This country-specific Q&A gives an overview of mergers and acquisition law, the transaction environment and process as well as any special situations that may occur in Brazil.
It also covers market sectors, regulatory authorities, due diligence, deal protection, public disclosure, governing law, director duties and key influencing factors influencing M&A activity over the next two years.
This Q&A is part of the global guide to Mergers & Acquisitions. For a full list of jurisdictional Mergers & Acquisitions Q&As visit http://www.inhouselawyer.co.uk/index.php/practice-areas/mergers-acquisitions/
What are the key rules/laws relevant to M&A and who are the key regulatory authorities?
Any Brazilian M&A Agreement is subject to civil law. The Civil Code (Law No. 10.406/01) is hence the key M&A law applicable in the country (the “Brazilian Civil Code”). The Brazilian corporation law (Law No. 6.404/76) is also of key importance (the “Brazilian Corporation Law”) and applies in most of the agreements of the country, as sizeable and relevant M&A involve corporations in the large majority of cases. A combination of skills related to the interpretation and the application of the Brazilian Civil Code and the Brazilian Corporations Law is thus indispensable for a Brazilian M&A lawyer.
M&A involving publicly held companies (which in Brazil may be listed (traded) or not) requires knowledge about the capital markets law (Law No. 6385/76) and the regulations issued by the Brazilian securities and exchange commission (Comissão de Valores Mobiliários - “CVM”). As in any relatively developed capital markets, in Brazil there are several types and layers of regulation issued by the CVM that may be applicable depending on the structure of the deal. The instructions that affect the majority of the deals of listed companies, however, are those applicable to the disclosure of relevant acts or facts to the market (CVM Instruction No. 358/02) and the several different types of mandatory tender offers which may result from M&A transactions (CVM Instruction No. 361/02).
The Brazilian Central Bank (Banco Central do Brasil - “BCB”) is the most important regulatory authority for cross-border M&A, essentially because its regulations apply to all. Although there is no direct personal interaction between the parties of an M&A transaction with BCB officials, it is very important that they have in mind the requirements related to the registration of foreign capital in Brazil. To make a long story short, with very few exceptions there is not prior approval for the investment in Brazil, but all monies invested in the market must be registered through the central bank electronic registration system (which is a simple and straightforward procedure). There are several types of registration. An investment may be subject to higher capital gains taxes depending on the type of registration at the time of investment, conversion and disinvestment.
Finally, the Brazilian antitrust authority (“CADE”) is obviously key in an M&A involving concentration. A few years ago the Brazilian antitrust clearance system moved from post-deal to pre-deal, so it is now very important in a Brazilian M&A to be familiar with the CADE precedents both because this authority is very strict in blocking undue concentration (last year alone the a large merger in the oil distribution market and another in the education sector were blocked) and to build a contract that at the same time preserves the value of the merged company after signing and until closing and is in line with regulations.
What is the current state of the market?
There were different trends. Big ticket M&A lived off very large fire sales from companies involved in the lava-jato scandal. Out of companies and pockets of activity caused the spike. Big deals had to be closed in record time, and there was a flight to quality. This is phenomena, however, is restricted to the traditional market heavy hitters who hold the relationships and have the profile necessary to capture the work. The good news is that this depression is currently being reverted, and the M&A market in general is likely to pick-up. Other aspects worth mentioning are the Brazilian market credit constrain – BNDES and other public banks no longer have the same ability to finance Companies at the same level and prices of the past. Such lack of liquidity may put the Brazilian capital markets and private equity firms as major sources of finance to publicly held and middle market companies, respectively. In addition, the Brazilian assets are still undervalued (i.e. the market believes there is sufficient room to increase the current the stock exchange level from 84,000 points to 100,000 points), which should have a positive impact on the opportunities for the private equity industry.
Which market sectors have been particularly active recently?
Infrastructure is, by far, the sector where most of the activity is happening because of the combination of several different factors. The car wash corruption scandal (which affected most - if not all - the major Brazilian infrastructure conglomerates) dried the debt and equity capital markets for those involved in a time where the backlog of projects - and hence funding - was huge. That forced the market to turn to the next best way to access funding - M&A.
The hospital industry is also worth noticing as a safe bet. The recent lifting of the restrictions to foreign investors in equity is attracting foreigners to implement acquisitions in the country. Other industries that had also noted an intense M&A activity are the following: insurance, ports and education industries.
What do you believe will be the three most significant factors influencing M&A activity over the next 2 years?
The potential economic recovery of the country is the first one, without the shadow of a doubt. The very same crisis that held business and deals back in the last couple of years is likely to cause a spike of activity in the next 2 years. The deals that did not occur in the recent past will occur, and the deals that were supposed to occur will not be held back. It is double the regular activity and it could spread through the entire economy. In the infrastructure industry we will continue to notice the effects of the Car Wash. Access to fresh cash is like oxygen to large infrastructure groups and such access is only possible these days through M&A. Another factor that may influence the M&A activities is the presidential election which may result in the adoption of a liberal agenda which is likely to strengthen deal activity. As the government retreats from intervention there is privatization and all the activity that it causes, sale of participation in very important segments of the economy -, as well as a general confidence that this type of environment creates.
What are the key means of effecting the acquisition of a publicly traded company?
From a technical and literal perspectives there are very few actual mergers (or amalgamations - defined as the merger of two companies to create a new one) in Brazil. Tax issues usually prevent this from happening, as the tax loss carry forwards of both companies involved may be lost, which is a relevant impact. Companies usually combine their activities by merging another company or being merged in another company. This is valid both for listed and non-listed companies. In very particular cases, however, amalgamations have occurred. Such amalgamations were driven by capital market issues, and target at neutralizing poison pills, shark repellents, etc. In a nutshell, amalgamations may neutralize poison pills because the CVM understood in some cases in the past that poison pills may not apply as a result of amalgamations because there is a new company arising from such type of corporate restructuring (and hence the old bylaws which contain the poison pills do not apply). Finally, it is extremely important to consider the provisions of CVM’s opinion No. 35 (parecer de orientação CVM No. 35) when considering a merger between related parties. Special rules apply in this case, such as the formation of special committees of the board must be formed to consider the appraisal of the companies being merged. A merger between related parties in Brazil can get very complicated.
What information relating to a target company will be publicly available and to what extent is a target company obliged to disclose diligence related information to a potential acquirer?
Brazilian listed companies must disclose periodic and non-periodic information. Both are disclosed through electronic systems by the CVM and the local stock exchange (BMFBovespa). The most important periodic information are of course the financial statements. However, Brazilian companies are also obliged to disclosed and regularly update a standard form, called FR (formulário de referência), which is similar to the US 20-F. The bylaws and minutes of shareholders’ meetings and board of director’s meetings are also available to the general public. Non-periodic information is disclosed to material facts, which are essentially notices to the general publics about facts, acts or omissions of the management and/or affecting the business of the company that may influence the decision of shareholders to buy, sell or maintain shares of the company. A pretty satisfactory due diligence may be implemented through these documents. Truth is, however, that M&As in Brazil usually include and required a deeper level of scrutiny. Buyers, sellers and sometimes the target company hence usually execute NDAs and set up data rooms with information which is not generally available in the context of the negotiations.
To what level of detail is due diligence customarily undertaken?
Due diligence exercises in sophisticated M&A in Brazil is usually very deep and detailed, even in the case of listed companies. It involves at the very least legal, financial and accounting specialists, plus specialists in the industry where the target operates. Due diligence usually starts immediately after the execution of an NDA, which in some cases is coupled with an exclusivity agreement, and lasts until the very last day before the execution of the definitive agreements.
What are the key decision-making organs of a target company and what approval rights do shareholders have?
Unlike in the US and in the UK, Brazilian companies and corporations usually have a very clear and visible controlling shareholders. So, as far as “pure” M&A deals are concerned (e.g., those involving a disposal of control or a relevant part of the capital stock by a controlling or a relevant shareholder), the approval rights of shareholders are very limited. Brazilian regulation however establishes mandatory tender offers (“MTO”) which are triggered in several cases, the most visible and important of which is the MTO caused by a disposal of the controlling stake of a listed company. In this case, minority shareholders would be entitled to sell their shares to the new controlling shareholder for at least 80% of the value paid to the party disposing of the controlling stake (this percentage however usually moves all the way up to 100%, depending on the corporate governance level where the company is listed at the local stock exchange). Also, several bylaws contain poison pills which push the value of an M&A up by increasing the cost of acquisition of control to a new buyer.
What are the duties of the directors and controlling shareholders of a target company?
Directors are responsible for the company implementing its business purposes and exercising its powers. Unlike other jurisdictions, in Brazil the directors' responsibility is primarily to the company (as opposed to responsibility before the shareholder who appointed him/her), but responsibility may also be owed to co-directors, employees and creditors of the company. Directors' duties broadly comprise the general duties of directors set out in the Brazilian Corporation Law, fiduciary duties, and other statutory duties. Any or all of these may be relevant to a particular situation, but the most important are the duty of care, duty of loyalty, duty of abstention in the event of a conflict of interest and duties of confidentiality and information, as applicable. The most important are, of course, the duty of care and the duty of loyalty. In a nutshell, the duty of care requires that directors, prior to making a business decision, get informed of all reasonably available material information and consider alternatives (business judgment rule). Directors are also required to perform their duties diligently, keep themselves informed about the company's affairs and, with their co-directors, supervise and control such affairs. Overall, this responsibility cannot be delegated to any party. However, this does not prevent directors from relying on the experience and expertise of their colleagues. Directors must perform their duties in the best interests of the company and keep its affairs confidential (duty of confidentiality) - section 155 of the Brazilian Corporations Law. The duty of loyalty requires that directors act to protect the interests of the company and refrain from activities that would harm or disadvantage the company and its shareholders. This duty also imposes a duty of disclosure where failure to disclose could put the corporation or its shareholders in disadvantage. The duty of loyalty is implicated when a conflict arises between a director’s duty and his self-interest.
Do employees/other stakeholders have any specific approval, consultation or other rights?
Not usually. Some corporations (mostly those on which the government holds a relevant equity stake) allocate one of the board seats to employees, but this is as far as the employees influence in M&A deals.
To what degree is conditionality an accepted market feature on acquisitions?
Conditionality exists and is usually acceptable both by the regulators and the market in general. It is common, for example, that voluntary tender offers in Brazil are conditional upon the reaching of certain thresholds. Of course one needs to examine on a case-by-case basis to ensure that the conditions are acceptable from a regulatory and legal perspectives, but they usually are. Having said that, there was a spike in sophisticated deals (and hence in sophisticated structures, including those conditional, from 2007 through 2012). Truth to be said, the market went on a halt after that and very few sophisticated deals went through.
What steps can an acquirer of a target company take to secure deal exclusivity?
Exclusivity in Brazil is contractual. Therefore, obtaining the exclusivity depends on the leverage of the buyer during the acquisition process. Competitive M&A transactions in Brazil occur as in any other developed market worldwide. There is a stage where multiple potential buyers present non-binding offers. Only a handful - or one - make it to the second round. This is the stage where exclusivity is usually sought. The trick when exclusivity is obtained is to make it enforceable. It has to cover the seller and its economic group, as well as service providers. On top of that, Brazilians frequently establish compensatory fines in exclusivity agreements at a high value to ensure enforceability and, on the other hand, to avoid pointless and lengthy discussions on the damage caused by the breach of exclusivity provisions. The reverse side of this strategy is allowing the seller to “trade” on the exclusivity, since it has a clear value. However, this is almost never the case, as the values tend to be considerable. Several sellers, however, because of cultural issues, tend not to agree on fines. In a nutshell, exclusivity is a very complicated issue in Brazil, specifically when the market is on the rise.
What other deal protection and costs coverage mechanisms are most frequently used by acquirers?
Confidentiality, of course, but a noticeable change in the last couple of years has been the acceptance by certain sellers to underwrite due diligence and advisory costs of the potential buyers in deals where the assets are less attractive. There are several different models and variations, but the general concept is that the seller accepts to pay - or reimburse - the buyer if the deal does not close.
Which forms of consideration are most commonly used?
Cash, although some companies started to use equity as part of the consideration or in the context of contingent payments, ratchets or guaranteed IRRs. These alternative methods however highly depend on the reliability of the scrutiny of the listed companies. I believe that as the country and its capital markets develop one will more and more see that happening.
At what ownership levels by an acquirer is public disclosure required (whether acquiring a target company as a whole or a minority stake)?
The general concept is that any material information has to be disclosed, which are defined as information related to acts, facts or omissions of the target that can affect (i) the market price of the target’s securities or other securities backed by them; (ii) investors’ decisions to buy, sell, or preserve those securities; and (iii) investors’ decision to exercise any rights arising from the target’s securities or other securities backed on them. There are several different approaches to this rule, the most common of which is the disclosure at the time of execution of the definitive binding agreements. However, some more conservative players disclose the material information related to M&A deals at an earlier stage - for example, at the time of the receipt of proposals or execution of exclusivity agreements. The golden rules, of course, is that one must disclose the material information once there is a leak or a potential leak into the market.
At what stage of negotiation is public disclosure required or customary?
Usually no disclosure is required until there is a binding offer. However, any fact that may affect the trading price of the shares must be immediately disclosed to the market which can easily be the case of any M&A involving any listed company. Hence, if the negotiation leaks, the parties may have to inform the market the status of the negotiation at a very early stage and even before a binding offer exists.
Is there any maximum time period for negotiations or due diligence?
Are there any circumstances where a minimum price may be set for the shares in a target company?
There are some provisions in bylaws of companies - which are generally incorrectly called “poison pills” in the Brazilian market - that force a potential buyer to calculate the price to be paid to the minority shareholders according to certain formulae that lifts the price up. There are also rules related to mandatory tender offers that apply.
Is it possible for target companies to provide financial assistance?
Although there are no restrictions for a company to financial assistance, companies usually do not perform such activities, as there can be negative consequences in such case. This is because the shareholders and the management of the company may be held personally liable, as per Brazilian law, for acts that are not in the best interest of the companies (in the case of the managers, for abuse of controlling shareholder rights).
Which governing law is customarily used on acquisitions?
Brazilian law is used in almost 100% of the deals. Having said that, it is possible to use foreign law in Brazil. The foreign law most frequently used is New York’s. The trick in these cases in Brazil is to agree on arbitration with a venue in the country. For technical reasons this makes the issuance of the arbitration award and its enforcement faster, as it does not need to go through a validation procedure at the Brazilian superior court (the country is not a signatory of international conventions that make the enforcement or arbitration award issued outside the territory automatic).
What public-facing documentation must a buyer produce in connection with the acquisition of a listed company?
In the non-solicited acquisition of Brazilian listed companies which, as mentioned above, are very rare, the potential buyers have to produce the bid documents (edital) which contains very basic information about the proposed acquisition (such as, but not limited to, price, conditions, etc.). Other than that the documents filed with the antitrust authorities are public unless a specific request for privacy is made at the time of filing (such privacy only being possible in certain specific cases - but not all).
What formalities are required in order to document a transfer of shares, including any local transfer taxes or duties?
One has to register the transfer of the shares in the share register transfer book of the company to effect the transfer of the shares in the case of a corporation or, if that is the case, require that the transfer is recorded by the custodian of the shares. Income tax on capital gains and certain social contributions will be due if there are capital gains, but no specific stamp taxes or duties are due in the country.
Are hostile acquisitions a common feature?
No. Hostile acquisitions are almost non-existent in Brazil. They have been attempted in a couple of cases in the past, but were not successful. There are several Brazilian companies which do not have a clear - or formal - controlling shareholder, but in almost 100% of the cases some of the shareholders have a very relevant stake of the capital stock (more than 20%). It is thus very easy for these shareholders to react to an unsolicited bid and block the sale. There are some remarkable cases in Brazil where the board rejected an unsolicited bid in less than 24 hours. My opinion on this is that the capital markets of Brazil still has a long way forward as far as hostile bids are concerned.
What protections do directors of a target company have against a hostile approach?
Certain Brazilian corporations have included poison pills in their bylaws (which are locally described as provisions that target at forcing a buyer to acquire 100% of the capital stock of the company - including non-voting shares and/or forcing the buyer to appraise the shares of the company in accordance with certain methods which tend to make the pricing higher. When examining unsolicited bids, the members of the board of a Brazilian company ideally should act as it is expected for professionals at their level. This means that financial and legal assistance should be sought in the form of legal and fairness opinions as well as in the form of appraisal reports. Truth to be said, however, this is a very incipient market for the time being in Brazil.
Are there circumstances where a buyer may have to make a mandatory or compulsory offer for a target company?
Yes. Brazilian law ensures tag along rights to minority voting shareholders in the event of transfer of “control” by imposing on the purchaser the obligation to proceed with a tender offer for the acquisition of all outstanding voting shares of the company. Under Law No 6,404/76 (Brazilian Corporations law), “control” means the possession, directly, of the power to direct the voting rights of the majority of voting shares at a general shareholders’ meeting and the right to elect the majority of the company’s officers and directors, whether through the ownership of voting securities, by contract or otherwise, which means that the controlling shareholder must hold individually 50% +1 of the voting shares of the company at a general shareholder’s meeting.
For public companies listed on B3 S.A. – Brasil, Bolsa, Balcão (“B3”), “control” (in addition to the above definition of “control”) means the actual and effective power to direct the company’s activities and to establish the guidelines for the operation of its management bodies, directly or indirectly, in fact or in law. Presumption of control will exist where one or more persons are under common control or bound by a shareholders’ agreement that holds enough shares to ensure an absolute majority of votes accorded to the shareholders present at the company’s previous three general meetings, even if they do not hold the number of shares that actually provide them with an absolute majority of the voting stock.
Brazilian listed companies may include in their corporate documents poison pills, tender offer requirements or other protections that have to be considered prior to the acquisition of any shareholding. Please note that the companies are free to establish its poison pill’s threshold under its constitutional documents and there is no legislation on this matter.
The bylaws of the company may extend such tag along rights to transactions that do not qualify as a transfer of control (but rather qualify as an acquisition of a certain percentage of outstanding stock i.e. in most cases around 20%, including preference shares. The bylaws of a company may also state a premium for the acquisition of a certain percentage of outstanding stock).
Finally, there is also the The Brazilian Takeover Panel (“CAF”) which is a private panel composed of eleven (11) financial and capital markets experts. In this specific case, companies willing to adhere will be expected to formally and publicly submit themselves to the CAF.
CAF establishes a new type of tender offer: the Material Ownership Tender Offer (“MOT”). In case of MOT, the adherent company chooses a percentage from 20% up to 30% of the shares of voting stock as an automatic trigger to obligate the person who reached the material ownership to carry out the tender offer for all other shares and securities convertible into shares issued by the adherent company. The Tender Offer price must at least equal to the highest buy price the acquirer may have paid for voting share in the market within the period of 12 months preceding the date of the tender offer trigger or other criterion determined by CAF, under exceptional circumstances and acting upon request.
If an acquirer does not obtain full control of a target company, what rights do minority shareholders enjoy?
Additional governance rights may include, right to appoint director(s), to veto certain important company matters such as (i) corporate reorganizations, (ii) corporate indebtedness; (iii) corporate business plan; (iv) sale of key corporate assets, etc. Additional economic rights may include tag along and drag along rights, piggy-back and qualified IPO rights.
Is a mechanism available to compulsorily acquire minority stakes?
Under Brazilian Corporate Law, if less than 5% of all shares issued by the target company remain outstanding in the market after the De-listing Tender Offer auction, the target company shareholders may approve the redemption of such shares (“squeeze out”) based on the price reached in the De-listing Tender Offer, provided the company deposits the amount owed to the minority shareholders with a banking institution duly authorized by the Brazilian securities and exchange commission (CVM).