Wednesday, 3 September 2008

One Unenforceable Contract a Day Keeps Investors Away:

Problems in enforcing contracts in Brazil

In the book of Enoch (2: para.23), God affirmed: “My Word is My Deed.” In an ideal world, human beings would be as honest and integral as God and there would be no need for contracts: everyone would take the other’s Word as a solid and reliable guarantee of performance. But once we walk through the inflamed gates of the commercial world, contractual arrangements form the status quo. As a growing economic powerhouse, Brazil really ought to consider reforming some aspects of its Contract Laws. The current contractual system in Brazil may repel investors and send the wrong message to the international financial community.

Efficient contract enforcement encourages businesses to engage with new customers and new markets. Yet in Brazil most courts are slow, inefficient, unpredictable and even corrupt. It is also unfortunate that most courts have little experience with commercial cases. Arbitration is supposed to expedite contract enforcement. However, because companies have traditionally been unwilling to use arbitration, firms go to court to force the other party into arbitration. Arguably this step defeats the purpose of arbitration, which is to avoid going to court in the first place.

Trials can last for years; multiple appeals are common—increasing costs and uncertainty (in Brazil, 88% of commercial cases are appealed, in Argentina 13%, Peru 17%, and in Mexico 30% - World Bank 2007 figures). Recent changes in the Code of Civil Procedure set time limits on appeals and eliminate the suspension of the court process when the judicial decision is appealed before the judgment in order to introduce new evidence or call on experts (interlocutory appeals).

The Supreme Court in Brazil handles more than 100,000 cases a year versus approximately 200 cases handled by its counterpart in the United States and frequently, judicial decisions are perceived to be pro-debtor.

Whereas US courts tend to validate “choice of law” clauses, Brazilian courts tend to favour Brazilian Law. Clearly, such a paternalistic stance undermines contractual flexibility and is arguably “anti-market” in nature. This damages the country’s international commercial appeal by increasing what economist Ronald Coase calls “transaction costs” – which are those costs incurred in the negotiation process.

Thus, as part of a larger reform package, it would probably be a good idea to set up specialized commercial courts in Brazil. Specialized courts are associated with faster and cheaper contract enforcement in industrialized and middle income countries. One reason is that judges become experts in handling commercial disputes. In addition, commercial courts often require less formal procedures resulting in faster trials. Businesses that have little or no access to efficient courts must rely on other mechanisms—both formal and informal, such as trade associations, social networks, credit bureaus or private information channels—to decide with whom to do business and under what conditions. Businesses may also adopt conservative business practices and deal only with a small group of people linked through kinship, ethnic origin, or previous dealings. Transactions are then structured to forestall disputes. Whichever alternative is chosen, economic and social value may be lost. The main reason to regulate procedures in commercial dispute resolution is that informal justice is vulnerable to subversion by the rich and powerful. But heavy regulation of dispute resolution has negative consequences. Across the region, the more complex the procedures, the longer the delays and the higher the cost to enforce a contract. Less wealth is created and bearing that in mind less people around the world will be interested in investing in Brazil.


CKennedy said...

I have recently been involved in a contractual dispute in Brazil and I agree with the author: the Brazilian contractual system is good but could be better - and speedier!

Flynn Jenson said...

I think the overall views of the author are very intelligent, thank you for your insight sir.