By Aarón Levet V and Alberto Solís M*
I. OVERVIEW OF M&A ACTIVITY
Mexico is a promising market for M&A transactions. Despite the images of violence that have been in the news in recent years, interest in investing in Mexico by multinational companies has been increasing every year, confirming that publicity regarding a general and rampant lack of security in Mexico is, in some cases, simply a matter of perception.
During 2010, Mexico reported M&A transactions worth $41.05 billion, compared to the $50.9 billion reported in the US over the same period, which indicates that many investors are focusing their investments in emerging markets like Mexico.
Financial stability, the fact that Mexico has executed free trade agreements with 44 countries, a favourable legal environment and a stable democracy are some of the main factors that investors have taken into consideration when continuing to invest in Mexico.
II. GENERAL INTRODUCTION TO THE LEGAL FRAMEWORK FOR M&A
The Mexican legal regime applicable to M&A transactions is relatively flexible and generally allows the parties to structure transactions according to international custom and practice; however, because of our civil law system, particular formalities should be observed in all M&A transactions.
Mexico does not have a specific M&A statute. The following laws and regulations apply to M&A transactions in general: the Mexican Constitution, the General Law on Business Organisations, (‘the Corporations Law’), the Foreign Investment Law (‘the LIE’), the Securities Market Law (‘the LMV’), the Federal Anti-Trust Law (‘the Mexico 401 Anti-Trust Law’), the Federal Labour Law (‘the LFT’), and the Industrial Property Law, to mention a few. There are other laws that are relevant depending on the specific sector involved.
Notwithstanding the wide variety of laws that may apply, one of the most important considerations for a foreign acquirer is the foreign investment legal regime that applies to the business activity in which the entity to be acquired participates. Under the LIE, the participation of foreign investors and Mexican corporations in which foreign investors participate in certain activities is either forbidden or restricted to a certain percentage or, in some cases, requires prior authorisation from the Mexican government, although the number of activities in which foreign investment is restricted or prohibited has decreased through the years.
The LIE defines foreign investment as the participation of foreign investors or by Mexican companies with a majority of foreign capital, in any proportion, in the capital stock of Mexican companies and participation of foreign investors in activities and acts specified in the LIE. Except as otherwise provided, foreign investors may participate in any proportion in the capital stock of Mexican companies, acquire fixed assets, participate in new economic activities or in the manufacture of new product lines, open and operate facilities, and expand or relocate those already existing.
On transactions that exceed the assets threshold provided by the LIE (approximately 2.68 billion Mexican pesos in accordance with the threshold published in the Official Gazette of the Federation on 23 June 2010), irrespective of the economic activity, the prior authorisation of the National Commission of Foreign Investments is required if the foreign investor plans to participate, directly or indirectly, in more than 49 per cent of the Mexican company.
The different forms of organisation of business entities in Mexico are governed by the Corporations Law, which is federal in nature and applies throughout the country.
The Sociedad Anónima (‘SA’) and the ‘Sociedad de Responsabilidad Limitada’ (‘SRL’) are the most common investment vehicles used by domestic and foreign investors, based on the possibility to centralise, in principle, all liabilities in the company, being the liability of the shareholders or partners limited to the amount of their contributions to the corporate capital of the company. The SRL, which is regarded as a US partnership for US tax purposes, has become the most popular vehicle for US investors.
The SA and the SRL may be organised under the modality of ‘Variable Capital’, allowing for increases or reductions of the corporate capital with more flexibility. The LMV contemplates a variation to a SA called Sociedad Anónima Promotora de Inversión (‘SAPI’), which grants to its shareholders broader flexibility in certain business decisions, such as the issuance of shares with no voting or with different voting rights, the possibility to include a different treatment among the shareholders regarding the distribution of dividends or other economic rights, and limitations to the veto or first refusal rights to certain classes of shares.
Subject to any tax structure, this vehicle is highly recommended in transactions with different groups of investors. In the real estate sector, the Sibra (Sociedad de Inversión en Bienes Raices) is a vehicle that may offer certain tax benefits, mainly to investors in the commercial real estate industry. Sibras are organised under the Corporations Law (which also can be Mexico 402 incorporated as SAPIs). Subject to certain specific rules, practically all of its capital shall be, directly or indirectly, invested in real estate assets in Mexico.
Although rarely used (due to tax and other contractual implications), a branch of a foreign corporation and the joint venture agreements should also be mentioned as investment vehicles available under Mexican law.
III. DEVELOPMENTS IN CORPORATE AND TAKEOVER LAW AND THEIR IMPACT
The current administration and the Congress have been making efforts aimed at fostering growth and development in the economy and at the same time elevating the standards of behaviour of key players.
The Congress is reviewing an initiative for a Public–Private Associations Law (‘LAPP’), to regulate the participation of the private sector, whether Mexican or not, in the construction and operation of electricity plants, hospitals, schools, hydraulic facilities and prisons, therefore rendering services to the Mexican government. The main purpose of this law would be to allow the private sector to operate the infrastructure constructed, as opposed to only constructing it for subsequent operation by the government. If approved, the LAPP will help to accomplish the targets provided in President Calderón’s National Infrastructure Programme 2007–2012 (‘PNI’) and, consequently, to expand the number of M&A transactions in Mexico.
Recent amendments to the Anti-Trust Law (enacted on April 2011) and correlative amendments to the Federal Criminal Code, the Federal Tax Code and other ancillary legal provisions are of significant relevance for M&A transactions. The most significant changes to the Anti-Trust Law are:
a. Penalties for violations to the Anti-Trust Law were substantially increased. Penalties will be calculated according to the taxable income of the corresponding party (10 per cent in the event of absolute, and 8 per cent if relative, monopolistic practices), excluding income obtained abroad and income subject to a preferential tax regime.
b. Absolute monopolistic practices are considered a criminal offence sanctioned with imprisonment penalties (from three to 10 years) and will automatically be prosecuted by the Federal Anti-Trust Commission (‘the CFC’).
c. Individuals or corporations are entitled to voluntarily restore the competition process, in which case the processes against monopolistic practices would be terminated early.
d. The concept of ‘joint substantial power in the relevant market’ (referring to two or more economic agents that jointly trigger the ‘substantial power’ concept provided in the Anti-Trust Law) was included.
e. Pre-emptive measures (such as the suspension of specific acts) are now available in cases where it is considered that irreversible damage could be caused to the competition process.
f. It is no longer necessary to obtain authorisation from a judge to carry out verification visits or to issue a previous notice to the visited party to that effect.
g. The CFC has authority to request reports and documents from any individual or governmental authority.
h. The mechanism for the notification of concentrations was simplified.
In July 2010, the Federal Law for Protection of Personal Data in Possession of a Person (‘the Data Protection Law’) was published, which is focused on preserving the right of any individual to protect his or her personal data. The law applies throughout Mexico and binds every private person, whether an individual or entity, that obtains, uses, discloses or stores personal data, with certain exceptions, thus warranting privacy and the right of self-determination over personal data. It is anticipated that the new incentive contracts recently approved by Petroleos Mexicanos, by which private investors will be able to participate in bids for oil exploration and production with much less restrictions, will attract M&I transaction in the energy sector.
IV. FOREIGN INVOLVEMENT IN M&A TRANSACTIONS
Preliminary reports for 2010 reflect that foreign direct investment (‘FDI’) into Mexico amounted to approximately $18.68 billion. As a result of the various tax and free trade agreements executed by Mexico, FDI during 2010 coming from the Netherlands was the most represented with 47 per cent of the total, followed by the US (28 per cent), Spain (7.6 per cent), Canada (4.6 per cent) and other countries (12.21 per cent). Comparing the total FDI that entered Mexico during 2009 ($11.4 billion) with the amount that entered during 2010, there is a significant increase in the FDI attracted by Mexico. The areas of interest for FDI also changed significantly between the first quarter of 2009 to the first quarter of 2010. The most affected sectors were construction and services, while those in which FDI increased were the maquila industry, general commerce, financial services, administration and lease of assets and real estate, and common and social services, including hotels, restaurants, professional, technical and personal services.
V. SIGNIFICANT TRANSACTIONS, KEY TRENDS AND HOT INDUSTRIES
The second biggest M&A deal reported in the world in 2010 was carried out between Mexican entities, with America Movil SAB de CV’s $2.1 billion acquisition of Carso Global Telecom SAB de CV, a Mexico City-based telecoms services provider. The reason behind America Movil’s acquisition was to achieve a more efficient use of the network, systems and information processes of both companies, as well as to improve the research and development in the telecoms and information technologies fields. Also, during January 2010, Fomento Empresarial Mexicano SA de CV (‘FEMSA’) disclosed the deal reached with Heineken for the purchase of Cervecería Cuauhtémoc Moctezuma, FEMSA’s beer division, for $7.34 billion. FEMSA received 20 per cent of Mexico 404 Heineken and three seats on its board, becoming the first partner of Heineken in its history of more than 146 years.
There are negotiations under way for the merger of the two largest Mexican banks, IXE Banco and Banorte, a transaction that is expected to occur before the end of this year. According to recent financial reports, it is expected that investments in real estate and transportation infrastructure sectors will increase by the last quarter of 2011.
VI. FINANCING OF M&A: MAIN SOURCES AND DEVELOPMENTS
There are no special requirements to finance M&A transactions in Mexico, and general requirements apply, such as thin capitalisation rules, arm’s-length transactions with related parties, etc. The financing part of an M&A transaction is of the utmost importance and the negotiation of the financing is therefore a key element both with the counterparty and with the creditor. Also, investment funds play an important part in M&A transactions in Mexico and their involvement in these kinds of projects has increased significantly during recent years.
In most of the M&A transactions carried out in Mexico involving financing, the funds for the acquisition come from foreign sources. Despite the tax effects deriving from contracting a loan with a foreign entity, there is a credit shortage in the Mexican market, in addition to the fact that the interest rates that Mexican banks offer are still high compared to other sources, thus financing from abroad is still prevailing. Interest payments to non-Mexican residents are subject to a reduced tax rate of 4.9 per cent during 2011 for financial institutions complying with certain requirements and registration, or higher rates depending on the nationality and tax residence of the recipient of the interest payment.
VII. EMPLOYMENT LAW
When doing business in Mexico, a comprehensive assessment of our labour and social security laws, as well as of the collective and individual labour relationships, compensation requirements and other employment-related contributions and taxes is of the essence. The LFT regulates the relationships between employer and employee, between unions, employees and employers, as well as the activities of the labour authorities. The Social Security Law regulates employer, employee and government participation in the various federal social-benefit programmes through the Mexican Social Security Institute. The Workers’ Housing Fund Law regulates employer, employee and government participation in the Institute of the National Fund for Employees’ Housing.
There are alternatives to administer and manage the effect of the statutory profit sharing to workers, which need to be evaluated on a case-by-case basis.
An M&A transaction involving the acquisition of shares would not impose any legal obligation per se on the acquiring entity as the acquired entity will continue to be primarily responsible for the compliance in terms of labour matters, and employees or unions will not usually have any special rights as a result of the transaction. It is not common to have change-of-control provisions triggering special rights under individual Mexico 405 or collective employment agreements, and the LFT certainly does not grant any special rights in this case either.
If the M&A deal is contemplated as an acquisition of assets, the employees may begin working for the acquiring entity either with their prior labour rights in place (e.g., seniority, benefits) or not, in which case a new labour relationship would commence. If the acquiring entity is not expected to assume the labour obligations and contingencies, the existing labour relationship would need to be previously terminated by entering into termination agreements with the employees, which must be ratified before the labour boards to be enforceable. As part of the termination process, the employer would have to grant the employees the statutory severance payments (or the amount that is agreed in lieu) to legally terminate the employment relationship. Thereafter, the acquirer may retain the employees under the conditions agreed with them. If the acquiring entity is expected to assume the labour obligations, the most efficient manner to carry out the transfer of the employees would be through a substitution of employer procedure whereby the acquirer as the new employer only has to notify the employees that, effective as of a certain date, the employees will be employed by the acquirer. The employees do not have to consent to said procedure, and would not be entitled to a severance payment if the new employer respects and recognises their rights and terms of employment. UIT respect to unionised employees, the union must be notified of any change, which in turn will notify the unionised employees.
In this scenario, the prior employer will be jointly liable with the new employer for compliance with obligations and liabilities that arose prior to the employer substitution for a period of six months.
Aspects related to the participation of labour organisations or unions require adequate ‘collective planning’ in order to achieve employment stability, a proper labour environment and eventually allow the business to apply its own working principles and practices. In new businesses, the employees’ desire to become organised generally as a consequence of the company’s exposure to external factors, such as union intervention, which has forced employers to look to preventive solutions. It is always recommendable to have a relationship with a union that shares the labour vision of the employer, regardless of the number of employees in a determined entity.
To avoid baseless union intervention, employers normally approach unions rather than waiting for the union to approach the company. Union selection must be based on several circumstances including: location of the facility, industry sector and level of education of employees required for unionisable positions, size of the work force and experience of other businesses of the same industry, among others. Meetings with the top leadership of the different available organisations to define their interest to participate in the project under the company’s standards are highly advisable. In anticipation, it is recommendable to study the target unions.
Currently there are certain discussions at Congress regarding substantial amendments to the labour legal frame in Mexico; however, it is not anticipated that such amendments will change the form in which an employer needs to structure its labour strategy or in which labour issues shall be addressed in an M&A transaction, or both.
VIII. TAX LAW
The Mexican Congress approved amendments to the tax regulations that became effective in 2010, basically establishing short-term measures to help overcome the worldwide economic crisis. A summary of those measures include:
a. An increase in the income tax rate applicable to individuals and corporations from 28 per cent to 30 per cent to be reduced gradually until it returns to its 28 per cent original rate in 2014. For 2011 the rate remains at 30 per cent.
b. Value-added tax (‘the IVA’) was increased for 2010 from 15 per cent (applicable in general) and 10 per cent (applicable in the border region), to 16 per cent and 11 per cent, respectively.
c. A cash deposits tax (‘the IDE’) at the rate of 3 per cent applicable to deposits in cash carried out with the same bank institution in excess of 15,000 Mexican pesos during the same month.
d. A special tax for products and services (‘the IEPS’) at the rate of 3 per cent was introduced for services rendered through the telecommunications public network (with specific exemptions). The IEPS rates applicable to the importation and sale of alcoholic beverages and beer are gradually increased through 2012, but in 2014, they will return to their original rates. A special contribution was imposed on the sale of tobacco, and the IEPS rate applicable to carry out bets and lotteries was increased from 20 to 30 per cent.
e. All cash deposits in dollars above the amount equivalent to 15,000 Mexican pesos shall pay a tax at the rate of 3 per cent.
The Tax Administration Service Authority is authorised to request to the Mexican commercial banks to freeze bank accounts immediately on receipt of a request from the authority, as well as to request taxpayers’ information to the Insurance and Bonds National Commission and the Retirement Savings System Commission.
Tax implications deriving from M&A transactions should be carefully reviewed and evaluated. The following is a discussion on tax aspects applicable to a non Mexican acquirer:
i Share transactions
The transfer of shares (or equity participations) issued by a Mexican entity is considered a taxable event. The acquisition of shares of a Mexican entity is not taxed for the acquirer provided the acquisition is carried out at a fair market value. If the acquirer is a foreign entity with no permanent establishment in Mexico, no withholding obligation applies to the acquirer either. There are, of course, tax considerations that apply to the acquisition of a Mexican entity. However, in general terms, a foreign private acquirer of a Mexican entity is not required to make any tax payment or withholding solely due to the acquisition of shares of a Mexican entity.
ii Asset transactions
In the acquisition of moveable items, the acquirer is required to pay IVA, with the exception of export transactions. As for the acquisition of real estate, throughout Mexico, a municipal tax applies payable by acquirer upon the signature of the title documents before the notary public. The applicable tax rate varies depending upon the municipality, but in most parts of the territory it is approximately 2 per cent. IVA for the value of the constructions shall apply. Typically, the value measure is the highest between the sale price, the appraised value and the cadastral value of the property.
All real properties must be acquired through a purchase and sale agreement, executed in the form of a public deed and granted before a Mexican notary public and filed for registration with the respective Public Registry of Property. It is customary that all related costs for the acquisition of a real property (notarial and appraiser’s fees, registration duties and associated expenses) are paid by the acquirer. In certain specific transactions it is possible to defer the payment of these taxes and transfer them to the final acquirer of the property by the use of a trust agreement.
IX. COMPETITION LAW
In 2010, the Commission issued approximately 90 resolutions regarding concentrations that had been notified and it is expected that 2011 will conclude at least in a similar trend. As mentioned in chapter III above, there have been recent amendments to the applicable legal frame and during 2011 the CFC has imposed one of the higher fines for not complying with the provisions of the Anti-Trust Law, in the amount of 11.989 billion pesos (imposed on Radiomovil Dipsa (Telcel) one of Carlos Slim’s companies. The Anti-Trust Law requires prior notice to be given to the Commission of any concentration that exceeds any of the following thresholds:
a. if the price of the overall transaction (regardless of where it occurs, as long as it has a direct or indirect impact in Mexico), is greater than the equivalent of 18 million times the daily wedge (‘DW’);
b. if the overall transaction entails the accumulation of 35 per cent or more of the assets or shares of an economic agent, the value of whose assets or sales in Mexico is greater than the equivalent of 18 million times the DW; or
c. if two or more economic agents take part in the transaction, and: whether separately or together, the value of their assets or annual sales volume is greater than the equivalent of 48 million times the DW; and the transaction entails an additional accumulation of assets or capital stock in Mexico greater than the equivalent of 8.4 million times the DW. The concentration notice must be filed before any of the following events occurs: (1) the legal act is completed under applicable law or, if applicable, the condition precedent to the act is met; (2) an economic agent acquires or exercises de facto or de jure control, directly or indirectly, over other economic agents or trust interests, equity participations or shares of other economic agents; (3) the parties sign a merger agreement; or (4) if the concentration involves a succession of acts, the act that, when completed, results in the concentration exceeding the aforementioned threshold amounts.
If any of these events occurs outside Mexico, the economic agent must file the notice before the event has legal or material effects in Mexico. The Commission has 35 calendar days (plus an additional 40 calendar days in exceptionally complex cases) to examine the concentration and determine whether to approve, conditionally approve or disallow it, based on a duly founded resolution. The aforementioned terms may be reduced to 15 calendar days if it is evident that the transaction will not have a negative effect on competition and this is shown by the parties. If the Commission fails to act within that period, the Anti-Trust Law deems the concentration approved. If the Commission imposes conditions, they must be proportional to and directly linked to correcting the effects of the concentration, and the notifying parties may request the Commission to consider proposals from the parties before rendering its decision.
The general rule is that the agents need not wait for the Commission to issue a resolution to be able to close the transaction. Therefore, the parties may proceed with the closing after the filing has been made unless the Commission issues a ‘stop order’ within 10 business days. In this case, the transaction may not be closed until the Commission issues its resolution.
Once the Commission has expressly authorised a concentration, third parties cannot challenge the concentration unless they can prove that the Commission based its resolution on false information. For a concentration that does not require prior notice, the Commission or any interested party may raise a challenge within a year of the date the concentration occurred.
The Anti-Trust Law vests the Commission with significant powers to prevent, punish, and deter anti-competitive conduct. With respect to a concentration, in addition to imposing a substantial monetary fine, the Commission may order the total or partial divestiture of the result of a wrongful concentration.
The stability that the Mexican economy demonstrated during the worldwide financial crisis, together with the new Pemex ‘incentive contracts’, the amendments to the Anti-Trust Law, and others that are expected to be implemented in the near future, should attract investment into Mexico. Additionally, the uncertainty surrounding the larger world economies has shifted attention to emerging markets with solid economies such as Mexico. Another relevant fact that must be considered by investors is that a significant portion of the total fund of $253 billion provided by the PNI for the planned development of infrastructure from 2007 to 2012 has not been allocated yet. Therefore, there are important investment opportunities in infrastructure in roads, railways, harbours, airports, telecommunications, potable water and sewerage, irrigation and flood control, electricity, hydrocarbon production, and oil and gas refining, with an emphasis on the amounts to be allocated on hydrocarbon production, electricity, oil refining, gas and petrochemicals, roads and telecommunications.
*AARÓN LEVET V
Santamarina y Steta SC
Aarón Levet V has been with Santamarina y Steta since 1980, and became a partner of the firm effective 1 January 1990. Mr Levet obtained his law degree (licentiate) in 1983 from the Universidad Nacional Autonoma de Mexico and is licensed and admitted to practise law in Mexico. His professional practice is focused on tourism, hospitality, finance and M&A sectors, representing Mexican and non-Mexican clients in Mexico and abroad with regard to Mexican issues.
*ALBERTO SOLÍS M
Santamarina y Steta SC
Alberto Solís M is a senior associate with Santamarina y Steta since 2001. Mr Solís is admitted to practise law in Mexico, where he obtained his law degree (licentiate) from the Universidad Panamericana in Mexico City. He studied for his master of laws at the University of Nebrija in Madrid, Spain in 2003. His practice includes M&A, bank lending, hospitality and general corporate matters advising Mexican and foreign clients.