Recent years have seen a surge of merger and acquisition (M&A) activity in Brazil as the result of a positive macroeconomic and social outlook, and political stability. Foreign investors have participated intensively in this activity, and new ones appear daily who want to start new operations or acquire existing businesses.
Although the country is very friendly to foreign investment, newcomers should pay attention to two preliminary issues when considering whether to make an acquisition in Brazil. The first is whether the relevant sector has any restrictions on foreign ownership. Health services, rural land, financial institutions, air carriers, publishing and television all carry some form of restriction.
The second consideration is whether the sector is heavily influenced by government policies that may have an effect on future cash flow. Energy, education and health are examples of such sectors.
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Some industries are operated via government concessions, and the terms of such agreements are germane to an accurate evaluation of the business and an appropriate structure for the M&A transaction. Concession agreements typically require the consent of the applicable government authority before any transfer of control can occur.
Once these preliminary issues have been settled and the main business conditions of the acquisition have been agreed with the seller in a letter of intent, it is time to start a legal and accounting due diligence of the target.
Conducting due diligence
Key areas in a due diligence effort in Brazil can vary widely depending on the industry involved. Nevertheless, almost all industries are sensitive to certain factors, such as employment. Labour costs are considerably higher than in many other jurisdictions, due to the many employment benefits imposed by law. As a result, many companies either simply do not follow the rules or create alternative structures to reduce costs. In either case, such practices usually result in significant contingencies for the company.
Another key area of concern is taxation. The Brazilian tax system is very complex and burdensome. Brazil is a federation and its member states have great autonomy in regulating important policy areas, including taxes. Many companies fail to pay the proper taxes, either because it is not clear which taxes are due or because the business would not be profitable if all the taxes were paid.
The related issue of tax benefits is also significant. It is not uncommon for individual states to give certain benefits to companies in order to attract their business, sometimes to the detriment of other states. Therefore, when considering the acquisition of a target that holds a tax benefit, one should review it carefully in order to evaluate whether the benefit could be easily revoked, or whether other states will question its validity in court.
Environmental factors, depending on the industry – mining, oil and gas, ports, and heavy industries, for example – may be highly significant as well. Brazil has strict legislation that imposes a high standard of responsibility and severe penalties, but it is still common to find companies that do not comply.
Environmental permits are a related factor. In some industries, such as ports, and some locations there is still some dispute about whether the federal or the state government is responsible for granting permits. Therefore, ensuring that the target has the proper environmental permits is crucial.
Other important areas in due diligence are: corporate (especially if the target is a publicly listed company, in which case minority shareholder rights should be considered); intellectual property; real estate; and contracts.
When conducting due diligence, one must consider that the various contingencies may have different statutes of limitations and that contractual limitation, or allocation of responsibilities for such contingencies, may be valid only between the parties, rather than imposed before the government authorities. It is thus common to agree with the seller on some form of guarantee or collateral, if the seller is assuming responsibility for past contingencies.
Structuring the deal
Once this step has been concluded, it is time to consider the best structure for the transaction. The location of the acquisition vehicle will be affected by a series of factors, especially for tax reasons, so determining whether a tax treaty is in effect between Brazil and the country of the acquirer is pertinent. Depending on accounting and tax issues, the purchaser might pursue an asset or a stock acquisition, and will decide whether to buy all or a portion of the business.
It is also important to consider antitrust issues. Regulation in Brazil has changed recently and if the transaction needs to be submitted to the antitrust authorities, such approval must now be obtained before the transaction is closed.
The investment will need to be registered with the Brazilian Central Bank. The foreign shareholder should be registered with the Brazilian tax authorities and should also grant a power of attorney to a representative resident in Brazil. If the target is a publicly listed company, it may also be necessary to register with the Brazilian Securities Commission.
Drafting the documents
Once these issues have been determined, it is time to draft the proper documents. The stock purchase agreement will normally establish the conditions for payment of the purchase price, the prerequisite conditions for closing, representations and warranties from the seller and the purchaser, indemnification provisions, confidentiality and non-compete obligations, and the dispute resolution mechanism.
The purchase agreement may be governed by Brazilian or other foreign law, and it is advisable to elect arbitration as the dispute resolution mechanism. Such arbitration may take place in or outside of Brazil, but arbitrations conducted outside the country need to be homologated by the Superior Court of Justice in Brazil before they can be enforced against the seller, a process that can be time consuming.
If the purchaser is not acquiring 100% of the target, a shareholder agreement regulating the governance of the company is recommended. Once those agreements are negotiated, the final corporate documents are signed reflecting the transfer of ownership.
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Carlos Alexandre Lobo is a partner at Veirano Advogados. He can be contacted at +55 21 3824 4747 or by email at carlos.lobo@veirano.com.br
