When M&A transactions in Brazil are deemed not successful by the investor the main reason for underperformance is generally the existence of debts or fiscal/labor contingencies materialized higher than evaluated, or unexpected material adverse changes.
The reasons for overlooking the debts and fiscal/labor contingencies is often the rush to close the investment. Either for avoiding a competitor to acquire the target, or to keep the leading position of the market share, for certain cases, the buyers may have not paid proper attention to what their advisors had to say before closing the deal.
Local legal advisors
The legal advisors may take, for the perception of the executives eager to complete an acquisition, a bit longer than expected to round up facts and properly report the risks found. The perception for this lower pace to reach out the conclusions may differ from the executives due to the delay of seller to provide documents or clarify questions raised.
Slowing down a bit to the benefit of certainty is a sound advice.
Experienced Brazilian advisors shall always be included among the teams. Their knowledge on facing subtle change of applicable laws, rules or predominant court decisions is certainly valuable for better understanding the status of the target and the ways to mitigate risks.
Certain facts may not seem at first as significant risk for first timers dealing with Brazilian matters. However, the advisors do have a reason to raise the point and should be properly heard. Examples such as absence of one single clear certificate issued by a government department or a missing report on disposal of solid residues, that may not seem a big issue, could turn into a risk of suspension of activities of a plant.
An audit company is usually hired to identify tax and labor contingencies, but the audit company does not evaluate nor assess the numbers, only the maximum exposure. The legal advisors are in charge of the risk assessment and determination of the estimate of the contingencies. It is up to the buyer to accept and negotiate the relevant coverage for such contingencies.
Seller may not give full details of all issues of the target at first. It is the role of the advisors to investigate, request further documents and clarification to bring matters that affect the business to buyer’s attention. In a good faith scenario, seller would be willing to discuss the matters, to avoid future disputes or frustrations to buyer.
Charges, penalties, interests and other compensations in financial operations turns these contracts full of minor details and very complex in anywhere in the world. Brazilian contracts are not exception. That is the reason why a proper assessment of the financial operations and obtain the real picture of the debt and related costs.
As usual, attention to change of control provisions are also relevant to mitigate risks – absence of consent or non-compliance of the required steps prior to closing the operation can cause acceleration of the financial operation and trigger cross-default provisions in other contracts that can also lead to acceleration of the financial operations.
Calculation and estimate of tax contingencies are specific for each tax and requires knowledge and a sound judgment to estimate exposure and appoint measures to cover the risks. Same level of care applies to labor-related contingencies.
Tax and labor matters are usually the most relevant risks to be observed in a Brazilian target. Complexity of regulation and the amount of obligations to fulfill makes these points significant.
Material adverse change
Material adverse change clauses – “MAC Clauses” – are contractual provisions to mitigate negative effects or a substantial change to the parties. These provisions are admitted in Brazilian law, in view the M&A transaction documents are executed in good faith and respecting the parties’ freedom to commit to certain obligations.
Needless to say, the MAC Clauses should contain crystal clear language, with objective description of the facts, well defined applicable time period, cause and consequences duly described for proper and easy execution. If not, determination of MAC Clause event shall end on a dispute.
In the absence of MAC Clauses, Brazilian Civil Code contemplates the ability to any party in a continuous contractual relation to seek for the termination of the contract, by virtue of extraordinary and unpredictable facts, in the event such party is affected with excessive onus and generates extreme advantage to another party. Determination whether the parties were subject to extraordinary and unpredictable facts would depend nevertheless on ruling by a judge or arbitrator, as provided in the acquisition documents.
Guarantees and Indemnification
For avoidance of future problems, the buyer should obtain strong and prompt executable guarantees. The (a) ability to withhold payments, (b) deposit of part of the purchase price in escrow account with clear rules for withdrawing the escrow amount are most likely measures to ensure a prompt indemnification. From previous experiences, other guarantees like pledge of shares, personal guarantee, lien or even chattel mortgage over real property are harder to execute and indemnify the prejudiced party.
De minimis clauses (minimum amount for a party to be indemnified – if not reached, the prejudiced party is not going to receive any indemnification) or basket (limitation of indemnifiable amount) are additions to the provisions for guarantees also acceptable for Brazilian M&A transactions.
The experienced advisors will make a difference to assist on the drafting of these provisions and to reflect what the parties discussed and agreed on the table.
A conscious buyer will certainly avoid the risk of incurring in heavy break-up fees, with proper assessment provided by competent advisors of what may happen until closing. Nevertheless, in certain cases, even after signing a binding document, it might make sense paying a break-up fee even if substantial rather than entering into a risky transaction.
Recent Brazilian M&A transactions have included break-up fees, applicable in case of the regulatory restrictions are too high or in case the buyer gives up the acquisition. The highest break-up fee known was included in an offer made by Paper Excellence (member of Asia Pulp and Paper, based in Indonesia) was BRL 4 billion (over USD 1 billion or around EUR 900 million). The deal was not closed as another bidder had better credit check (even proposing lower break-up fees).
In 2015, Ânima paid BRL 46 million (around USD 12.5 million or EUR 10.6 million) of break-up fees to Whitney do Brasil – education sector – for giving up the acquisition due to changes on students’ public financing rules. In 2018, Ultragaz paid BRL 280 million (around USD 75 million or EUR 64 million) in break-up fees to Liquigás, due to the veto by the Brazilian antitrust authority for the operation.
In this regard, the recommendations to avoid the referred reasons for a not satisfactory failure in M&A transactions in Brazil are:
- Rely on local advisors: make sure that local Brazilian experts are included in the advisory team – the proper Brazilian legal, accountancy, tax and business experts can provide you with the necessary and valuable information for the proper decision-making process;
- Listen to what the local advisors have to say: some matters raised may not seem to harm the deal, but it is important to let your advisor give you the full explanation and the reasons why the advisor is concerned about the topic. The advisor has a reason to bring the matters to discussion;
- On the buy-side, ensure the existence of proper guarantees – feasible and enforceable – for prompt reimbursement of the losses, instead of discussions or long disputes;
- Be very attentive in the preparation and discussion of the indemnification, procedure for indemnifying a prejudiced party, accommodating the business negotiation and the coverage to the risks explained by the advisors;
- MAC Clauses shall be clear, precise and objective; and
- However hard may be, it might make sense paying a break-up fee instead of completing a risky transaction.