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The Brazilian New Legal Framework for Basic Sanitation that was introduced by Law No. 14.026/2020, published on July 16, 2020 in the Federal Official Gazette (“DOU”), has as some of its relevant provisions the extinction of the so-called “program agreements”/contratos de programa (celebrated without the prior observation of the due bidding process) and the mandatory provision of performance targets and universalization of services in the agreements that must meet the requirements of proof of the economic and financial capacity of public service providers of water supply or sanitary sewage.

The methodology that must be followed to prove the economic-financial capacity mentioned herein was regulated by Decree No. 10.710/2021, published in the DOU on the 1st of June, 2021, consisting of two successive phases that shall involve the presentation of documents and information for approval by the competent regulatory authorities until December 31^st, 2021. The first phase will function as a screening, approval in such stage is mandatory in order for the company to participate in the second phase. The deadline for completion of the process of proof of economic and financial capacity, including any decisions regarding administrative appeals, is March 31^st, 2022.

In the first phase, the consolidated financial statements of the economic group to which each provider belongs, duly audited and referring to the last 5 (five) required financial years, shall be analyzed in order to determine compliance with the minimum reference indexes of the financial indicators, defined in said Decree such as (i) net margin ratio without depreciation and amortization above zero; (ii) indebtedness index less than or equal to one; (iii) return on equity ratio greater than zero; and (iv) cash sufficiency ratio greater than one.

In the second phase, feasibility studies will be presented, which should demonstrate the estimated investment necessary to reach the universalization targets for a regular contract in force for water supply or sanitary sewage, as well as global investment reflecting the universalization targets. For approval in the second phase, the compatibility of all documents presented will be analyzed, in addition to the necessary proof, based on the presentation of feasibility studies, of a global cash flow with a net present value equal to or greater than zero.

The regulatory entities shall issue supporting decisions regarding the proof or lack of proof regarding the economic and financial capacity of the service provider, and the conclusions indicated in the reports, studies and other documents presented by the service providers does not necessarily bind the regulatory entities, which may, therefore, base their conclusions on other documents and information to which they may have access.

In relation to providers that are not successful in proving their economic and financial capacity, under the terms of the Decree herein studied: (i) the so called program agreements which establish the conditions for the provision of public water supply or sanitary sewage services will be considered irregular, therefore, such services will not be allowed to continue to be provided under such agreements; and (ii) the necessary additional amendments for inclusion of the goals of universalization of services, mentioned at the beginning of this article, will not be able to be executed, thus preventing the maintenance of the provision of services.

With such regulation came the divided positions of the public and private sector. State-owned companies that provide services of water supply or sanitary sewage based on “program agreements” can be perceived as the main affected and, although access to the Judiciary Power has not yet been verified, the discontent of these companies is known, mainly, with the deadline for submitting the documentation to the regulatory authorities ending in December 2021 and with the impossibility of extending the program agreements in force as a means of proving the required economic-financial capacity.

The perception has been that the aforementioned regulation is an expression of the Brazilian Federal Government intention to privatize this kind of service and considers as a premise that the requirement of economic and financial proof will screen which state-owned companies will be able to remain in the quality of water supply or sanitary sewage providers and which ones will lose these contracts, and for some companies the latter shall result in privatization.