Are you a business owner in the real estate sector, involved with construction companies, land developers, and various SPEs (Special Purpose Entities) across different cities and states? Or perhaps you manage your companies through a holding company, seeking strategic and tax planning? While these structures offer many advantages, they can also present significant risks if not managed properly. The biggest risk is the characterization of an economic group, which can lead to joint liability among your companies.
In this article, we’ll explain how SPEs (Special Purpose Entities) work, the role of holding companies, and how you can protect your businesses from being improperly classified as part of an economic group. Learn how to maintain the legal and financial independence of your companies and prevent your assets from being compromised.
What Is an Economic Group and What Are the Risks?
An economic group is characterized when there is control, direction, or coordination between two or more companies. According to the Consolidation of Labor Laws (CLT) in Brazil, when companies are seen as part of an economic group, they can be jointly liable for each other's obligations, such as labor, tax, or civil debts. This means that one company can be held responsible for paying another company's debts, which can jeopardize your entire asset base.
The main criteria that can lead to the classification of an economic group include:
Common Control: When one person or entity has control over multiple companies.
Asset Confusion: When there is a mixing of assets, accounts, or management between the companies.
Operational Coordination: When companies operate as if they are a single entity, sharing resources, employees, or common structures.
The consequence of being considered an economic group is serious: joint liability. This means that if one company incurs a debt, all other companies in the group can be called upon to settle it.
SPEs and Real Estate Partnerships – Avoiding Cross-Contamination Between Companies
SPEs (Special Purpose Entities) are a common structure in the real estate sector, used to isolate high-risk projects such as land developments or specific ventures. The goal of an SPE is to limit the risk to that particular project, ensuring that a failure in one SPE does not affect the assets or other companies within the same group.
However, risks remain. If an SPE shares resources or management with other companies, or if there are cross-guarantees between the SPEs and other companies, this could lead to the characterization of an economic group. Here are best practices to protect your SPEs and ensure the independence of each one:
Independent Management: Each SPE should have its own management and should not rely on the administration of a construction or land development company. This ensures that operational decisions are made within the SPE and not by a centralized command.
Strict Accounting Separation: SPEs must maintain entirely separate accounting from other companies. Any transactions between them should be formalized with appropriate contracts.
Avoid Cross-Guarantees: Never use one SPE’s assets to guarantee another company’s or SPE’s debts. This is one of the main factors that can lead to asset confusion.
Service Contracts: If the construction or development company provides services to the SPE, these services must be formalized with clear contracts, stipulating values and deadlines.
Holdings – How to Centralize Control Without Creating an Economic Group
Creating a holding company to manage construction companies, developers, and SPEs can be a great strategy for tax and succession planning. The holding company allows for centralized administration while optimizing financial management. However, when there is no clear separation between the holding company and its subsidiaries, there is a risk of being classified as an economic group.
To prevent the holding company from compromising the autonomy of your businesses, it is important to follow certain governance rules:
Separate Accounting and Management: Although the holding company is the controller, each subsidiary should have its own accounting and operational management. The holding company should not directly interfere in the daily operations of its subsidiaries.
Autonomy in Operational Decisions: Even though the holding company may centralize strategic decisions, each subsidiary must be autonomous in its day-to-day operations. This includes having its own directors and making decisions specific to the subsidiary’s business.
Avoid Asset Confusion: The holding company should not mix its assets and resources with those of its subsidiaries. Any resource transfers between the holding company and its subsidiaries should be formalized through loan agreements, with all terms specified.
Debt Guarantees: The holding company and its subsidiaries should not be involved in guaranteeing each other’s debts. Each company must be responsible for securing its own financial obligations.
General Precautions to Avoid Economic Group Characterization
To ensure that your businesses and SPEs operate independently and are not characterized as an economic group, it is essential to adopt sound governance practices and maintain asset separation.
Here are some additional tips:
Formalize Everything: Any relationship between the companies in your group (whether it be a service provision, loan, or any financial transaction) should be formalized through clear and transparent contracts.
Separate Operational from Strategic Management: While the holding company can make strategic decisions, the operational management of each company should be individualized.
Regular Audits: Conduct periodic audits to ensure that there is no asset or financial confusion between the controlled companies.
Preventive Legal Consultancy: Work with specialized lawyers to review contracts and governance practices, ensuring that your companies comply with the law and avoid the risk of being classified as an economic group.
Conclusion
Companies that use SPEs and holding companies as part of their business strategies in the real estate sector must adopt rigorous governance and management practices to avoid being improperly classified as an economic group. The key to protecting your assets is ensuring accounting, operational, and asset separation between companies, avoiding cross-guarantees and excessive centralization of decisions.
With the right practices, it is possible to maximize the benefits of these structures while minimizing legal risks. Keep following our blog for more tips on business management and asset protection.
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