A legal due diligence of a Brazilian target company should analyze the existence and the content of Agency Agreements, including values paid to the agent and the nature of such payments and the factual situation of the target’s agents, in order to evaluate potential contingencies.
One usual suspect in legal due diligences of Brazilian target companies in M&A transactions that should not be overlooked is the existence of agency agreements, due to:
- the obligation to indemnify the agent stipulated by law: at least 1/12th of all commissions paid throughout the entire term of the agency agreement; and
- the risks for the agency being disregarded and considered as an employment relationship, subjecting the principal to compensate the agent as an employee with all rights, benefits, taxes and social contributions.
This should be considered for evaluation of potential contingencies and the impacts on the valuation of the target.
No doubt that agents can be an important component of the sales force of the business and can be strategic for the activity of the principal, in view of a certain independence and for not increasing the payroll of a company.
On the other hand, under Brazilian laws, the protective nature of the agency demands the principal a considerable level of attention.
Brazilian Federal Law No. 4,886/65 as amended – the Brazilian Agency Law – determines that the agent is entitled to, at the termination of an agency agreement, receive an indemnification of 1/12th calculated over all the commissions paid throughout the duration of the entire period of the agency agreement.
The Brazilian Agency Law stipulates that if the parties sign a new contract within 6 months after the expiration of the previous, the relation between agent and principal shall be deemed as the same relationship and thus, the duration to calculate the indemnification shall encompass the entire period (past and subsequent contract).
Termination by the agent
The Brazilian Agency Law also stipulates situations that agent could terminate the contract and still be entitled to receive the 1/12th indemnification:
- reduction of the activities in disagreement with the contractual stipulation
- breach of exclusivity (territory and/or products), if so stipulated in the agreement
- determination of prices that makes the agency unfeasible and
- default on payment of the commissions
- force majeure
Termination without cause
Termination without cause can be done, upon payment to agent of the indemnification and with a previous notice of at least 30 days, in which situation the agent shall receive the payment of 1/3 of the remuneration received during the previous 90 days prior to the termination.
Can principal avoid the indemnification?
The only cases where the 1/12th indemnification would not be applicable are when the contract is terminated by principal with cause. The Brazilian Agency Law has limited situations for principal to terminate the contract with cause:
- acts by agent causing disrepute of the principal
- breach of obligations related to the agency activities
- criminal conviction related to honor, reputation
These situations shall be clearly demonstrated. Producing the sufficiently strong evidence of the facts to configure cause for termination may not be an easy task, considering some of the facts may be subject to construing and interpreting by the parties, witnesses and ultimately the judge.
As a result, from past experiences, it is rare to see principals in conditions not to incur in the 1/12th indemnification.
Potential risk: configuring employment relationship
In addition to the indemnification, the activities developed by the agent could eventually be deemed as performed by a regular employee of the principal and, in this case, principal could be subject to compensate the agent as an employee.
Agent vs. employee
For the appreciation of the employment relationship, the individual acting as agent shall file a labor claim and demonstrate the existence of the employment relationship.
The Labor Court judge will consider the factual situation, prevailing upon the written agreements or other formal documents. The judge may rely on e-mails, witnesses and other evidence.
The elements of an employment relationship are:
- Individual: in case the individual acts by himself to perform the services; Personal services: the services are in fact performed by the individual specifically to the Principal;;
- Non-eventuality – exclusivity: the services are rendered in a regular basis;
- Subordination: key factor – the individual has to follow strict instructions directed by principal, such as reporting to an employee of the principal, determined visits;
- Rewarding – fixed remuneration: the individual is awarded regular amounts and expenses allowances
In the event the individual can demonstrate the existence of the elements to configure an employment relationship, he/she could have an award to entitle him/her to have his remuneration considered as of a regular employee for the last 5 years.
As a result, the individual would be awarded the payment of Christmas bonus (equivalent to 1 monthly remuneration per year), vacation allowance (1/3 of a monthly remuneration per year), unemployment guarantee fund (1 monthly remuneration per year) plus other benefits that he/she would be given as an employee of principal (based on the collective bargaining agreement between the employees’ and employers’ unions). The company would also be obliged to make the payment of the co-related social security contributions.
Needless to say, the result could turn into a considerable potential contingency.