In effect since July 1, Normative Instruction No. 81/20, published by the Brazilian Department of Company Registration and Integration (DREI), of the Ministry of Economy, repeals various previous normative instructions with the purpose of consolidating the rules relating to the public registration of companies and bringing in some innovations in the wake of Law No. 13,874/19 (the Economic Freedom Law).

Among the rules repealed is Normative Instruction No. 35/17, which contained provisions on "(...) acts of transformation, incorporation, merger and spin-off involving businessmen, companies, as well as the conversion of a simple company into a business company and vice-versa" and, in its article 30, it categorically mentioned that "the conversion of a business company into a non-profit company and vice-versa is prohibited".

The prohibition presented by IN 35 was based on the understanding that the legal framework of business companies was incompatible with the legal framework for non-profit associations, which cannot distribute profits and assets to their members. In such a situation, therefore, the association should be dissolved and a new business company set up. This is because according to article 61 of the Civil Code, in the event of dissolution of an association, the remainder of its net equity shall be allocated to the non-economic entity designated in the bylaws or to the municipal, state, or federal institution with identical or similar purposes. Transforming the association into a business company would mean creating a possibility of returning assets to the partners.

It was also argued that article 1,113[1] of the Civil Code would not apply to non-profit companies since it is included in the Special Part of the Civil Code, which refers to companies, and not in its General Part, which would apply to legal entities in general.

However, IN 81, in its Chapter V, called “Conversion of a partnership (sociedade simples) or association into a business company (sociedade empresária) and vice-versa", with a structure quite similar to Chapter V of IN 35, removed the prohibition on converting a non-profit company into a business company provided for in IN 35 and dealt, in its article 84, with the filing of an instrument of conversion of a partnership or association into an business company.

Under the terms of this article, the instrument of conversion must initially be registered with the Civil Registry in which the partnership or association is registered, and later, together with the amendment and restatement of the organizational documents of the respective corporate type, it shall be submitted for filing with the commercial registry of the same state of the federation or a different one. If the new corporate type is a corporation, the complete list of shareholders must be presented, with an indication of the number of shares resulting from the conversion, since such information would only appear in the corporate books, not in the bylaws (in the case of a limited liability company, the information on quotaholders is part of the articles of association).

From an analysis of the new regulations, it is clear that there has been a fundamental change in the position of the DREI regarding the change in the form of a legal entity from an association (or from a non-profit company type) to a business company.

In dealing with the change in the form of a legal entity as a "conversion" and not as a "transformation", it seems to us that the DREI sought to avoid discussion on the possibility of applying the institute of "transformation" to legal entities other than companies, focusing only on the possibility that a non-profit entity may become, through a simple formal act of registration, a for-profit entity.

Thus, IN 81, in its article 74, established that, after registration with the Civil Registry, the instrument of conversion of a partnership or association into a business company shall be filed with the commercial board of the headquarters, accompanied by the amendment and restatement of the organizational documents of the respective corporate type.

Thus, even though the conversion of a legal entity from an association into a business company has been accepted by the DREI from the standpoint of public registration, there are still controversies regarding its legal possibility, and some practical difficulties of an accounting and tax nature need to be faced.

For example, there are no legal parameters for the formation of the capital stock of the company, with the definition of the number and equity value of the quotas or shares newly issued, having an impact on equity accounts. Some associations have securities representing ideal fractions of their assets, corresponding to the contributions made by the members, so-called "equity securities", which would allow for a smooth transition from the association's equity accounts to the business company due to their similarity with the concept of quotas/shares and capital stock. Other associations, however, have no equity securities and so it will be impossible to determine the number of quotas or shares to be assigned to each member of the association.

In the demutualization process of the São Paulo Stock Exchange (Bovespa) and the Futures and Commodities Exchange (BM&F), such associations had equity securities representing their assets, held by the then associates, securities, and commodities and futures brokers. Demutualization was not implemented through transformation, but through the spin-off of associations and merger of the net assets into new companies. Each member received shares issued by such companies in the proportion and value of the equity securities they held in the associations.

Thus, if there are equity securities, the adequacy of the equity accounts as a result of their conversion into a business company would be feasible in proportion to the equity securities of the members, and the value of the capital stock of the company would correspond to the value of the equity of the association.

In the event that the association does not have net equity, it would be necessary for the members to subscribe, in the desired proportion, new quotas/shares for formation of capital stock (as in the incorporation of a company) to be paid up in accordance with the rules established in the subscription instrument.

[1] “Article 1,113. The act of transformation is independent of the winding up or liquidation of the company, and will obey the guiding principles themselves of the constitution and registration of the entity type into which it will be converted."