Marvellous as ever?

Source: Latin Lawyer
By Luis Bulcao Pinheiro

 

“O Rio de Janeiro continua lindo (Rio de Janeiro keeps its beauty)” are the words to Gilberto Gil’s immortal samba, but after years of economic decline, skyrocketing violence and corruption scandals, has the appeal of Brazil’s cidade maravilhosa remained intact?

If Rio de Janeiro’s most famous landmark, the statue of Christ the Redeemer, could react to what has occurred under its outstretched arms over the past five years, it might be covering its face in shame. Recently Rio has been the backdrop to a depressing sequence of events: surging violence, collapsing public finances, bankrupted companies, fleeing investors and a long list of postponed construction projects. Brazil’s two-year recession, which lasted from 2015 to 2016, caused the country’s GDP to shrink by 7.2%. But in the state of Rio the downturn was deeper and lasted longer. The state’s economy plunged by 7.6% in the same period. While Brazil managed to close 2017 with a small measure of GDP growth, Rio only reported growth of just above the 0% mark in the second quarter of 2018. Unemployment is also more severe in Rio: for Brazil as a whole it stands at around 13%, but in Rio it still hits the 15% mark.

There is a combination of factors to blame for Rio’s downward spiral. “Perfect storm is the right expression,” says Rio-born Francisco Müssnich, from BMA – Barbosa, Müssnich, Aragão. Before the crisis Rio went through a period of growth, and although there were high hopes this fortune would be sustained, much of it was not built on solid ground. “There was a bubble of credit and consumerism created by Dilma Rousseff’s economic policies, dubbed the ‘new economic matrix’,” says Ivan Tauil, from Tauil & Chequer Advogados in associationwith Mayer Brown. Some – like infamous billionaire businessman Eike Batista – generated vast amounts of wealth before ultimately crashing. “It was not sustainable: Brazil was producing at a very high cost and when this cycle lost its breath, the country was hit simultaneously by other crises,” says Tauil.

The meltdown of Batista’s empire – all concentrated in Rio – came first. It was followed by the effects of the Car Wash investigation, which gained momentum in 2014. The scandal hit the core of Brazil’s oil sector, which drives Rio’s economy. On the back of the Car Washprobe, a series of additional criminal investigations concentrating on Rio’s state government led to the arrest of several members of Rio’s business elite and political community. Sérgio Cabral – who was state governor during the bonanza years – was sentenced to serve more than 100 years in prison for a series of crimes, including bribery and money laundering. Many in his inner circle were implicated. “The government’s structure was found by prosecutors to be completely corrupted,” says BMA’s Mussnich. “This rabble plundered state resources and left it with no investment capacity.”

With its finances in tatters, Rio became the face of Brazil’s downturn. But now there are tentative signs of recovery. Regulatory changes to the oil industry have diminished the role of Petrobras and made room for private players, while a newly elected government and measures of fiscal responsibility may be indications of a brighter future. But if Rio is to re-emerge and sustain a new period of growth it will need to avoid the pitfalls of the past.

Navigating troubled waters

The decline of Brazil’s most famous city led Rio’s dynamic legal market to suffer too. Clients tightened their budgets and some assigned less work. A handful of São Paulo firms report that the past few years have seen more and more Rio lawyers knocking at their doors seeking better opportunities. Under normal circumstances such comments should be taken with a pinch of salt – given the notorious historic rivalry between the inhabitants of Brazil’s two biggest cities – but Rio’s much-publicised decline makes such claims more credible. What can be said for certain is that some Rio outfits under­standably found it difficult to maintain the large structures the good times that preceded the crisis had required.

Rio witnessed the departure of international lawyers too. Hogan Lovells LLP, which entered Brazil in 2013 by opening an office in Rio, is the latest to leave. As of August 2018, its nine Brazil-based lawyers are all based in São Paulo. Meanwhile Norton Rose Fulbright has reduced the number of lawyers it has in the city and now has just one partner who splits her time between Rio and São Paulo.

There were some notable reorganisations as the market adjusted to a drastically different set of circumstances. In late 2016, São Paulo’s L O Baptista parted ways with its Rio partners, Schmidt, Valois, Miranda, Ferreira, Agel. In 2017, corporate governance specialists Carvalhosa e Eizirik Advogados also split. Modesto Carvalhosa opted to keep his practice in São Paulo, while Nelson Eizirik maintained a firm in Rio and a few people in São Paulo.

A year later, Lobo & Ibeas, a traditional Rio firm highly rated for its mining and environment lawyers, disbanded. Its former partners looked for more dynamic practices in several different, smaller and perhaps more nimble, outfits. Different factors contributed to each case, but Rio’s decay was always in the background.

The crisis pushed some firms to adapt their strategies. Some chose to shape their service offering to target high-demand areas by establishing new practice areas. Kincaid Mendes Vianna, a traditional maritime law firm that recently moved to new offices with a panoramic view over the shipping industry at Guanabara Bay, saw demand for work related to vessels supporting the oil industry fall sharply. “The firm, of course, was affected by the crisis, mainly with the reduction of new projects and investors, as were most firms in Rio due to the downturn of the oil and gas market,” acknowledges partner Camila Mendes Vianna. “On the other hand, there was a strong increase of contractual disputes and our arbitration and litigation practice has been quite busy over the past two years. The crisis also drove us away from our comfort zone and we took the time to modernise, and reassess contracts with suppliers to negotiate better prices,” she says.

The crisis was a shock to the system that led partners to take an aggressive approach. The firm chose to diversify by investing in other areas beyond its maritime law specialism, such as trade, as well as targeting the logistics and gas sectors. That required hiring more lawyers. It also invested in a São Paulo office, now boosted by the presence of a partner, and moved offices in Rio.

Rio-born firms with a strong presence outside of Rio were protected to some degree from their home town’s malaise by all-important revenue streams from elsewhere, such as São Paulo. Major-league firms such as BMA and Veirano Advogados were established in Rio, but both have built offices in São Paulo that are now as prominent. Campos Mello is another Rio-born firm that is decidedly outward looking and has been for some time. After forming an association with DLA Piper in 2010, the firm expanded its presence in São Paulo and opened a representative office in New York. Today, the firm actually has more partners in São Paulo (15) than it does in Rio (14). Historically known for the strength of its real estate practice, the firm doubled up its efforts in areas such as corporate, banking, tax, and oil and gas, and was therefore in a much better position by the time the crisis hit. “Diversifying our practice was crucial to surviving the crisis,” says managing partner Fabio Campos Mello. “If we had just focused on the real estate market in Rio, for example, the crisis would have affected us enormously, but we doubled our revenues since 2015 because we could diversify, anticipating market dynamics,” he says.

Countercyclical work kept many lawyers busy during Rio’s downturn and helped some firms compensate for a lack of demand in areas dependent on economic growth. In a sea of cancelled contracts, large-scale divestments and bankruptcy filings – consider that of Batista’s EBX group, or Oi’s record-breaking restructuring process, for a few good examples of these – some well-equipped boats found plenty of fish. Fierce litigators, skilful dealmakers and anti-corruption experts all found themselves in high demand in Rio’s altered state.

Petrobras’ divestment programme is an example of high-profile work generated by the crisis. Off the back of the Car Wash operation, following the fall in oil prices and faced with a large debt burden, the state-owned oil company undertook a US$21 billion divestment programme between 2017 and 2018. One such deal from 2017 saw it sell a stake in its largest oilfield to Equinor (the company formerly known as Statoil) for US$2.9 billion. Huge sell-offs required the expertise of the top echelon of dealmakers in Rio, and often brought in a lot of work. “Those deals are highly complex and demand the involvement of lawyers from several departments of the firm,” says Demarest Advogados’ João Luis Ribeiro de Almeida. BMA, Machado Meyer Advogados, Mattos Filho, Veiga Filho, Marrey Jr e Quiroga Advogados, Pinheiro Neto Advogados, Pinheiro Guimarães Advogados and Veirano are among the Brazilian firms to have won work from Petrobras’ divestment programme (often in conjunction with teams from international firms too).

While they have to contend with high overheads, the elite transactional firms capable of staffing massive deals are perhaps best suited to service the kind of complex and sensitive dealmaking that occurred in Rio during the downturn. “You cannot represent clients in these transactions if you don’t have well-developed tax, labour, environment, compliance and litigation departments,” says Mattos Filho’s Giovani Loss.

Medium-sized firms suffered the most, says Mattos Filho’s managing partner, José Eduardo Queiroz. “Boutiques can be sleek and cost-efficient. But for middle-range firms it got harder to justify their high costs as they are not as well equipped as large firms,” he says. Smaller shops with a recognised pedigree in some sectors – as opposed to newer entries – may also have been in a more favourable position because they could rely on their long-standing good reputation and tested capabilities to win favour with clients. “The protagonists are the last to be hit, because the lake draws from its edges,” says Tauil & Chequer’s Tauil. “Those at the periphery lost clients,” he says.

Betting on somewhere else or cutting costs and waiting for better times has been the norm for Rio’s legal market in the past few years. One exception was Mattos Filho. Now celebrating 20 years since it inaugurated its office in Rio, the firm has positioned itself among the larger players there (it has 95 lawyers in the city, of which 14 are partners).

Much of its powering up occurred in the last five years: the number of lawyers in the Rio office shot up by a massive 75% in that period. Mattos Filho, which traditionally used its Rio office as a hub for infra­structure, oil and gas, and electricity work, also created dedicated teams for insurance, intellectual property, labour and environment, services that it had previously reserved for São Paulo. The firm says taking a long-term view is at the core of its strategy, which explains why it decided to invest in Rio during both good and bad times.

The calm after the storm?

Recent developments have given some reason to be more optimistic about Rio’s trajectory. In 2016, legislators released Petrobras from the burden of being the sole controller of pre-salt fields. They also made strict local content rules more flexible (the rules had been intended to develop the national industry but ultimately delayed and increased the costs of the exploration of pre-salt oil).

As a result, international companies have increased their participation in concessions. The most recent auction upon going to press was held in September and saw companies such as ExxonMobil, Shell and Chevron snap up the majority of oil blocks on offer.

The knock-on effect such investments will have on Rio’s economy might take some time to materialise, but they represent an important sign that companies are willing to plug capital into Rio. “The fact that companies invested in concessions is a really good indicator,” says Mattos Filho partner Giovani Loss. “This will put Rio’s economy back together again.” The pre-salt is expected to attract 320 billion reais (US$85 billion) in investment, making Brazil one of the world’s largest oil producers. “This will change the world’s geopolitics and take Rio’s economy to another level,” says Pinheiro Neto Advogados partner Marcelo Viveiros.

Part of the attraction of Rio’s oil industry lies in the fact that, since 2016, oil prices have gone up. As a result Petrobras is beginning to reap the benefits of some of the investments it still holds in the pre-salt. The company’s production there has been increasing steadily.

Petrobras now operates under revamped governance – which it adopted in response to Operation Car Wash – and has settled corruption charges and doubled down on compliance and efficiency. The divestment programme has reduced Petrobras’ debts, allowing the company to focus more on production and exploration, which are its main areas of revenue.

Several law firms – such as Machado Meyer, Demarest Advogados and BMA – that were not traditionally the first port of call for oil clients are manoeuvring to get a piece of the pie. “We are watching develop­ments with optimism and international players are watching even more closely,” says Demarest’s João Almeida, whose firm represented a Qatari company in September’s pre-salt areas auction.

After so much dismay, locals are eager to put the past behind them, but many are cautious about whether Rio’s return to form will be sustainable. For a start, the state remains over-reliant on the oil industry and lack of diversification has hurt it in the past. “Rio needs to use the revenue from the oil industry to strengthen other sectors of its economy,” urges Schmidt Valois partner Paulo Valois. “This is something the state failed to do during the boom years.”

In 2017, Rio introduced an economic recovery plan, combining cuts in public spending and measures to increase govern­ment revenues, such as privatisations, concessions and cuts in tax discounts. Some see this as a roadmap that presents the best – and perhaps the only – way to drive Rio out of the swamp. They feel that, if the public administration is able to put its finances back into good shape, Rio has the capability to bounce back. Following presidential and state elections in October, many think Rio now has the opportunity for a restart. “The commitment to achieve fiscal balance, the projected growth of the infrastructure sector in line with the policies of the new president and the increase in the participation of international players in the oil sector are pointing to a change in fortunes,” says Mattos Filho’s Pablo Sorj. While it is far from certain yet that President Jair Bolsonaro will be able to deliver the package of liberal economic policies he promised during his campaign, he has attracted the support of many in Brazil’s business community. (Wilson Witzel, who will become Rio’s governor in January, is an even greater enigma; virtually unknown before the elections, he emerged weeks before polling day and swept to victory on the back of Bolsonaro’s support.)

The state government has a difficult task ahead; following a polarised election, it is likely to face fierce opposition. Meanwhile, in November federal police entered the state government’s headquarters and arrested incumbent governor Luiz Fernando Pezão. He is accused of receiving bribes while deputy governor, which he denies. It meant that in the last few days of 2018, Rio faced an all too familiar scenario, one that is mired in political instability and the incriminations of those in power.

‘Continua lindo’

When planes approaching Rio tilt sideways on the descent to Santos Dumont airport, and travellers get a view of the cidade ­maravilhosa’s unique landscape, it is hard to disagree with Gil. Rio’s beauty is overwhelming. But, as locals know only too well, Rio does not handle storms well. When it rains, the streets quickly become flooded and the hills are prone to tragic mudslides that sweep away everything in their path. With no storm, the sun shines intensely. Perhaps too much. So that it may, as Chico Buarque – another respected Brazilian composer – writes, “blur your vision and your reason”. Witnesses to the unsustainable extravaganza that preceded the crisis will know that feeling all too well.

Those contemplating a brighter future on the horizon are pinning their hopes on the resurgence of Rio’s oil industry. But if a new period of growth is to be sustainable, Rio will need much more reliable governance from those who manage and drive its economy than it has had in recent years. Only by drawing a line under the mistakes of the past will Rio’s allure remain intact, come rain or shine.