Editor Facing 12 Years in Prison Under Anti-Terrorism Law, REP.WITHOUT BORDERS (May 14, 2014), http://en.rsf.org/argentina-newspaper-editor-facing-12-years-14-05-2014,46281.html.

2015] BEST BUSINESS PRACTICES 103

reaffirmed concerns surrounding the indeterminacy of the law.16 TheAmerican Civil Liberties Union (ACLU) echoed these concerns, worry-ing that such over-broad anti-terrorism statutes may be, and have alreadybeen in other countries, applied to “peaceful domestic dissent.”17

This open-ended definition of a terrorist and terrorist act and the doub-ling of criminal penalties associated with such a classification are particu-larly troubling when one looks to the organization that is claimed to havespurred Argentina’s change in law. As a member of the Financial ActionTask Force (FATF), Argentina is bound by its membership to enforce theorganization’s mandates and recommendations.18 The FATF has fortyclear recommendations that it requires all members to implement in lawto combat money laundering and the financing of terrorism.19 But eventhe FATF has a limited view of terrorism. At its broadest point, theFAFT uses similar language to Argentina’s sweeping definition but limitsit to “situation[s] of armed conflict.”20

II. R.R. DONNELLEY: TERRORIST PRINTER

On August 11, 2014, R.R. Donnelley Argentina S.A. filed for bank-ruptcy and liquidation in Argentina.21 R.R. Donnelley Argentina S.A. isa subsidiary of the U.S.-based RR Donnelley & Sons Company22, theworld’s largest printing firm.23 As a part of the company’s bankruptcyliquidation, its printing facility on the outskirts of Buenos Aires was ini-tially shut down, laying off about 400 workers.24 This marks one of thelargest closures in Argentina this year.25

16. IAPA Voice Concern at Anti-Terrorist Law in Argentina, INTER AM. PRESS ASS’N(May 13, 2014), http://www.sipiapa.org/en/iapa-voices-concern-at-anti-terrorist-law-in-argentina/.

17. ACLU, “TAKE BACK THE STREETS”: REPRESSION AND CRIMINALIZATION OF PRO-

TEST AROUND THE WORLD, 58 (2013), available at https://www.aclu.org/files/as-sets/global_protest_suppression_report_inclo.pdf.

18. FATF Members and Observers, FATF, http://www.fatf-gafi.org/pages/aboutus/membersandobservers/ (last visited Mar. 25, 2015).

19. INTERNATIONAL STANDARDS ON COMBATING MONEY LAUNDERING AND THE FI-

NANCING OF TERRORISM & PROLIFERATION: THE FATF RECOMMENDATIONS,FATF 11-22 (2012), available at http://www.fatf-gafi.org/media/fatf/documents/rec-ommendations/pdfs/FATF_Recommendations.pdf.

20. Id. at 122.21. RR Donnelley Letter Regarding the Bankruptcy of R.R. Donnelley Argentina S.A.,

GLOBE NEWSWIRE (Aug. 16, 2014), http://globenewswire.com/news-release/2014/08/16/659154/10094988/en/RR-Donnelley-Letter-Regarding-the-Bankruptcy-of-R-R-Donnelley-Argentina-S-A.html.

22. Id.23. Open-Book Management, ECONOMIST (June 8, 2009), http://www.economist.com/

node/13809344.24. Phil Rosenthal, R.R. Donnelley as an Argentine Terrorist is a Hard Zell, CHI. TRIB.

(Aug. 23, 2014), http://www.chicagotribune.com/business/columnists/ct-phil-rosen-thal-argentine-0824-biz—20140822-column.html.

25. Ken Parks, Christina Kirchner Threatens RR Donnelley with Criminal Charges forLayoffs, WALL ST. J. (Aug. 14, 2014, 11:21 PM ET), http://online.wsj.com/articles/cristina-kirchner-threatens-rr-donnelley-with-criminal-charges-for-layoffs-1408072907.


A. ARGENTINA’S THREAT OF ARTICLE 41(D)

On August 14, 2014, Argentinian President Kirchner went on nationaltelevision to respond to R.R. Donnelley’s bankruptcy.26 President Kirch-ner’s address alleged that the company’s filing for bankruptcy and closingof its printing facility was a purposeful attempt to disrupt Argentina’seconomy.27 Such an act would fall within the wide confines of Article41(d), and President Kirchner sought to invoke that very law to levy crim-inal sanctions against R.R. Donnelley.28 Argentina’s controversial anti-terrorism act, passed in 2011, was being used for the first time against aU.S.-based printing company.29 When one thinks of terrorist acts, this isnot the image that comes to mind. It was certainly not thought a terroristact in Twinsburg, Ohio.

President Kirchner alleged that R.R. Donnelley’s bankruptcy was “anattempt by vulture funds to incite fear,”30 and a “fraudulent maneuverand attempt to sow fear in the population.”31 At the time of R.R. Don-nelley’s move to close its Argentine subsidiary, Argentina’s economy ex-perienced inflation of 40 percent32, consumer prices had risen 16.7percent, and unemployment sat at a high of 11 percent.33 R.R. Donnel-ley’s bankruptcy filing also came just two weeks after a U.S. court ruledArgentina in default of its debts to hedge funds; a decision that threatensto further the country’s economic woes.34

B. R.R. DONNELLEY’S BUSINESS RATIONALE

It is no surprise that R.R. Donnelley takes issue with its characteriza-tion as a terrorist-minded vulture seeking to incite unrest and destabilizethe Argentinian economy. In an open letter published on the same day itfiled for bankruptcy, R.R. Donnelley outlined the rationale for its deci-sion to shut down its Argentinian operations.35 The company cited a lackof profitability and the continued decline of its business operations.36

The reasons for this lack of profitability include “rising labor costs, infla-tion, materials price increases, devaluation, and an inability to pay debts

26. Cristina Fernandez de Kirchner, CFK Anuncio Denuncia Penal Contra ImprentaMultinacional Donnelley [CFK Announced Criminal Complaint Against PrintingMultinational Donnelley], YOUTUBE (Aug. 14, 2014), http://www.youtube.com/watch?v=DE8bBRAbFe4.

27. Parks, supra note 25.28. Id.29. Id.30. Politics in Argentina: A Game of Polarisation, ECONOMIST (Sept. 1, 2014), http://

www.economist.com/blogs/americasview/2014/09/politics-argentina.31. From Deadbeat to Despot: Argentina Harasses a U.S. Company for Closing Up

Shop in Buenos Aires, WALL ST. J. (Sept. 3, 2014), http://online.wsj.com/articles/from-deadbeat-to-despot-1409608642.

32. Id.33. Rosenthal, supra note 24.34. Parks, supra note 25.35. RR Donnelley Letter Regarding the Bankruptcy of R.R. Donnelley Argentina S.A.,

supra note 21.36. Id.

2015] BEST BUSINESS PRACTICES 105

as they become due.”37 The bankruptcy and printing operations closurealso comes after months of ultimately fruitless negotiations with nationaland local labor unions to reduce labor costs and make profitabilityfeasible.38

Taken together, along with Argentina’s overall economic instability,none of these factors reek of a terrorist agenda to incite civil unrest orfear, or to illicitly gain money. On the contrary, in a recent SEC filing,R.R. Donnelley expects to pay between $15 and $20 million to pull itsoperations from Argentina.39

C. ARGENTINIAN REVERSAL AND WORKERS’ RESPONSE

After President Kirchner’s impassioned criticism of R.R. Donnelleyand its vulture intentions, the Argentine government ultimately declinedto pursue its terrorist allegations against the company.40 Instead, the gov-ernment is pursuing, in its courts, application of Law No. 27333 and itseconomic crime provisions.41 But this reversal is still no victory for R.R.Donnelley, as under the economic crime provisions Argentina seeks thearrest of R.R. Donnelley executives and prison sentences of up to sixyears.42 These laws and their application in the case of R.R. Donnelleyhave been compared to bills “that helped the Venezuelan government toexpropriate 1,193 companies, close 400,000 stores, and more than 2,000industries” by political opponents of President Kirchner.43

More recently, the judge overseeing the charges of fraudulent bank-ruptcy against R.R. Donnelley has permitted the impacted workers toform a co-op and take control of the facility.44 This also furthers the im-mediate attempts of workers to continue operations at the facility as soonas the day after its closure.45 The workers’ protests and control of thefacility even included placing a handmade sign renaming the facility forthemselves, the “Trabajadores RR Donnelley.”46

37. Id.38. Id.39. R.R. Donnelley & Sons Co., Current Report (Form 8-K) (Aug. 11, 2014), available

at http://www.sec.gov/Archives/edgar/data/29669/000118143114028833/rrd414358.htm.

40. Argentina Back-Steps on Applying ‘Anti-Terrorism’ Law on a U.S. Company,MERCOPRESS (Aug. 21, 2014), http://en.mercopress.com/2014/08/21/argentina-back-steps-on-applying-anti-terrorism-law-on-a-us-company.

41. Id.42. From Deadbeat to Despot, supra note 31.43. Id.44. Judge Hands Donnelley Control Over to Workers’ Co-Operative, BUENOS AIRES

HERALD (Oct. 6, 2014), http://www.buenosairesherald.com/article/171562/judge-hands-donnelley-control-over-to-workers-cooperative-.

45. Argentina: Workers Occupy RR Donnelley Factory After Illegal Foreclosure,REVOLUTION NEWS! (Aug. 13, 2014) http://revolution-news.com/argentina-work-ers-occupy-rr-donnelley-factory-illegal-closure/.

46. Id.


III. LOOKING AHEAD

With the criminal litigation ongoing against R.R. Donnelley, thereshould likely be concern for other U.S.-based businesses in decline in Ar-gentina. Even though the threats of pursuing an Article 41(d) actionwere ultimately empty, their attempted use bolsters the concerns thatsuch laws are overbroad and may be used to deter otherwise legal actionfor both individuals and businesses.47 At the very least, Article 41(d)’sprohibition of its use against acts exercising “human, social, or any otherconstitutional right”48 may not be strong enough to protect business ac-tions that appear on face to be motivated by determinations of best busi-ness practices. The 150-year-old printing firm49 may not be forced to takearms against a sea of terrorist accusations.50 This is not due to exonera-tion, but instead due to the ever-changing whims of a government choos-ing not to use a law that it believes it has every right to use in cases suchas this. The threat of the slings and arrows of outrageous fortune andgovernmental whims remain ever-present. Is evil something a business is,or something a business does? In Argentina the question remains unan-swered. Businesses would do well to consider the question seriously, astheir answer may not align with Argentina’s.

47. ACLU, supra note 17.48. Law No. 26734, Dec. 27, 2011, B.O. art. 3 (Arg.), available at http://www.infoleg

.gob.ar/infolegInternet/anexos/190000-194999/192137/norma.htm.49. Steven Rosenbush, Can 150-Year-Old Printer Go High Tech?: R.R. Donnelley

Plunges Into Developing Market for Printed Electronic Parts, WALL ST. J. (Aug. 18,2014, 7:47 PM ET) http://online.wsj.com/articles/can-150-year-old-printer-go-high-tech-1408405637.

50. See WILLIAM SHAKESPEARE, HAMLET act 3, sc. 1.

TRANS-PACIFIC PARTNERSHIP–IS IT

REALLY “NAFTA ON STEROIDS?”

Natalie Sears*

I. TRANS-PACIFIC PARTNERSHIP—IS IT THE NEW NAFTA?

WILL history repeat itself? That is the question many critics ofthe newest free trade agreement, the Trans-Pacific Partnership(TPP), are asking. The Office of the U.S. Trade Representa-

tive touts that the TPP is an ambitious, 21st century trade agreement thatthe United States is negotiating with eleven other countries throughoutthe Asia-Pacific region.1 The Office of the U.S. Trade Representativefurther claims it will unlock opportunities for American workers, families,businesses, and ranchers because of access to growing markets.2

Along with that claim, the government’s promise to eliminate tariffs,other barriers to goods and services trade, and investments with theseeleven other countries sounds exactly like the promises made twentyyears ago when the North American Free Trade Agreement (NAFTA)was implemented.3 Critics fear that history will repeat itself after theTPP is passed and the negative economic effects we have seen sinceNAFTA will be magnified with the TPP.4

II. WHAT IS THE TRANS-PACIFIC PARTNERSHIP?

A. NOT YOUR AVERAGE FREE TRADE AGREEMENT

Negotiations surrounding the TPP began in 2003 and continue today.5Although that amounts to twelve years’ worth of negotiating, many U.S.citizens are unfamiliar with the TPP because the press coverage has beenminimal and the government has yet to release a single text or negotiat-

* Natalie Sears is a J.D. Candidate, May 2015 and has a B.B.A. from Texas ChristianUniversity. She would like to thank her family and friends for their continuedsupport.

1. Overview of the Trans Pacific Partnership, OFFICE OF THE U.S. TRADE REPRESEN-

TATIVE, https://ustr.gov/tpp/overview-of-the-TPP (last visited Feb. 11, 2015).2. Id.3. PUB. CITIZEN’S GLOBAL TRADE WATCH, NAFTA’S 20-YEAR LEGACY AND THE

FATE OF THE TRANS-PACIFIC PARTNERSHIP 2 – 3 (Feb. 2014), available at http://www.citizen.org/documents/NAFTA-at-20.pdf.

4. Id.5. IAN F. FERGUSSON ET AL., CONG. RESEARCH SERV., THE TRANS-PACIFIC PART-

NERSHIP (TPP) NEGOTIATIONS AND ISSUES FOR CONGRESS 1 (2015), available athttps://www.fas.org/sgp/crs/row/R42694.pdf.

107


ing position to the public.6 Because of the secrecy surrounding the TPPnegotiations and provisions, the only information we have to rely on iswhat the government gives us.

The Office of the U.S. Trade Representative has provided an outline ofthe TPP’s provisions.7 The objectives of the United States in signing theTPP are reportedly to address issues such as: comprehensive market ac-cess, facilitation of production and supply chain among participatingmember-countries, promotion of trade/investment in innovative productsand services, constant updating to accommodate new trade issues, andadditional participating countries.8 With regards to the legal texts said tobe included in the TPP, provisions regarding issues such as competition,consumer protection, e-commerce, environment, intellectual property, le-gal issues, and technical barriers to trade will be addressed.9

The government states that the TPP’s eliminated tariffs will benefit sec-tors such as agriculture and textiles by removing fees associated withthese products’ exportation.10 For example, in Malaysia, the U.S. poultryfaces a 40 percent tariff, and in Vietnam, U.S. auto parts face a 27 percenttariff.11 Both of these, and many more, will be eliminated after the TPP’simplementation.12

B. HOW DOES THE TPP COMPARE TO NAFTA?

1. The TPP Expands NAFTA’s Reach

Although no one outside of the negotiating parties has access to thespecific text of the TPP, the government has provided basic provisions tobe included that show an immense similarity to NAFTA.13 In addition,portions of the TPP have been leaked to the public and those seen showan actual expansion from NAFTA’s framework and authority.14

The TPP, similar to NAFTA, will reportedly cover all aspects of com-mercial relations among the TPP countries.15 But the expansion in TPPis evident in its procedural practices. When NAFTA was implemented in1994, the agreed participants were limited to the United States, Canada,

6. The Trans-Pacific Partnership Agreement, PUB. KNOWLEDGE, http://tppinfo.org/(last visited Feb. 11, 2015).

7. Outlines of TPP, OFF. OF THE U.S. TRADE REPRESENTATIVE, https://ustr.gov/tpp/outlines-of-TPP (last visited Feb. 11, 2015).

8. TPP Issue-by-Issue Information Center, OFF. U.S. TRADE REPRESENTATIVE,https://ustr.gov/trade-agreements/free-trade-agreements/trans-pacific-partnership/tpp-issue-issue-negotiating-objectives (last visited Feb. 11, 2015).

9. Id.10. Trade in Goods, OFF. U.S. TRADE REPRESENTATIVE, https://ustr.gov/trade-agree-

ments/free-trade-agreements/trans-pacific-partnership/tpp-chapter-chapter-negoti-ating-0 (last visited Feb. 11, 2015).

11. Id.12. Id.13. PUBLIC CITIZEN’S GLOBAL TRADE WATCH, supra note 3, at 2.14. Id.15. See Outlines of TPP, supra note 7.

2015] “NAFTA ON STEROIDS?” 109

and Mexico.16 The TPP, however, may be the last treaty Washingtonever writes because it is leaving the door open to any and all future will-ing participants.17 Although the TPP currently includes the United Statesand eleven other countries, the number of participants could potentiallygrow even after the TPP has been signed and implemented for years.18

In addition to the expansion on the number of participants, the TPPalso plans to broaden the Investor-State Dispute Resolution provisionfound in NAFTA.19 Currently, NAFTA provides a private tribunal forforeign investors to resolve their issues with domestic governmental regu-lations.20 In the case that investors successfully claim these regulationsinterfere with their foreign investment, they can seek damages from thegovernment for lost profits and economic harm.21

The purpose of these investor-state arbitrations is to encourage foreigninvestment among the participating countries. Criticisms of the currentinvestor-state dispute resolution procedure found in NAFTA argue thatan expanded version in the TPP would only undermine governments’ au-thority to procure regulations in accordance with the safety of its owncitizens.22 Many worry that these investor-state arbitrations favor corpo-rations that invest in foreign countries while enabling them to sue govern-ments outside of their own domestic court systems.23

When evaluating the amount of settlements resolved in favor of foreigninvestors, it is easy to see that the criticisms have great merit. SinceNAFTA’s implementation, governments have been forced to pay corpo-rations more than $350 million following suits against matters like toxicbans, land-use policies, and forestry rules.24 Under NAFTA, there wereonly three governments and their accompanying foreign investors toworry about. When we consider the effect of twelve governments andthousands of foreign investors filing claims under investor-state arbitra-tion provisions, the amount of damages facing the governments couldeasily rise into the billions.

2. Why is the TPP necessary?

Many of the countries currently in negotiations regarding the TPP al-

16. M. ANGELES VILLARREAL & IAN F. FERGUSSON, CONGRESSIONAL RESEARCH

SERVICE NAFTA AT 20: OVERVIEW AND TRADE EFFECTS 1 (2014), available athttps://www.fas.org/sgp/crs/row/R42965.pdf.

17. Lori Wallach, NAFTA on Steroids, NATION (June 27, 2012), available at http://www.thenation.com/article/168627/nafta-steroids#.

18. Id.19. Id.20. NAFTA Investor-State Arbitrations, U.S. DEP’T ST., http://www.state.gov/s/l/c3439

.htm (last visited Feb. 12, 2015).21. Id.22. See Wallach, supra note 17.23. Id.24. See generally Table of Foreign Investor-State Cases and Claims Under NAFTA and

Other U.S. “Trade” Deals, PUB. CITIZEN (Feb. 2014), http://www.citizen.org/docu-ments/investor-state-chart1.pdf.


ready have free-trade agreements with the United States.25 So why areso many countries getting on board with the TPP? It could be the expan-sive access to new markets and favorable investment incentives. In real-ity, it appears that the countries aren’t actually jumping on board with allof the United States’ recommended provisions after all.26

Australia announced that it would not submit to the parallel court sys-tem found in NAFTA’s investor-state dispute resolution provision.27

New Zealand rejected a U.S. proposal to allow pharmaceutical compa-nies to challenge their government medicine regulations’ pricing deci-sions.28 In addition, every TPP participating country rejected the U.S.proposal to extend drug patent monopolies.29 Unlike many of the othercountries’ negotiating teams, the U.S. advisory members include manycorporate executives that are reaching for provisions similar to those re-jected by the participating countries in the hopes of gaining every advan-tage they can when sending their business to another country.30

Many TPP opponents contemplate that because most of the tariffs be-tween participating countries are already low, the TPP’s purpose must beto create regulations to favor corporate practices among the countries.31

One of the leaked portions of the TPP revealed that it is trying tostrengthen patents and related restrictions on selling drugs, which wouldresult in increased drug prices.32 But because the negotiating process hasbeen so secretive, people can only hypothesize what other provisions, be-sides those governing free trade, the TPP will contain.33

C. OPPONENTS WORRY THE TRANS-PACIFIC PARTNERSHIP IS

“NAFTA ON STEROIDS”

In addition to expansive provisions, the TPP is open to any country’sparticipation, even after it has been signed and put into practice. Schol-ars worry that the TPP’s plan to expand on NAFTA’s framework couldbe troublesome for countries that can’t keep up with increased economicpressures, resulting in the crisis seen in Mexico today.34

When NAFTA was originally negotiated, it was seen as an experi-

25. Trans-Pacific Partnership and all free trade deals help the United States, WASHING-

TON POST (Jan. 16, 2014), available at http://www.washingtonpost.com/opinions/trans-pacific-partnership-and-all-free-trade-deals-help-the-united-states/2014/01/16/c595da66-7ef5-11e3-93c1-0e888170b723_story.html.

26. See Wallach, supra note 17.27. Id.28. Id.29. Id.30. Trans-Pacific Partnership (TPP): Job Loss, Lower Wages and Higher Drug Prices,

PUB. CITIZEN, http://www.citizen.org/TPP (last visited May 3, 2015).31. Dean Baker, The Trans-Pacific Partnership: Warnings From NAFTA, HUF-

FINGTON POST (Jan. 20, 2014), http://www.huffingtonpost.com/dean-baker/the-trans-pacific-partner_b_4633675.html.

32. Id.33. Id.34. Id.


ment.35 NAFTA was a first of its kind in trade agreements, and the U.S.government made claims of economic and job growth that have yet to beseen in our country.36 In addition, since NAFTA, other trade agreementshave adopted its framework and seen their own negative effects.37 Forexample, the original U.S.-Korea Free Trade Agreement was entered intoin 2007 and re-formulated in 2011.38 Since its inception, there has been a“decline in U.S. exports to Korea”, but “a rise in imports from Korea.”39

The U.S. monthly trade deficit with Korea has increased 49 percent com-pared to the years before the U.S.-Korea Free Trade Agreement wassigned.40 These losses equate to more than lost exports—they translateinto thousands of lost jobs for American workers.41

The World Bank released reports that NAFTA led to rapid growth inMexico, but the Center for Economic Policy and Research quickly dis-claimed their numbers as misleading because developing countries, likeMexico, should have much faster GDP growth rates than rich countries.42

In fact, Mexico had the second slowest growth of any Latin Americancountry since NAFTA was implemented twenty years ago.43 The middleclass of Mexico has reportedly grown, but the poverty population stillremains high, equating to between one-fourth and one-half of the entireMexican population.44 In addition, wages in Mexico have now dropped“below pre-NAFTA levels as price increases for basic consumer goods”exceed wage increases.45

NAFTA, rather than creating the hundreds of thousands of jobs propo-nents believed it would, has contributed to a huge trade deficit with Mex-ico and Canada.46 In 2004, only ten years after NAFTA wasimplemented, one million jobs were estimated to have been lost becauseof U.S. firms embracing NAFTA’s foreign investor privileges.47 Morethan 845,000 additional jobs have been lost from the transfer of U.S. pro-duction plants to Canada and Mexico.48

35. PUB. CITIZEN’S GLOBAL TRADE WATCH, supra note 3, at 2.36. Id.37. Id. at 3.38. U.S.-Korea Free Trade Agreement, OFF. OF THE U.S. TRADE REPRESENTATIVE,

http://www.ustr.gov/trade-agreements/free-trade-agreements/korus-fta (last visitedFeb. 11, 2015).

39. PUB. CITIZEN’S GLOBAL TRADE WATCH, supra note 3, at 3.40. Id.41. Id.42. MARK WEISBROT, ET. AL., GETTING MEXICO TO GROW WITH NAFTA: THE

WORLD BANK’S ANALYSIS 4 (2004), available at http://www.cepr.net/documents/publications/nafta_2004_10.pdf.

43. Baker, supra note 31.44. William Booth and Nick Miroff, Mexico’s middle class is becoming its majority,

WASHINGTON POST (Mar. 17, 2012), http://www.washingtonpost.com/world/mex-icos-middle-class-is-becoming-its-majority/2012/03/14/gIQA9R0KJS_story.html.

45. PUB. CITIZEN’S GLOBAL TRADE WATCH, supra note 3, at 5.46. Id. at 3.47. Id.48. Id.


If the facts do not convince us that an expanded version of NAFTAwould be a bad idea, then the public consensus agreeing with that notionshould. In a 2012 Angus Reid Public Opinion Poll, 53 percent of Ameri-cans agreed that the “United States should ‘do whatever is necessary’ to‘renegotiate’ or ‘leave’ NAFTA.”49 This was the popular vote among allU.S. citizens—no matter what political party.50 Today, we face the chal-lenge of the TPP, an expanded version of NAFTA that has much farther-reaching implications. Not as many citizens know about the TPP becausethe government’s negotiations with participating countries have beenvery secretive and the media has been limited in its press coverage.51

When there is media coverage, the public outlets are primarily praising itsobjectives, similar to the way in which it portrayed NAFTA during itsadoption in 1994.

But some citizens are aware of the TPP and the majority of those thatknow about it do not support it. In 2014, a poll by Hart Research Associ-ates and Chesapeake Beach Consulting reported that 62 percent of U.S.voters opposed Fast Tracking the TPP.52 To fast track a trade agreementmeans to allow the President of the United States to negotiate interna-tional agreements that Congress can approve or disapprove but cannotamend whatsoever.53 Only 28 percent of U.S. voters were in favor of FastTracking this agreement, proving that the majority of those informed citi-zens aware of the TPP and its contents to not want to see it immediatelycome to fruition.54

D. EFFORTS TO STOP THE TRANS-PACIFIC PARTNERSHIP AGREEMENT

Although the government is trying to keep the contents of the TPPcovered up until negotiations are final, many people have already madeup their minds about this giant free trade agreement.55 Efforts all acrossAmerica are being made to inform citizens about the minimal informa-tion we do have about it because many worry that it will be a NAFTArepeat.56 Many people fear corporate and “political leaders of the PacificRim nations” are using the TPP to turn the regions into a “giant priva-tized corporate lake.”57

Multiple websites have been made in an effort to inform, criticize, andoutright halt the TPP’s progress and negotiations.58 For example, onemovement, called “STOP TPP” invites fellow citizens to inform othersabout what is wrong with the TPP and to join them “march[ing] in the

49. Id. at 5–6.50. Id. at 6.51. The Trans-Pacific Partnership Agreement, supra note 6.52. PUB. CITIZEN’S GLOBAL TRADE WATCH, supra note 3, at 6.53. Id. at 3.54. Id. at 6.55. See Stop TPP, STOP TTP, http://stoptpp.org/ (last visited Feb. 11, 2015).56. Id.57. The Call to Action, STOP TPP, htpp://stoptpp.org/the-call-to-action/ (last visited

Feb. 11, 2015).58. Stop TPP, supra note 55.


streets, with pots and pans, and banners and signs.”59 This group claimsthat the TPP would “create a super-treaty which would jeopardize thesovereignty of the nations involved by giving that power to large corpora-tions like Wal-Mart, Monsanto, [and] Goldman Sachs.”60 Another web-site, called “Flush the TPP!” urges citizens to take a pledge to oppose theTPP and reach out to local senators and representatives in hopes of gain-ing their own support as well.61

It seems as though the efforts to gain political support has been some-what fruitful.62 Senator Elizabeth Warren (D-MA), Representative AlanGrayson (D-FL), Representative Michelle Bachman (R-MN), and Repre-sentative Walter Jones (R-NC) have all expressed opposition to the FastTrack of the TPP and seek the text’s immediate release.63 Senator War-ren wrote a letter to the United States Trade Representative, Ron Kirk,and stated that “if transparency would lead to widespread public opposi-tion to a trade agreement then that trade agreement should not be thepolicy of the United States.”64 Many TPP opponents are hoping that across-partisan coalition can stop its implementation, similar to the four-teen other trade agreements stopped by this method within the past tenyears.65

Public opposition to the TPP has not been found only in the UnitedStates.66 Other demonstrations have been seen in Japan and Malaysia,while the lead TPP negotiator in Chile resigned due to his concern thatthe agreement would “restrict Chile’s ability to shape public policies, con-trol financial institutions and address issues of health, education anddevelopment.”67

E. WHAT IS TO BECOME OF THE TRANS-PACIFIC PARTNERSHIP?

So the question remains—will history repeat itself? This is the ques-tion many scholars, protestors, and even petitioners of the Trans-PacificPartnership are asking themselves. The government continues to reas-sure citizens and participating countries that the agreement is an ambi-tious, 21st century trade agreement that the United States is negotiatingwith eleven other countries throughout the Asia-Pacific region.68 Other

59. Id.60. The Facts, STOP TPP, http://stoptpp.org/thefacts/ (last visited Oct. 17, 2014).61. Stop the ‘Fast Track’ Train!, FLUSH THE TPP, http://www.flushthetpp.org/ (last vis-

ited Feb. 11, 2015).62. Kevin Zeese, Protest against the Trans-Pacific Partnership. Secret Negotations be-

hind Closed Doors, GLOBAL RES. (Sept. 29, 2013), http://www.globalresearch.ca/protest-against-the-trans-pacific-partnership-tpp-secret-negotiations-behind-closed-doors/5352012.

63. Id.64. Id.65. Id.66. Id.67. Id.68. See The United States in the Trans-Pacific Partnership, OFF. OF THE U.S. TRADE

REPRESENTATIVE, https://ustr.gov/about-us/policy-offices/press-office/fact-sheets/2011/november/united-states-trans-pacific-partnership (last visited Apr. 26, 2015).


government officials praise its job-creating benefits.69

But many people question the government’s claims when they haveseen the twenty-year effect of the North American Free Trade Agree-ment, which has brought increased illegal immigration and lost jobs.Promises made by proponents regarding the TPP sound very similar tothose issued by the government twenty years ago. Critics believe thathistory will only repeat itself with the TPP, and fear that due to the highnumber of participating countries involved, the negative effects of its im-plementation will be witnessed on an even larger scale. Only time cantell this story.

69. See generally Trans-Pacific Partnership, OFF. OF THE U.S. TRADE REPRESENTA-

TIVE, http://www.ustr.gov/tpp (last visited Feb. 11, 2015).

SUCCESSION TO THE THRONE AND THE

CANADIAN CHARTER OF RIGHTS

AND FREEDOMS

Christopher Cornell*

THIS article looks at the legal challenge raised in Teskey v. Canada(Attorney General) (Teskey) against the pending changes to thelegal rules governing succession to the thrones of the sixteen coun-

tries of which Queen Elizabeth II is monarch, at least as far as they applyto Canada,1 as well as the pending changes themselves.** Part I explainsthe motivation to change the rules governing succession. Part II discussesthe current rules governing succession to the throne and the backgroundof those rules. Part III discusses the agreement that led to the pendingchanges to the rules of succession. Part IV discusses Teskey’s Charterchallenge to the proposed changes to the line of succession and the rele-vant legal background information. And Part V concludes.

I. IMPETUS FOR CHANGE

The rules governing the succession to the thrones of the sixteen king-doms of which Queen Elizabeth II (the Queen) is monarch have devel-oped over the centuries in a manner that has left them with certainaspects that can charitably be described as unnecessarily unfair or dis-criminatory.2 Concerns over those discriminatory provisions governingthe succession to their shared monarchy led David Cameron, Prime Min-

* Christopher graduated with a Juris Doctor from the SMU Dedman School of Lawin May 2015 and served as the Canada Reporter for the SMU International LawReview Association for the 2014-2015 academic year. Prior to beginning lawschool he earned a Bachelor of Arts from Trinity University and a Master of Let-ters from the University of St. Andrews. Christopher would like to thank his fam-ily, friends, and professors for their continuing support of him in his academicendeavors.

** Editor’s Note: As this issue went to press it was announced that the legal andlegislative process to implement the changes to the line of succession discussed inthis article had been completed and that the changes would go into effect onMarch 26, 2015. E.g., Commencement of Succession to the Crown Act 2013: Writ-ten Statement - HCWS490, 24 Mar. 2015, PARL. DEB., H.C. (2015) 171WS; TheSuccession to the Crown Act 2013 (Commencement) Order 2015, SI 2015/894(U.K.).

1. Teskey v. Canada (Attorney General), 2013 ONSC 6386, paras. 1-4 (Can. Ont.Sup. Ct. J.), aff’d, 2014 ONCA 612 (Can. Ont. C.A.).

2. See HOUSE OF COMMONS LIBRARY, SUCCESSION TO THE CROWN BILL 2012-2013,2012-3, H.C. 12/81, at 6 (U.K.).

115


ister of The United Kingdom, to convene a meeting of all sixteen of theQueen’s prime ministers during the 2011 Commonwealth Heads of Gov-ernment Meeting in Perth, Australia.3 This meeting in turn led to thePerth Agreement, a unique sixteen-party agreement by the governmentsof the countries that share the Queen as their Head of State.4 The PerthAgreement represents a coordinated effort by all sixteen of the Queen’sgovernments to remove some of the discriminatory provisions governingthe succession to the throne.5

II. LEGAL HISTORY AND DEVELOPMENT OF THE RULESOF SUCCESSION AND THE SHARED MONARCHY

A. ORIGINS OF THE CURRENT RULES GOVERNING THE SUCCESSION

The rules of succession to the shared crown are derived primarily fromthe common law and three pieces of seventeenth and eighteenth centuryEnglish and British legislation: The Bill of Rights, The Act of Settlement,and The Royal Marriages Act, 1772.6

At present, common law rules of succession to the throne operatealong the same lines as feudal rules on hereditary land inheritance.7 Toillustrate, the Crown goes from the reigning monarch to his or her chil-dren (or those children’s descendants) in the following order: oldest sonto youngest son, and then oldest daughter to youngest daughter.8

The Bill of Rights, amongst other things, sets out the rule that the mon-arch may not be a Roman Catholic or married to a Roman Catholic byproviding for the automatic removal from the line of succession of anyperson who was Roman Catholic, became a Roman Catholic, or marrieda Roman Catholic, while any non-Roman Catholic children of such mar-riages remain in the line of succession.9 As far as it affects succession,The Act of Settlement reiterates the restrictions on Roman Catholicsfrom The Bill of Rights, limits succession to the legitimate Protestant de-scendants of Sophia, Electress of Hanover, and requires that the monarchbecome a member of the Church of England if not already a member atthe time of his or her ascension to the throne.10 It bears pointing out that

3. Id.4. See id.5. See id.6. See infra notes 7-17.7. See CABINET OFFICE, SUCCESSION TO THE CROWN BILL EXPLANATORY NOTES,

2012-3, H.L., at 5 (U.K.).8. See id.9. See The Bill of Rights, 1688, 1 W. & M. c. 2 (Eng.); see also Claim of Right Act

1689, W. & M. c. 28 (Scot.). While certain provisions of The Bill of Rights regulatesuccession to the throne in most of the U.K. and all of the other realms, within theU.K. nation of Scotland The Bill of Rights is not the law and instead those areas ofthe succession governed by The Bill of Rights elsewhere are governed in Scotlandby substantially similar language in the pre-union Scottish Parliament’s Claim ofRight Act 1689. See Claim of Right Act 1689, supra.

10. The Act of Settlement, 1700, 12 & 13 Will. 3 c. 2 (Eng.); see also Union with En-gland Act 1707, Ann. c. 7 (Scot.). Similarly to the situation with The Bill of Rights,those provisions of The Act of Settlement regulating succession to the throne in

2015] SUCCESSION TO THE THRONE 117

while the restrictions on the religion of the spouses of persons in the lineof succession only apply to and discriminate against Roman Catholics,11

the restrictions on the religion of persons in the line of succession, whileoriginally aimed at Roman Catholics, are actually discriminatory againstall non-Protestants because in order to be in the line one must be a Prot-estant.12 Further, the provisions affecting the monarch individually areeven more restrictive as the monarch must belong to the Church ofEngland.13

The Royal Marriages Act, 1772, applies to all descendants of George II(which after nearly 250 years for all intents and purposes includes every-one with any real chance of inheriting the throne) except his female de-scendants who marry into foreign families and the current monarch.14

The act stipulates that there are only two legal ways for affected personsto marry: (1) they must either receive the monarch’s permission for themarriage to occur, or (2) if they are over the age of twenty-five and havebeen refused the monarch’s permission, they may still marry if they de-clare to the Privy Council an intention to go through with their proposedmarriage and twelve months pass without both houses of the U.K. Parlia-ment passing measures declaring their disapproval.15 The legal conse-quences for marrying against the act are rather interesting: a marriageentered into in violation of the act by any descendant of George II towhom the act applies—including Roman Catholics, who cannot even in-herit the throne—will legally be considered to have never occurred andtherefore the position of any violator in the line of succession will not beaffected.16 Their spouses, on the other hand, will have no legal recogni-tion, and any children of a violating marriage will be considered illegiti-mate and, amongst other things, be unable to be in the line ofsuccession.17

most of the U.K. and all of the other realms are not the law within the U.K. nationof Scotland and instead those areas of the succession governed by The Act of Set-tlement elsewhere are governed in Scotland by substantially similar language inthe pre-union Scottish Parliament’s Union with England Act 1707. The one tech-nical difference between the two is that under The Act of Settlement the monarchhas to join the Church of England, while under the Union With England Act 1707the monarch must, in Scotland, preserve and maintain the Presbyterian Church ofScotland. See Union with England Act 1707, supra.

11. See The Bill of Rights, supra note 9.12. See The Act of Settlement, supra note 10.13. Id.14. Royal Marriages Act, 1772, 12 Geo. 3 c. 11 (Gr. Brit.).15. Id.16. See id.; see also VERNON BOGDANOR, THE MONARCHY AND THE CONSTITUTION

55 (1995) (discussing the restrictions of the act on Roman Catholic descendants ofGeorge II). One notable example of the restrictions in the act actually protectingthe royal involved occurred in 1785 when the then Prince of Wales was secretlymarried, without permission being sought or granted, to Mrs. Fitzherbert who wasRoman Catholic. If not for the Royal Marriages Act 1772 voiding his marriage,the Prince of Wales would have been barred by The Bill of Rights and The Act ofSettlement from succeeding his father as George IV. See BOGDANOR, supra note16, at 55.

17. See Royal Marriages Act 1772, supra note 14.


B. LEGAL HISTORY OF THE SHARED MONARCHY

The historical and legal origin of the shared monarchy can be traced tothe passage of the Statute of Westminster 1931 (the Statute), an act of theU.K. Parliament that established the legal framework that enabled Brit-ain’s self-governing colonies (then called dominions) to take completecontrol of their domestic and international affairs.18 The Statute itselfwas largely limited to ensuring that the U.K. Parliament could not passlegislation that was binding on any dominion unless the government of adominion asked for such legislation.19 But the Statute also effectively es-tablished that the dominions were from that point largely independent. Italso led to the later passage of domestic and U.K. legislation making thedominions fully independent, and helped to establish the model for Brit-ish colonial possessions to transition into fully independent nations (re-ferred to as realms) with their own separate crowns linked via a sharedmonarch.20 It should also be noted that in discussing the implementationof the agreement there has also been some mention of the Statute’s pre-amble, which purports to set out a requirement that any changes to thelaws regarding the line of succession or royal titles must be approved bythe parliaments of all of the realms, not just the U.K. Parliament.21 TheU.K. Government has, however, sidestepped this question in its entiretyby pointing out that as the Statute of Westminster is an act of the U.K.Parliament, the preamble and its text cannot impose any legal require-ments, though this would not be the case if the requirements in the pre-amble were part of the body of the statute.22 The Statute of Westminsterand its related, subsequent developments can thus be seen as leading tothe present shared monarchy where Elizabeth II is the queen of the six-teen fully sovereign nations commonly known today as the Common-wealth Realms.23

From a legal perspective, there is no disagreement that each of therealms maintains the option to unilaterally break its link with the monar-chy and adopt another form of government of its choosing.24 But disa-

18. See PETER BOYCE, THE QUEEN’S OTHER REALMS 26-27 (2008).19. Statute of Westminster, 1931, 22 & 23 Geo. 5 c. 4 (U.K.).20. See BOYCE, supra note 18, at 27 – 29.21. 13 Mar. 2013, PARL. DEB., H.L. (5th ser.) (2013) 309 (U.K.).22. See id.23. The sixteen Commonwealth Realms are the United Kingdom, Australia, New Zea-

land, Canada, Jamaica, Antigua and Barbuda, Belize, Papua New Guinea, St.Christopher and Nevis, St. Vincent and the Grenadines, Tuvalu, Barbados, Gre-nada, Solomon Islands, St. Lucia, and The Bahamas. See, e.g., The Royal House-hold, What is a Commonwealth Realm?, OFFICIAL WEBSITE BRIT. MONARCHY,https://www.royal.gov.uk/MonarchAndCommonwealth/QueenandCommonwealth/WhatisaCommonwealthRealm.aspx (last visited Apr. 24, 2015).

24. An early example of such a break would be India’s transition from colony to do-minion upon independence in 1947 when George VI officially became King ofIndia until the Indian Constitution had been drafted and entered into force in1950, at that point India changed overnight from a kingdom to a republic and itsofficial link with the king and the monarchy was unilaterally severed. See PamelaWhite, India, in COLUMBIA CHRONICLES OF ASIAN HISTORY AND CULTURE 312-15 (John S. Bowman ed., 2000).


greement exists as to whether a realm may retain the monarchy whileunilaterally changing some aspect of the institution, for instance, the rulesgoverning the line of succession, without doing so simultaneously with thegovernments of the other realms (though to date, no such change hasbeen attempted).25

The one historical example of a fully implemented multilateral changeto the nature of the shared monarchy is the legal process to implementthe abdication of Edward VIII and the subsequent ascension of GeorgeVI to the throne.26 In that instance Edward VIII signed an instrument ofabdication that was given legal effect when the His Majesty’s Declarationof Abdication Act, 1936 was enacted by the U.K., and with the consent oftheir governments, for Canada, Australia, New Zealand, and South Af-rica on December 11, 1936.27 The abdication was given legal effect in TheIrish Free State the following day with the enactment by the Irish Oi-reachtas (parliament) of the Executive Authority (External Relations)Act, 1936.28

From the time of the abdication to the present, reform of various as-pects of the monarchy connected to the succession has been a topic ofintense discussion and even legislative proposals in the U.K., including apledge to work for such change by then-Prime Minster Gordon Brown’sLabour Party in its manifesto for the 2010 U.K. General Election.29 Butit was not until October 28, 2011 that any concrete progress was made inthe push for reform. David Cameron and his fellow realm prime ministersheld the discussion at the Commonwealth Heads of Government Meetingin Perth. This ultimately resulted in their agreement to the common pro-gram of reforms to the nature of the monarchy now referred to as thePerth Agreement.30

III. THE PERTH AGREEMENT, SUBSEQUENTDEVELOPMENTS, AND THEIR LEGAL

IMPLEMENTATION

A. CHANGES TO BE BROUGHT ABOUT FOLLOWING

THE PERTH AGREEMENT

At the Commonwealth Heads of Government Meeting in Perth thesixteen realm prime ministers agreed to two concrete proposals to reform

25. See HOUSE OF COMMONS LIBRARY, supra note 2, at 8 – 9.26. See id. at 8.27. His Majesty’s Declaration of Abdication Act, 1936, 1 Edw. 8. c. 3 (U.K.).28. Executive Authority (External Relations) Act, 1936, (Act No. 58/1936) (Ir.). Al-

though there was no substantial legal consequence or harm from the Irish delay ingiving legal effect to Edward VIII’s abdication and the resulting twenty-four hourperiod where the realms did not share a common monarch, it is reasonable tospeculate that this incident may be one factor in the Perth Agreement’s require-ment that the anticipated changes must be legally enacted in all sixteen realmsbefore going into effect.

29. See HOUSE OF COMMONS LIBRARY, supra note 2, at 5 – 6.30. See id. at 6 – 7.


the line of succession to their shared throne.31 After the meeting inPerth, it emerged that there was in fact a third proposal for reform thathad been discussed by Cameron in the invitations he sent to his fellowrealm prime ministers to attend the meeting; and that, though not origi-nally a part of the earlier Perth Agreement, it had also been agreed to byall sixteen governments.32 The agreement to the third proposal effec-tively made it into a third component of the Perth Agreement. For thepurposes of this article, unless otherwise specified, references to theagreement should be read as referring to all three proposals.

1. The First Proposal

Under the first proposal, the common law of all sixteen countries ischanged so that the position of an individual in the line of successionwould be based just on when they were born.33 As a result, a daughterborn into the line would no longer be bumped down the line if her par-ents subsequently have a son in the succession.34 It was also agreed thatthe law implementing the change would be written in such a way that thischange would be retroactive to all births in the line of succession afterOctober 28, 2011, the day of the agreement.35

2. The Second Proposal

The second proposal agreed to at the Perth meeting allows anyone inthe line of succession to marry a Roman Catholic, ending the centuriesold discriminatory ban on persons in the line of succession marrying Ro-man Catholics while allowing them to marry spouses who are members ofany other (Christian or non-Christian) religion, or who profess no relig-ious faith at all.36 This would be accomplished by repealing the provi-sions of earlier legislation that remove persons who marry RomanCatholics from the line of succession.37 Notably, persons who had earlierbeen removed from the line of succession for marrying Roman Catholicswould be restored to the line, though no person returning to the line viathis change has a realistic chance of becoming monarch.38 But the ex-isting requirements that the monarch be a member of the Church of En-gland and that persons in the line of succession be Protestant will remainin force.39

While in Perth, Cameron described the thinking behind and rationalefor these two proposals by stating that, “The idea that a younger sonshould become monarch instead of an elder daughter simply because he

31. See infra notes 33-41.32. See CABINET OFFICE, supra note 7, at 2, 5.33. HOUSE OF COMMONS LIBRARY, supra note 2, at 6.34. See id.35. See id. at 10.36. See id. at 6.37. E.g., CABINET OFFICE, supra note 7, at 5.38. Id.39. See id.


is a man, or that a future monarch can marry someone of any faith excepta Catholic–this way of thinking is at odds with the modern countries thatwe have become.”40 Cameron also justified continuing the religious re-strictions that apply to the monarch and persons who are in the line ofsuccession by saying, “Let me be clear, the monarch must be in commu-nion with the Church of England because he or she is the head of thatChurch.”41

3. The Third Proposal

The third proposal agreed to by the sixteen governments would sub-stantially reform the requirements for persons in the line of succession toseek approval for their marriages.42 This reform would be accomplishedby repealing the Royal Marriages Act 1772 and instead only requiringpersons who, at the time they intend to marry, are one of the first sixpersons in the line of succession to seek the monarch’s consent.43 Nota-bly though, under the proposal, if the monarch refused to consent and theperson affected went ahead with the proposed marriage anyway, they andany children they might have would be removed from the line of succes-sion; though for all other purposes, the marriage itself would be legal andany children would be legitimate.44

The third proposal also makes every marriage ever voided under theRoyal Marriages Act 1772 legal. As long as the person involved was notat the time of the marriage one of the first six persons in the line of suc-cession, consent to the marriage was not sought, and no notice of intentto marry was given to the Privy Council, it was reasonable for the personconcerned to not know the act applied to them, and no one involved citedthe act as a basis for voiding the marriage.45 At the same time, the pro-posal has one stipulation declaring that the newly validated marriages arevalid for all purposes except for succession to the throne, keeping thehistorical line of succession intact.46 Effectively, this part of the proposalrenders most of the marriages ever voided by the Royal Marriages Act1772 valid, but with the caveat that, even though a marriage has beenvalidated, the removal from the line of succession of the person involvedand their descendants remains in effect.

40. Nicholas Watt, Royal Succession Gender Equality Approved by Commonwealth,GUARDIAN (Oct. 28, 2011, 7:29 AM), http://www.theguardian.com/uk/2011/oct/28/royal-succession-gender-equality-approved.

41. Girls Equal in British Throne Succession, BBC NEWS (Oct. 28, 2011, 1:43 PM),http://www.bbc.co.uk/news/uk-15492607.

42. See CABINET OFFICE, supra note 7, at 5.43. See, e.g., id. at 5 – 6.44. E.g., id. at 6.45. E.g., id.46. Id.


B. THE LEGAL PROCESS OF IMPLEMENTING THE PERTH AGREEMENT

At Perth, after coming to the agreement to change the rules of thesuccession, the sixteen prime ministers also agreed on a basic plan of ac-tion to implement the changes.47 This plan called for the Government ofNew Zealand to coordinate the multilateral sixteen party discussion as tohow the language implementing the agreement should be drafted andthen, once agreement on the language was reached, the U.K. Govern-ment would draft its own piece of legislation to implement it.48 Thatpiece of legislation would then be presented to the U.K. Parliament onlyonce the member of the U.K. Government responsible for coordinatingwith the other realms, Cameron’s then Deputy Prime Minister, NickClegg, had received written letters of consent from each of the realmsindicating they were ready to begin taking the necessary steps to imple-ment the changes.49 Clegg’s office confirmed on December 4, 2012, thatit had received all of those letters, and on December 13, 2012, the bill wasintroduced and given its first reading.50 For purposes of this article, dis-cussion will be limited to the passage of the relevant U.K. and Canadianlegislation.

1. Implementation of the United Kingdom Legislation

The U.K. legislation, the Succession to the Crown Act 2013 (SuccessionAct), is itself a rather short piece of legislation, consisting of less thanthree pages, one of which consists of just a schedule of items in previouslegislation that need to be changed in light of the agreement.51 The Suc-cession Act consists of five sections in addition to the above-mentionedschedule.52 The first of these sections implements the changes in regardto gender, the second addresses the changes in regard to the religiousrequirements of royal spouses, and the third—which is larger than thefirst two combined—contains all of the technical minutiae required to ef-fect the changes on consent to royal marriages.53 The fourth section ofthe Succession Act contains the technical details required to alter earlierlegislation to make it compatible with the new changes. The final sectioncontains the short name for the Succession Act and stipulates that it willgo into effect immediately, but that the other sections will only go intoeffect once the government so stipulates.54 This delay was deliberatelybuilt into the Succession Act so the U.K. Government would be able tomake sure that it implements the changes in unison with the otherrealms.55 The Succession Act was passed by the House of Commons on

47. See id. at 3.48. See id.49. See HOUSE OF COMMONS LIBRARY, supra note 2, at 9.50. Id. at 13.51. See Succession to the Crown Act 2013, c. 20 (U.K.).52. See id.53. See id. §§1 – 3.54. See id. §§4 – 5.55. See CABINET OFFICE, supra note 7, at 7.


January 28, 2013, and was then introduced in the House of Lords on Janu-ary 29, 2013, where it passed on April 22, 2013, before being sent to theQueen, who signed it into law on April 25, 2013.56

2. Implementation in Canada

On March 27, 2013, the Canadian Parliament’s Succession to theThrone Act, 2013 was signed into law.57 Through this act the CanadianParliament assented to “[t]he alteration in the law touching the Succes-sion to the Throne” set out in the U.K. Succession to the Crown Act2013.58 This choice of language is interesting in that it reflects that theCanadian Government believes that any change to the law of successionin the U.K. automatically applies to Canada as soon as it is assented to bythe Canadian Parliament.59 The legal basis for this argument rests firston an inferential principle of symmetry in the Canadian Constitution,which provides that the person occupying the throne of the U.K. is auto-matically the monarch of Canada.60 Under that legal logic Canadashould not have had to even pass its own legislation on the issue, but itwould appear that under Canadian law (unlike U.K. law61) the preambleto the Statute of Westminster is a substantive provision of that act itself.Thus, for the change to the line of succession to apply in Canada it mustfirst be assented to by the Canadian Parliament, as was done through theenactment of the Succession to the Throne Act, 2013.62

Despite the Canadian Parliament having passed legislation that it as-serts implemented the Perth Agreement under Canadian law, that legisla-tion has to date been attacked on two grounds. The first of these is thecontinuing bar on a Catholic monarch dealt with in Teskey and discussedin the next section.63 The second attack stems from what would appearto be a legitimate difference of legal opinion between the Government’sclaim that no constitutional amendment was necessary to incorporate thechanges to the line of succession into Canadian law64 and an alternatelegal argument that such a constitutional amendment was necessary65

that will ultimately probably have to be settled by the Supreme Court ofCanada.

In a legal complaint filed with the Superior Court of Quebec on June 6,2013, by two legal scholars from Laval University, Genevieve Motard and

56. Parliament of the U.K., Bill Stages—Succession to the Crown Act 2013, U.K. PAR-

LIAMENT, http://services.parliament.uk/bills/2012-13/successiontothecrown/stages.html (last visited Apr. 24, 2015).

57. See Succession to the Throne Act, 2013, S.C. 2013, c. 6 (Can.).58. Id.59. See Peter W. Hogg, Succession to the Throne, 33 NAT’L J. CONST. L. 83, 89-90

(2014).60. See id. at 92 – 93.61. See supra text accompanying notes 21 – 22.62. See Hogg, supra note 59 at 92.63. See infra Part IV.64. See supra text accompanying notes 57 – 60, 62.65. See,infra text accompanying notes 66 – 71.


Patrick Taillon, it is asserted that under Canadian law the Succession tothe Throne Act, 2013 is unconstitutional.66 The primary argument ad-vanced by Motard and Taillon is that changes to the line of successionfundamentally alter the “office of the Queen” and therefore to be consti-tutional, any changes to the line of succession must be approved by bothhouses of parliament and the legislatures of all the provinces under sec-tion 41(a) of the Constitution Act, 1982.67 The complainants also maketwo secondary arguments. First they argue that the Succession to theThrone Act, 2013 is additionally unconstitutional under the CanadianCharter of Rights and Freedoms, which is part of the Canadian Constitu-tion, because the Act fails to remove the discriminatory requirement thatthe monarch must be a member of the Church of England (a legal claimthat will be discussed below in relation to Teskey.)68 Their other secon-dary argument asserts that the Succession to the Throne Act, 2013 is un-constitutional because the United Kingdom’s Succession Act, whichcontains the changes that the Canadian act was passed to implement, waswritten in English, not in French.69 Interestingly, the challengers them-selves did not file their complaint out of opposition to the changes madeby the Succession to the Throne Act, 2013.70 Rather, they think thatunder the Canadian Constitution, the changes should have been ap-proved by the provincial legislatures and Parliament and that before thePerth Agreement can be operative in Canada that the legislation imple-menting it must be consented to by the provinces.71

It bears pointing out that the Canadian Government has noted thatwhen the Succession to the Throne Act, 2013 was being adopted, none ofthe provinces objected to not being consulted, with the obvious implica-tion being the provinces did not object because none of them thought

66. See, e.g., Janyce McGregor, Royal Baby Law Challenge Could End Up at SupremeCourt, CBC NEWS (June 12, 2013, 8:48 AM), http://www.cbc.ca/news/politics/royal-baby-law-challenge-could-end-up-at-supreme-court-1.1415337.

67. See Motion to Institute Proceedings for Declaratory Judgment at 2, Motard v. At-torney General of Canada (2013) (Can. Que. Super. Ct.) (initiating motion for thecurrent court proceedings filed before the Superior Court of Quebec by Motardand Taillon on 6 June 2013, please note that the court has yet to assign the case apublic docket number) available at http://s3.documentcloud.org/documents/712552/motard-taillon-requete-jugement-declaratoire.pdf; see also Constitution Act, 1982,being Schedule B to the Canada Act, 1982, c. 11 (U.K.), reprinted in R.S.C. 1985,app. II, no. 44 (Can.) (contains the constitutional provision Motard and Taillonclaim requires the federal parliament and the provincial legislatures to consent tothe changes to the line of succession for them to be constitutional).

68. See Motion to Institute Proceedings for Declaratory Judgment, supra note 67 at 3;see also Canadian Charter of Rights and Freedoms, Part I of the Constitution Act,1982, being Schedule B to the Canada Act, 1982, c. 11 (U.K.), reprinted in R.S.C.1985, app. II, no. 44 (Can.) (contains the constitutional provisions that Motard andTaillon claim render the Succession to the Throne Act, 2013 unconstitutional forfailing to remove the requirement that the monarch be a member of the Church ofEngland).

69. See Motion to Institute Proceedings for Declaratory Judgment, supra note 67, at 3.70. See McGregor, supra note 66.71. See, e.g., id.


that they were constitutionally required to give their consent.72 Further,it can easily be argued that the Canadian Government’s approach is thecorrect one when implementing changes to ensure that the U.K. and Ca-nada have the same monarch, but if Canada were to alter its law so that ithad a monarch other than the monarch of the U.K., then it would benecessary for both Parliament and the provinces to consent to thechanges in the form of a constitutional amendment.73 Both the challeng-ers and the Canadian Government believe strongly in the merits of theirlegal arguments, and as a result, this case will likely be litigated until theCanadian Supreme Court issues a definitive ruling.74 Such a ruling how-ever might be some time coming as Motard and Taillon’s case will not beheard by the Superior Court of Quebec until June 2015.75

IV. TESKEY V. CANADA (ATTORNEY GENERAL) AND THEBAR ON A CATHOLIC MONARCH

A. TESKEY V. CANADA (ATTORNEY GENERAL)OR O’DONOHUE REVISITED

Following the enactment of the Succession to the Throne Act, 2013,Bryan Teskey, a Canadian Roman Catholic who had recently completedlegal studies at the University of Ottawa, challenged the law in the Onta-rio Superior Court of Justice.76 Teskey argued that the Succession to theThrone Act, 2013 and the Perth Agreement it meant to implement vio-lated the Canadian Constitution, specifically its Canadian Charter ofRights and Freedoms, by not removing the legal ban on a Roman Catho-lic becoming monarch of Canada.77

The same issue of the discriminatory ban on Roman Catholics becom-ing monarch of Canada had been dealt with by the Ontario courts a dec-ade earlier in O’Donohue v. Canada.78 In that case, Tony O’Donohueunsuccessfully argued that that the legislation setting out the ban on Ro-man Catholics becoming monarch, the Act of Settlement, was unconstitu-tional and should be struck down for violating the Charter.79 Inaddressing O’Donohue’s claim, the Ontario Superior Court of Justiceruled that the rules excluding Roman Catholics from the line of succes-sion were part of the Canadian Constitution and thus were not subject to

72. See id.73. See Hogg, supra note 59, at 93.74. See McGregor, supra note 66.75. Allison Jones, Royal Baby Law Stands as Court Dismisses Catholic Challenge,

CBC NEWS (Aug 27, 2014, 7:32 AM), http://www.cbc.ca/m/news/politics/royal-baby-law-stands-as-court-dismisses-catholic-challenge-1.2748020.

76. Yamri Taddese, Law Grad Plans Appeal After Royal Succession Challenge Dis-missed, L. TIMES (Sep. 2, 2013, 8:01 AM), http://www.lawtimesnews.com/201309023425/headline-news/law-grad-plans-appeal-after-royal-succession-challenge-dismissed.

77. Id.78. O’Donohue v. Canada, 2003 CarswellOnt 2573 (Can. Ont. Sup. Ct. J.) (WL), aff’d,

2005 CarswellOnt 951 (Can. Ont. C.A.) (WL).79. Id. para. 1.


a challenge via the Charter because it does not apply to other parts of theConstitution.80 The court further ruled that because there was no validconstitutional challenge to be raised, O’Donohue did not have standingto bring a case.81 The Court of Appeal for Ontario affirmed the lowercourt ruling in a one-paragraph opinion stating that it agreed with theruling of the lower court.82

In its ruling in Teskey, the Ontario Superior Court of Justice made itclear that this case was similar to O’Donohue and that its ruling wasbound by earlier precedent.83 With that in mind, the court dismissed thecase for the similar reasons of there being no issue for the court to con-sider and Teskey’s lack of standing to bring a claim.84

In setting out its analysis for why the case should be dismissed, thecourt liberally quoted from and cited to O’Donohue.85 In this case, Tes-key objected to the implementation of the Perth Agreement in Canadabecause the discriminatory provision barring a Catholic from becomingCanada’s monarch was to remain in place.86 This might have very likelybeen an attempt to get around O’Donohue by arguing that the new legis-lation opened the rules of succession to Charter review and presumablyinvalidation. In any case, with respect to the rules of succession, thecourt, while citing to O’Donohue, held that the rules were a part of theConstitution and thus not subject to Charter review.87 Teskey, likeO’Donohue, argued that Canada could and should adopt a different (andnon-Catholic excluding) set of rules—and possibly a different monarchfrom the U.K.—but the court rejected that outright by stating that such achange would fundamentally alter the Canadian Constitution and “wouldinvolve the court changing, rather than protecting, our fundamental con-stitutional structure.”88 The court further opined that the changes envi-sioned by the Perth Agreement and assented to by the Succession to theThrone Act, 2013 were properly implemented with respect to Canada asthe U.K. had expressed a desire to modify some of the rules of successionand the Canadian Parliament had consented to those changes in accor-dance with the process established by the Statute of Westminster.89 Inregard to standing, the court held that Teskey was:

“[A] member of the Catholic faith but that appears to be his onlyinterest in the issues raised in this application. He has no connectionto the Royal Family. He raises a purely hypothetical issue whichmay never occur, namely a Roman Catholic Canadian in line for suc-

80. Id. paras. 36 – 37.81. Id. para. 39.82. O’Donohue v. Canada, 2005 CarswellOnt 951, para. 1 (Can. Ont. C.A.) (WL).83. Teskey v. Canada (Attorney General), 2013 ONSC 6386, para. 7 (Can. Ont. Sup.

Ct. J.), aff’d, 2014 ONCA 612 (Can. Ont. C.A.).84. Id.85. See, e.g., id. paras. 8 – 15.86. Id. para. 8.87. Id. paras. 12, 15.88. Id. para. 13.89. Id. para. 14.


cession to the throne being passed over because of his or her relig-ion. Should this ever occur a proper factual matrix would beavailable to the court to deal with a matter of this importance.”90

Effectively, setting aside the fact that the issue was already non-judicia-ble because of the rules of succession not being subject to the Charter,Teskey did not have standing to bring his case because although he wasRoman Catholic, he was not a member of the Royal Family, and therewas no overriding public interest to protect because there may very wellnever end up being a Roman Catholic Canadian excluded from thethrone because of their religion.91 On appeal, in August 2014 the Courtof Appeal for Ontario agreed with the lower court and dismissed Teskey’sappeal due to a lack of both standing and any issue for the court to de-cide.92 It would thus appear (pending any further judicial action to thecontrary) that the prohibition on the Canadian Monarch being Catholic,while discriminatory, is perfectly—if not fundamentally—constitutional.

V. CONCLUSION

Elizabeth II’s prime ministers set out to alter the rules governing theline of succession to make them fairer to those individuals to whom theyapplied. Teskey argued that because members of the Roman Catholicfaith were still excluded from the throne, the changes to the rules of suc-cession and the rules themselves were, in terms of Canadian law, uncon-stitutionally discriminatory under the Charter of Rights and Freedoms.The Ontario courts disagree, holding that as long as they were properlyimplemented, the changes to the rules of succession were themselves apart of the Canadian Constitution and thus protected from Charter re-view. Therefore, it would seem that if those provisions of the rules ofsuccession that Teskey and O’Donohue deplore are to be changed or re-moved it will have to be accomplished politically and legislatively throughanother multilateral agreement similar to the Perth Agreement ratherthan judicially through the courts.

90. Id. para. 16.91. See id. paras. 15 – 16, 19.92. Teskey v. Canada (Attorney General), 2014 ONCA 612, paras. 5 – 6 (Can. Ont.

C.A.).