Italy – M&A – Conventional guarantees and « WARRANTY & INDEMNITY » insurance policies

17 février 2020

  • Italie
  • F&A

This week the Interim Injunction Judge of the Netherlands Commercial Court ruled in summary proceedings, following a video hearing, in a case on a EUR 169 million transaction where the plaintiff argued that the final transaction had been concluded and the defendant should proceed with the deal.

This in an – intended – transaction where the letter of intent stipulates that a EUR 30 million break fee is due when no final agreement is signed.

In addition to ruling on this question of construction of an agreement under Dutch law, the judge also had to rule on the break fee if no agreement was concluded and whether it should be amended or reduced because of the current Coronavirus / Covid-19 crisis.

English Language proceedings in a Dutch state court, the Netherlands Commercial Court (NCC)

The case is not just interesting because of the way contract formation is construed under Dutch law and application of concepts of force majeure, unforeseen circumstances and amendment of agreements under the concepts of reasonableness and fairness as well as mitigation of contractual penalties, but also interesting because it was ruled on by a judge of the English language chamber of the Netherlands Commercial Court (NCC).

This new (2019) Dutch state court offers a relatively fast and cost-effective alternative for international commercial litigation, and in particular arbitration, in a neutral jurisdiction with professional judges selected for both their experience in international disputes and their command of English.

The dispute regarding the construction of an M&A agreement under Dutch law in an international setting

The facts are straightforward. Parties (located in New York, USA and the Netherlands) dispute whether final agreement on the EUR 169 million transaction has been reached but do agree a break fee of €30 million in case of non-signature of the final agreement was agreed. However, in addition to claiming there is no final agreement, the defendant also argues that the break fee – due when there is no final agreement – should be reduced or changed due to the coronavirus crisis.

As to contract formation it must be noted that Dutch law allows broad leeway on how to communicate what may or may not be an offer or acceptance. The standard is what a reasonable person in the same circumstances would have understood their communications to mean.  Here, the critical fact is that the defendant did not sign the so-called “Transaction Agreement”. The letter of intent’s binary mechanism (either execute and deliver the paperwork for the Transaction Agreement by the agreed date or pay a EUR 30 million fee) may not have been an absolute requirement for contract formation (under Dutch law) but has significant evidentiary weight. In M&A practice – also under Dutch law – with which these parties are thoroughly familiar with, this sets a very high bar for  concluding a contract was agreed other than by explicit written agreement. So, parties may generally comfortably rely on what they have agreed on in writing with the assistance of their advisors.

The communications relied on by claimant in this case did not clear the very high bar to assume that despite the mechanism of the letter of intent and the lack of a signed Transaction Agreement there still was a binding agreement. In particular attributing the other party’s advisers’ statements and/or conduct to the contracting party they represent did not work for the claimant in this case as per the verdict nothing suggested that the advisers would be handling everything, including entering into the agreement.

Court order for actual performance of a – deemed – agreement on an M&A deal?

The Interim Injunction Judge finds that there is not a sufficient likelihood of success on the merits so as to justify an interim measure ordering the defendant to actually perform its obligations under the disputed Transaction Agreement (payment of EUR 169 million and take the claimant’s 50% stake in an equestrian show-jumping business).

Enforcement of the break fee despite “Coronavirus”?

Failing the conclusion of an agreement, there was still another question to answer as the letter of intent mechanism re the break fee as such was not disputed. Should the Court enforce the full EUR 30 million fee in the current COVID-19 circumstances? Or should the fee’s effects be modified, mitigated or reduced in some way, or  the fee agreement should even be dissolved?

Unforeseen circumstances, reasonableness and fairness

The Interim Injunction Judge rules that the coronavirus crisis may be an unforeseen circumstance, but it is not of such a nature that, according to standards of reasonableness and fairness, the plaintiff cannot expect the break fee obligation to remain unchanged. The purpose of the break fee is to encourage parties to enter into the transaction and attribute / share risks between them. As such the fee limits the exposure of the parties. Payment of the fee is a quick way out of the obligation to pay the purchase price of EUR 169 million and the risks of keeping the target company financially afloat. If financially the coronavirus crisis turns out less disastrous than expected, the fee of EUR 30 million may seem high, but that is what the parties already considered reasonable when they waived their right to invoke the unreasonableness of the fee. The claim for payment of the EUR 30 million break fee is therefore upheld by the Interim Injunction Judge.

Applicable law and the actual practice of it by the courts

The relevant three articles are in this case articles 6:94, 6:248 and 6:258 of the Dutch Civil Code. They relate to the mitigation of contractual penalties, unforeseen circumstances and amendment of the agreement under the tenets of reasonableness and fairness. Under Dutch law the courts must with all three exercise caution. Contracts must generally be enforced as agreed. The parties’ autonomy is deemed paramount and the courts’ attitude is deferential. All three articles use language stating, essentially, that interference by the courts in the contract’s operation is allowed only to avoid an “unacceptable” impact, as assessed under standards of reasonableness and fairness.

There is at this moment of course no well- established case law on COVID-19. However, commentators have provided guidance that is very helpful to think through the issues. Recently a “share the pain” approach has been advocated by a renowned law Professor, Tjittes, who focuses on preserving the parties’ contractual equilibrium in the current circumstances. This is, in the Court’s analysis, the right way to look at the agreement here. There is no evidence in the record suggesting that the parties contemplated or discussed the full and exceptional impact of the COVID-19 crisis. The crisis may or may not be unprovided for.  However, the court rules in the current case there is no need to rule on this issue. Even if the crisis is unprovided for, there is no support in the record for the proposition that the crisis makes it unacceptable for the claimant to demand strict performance by the defendant. The reasons are straightforward.

The break fee allocates risk and expresses commitment and caps exposure. The harm to the business may be substantial and structural, or it may be short-term and minimal. Either way, the best “share the pain” solution, to preserve the contractual equilibrium in the agreement, is for the defendant to pay the fee as written in the letter of intent. This allocates a defined risk to one party, and actual or potential risks to the other party. Reducing the break fee in any business downturn, the fee’s express purpose – comfort and confidence to get the deal done – would not be accomplished and be derived in precisely the circumstances in which it should be robust. As a result, the Court therefore orders to pay the full EUR 30 million fee. So the break fee stipulation works under the circumstances without mitigation because of the Corona outbreak.

The Netherlands Commercial Court, continued

As already indicated above, the case is interesting because the verdict has been rendered by a Dutch state court in English and the proceedings where also in English. Not because of a special privilege granted in a specific case but based on an agreement between parties with a proper choice of forum clause for this court. In addition to the benefit to of having an English forum without mandatorily relying on either arbitration or choosing an anglophone court, it also has the benefit of it being a state court with the application of the regular Dutch civil procedure law, which is well known by it’s practitioners and reduces the risk of surprises of a procedural nature.  As it is as such also a “normal” state court, there is the right to appeal and particularly effective under Dutch law access to expedited proceeding as was also the case in the example referred to above. This means a regular procedure with full application of all evidentiary rules may still follow, overturning or confirming this preliminary verdict in summary proceedings.

Novel technology in proceedings

Another first or at least a novel application is that all submissions were made in eNCC, a document upload procedure for the NCC. Where the introduction of electronic communication and litigation in the Dutch court system has failed spectacularly, the innovations are now all following in quick order and quite effective. As a consequence of the Coronavirus outbreak several steps have been quickly tried in practice and thereafter formally set up. At present this – finally – includes a secure email-correspondence system between attorneys and the courts.

And, also by special order of the Court in this present case, given the current COVID-19 restrictions the matter was dealt with at a public videoconference hearing on 22 April 2020 and the case was set for judgment on 29 April 2020 and published on 30 April 2020.

Even though it is a novel application, it is highly likely that similar arrangements will continue even after expiry of current emergency measures. In several Dutch courts videoconference hearings are applied on a voluntary basis and is expected that the arrangements will be formalized.

Eligibility of cases for the Netherlands Commercial Court

Of more general interest are the requirements for matters that may be submitted to NCC:

  • the Amsterdam District Court or Amsterdam Court of Appeal has jurisdiction
  • the parties have expressly agreed in writing that proceedings will be in English before the NCC (the ‘NCC agreement’)
  • the action is a civil or commercial matter within the parties’ autonomy
  • the matter concerns an international dispute.

The NCC agreement can be recorded in a clause, either before or after the dispute arises. The Court even recommends specific wording:

“All disputes arising out of or in connection with this agreement will be resolved by the Amsterdam District Court following proceedings in English before the Chamber for International Commercial Matters (“Netherlands Commercial Court” or “NCC District Court”), to the exclusion of the jurisdiction of any other courts. An action for interim measures, including protective measures, available under Dutch law may be brought in the NCC’s Court in Summary Proceedings (CSP) in proceedings in English. Any appeals against NCC or CSP judgments will be submitted to the Amsterdam Court of Appeal’s Chamber for International Commercial Matters (“Netherlands Commercial Court of Appeal” or “NCCA”).”

The phrase “to the exclusion of the jurisdiction of any other courts” is included in light of the Hague Convention on Choice of Court Agreements. It is not mandatory to include it of course and parties may decide not to exclude the jurisdiction of other courts or make other arrangements they consider appropriate. The only requirement being that such arrangements comply with the rules of jurisdiction and contract. Please note that choice of court agreements are exclusive unless the parties have “expressly provided” or “agreed” otherwise (as per the Hague Convention and Recast Brussels I Regulation).

Parties in a pending case before another Dutch court or chamber may request that their case be referred to NCC District Court or NCC Court of Appeal. One of the requirements is to agree on a clause that takes the case to the NCC and makes English the language of the proceedings. The NCC recommends using this language:

We hereby agree that all disputes in connection with the case [name parties], which is currently pending at the *** District Court (case number ***), will be resolved by the Amsterdam District Court following proceedings in English before the Chamber for International Commercial Matters (“Netherlands Commercial Court” or ”NCC District Court). Any action for interim measures, including protective measures, available under Dutch law will be brought in the NCC’s Court in Summary Proceedings (CSP) in proceedings in English. Any appeals against NCC or CSP judgments will be submitted to the Amsterdam Court of Appeal’s Chamber for International Commercial Matters (“Netherlands Commercial Court of Appeal” or “NCC Court of Appeal”).

To request a referral, a motion must be made before the other chamber or court where the action is pending, stating the request and contesting jurisdiction (if the case is not in Amsterdam) on the basis of a choice-of-court agreement (see before).

Additional arrangements in the proceedings before the Netherlands Commercial Court

Before or during the proceedings, parties can also agree special arrangements in a customized NCC clause or in another appropriate manner. Such arrangements may include matters such as the following:

  • the law applicable to the substantive dispute
  • the appointment of a court reporter for preparing records of hearings and the costs of preparing those records
  • an agreement on evidence that departs from the general rules
  • the disclosure of confidential documents
  • the submission of a written witness statement prior to the witness examination
  • the manner of taking witness testimony
  • the costs of the proceedings.

Visiting lawyers and typical course of the procedure

All acts of process are in principle carried out by a member of the Dutch Bar. Member of the Bar in an EU or EEA Member State or Switzerland may work in accordance with Article 16e of the Advocates Act (in conjunction with a member of the Dutch Bar). Other visiting lawyers may be allowed to speak at any hearing.

The proceedings will typically follow the below steps:

  • Submitting the initiating document by the plaintiff (summons or request as per Dutch law)
  • Assigned to three judges and a senior law clerk.
  • The defendant submits its defence statement.
  • Case management conference or motion hearing (e.g. also in respect of preliminary issues such as competence, applicable law etc.) where parties may present their arguments.
  • Judgment on motions: the court rules on the motions. Testimony, expert appointment, either at this stage or earlier or later.
  • The court may allow the parties to submit further written statements.
  • Hearing: the court interviews the parties and allows them to present their arguments. The court may enquire whether the dispute could be resolved amicably and, where appropriate, assist the parties in a settlement process. If appropriate, the court may discuss with the parties whether it would be advisable to submit part or all of the dispute to a mediator. At the end of the hearing, the court will discuss with the parties what the next steps should be.
  • Verdict: this may be a final judgment on the claims or an interim judgment ordering one or more parties to produce evidence, allowing the parties to submit written submissions on certain aspects of the case, appointing one or more experts or taking other steps.

Continuous updates, online resources Netherlands Commercial Court

As a final note the English language website of the Netherlands Commercial Court provides ample information on procedure and practical issues and is updated with a high frequence. Under current circumstance even at a higher pace. In particular for practitioners it’s recommended to regularly consult the website. https://www.rechtspraak.nl/English/NCC/Pages/default.aspx

One of the most tricky steps in any M&A operation is when the issue of « warranties », in particular with reference to the economic situation, the balance sheet and the financial position of the company or business (or of a branch), namely the so-called « business warranties« .

On one side, the buyer would like to « ironclad » his investment by reducing the risk of an unpleasant surprise to a minimum. The seller, by contrast, wishes to provide the least possible warranties, which often translate in a provisory restriction on the full enjoyment of the proceeds; the same may be essential for further investment.

It should be noted, first of all, that the term « warranties » is usually referred to, in a non-technical acceptation, to a complex set of contractual provisions containing:

  • any seller’s statements about the health of the company or business (or branch of business) being transferred;
  • any compensation obligations undertaken by the seller in case of « violation » (i.e. mistruth) of the assertions;
  • any remedies provided to ensure the effectiveness of the indemnity obligations entered into.

While there are several reasons why this set is necessary, the most significant one is that in M&A contracts, statutory sale warranties only apply to the good sold; therefore, if the good sold is an equity investment, the warranties do not cover any of the company’s underlying assets; and even as they exceptionally do apply, short terms and strict limitations still justify an ancillary obligation designed to ensure the economic success of the transaction.

As confirmed by current practice, there is not a single M&A agreement that does not include a set of warranties.

In particular, representations typically incorporate the buyer’s due diligence, which for its part usually follows a non-disclosure agreement (NDA) to protect any information disclosed.

Any criticalities identified should be properly mentioned. Clearly, wherever a criticality arises, it may not necessarily trigger an indemnity obligation. It will be up to the parties to lay down the rules, as they may also provide that any related risk is to be borne by the buyer; this may be offset by a reduction in the price.

Some aspects of the compensation obligation will have to be carefully negotiated. The main ones are certainly:

  • duration (e.g. longer for tax-related warranties);
  • who is entitled to compensation (the buyer or the company; one or the other as the case may be);
  • any deductions and/or limitations (e.g. tax losses);
  • compensation cap;
  • any possible deductible;
  • the compensation procedure (e.g. application deadlines, settlement procedure, particular circumstances).

These are highly relevant aspects and should by no means be underestimated. As an example, it is obvious that if the compensation procedure is poorly regulated, all the previous efforts are jeopardised.

Finally, suitable measures to ensure an effective protection of the buyer must be provided. Among these, the most conventional tools are:

  • the surety;
  • the “independent contract of guarantee”;
  • the escrow;
  • the deferment of payment;
  • the “earn-out”-scheme;
  • the “price adjustment”;
  • the letter of patronage;
  • the pledge and/or mortgage.

These are more or less widely used instruments, each one with its pros and cons.

At this point, however, we would like to address a new tool with an insurance character, which has been being used recently: the so-called « Warranty & Indemnity Policies« .

With a W&I insurance policy, basically, the insurer assumes the risk resulting from breaches of warranties and indemnities included in an M&A contract upon payment of a premium.

It is obviously a key condition that the violation arose from facts preceding the closing and which were not known at that time (and, therefore, not highlighted by the due diligence carried out).

The insurance policy may be subscribed by the buyer (buyer side) or the seller (seller side). Usually the first option is preferred. These W&I insurance policies come with a number of advantages:

  • a warranty is given even when the seller has been unwilling to commit himself contractually;
  • the insurance policy usually does not provide for any recourse against the seller, other than in the case of malice, so that the seller is fully released;
  • it is also possible to achieve a higher ceiling than that provided for in a purchase agreement;
  • likewise, coverage may be provided for a longer period;
  • it is easier to deal with the seller, especially if there are several and some are still part of the company, perhaps as members of the Board of Directors;
  • compensation procedures become significantly easier, especially in cases where there are multiple sellers, including individuals;
  • the buyer gains a higher certainty of solvency.

The cost of the insurance policy may be shared between the parties, eventually by discounting the purchase price, which the seller may be more willing to grant, considering that he will not be required to issue other warranties and can immediately use the proceeds of the sale.

Premiums are usually set somewhere between 1% and 2% of the compensation limit (with a minimum premium).

Besides the price, which makes the tool mostly suitable for operations of not modest entity, currently, the main limitation seems to be the commonly required deductible, equal to 1% of the Enterprise Value of the Target, which may be reduced to 0.5% in case of higher premiums. Keep in mind that the W&I insurance policy implies a review of the due diligence by the insurance company, which can translate into an actual intervention in the negotiation of the warranties.

Beyond this, this tool needs to be carefully evaluated: facing highly complex scenarios, it could be the ideal solution to solve an impasse in negotiations and make relations between professional investors and SMEs easier.

Acquisitions (M&A) in Italy are carried out in most cases through the purchase of shareholdings (‘share deal’) or business or business unit (‘asset deal’). For mainly tax reasons, share deals are more frequent than asset deals, despite the asset deal allows a better limitation of risks for the buyer. We will explain the main differences between share deal and asset deal in terms of risks, and in terms of relationships between seller and buyer.

Preference for acquisitions through the purchase of shareholdings (‘share deal’) rather than the purchase of business or business unit (‘asset deal’) in the Italian market

In Italy, acquisitions are carried out, in most cases, through the purchase of shareholdings (‘share deal’) or of business or business unit (‘asset deal’). Other structures, such as mergers, are less frequent.

By purchasing shareholdings of the target company (‘share deal‘), the buyer indirectly acquires all the company’s assets, liabilities and legal relationships. Therefore, the buyer bears all the risks relating to the previous management of the company.

With the purchase of the business or of a business unit of the target company (‘asset deal‘), the buyer acquires a set of assets and relationships organized for the operation of the business (real estate, machineries, patents, trademarks, employees, contracts, credits, debts, etc.). The advantage of the asset deal lies in the possibility for the parties to select the assets and liabilities included in the deal: hence the buyer can limit the legal risks of the transaction.

Despite this advantage, most acquisitions in Italy are made through the purchase of shareholdings. In 2018, there were approximately 78,400 purchases of shareholdings (shares or quotas), while there were approximately 35,900 sales of businesses or business units. (source: www.notariato.it/it/news/dati-statistici-notarili-anno-2018). It should be noted that the number of transfers of business also includes small or very small businesses owned by individual entrepreneurs, for whom the alternative of the share deal (though feasible, through the contribution of the business in a newco and the sale of the shares in the newco) is not viable in practice for cost reasons.

Taxation of share deal and asset deal in Italy

The main reason for the preference for share deal over asset deal lies in the tax costs of the transaction. Let’s see what they are.

In a share deal, the direct taxes borne by the seller are calculated on the capital gain, according to the following rates:

  • if the seller is a joint-stock company (società per azioni – s.p.a.; società a responsabilità limitata – r.l.; società in accomandita per azioni – s.a.p.a.), the corporate tax rate is 24% of the capital gain. However, under certain conditions, the so-called PEX (participation exemption) regime is applied with the application of the rate of 24% on 5% of the capital gain only.
  • If the seller is a partnership (società semplice – s.s.; società in nome collettivo – s.n.c..; società in accomandita semplice – s.a.s.) the capital gain is fully taxable. However, under certain conditions, the taxable amount is limited to 60% of the amount of the capital gain. In both cases, the taxable amount is attributed pro rata to each shareholder of the partnership, and added to the shareholders’ income (the tax rate depends on the shareholders’ income).
  • If the seller is a natural person, the rate on the capital gain is 26%.

A share deal is subject to a fixed registration tax of € 200,00, normally paid by the buyer.

In an asset deal, the direct taxes to be paid by the seller are calculated on the capital gain. If the seller is a joint-stock company, the corporate tax rate is 24% of the capital gain. If the seller is a partnership (with individual partners) or an individual entrepreneur, the rate depends on the seller’s income.

In an asset deal the transfer of the business or of the business unit is subject to registration tax, generally paid by the buyer. However both the seller and the buyer are jointly and severally liable for the payment of the registration tax. The tax is calculated on the part of the price attributable to the assets transferred. The price is the result of the transferred assets minus the transferred liabilities. The tax rate depends on the type of asset transferred. In general:

  • movable assets, including patents and trademarks: 3%;
  • goodwill: 3%;
  • buildings: 9%;
  • land: between 9% and 12% (depending on the buyer).

If the parties do not apportion the purchase price to the different assets in proportion to their values, the registration tax is applied to the entire purchase price at the highest rate of those applicable to the assets.

It should be noted that the tax authorities may assess the value attributed by the parties to real estate and goodwill, with the consequent risk of application of higher taxes.

Share deal and asset deal: risks and responsibilities towards third parties

In the purchase of shares or quotas (‘share deal‘), the purchaser bears, indirectly, all the risks relating to the previous management of the company.

In the purchase of business or business unit (‘asset deal‘), on the other hand, the parties can select which assets and liabilities will be transferred, hence establishing, among them, the risks that the buyer will bear.

However, there are some rules, which the parties cannot derogate from, relating to relationships with third parties, that have a significant impact on the risks for the seller and the buyer, and therefore on the negotiation of the purchase agreement. The main ones are as follows.

  • Employees: the employment relationship continues with the buyer of the business. The seller and the buyer are jointly and severally liable for all the employee’s rights and claims at the time of transfer (art. 2112 of the Italian Civil Code).
  • Debts: the seller is obliged to pay all debts up to the date of transfer. The buyer is liable for the debts that are shown in the mandatory accounting books (art. 2560 of the Italian Civil Code).
  • Tax debts and liabilities: the seller is obliged to pay debts, taxes and tax penalties relating to the period up to the date of transfer. In addition to the liability for tax debts resulting from mandatory accounting books (Article 2560 of the Italian Civil Code), the buyer is liable for taxes and penalties, even if they are not shown in the accounting books, with the following limits (Article 14 of Legislative Decree 472/1997):
  • the buyer benefits from the prior enforcement of the seller;
  • the buyer is liable up to the value of the business or business unit;
  • for taxes and penalties not emerging from a tax audit by the tax authorities that has taken place before the date of transfer, the buyer is liable for those relating to the year of the sale of the business and the two preceding years only;
  • the tax authorities shall issue a certificate on the existence and amount of debts and ongoing tax audits. If the certificate is not issued within 40 days of the request, the buyer will be released from liability. If the certificate is issued, the buyer will be liable up to the amount resulting from the certificate.
  • Contracts: the parties can choose which contracts to transfer. With respect to the contracts transferred, the buyer takes over, even without the consent of the third contracting party, contracts for the operation of the business that are not of a personal nature. In addition, the third contracting party may withdraw from the contract within three months if there is a just cause (e.g. if the buyer does not guarantee to be able to fulfil the contract due to his financial situation or technical skills) (Art. 2558 of the Italian Civil Code).

Some ways to deal with the risks

To manage the risks arising from third party liability and the general risks associated with the acquisition, a number of negotiation and contractual tools can be used. Let’s see some of them.

In an asset deal:

Employees: it is possible to agree with the employee changes to the contractual terms and conditions, and waive of joint and several liability of the buyer and seller (pursuant to art. 2112 c.c.). In order to be valid, the agreement with the employee must be concluded with certain requirements (for example, with the assistance of the trade unions).

Debts:

  • transfer the debts to the buyer and reduce the price accordingly. The price reduction leads to a lower tax cost of the transaction as well. In case of transfer of debts, in order to protect the seller, a declaration of release of the seller from liability pursuant to art. 2560 of the Italian Civil Code can be obtained from the creditor; or, the parties can agree that the payment of the debt by the buyer will take place at the same time as the transfer of the business (‘closing‘).
  • For debts not transferred to the buyer, obtain from the creditor a declaration of release of the buyer from liability pursuant to art. 2560 of the Italian Civil Code.
  • For debts for which it is not possible to obtain a declaration of release from the creditor, agree on forms of security in favor of the seller (for debts transferred) or in favor of the buyer (for debts not transferred), such as, for example, the deferment of payment of part of the price; the escrow of part of the price; bank or shareholder guarantees.

Tax debts and tax liabilities:

  • obtain from the tax authorities the certificate pursuant to art. 14 of Legislative Decree 472/1997 on debts and tax liabilities;
  • transfer the debts to the buyer, and reduce the price accordingly;
  • agree on forms of guarantee in favor of the seller (for debts transferred) and in favour of the buyer (for debts not transferred or for tax liabilities), such as those set out above for debts in general.

Contracts: for those that will be transferred:

  • verify that the seller’s obligations up to the date of transfer have been properly performed, in order to avoid the risk of disputes by the third contracting party, that could stop the performance of the contract;
  • at least for the most important contracts, obtain in advance from the third contracting party the approval of transfer of the contract.

In a share deal some tools are:

  • Due diligence. Carry out a thorough legal, tax and accounting due diligence on the company, to assess the risks in advance and manage them in the negotiation and in the acquisition contract (‘share purchase agreement’).
  • Representations and warranties (‘R&W’) and indemnification. Provide in the acquisition contract (‘share purchase agreement’) a detailed set of representations and warranties – and obligations to indemnify in the event of non-compliance – to be borne by the seller in relation to the situation of the company (‘business warranties‘: balance sheet; contracts; litigation; compliance with environmental regulations; authorizations for the conduct of business; debts; receivables, etc.). Negotiations on representations and warranties normally are carried on taking into account the outcomes of due diligence. Contractual representations and warranties on the situation of the company (‘business warranties‘) and contractual obligation to indemnify, are necessary in share deals in Italy, as in the absence of such clauses the buyer cannot obtain from the seller (except in extraordinary circumstances) compensation or indemnity if the situation of the company is different from that considered at the time of purchase.
  • Guarantees for the buyer. Means of ensuring that the buyer will be indemnified in the event of breach of representations and warranties. Among them: (a) the deferment of payment of part of the price; (b) the payment of part of the price in an escrow account for the duration of the liabilities arising from the representations and warranties and, in case of disputes between the parties, until the dispute is settled; (c) bank guarantee; (d) W&I policy: insurance contract covering the risk of the buyer in case of breach of representations and warranties, up to a maximum amount (and excluding certain risks).

Other factors influencing the choice between share deal and asset deal

Of course, the choice to carry out an acquisition operation in Italy through a share deal or an asset deal also depends on other factors, in addition to the tax cost of the transaction. Here are some of them.

  • Purchase of part of the business. The parties chose the asset deal when the transaction does not involve the purchase of the entire business of the target company but only a part of it (a business unit).
  • Situation of the target company. The buyer prefers the asset deal when the situation of the target company is so problematic that the buyer is not willing to assume all the risks arising from the previous management, but only part of them.
  • Maintenance of a role by the seller. The share deal is a better option when the seller will keep a role in the target company. In this case, the seller frequently retains, in addition to a role as director, a minority shareholdings, with exit clauses (put and call rights) after a certain period of time. The exit clauses often link the price to future results and, therefore, in the interest of the buyer, motivate the seller in his/her role as director, and, in the interest of the seller, put a value on the company’s earnings potential, not yet achieved at the time of purchase.

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.

Indemnification

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.

The author of this article is Paulo Yamaguchi

The procedure to incorporate a foreign owned company in Spain is, in principle, easy and straight forward, however it is necessary to take into account certain new requirements derived from the tax and the anti-money laundering regulations, which could cause long delays in the incorporation process, even to EU and US companies, if they are not well advised and managed from the beginning of the procedure.

The first step consist in collecting information about the foreign shareholder, in order to be able to prove its legal existence and activities: the foreign shareholder(s) will have to grant before a Notary Public in its country of residence a power of attorney authorising somebody in Spain to obtain its tax identification number (“NIE”), and also represent it before the Spanish notary when signing the deed of incorporation. In case the foreign shareholder is an individual person, the NIE should be applied for before the Spanish police or the Spanish Consulate at the country where the investor lives.

If the shareholder is a corporation, apart from the Power of Attorney, it will have to obtain a certificate from its Companies’ Registry or Chamber of Commerce, stating its legal existence and main characteristics. This document is called “good standing certificate” (in the UK and US), “K-bis” (in France), “KvK” (in the Netherlands) or “visura” (in Italy). These two documents, the Power of Attorney mentioned in the above paragraph and the certificate from the Companies’ Registry, will have to be Apostilled or legalized by the correspondent Ministry, and Sworn translated into Spanish. Please note that we use to draft bilingual powers of attorney in order to avoid its sworn translation.

The foreign shareholder will have to prove that its income is obtained from legal activities in order to be able to open a bank account in the name of the new company. The main document to prove this could be the Corporate or the Personal Income Tax return filed in its country of residence, but there could be other means, especially in case of individual persons.

In case of a corporate shareholder, it will be necessary as well to declare, in principle through a public deed granted in Spain, who are the individual persons who, directly or through other companies, will hold more than a 25% interest in the new company to be incorporated. In case nobody holds more than a 25% (i.e. because there are 5 individual shareholders, holding each of them a 20%), it is declared that the effective control of the new company corresponds to its director.

At this stage, it is also necessary to mention that the person(s) who will be the director(s) of the new company, in case they are foreigners, will also need to obtain their personal “NIE”. The NIE should be applied for before the Spanish police (this could be done by a proxy duly authorised though a Power of Attorney granted by the foreign director) or before the Spanish Consulate nearest to the city where the investor lives. In order to be a director of a Spanish company it is not necessary to be a shareholder, nor to have residence and work permit in Spain (provided the foreign director does not live in Spain).

Meanwhile the necessary documents (Powers of Attorney, Companies’ Registry certificate, etc.) are being prepared by the foreign shareholder, the lawyer in Spain will apply for the new company’s name. It is advisable to point out that generic or usual names are not available quite often, therefore it is necessary to think in original names. Three different names could be applied for simultaneously.

The drafting of the company’s Articles of Association or By Laws could be very quick, except if the company is going to have several shareholders and they wish specific clauses. In this case, it is also advisable to draft a Shareholders Agreement. The Shareholders’ Agreement could just contain some basic rules on dedication, compensation, non-competition, etc. and some more sophisticated rules on the sale of shares (tag along and drag along rights). As regards the By-Laws, they should mention the company’s name, its activity or activities, address in Spain –which cannot be just a P.O. Box-, share capital, number of shares and its face value, and starting date for the fiscal year, among other standard clauses.

The management of the company could be organized through a sole director, two directors who could act jointly or separately, and in case there are more than three directors, they should organize themselves through a Board of Directors, being usual in this case to appoint a C.E.O. In order to be a director it is not necessary to be a shareholder. Under Spanish laws, the director(s) could be held liable for some company’s debts under certain circumstances which are legally defined. For this reason, it is necessary that the directors formally accept their appointment (personally appearing before the Notary or through a Power of Attorney).

Before the incorporation, it will be necessary that either the new company’s director (the person to be appointed) or the representative of the corporate shareholder appears personally before the bank where the company will have its first bank account and signs the correspondent documents (KYC regulation). Once the bank account is opened, the shareholder will have to send a bank transfer for the new company’s share capital. In Spain, the minimum share capital for a limited company (S.L.) is Euros 3.000, while for a “Sociedad Anónima” (S.A.) it is Euros 60.000, but only 25% should be paid off at the incorporation moment. It is interesting to note that contributions to the share capital could be made in cash – which is the most common operation, especially at the incorporation – or in kind, with any type of assets: real estate, machinery, goods, trademarks, etc. The money for the share capital should be sent to the new company’s bank account from an account owned by the shareholder (or from each account owned by each shareholder, should they be several ones), not by any other different person. Once the Spanish bank receives the transfer, it will issue a certificate, which is necessary in order to incorporate the company.

Once all the documents are ready, it is possible within very few days (almost immediately) to make the appointment with the Notary and sign the public deed of incorporation. This can be done at any notary in Spain, not being necessary that the notary practises at the same city where the company will have its corporate address. In order to summarize, the list of the necessary documents is:

  • Power(s) of Attorney granted by the foreign shareholder(s), apostilled and sworn translated.
  • Certificate regarding the legal existence of the foreign shareholder (only if it is a corporation), apostilled and sworn translated.
  • Statement on who are the last individual shareholders holding more than 25% interest in the new company, directly or indirectly (only in case of corporate shareholders).
  • NIE of the foreign shareholder(s).
  • NIE of the new company’s director(s), should they be a foreigners.
  • Certificate for the new company’s name.
  • Articles of Association.
  • Bank certificate regarding the contribution to the new company’s share capital.

The deed of incorporation is signed by the proxy (or the individual shareholder(s), should they prefer to personally appear before the notary) before the chosen public notary, being also necessary to sign an official form to report the foreign investment to a public registry depending on the Spanish Ministry of Finance.

Once the deed of incorporation is signed, the next steps consist in applying before the tax authorities to obtain the new company’s tax number (NIF / CIF) and filing the deed of incorporation before the Companies’ Registry. Some banks do allow new companies to operate once they have the NIF (which could be 2-3 days after the incorporation), while others request to wait until the deed of incorporation is filed at the Companies’ Registry (2-3 weeks).

An estimation of the necessary time to complete all the procedure is 30-45 days, but of course the main delay is related to speed of the foreign investor in obtaining the necessary documents.

Please note that if you wish to incorporate a foreign owned company in Spain it is always necessary to seek specific professional advice, as each case is different and regulations and the application of such regulations vary from time to time. The above article just explains the main steps and requirements for the incorporation of a company.

In all M&A operations one of the issues that deserves special attention as regards its analysis, ascertainment and negotiation is the tax liabilities. Even though the parties could agree on the amount of such contingencies, to negotiate the possible guarantees that the seller should grant in order to protect the buyer from a possible claim by the tax authorities, the term during which the guarantees should be in force, and to agree on the communication mechanisms between the parties (buyer and seller) and the legal defense strategies if such claim from the tax authorities arises, requires substantial negotiation efforts.

When the acquisition operation is formalized not through the purchase of shares, but through the purchase of the assets that form a business unit, the Spanish General Tax Law (“Ley General Tributaria” or “LGT”) provides a mechanism which implies an exception to the general principle provided by article 42 of the same law. Article 42 of LGT establishes the joint liability of the purchaser of a business unit for the tax liabilities of the selling company (“tax liability derived from company’s succession”). That is, in principle, according to article 42 of the LGT “the persons or entities that continue by any mean in the ownership or exercise of economic activities (the buyers) will be jointly liable with the previous owner for the tax liabilities derived from the exercise of such economic activities incurred by such previous owner”.

However, the joint tax liability of the buyer could be limited through the application before the tax authorities of the tax certificate regulated by article 175.2 of the LGT. This certificate should be applied for by the prospective buyer, with the authorization of the present owner (the seller), and, once issued, the tax liability of the buyer becomes limited to the debts, penalties and liabilities mentioned in the certificate. If the certificate is issued without mentioning any amount, or if the tax authorities do not issue it within a three months term from the application’s date, the applicant (the buyer) will be released from any tax liability derived from company’s succession.

The tax certificate for succession purposes includes the main taxes, as Value Added Tax and Corporate Income Tax, and can include as well debts derived from the withholding taxes on employees’ payroll, which in case of companies with a big number of employees could be of an outstanding amount. However, the buyer’s joint liability for salaries, related payroll amounts and social security contributions cannot be limited by such certificate, and such liability will always be joint with the business unit seller’s liability.

The application for the tax certificate should be filed before the acquisition of the business unit is completed, even if the issuance of the certificate takes place later tan the closing date (but of course, it is wiser to not close the acquisition before having the certificate). The certificate’s validity lasts for one year, as regards periodical tax obligations (for example, Value Added Tax, Corporate Income Tax and withholding taxes on salaries) and for three months as regards non periodical tax obligations.

It is very important to apply for the right tax certificate (“certificate for succession purposes according to article 175.2 of LGT”), and to not make a mistake and apply, for example, for the certificate regarding having fulfilled all tax obligations (“certificado de estar al corriente de las obligaciones fiscales”). Case law is plenty of judgments where a buyer applied for the wrong certificate, which showed no liabilities, and later on such buyer has been sentenced to pay the tax liabilities incurred by the previous owner of the business unit.

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.

  1. 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.

  1. Debt

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.

  1. Tax/labor contingencies

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.

  1. 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.

  1. 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.

  1. Break-up Fees

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.

  1. Recommendations

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.

The author of this article is Paulo Yamaguchi

Chinese outbound M&A was one of the main topics of interest at the 2017 Hong Kong IFLR Forum on M&A in Asia, a great event with an outstanding level of speakers and very interesting discussions on various themes related to international investments.

All the attendants shared the view that momentum for Chinese overseas investments is still strong, despite the recent policy aiming at curbing the outflow of capitals from China.

A particularly interesting session was that on “best practices to overcome credibility and experience gaps increasingly faced by “off the radar” Chinese bidders”.

Opening a one-to-one negotiation or letting a Chinese company bid at an auction involves often great deal of uncertainty, as most participants to the session shared the experience of having seeing their Chinese counterpart walk away from the negotiation without any explanation (the so-called “Random Investors”).

I have scribbled down the take-aways of the discussion as follows.

Main clues to spot early on the Random investor:

  • the Company pops out from nowhere and has no track record of overseas investments;
  • the Company has no legal or financial advisors, or if they do, their advisors are not experienced in overseas transactions;
  • the Company has excellent advisors… but has not paid their fees (yes, that happens)
  • the target does not belong to the Company’s core business (and there is no explanation for their interest for the deal);

What should you do to be on the safe side?

  • request a written declaration of interest, expressing the reasons why the Company wants to invest in the target and what is their mid term strategy, signed and stamped by the legal representative (if they are not ready to hand over this letter the game can stop here).
  • If the Company represents a group of investors, require full disclosure and letters of confirmation from all parties, from day one (AC Milan’s case is a good example of what happens later on if there is no disclosure of all players, and their stakes in the deal);
  • request proof that the Company has filed the application for the authorisation to invest overseas (due to the recent tightening of controls on capital outflow, this step is fundamental);
  • request proof that they have the finance needed for the deal (either onshore or, better, off-shore);
  • make clear that you will require a « break fee » (which can vary from 5 to 10%) in case they walk away from the negotiation (we have heard of US companies expecting 30 to 50% break fee on the value of the deal…)

Simone Rossi

Domaines d'intervention

  • Entreprise
  • Contrats
  • Fusions et acquisitions
  • Insolvabilité
  • Fonds d'investissement privés
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    Acquisitions (M&A) in Italy: share deal or asset deal

    25 septembre 2019

    • Italie
    • Entreprise
    • F&A
    • Capital-investissement

    This week the Interim Injunction Judge of the Netherlands Commercial Court ruled in summary proceedings, following a video hearing, in a case on a EUR 169 million transaction where the plaintiff argued that the final transaction had been concluded and the defendant should proceed with the deal.

    This in an – intended – transaction where the letter of intent stipulates that a EUR 30 million break fee is due when no final agreement is signed.

    In addition to ruling on this question of construction of an agreement under Dutch law, the judge also had to rule on the break fee if no agreement was concluded and whether it should be amended or reduced because of the current Coronavirus / Covid-19 crisis.

    English Language proceedings in a Dutch state court, the Netherlands Commercial Court (NCC)

    The case is not just interesting because of the way contract formation is construed under Dutch law and application of concepts of force majeure, unforeseen circumstances and amendment of agreements under the concepts of reasonableness and fairness as well as mitigation of contractual penalties, but also interesting because it was ruled on by a judge of the English language chamber of the Netherlands Commercial Court (NCC).

    This new (2019) Dutch state court offers a relatively fast and cost-effective alternative for international commercial litigation, and in particular arbitration, in a neutral jurisdiction with professional judges selected for both their experience in international disputes and their command of English.

    The dispute regarding the construction of an M&A agreement under Dutch law in an international setting

    The facts are straightforward. Parties (located in New York, USA and the Netherlands) dispute whether final agreement on the EUR 169 million transaction has been reached but do agree a break fee of €30 million in case of non-signature of the final agreement was agreed. However, in addition to claiming there is no final agreement, the defendant also argues that the break fee – due when there is no final agreement – should be reduced or changed due to the coronavirus crisis.

    As to contract formation it must be noted that Dutch law allows broad leeway on how to communicate what may or may not be an offer or acceptance. The standard is what a reasonable person in the same circumstances would have understood their communications to mean.  Here, the critical fact is that the defendant did not sign the so-called “Transaction Agreement”. The letter of intent’s binary mechanism (either execute and deliver the paperwork for the Transaction Agreement by the agreed date or pay a EUR 30 million fee) may not have been an absolute requirement for contract formation (under Dutch law) but has significant evidentiary weight. In M&A practice – also under Dutch law – with which these parties are thoroughly familiar with, this sets a very high bar for  concluding a contract was agreed other than by explicit written agreement. So, parties may generally comfortably rely on what they have agreed on in writing with the assistance of their advisors.

    The communications relied on by claimant in this case did not clear the very high bar to assume that despite the mechanism of the letter of intent and the lack of a signed Transaction Agreement there still was a binding agreement. In particular attributing the other party’s advisers’ statements and/or conduct to the contracting party they represent did not work for the claimant in this case as per the verdict nothing suggested that the advisers would be handling everything, including entering into the agreement.

    Court order for actual performance of a – deemed – agreement on an M&A deal?

    The Interim Injunction Judge finds that there is not a sufficient likelihood of success on the merits so as to justify an interim measure ordering the defendant to actually perform its obligations under the disputed Transaction Agreement (payment of EUR 169 million and take the claimant’s 50% stake in an equestrian show-jumping business).

    Enforcement of the break fee despite “Coronavirus”?

    Failing the conclusion of an agreement, there was still another question to answer as the letter of intent mechanism re the break fee as such was not disputed. Should the Court enforce the full EUR 30 million fee in the current COVID-19 circumstances? Or should the fee’s effects be modified, mitigated or reduced in some way, or  the fee agreement should even be dissolved?

    Unforeseen circumstances, reasonableness and fairness

    The Interim Injunction Judge rules that the coronavirus crisis may be an unforeseen circumstance, but it is not of such a nature that, according to standards of reasonableness and fairness, the plaintiff cannot expect the break fee obligation to remain unchanged. The purpose of the break fee is to encourage parties to enter into the transaction and attribute / share risks between them. As such the fee limits the exposure of the parties. Payment of the fee is a quick way out of the obligation to pay the purchase price of EUR 169 million and the risks of keeping the target company financially afloat. If financially the coronavirus crisis turns out less disastrous than expected, the fee of EUR 30 million may seem high, but that is what the parties already considered reasonable when they waived their right to invoke the unreasonableness of the fee. The claim for payment of the EUR 30 million break fee is therefore upheld by the Interim Injunction Judge.

    Applicable law and the actual practice of it by the courts

    The relevant three articles are in this case articles 6:94, 6:248 and 6:258 of the Dutch Civil Code. They relate to the mitigation of contractual penalties, unforeseen circumstances and amendment of the agreement under the tenets of reasonableness and fairness. Under Dutch law the courts must with all three exercise caution. Contracts must generally be enforced as agreed. The parties’ autonomy is deemed paramount and the courts’ attitude is deferential. All three articles use language stating, essentially, that interference by the courts in the contract’s operation is allowed only to avoid an “unacceptable” impact, as assessed under standards of reasonableness and fairness.

    There is at this moment of course no well- established case law on COVID-19. However, commentators have provided guidance that is very helpful to think through the issues. Recently a “share the pain” approach has been advocated by a renowned law Professor, Tjittes, who focuses on preserving the parties’ contractual equilibrium in the current circumstances. This is, in the Court’s analysis, the right way to look at the agreement here. There is no evidence in the record suggesting that the parties contemplated or discussed the full and exceptional impact of the COVID-19 crisis. The crisis may or may not be unprovided for.  However, the court rules in the current case there is no need to rule on this issue. Even if the crisis is unprovided for, there is no support in the record for the proposition that the crisis makes it unacceptable for the claimant to demand strict performance by the defendant. The reasons are straightforward.

    The break fee allocates risk and expresses commitment and caps exposure. The harm to the business may be substantial and structural, or it may be short-term and minimal. Either way, the best “share the pain” solution, to preserve the contractual equilibrium in the agreement, is for the defendant to pay the fee as written in the letter of intent. This allocates a defined risk to one party, and actual or potential risks to the other party. Reducing the break fee in any business downturn, the fee’s express purpose – comfort and confidence to get the deal done – would not be accomplished and be derived in precisely the circumstances in which it should be robust. As a result, the Court therefore orders to pay the full EUR 30 million fee. So the break fee stipulation works under the circumstances without mitigation because of the Corona outbreak.

    The Netherlands Commercial Court, continued

    As already indicated above, the case is interesting because the verdict has been rendered by a Dutch state court in English and the proceedings where also in English. Not because of a special privilege granted in a specific case but based on an agreement between parties with a proper choice of forum clause for this court. In addition to the benefit to of having an English forum without mandatorily relying on either arbitration or choosing an anglophone court, it also has the benefit of it being a state court with the application of the regular Dutch civil procedure law, which is well known by it’s practitioners and reduces the risk of surprises of a procedural nature.  As it is as such also a “normal” state court, there is the right to appeal and particularly effective under Dutch law access to expedited proceeding as was also the case in the example referred to above. This means a regular procedure with full application of all evidentiary rules may still follow, overturning or confirming this preliminary verdict in summary proceedings.

    Novel technology in proceedings

    Another first or at least a novel application is that all submissions were made in eNCC, a document upload procedure for the NCC. Where the introduction of electronic communication and litigation in the Dutch court system has failed spectacularly, the innovations are now all following in quick order and quite effective. As a consequence of the Coronavirus outbreak several steps have been quickly tried in practice and thereafter formally set up. At present this – finally – includes a secure email-correspondence system between attorneys and the courts.

    And, also by special order of the Court in this present case, given the current COVID-19 restrictions the matter was dealt with at a public videoconference hearing on 22 April 2020 and the case was set for judgment on 29 April 2020 and published on 30 April 2020.

    Even though it is a novel application, it is highly likely that similar arrangements will continue even after expiry of current emergency measures. In several Dutch courts videoconference hearings are applied on a voluntary basis and is expected that the arrangements will be formalized.

    Eligibility of cases for the Netherlands Commercial Court

    Of more general interest are the requirements for matters that may be submitted to NCC:

    • the Amsterdam District Court or Amsterdam Court of Appeal has jurisdiction
    • the parties have expressly agreed in writing that proceedings will be in English before the NCC (the ‘NCC agreement’)
    • the action is a civil or commercial matter within the parties’ autonomy
    • the matter concerns an international dispute.

    The NCC agreement can be recorded in a clause, either before or after the dispute arises. The Court even recommends specific wording:

    “All disputes arising out of or in connection with this agreement will be resolved by the Amsterdam District Court following proceedings in English before the Chamber for International Commercial Matters (“Netherlands Commercial Court” or “NCC District Court”), to the exclusion of the jurisdiction of any other courts. An action for interim measures, including protective measures, available under Dutch law may be brought in the NCC’s Court in Summary Proceedings (CSP) in proceedings in English. Any appeals against NCC or CSP judgments will be submitted to the Amsterdam Court of Appeal’s Chamber for International Commercial Matters (“Netherlands Commercial Court of Appeal” or “NCCA”).”

    The phrase “to the exclusion of the jurisdiction of any other courts” is included in light of the Hague Convention on Choice of Court Agreements. It is not mandatory to include it of course and parties may decide not to exclude the jurisdiction of other courts or make other arrangements they consider appropriate. The only requirement being that such arrangements comply with the rules of jurisdiction and contract. Please note that choice of court agreements are exclusive unless the parties have “expressly provided” or “agreed” otherwise (as per the Hague Convention and Recast Brussels I Regulation).

    Parties in a pending case before another Dutch court or chamber may request that their case be referred to NCC District Court or NCC Court of Appeal. One of the requirements is to agree on a clause that takes the case to the NCC and makes English the language of the proceedings. The NCC recommends using this language:

    We hereby agree that all disputes in connection with the case [name parties], which is currently pending at the *** District Court (case number ***), will be resolved by the Amsterdam District Court following proceedings in English before the Chamber for International Commercial Matters (“Netherlands Commercial Court” or ”NCC District Court). Any action for interim measures, including protective measures, available under Dutch law will be brought in the NCC’s Court in Summary Proceedings (CSP) in proceedings in English. Any appeals against NCC or CSP judgments will be submitted to the Amsterdam Court of Appeal’s Chamber for International Commercial Matters (“Netherlands Commercial Court of Appeal” or “NCC Court of Appeal”).

    To request a referral, a motion must be made before the other chamber or court where the action is pending, stating the request and contesting jurisdiction (if the case is not in Amsterdam) on the basis of a choice-of-court agreement (see before).

    Additional arrangements in the proceedings before the Netherlands Commercial Court

    Before or during the proceedings, parties can also agree special arrangements in a customized NCC clause or in another appropriate manner. Such arrangements may include matters such as the following:

    • the law applicable to the substantive dispute
    • the appointment of a court reporter for preparing records of hearings and the costs of preparing those records
    • an agreement on evidence that departs from the general rules
    • the disclosure of confidential documents
    • the submission of a written witness statement prior to the witness examination
    • the manner of taking witness testimony
    • the costs of the proceedings.

    Visiting lawyers and typical course of the procedure

    All acts of process are in principle carried out by a member of the Dutch Bar. Member of the Bar in an EU or EEA Member State or Switzerland may work in accordance with Article 16e of the Advocates Act (in conjunction with a member of the Dutch Bar). Other visiting lawyers may be allowed to speak at any hearing.

    The proceedings will typically follow the below steps:

    • Submitting the initiating document by the plaintiff (summons or request as per Dutch law)
    • Assigned to three judges and a senior law clerk.
    • The defendant submits its defence statement.
    • Case management conference or motion hearing (e.g. also in respect of preliminary issues such as competence, applicable law etc.) where parties may present their arguments.
    • Judgment on motions: the court rules on the motions. Testimony, expert appointment, either at this stage or earlier or later.
    • The court may allow the parties to submit further written statements.
    • Hearing: the court interviews the parties and allows them to present their arguments. The court may enquire whether the dispute could be resolved amicably and, where appropriate, assist the parties in a settlement process. If appropriate, the court may discuss with the parties whether it would be advisable to submit part or all of the dispute to a mediator. At the end of the hearing, the court will discuss with the parties what the next steps should be.
    • Verdict: this may be a final judgment on the claims or an interim judgment ordering one or more parties to produce evidence, allowing the parties to submit written submissions on certain aspects of the case, appointing one or more experts or taking other steps.

    Continuous updates, online resources Netherlands Commercial Court

    As a final note the English language website of the Netherlands Commercial Court provides ample information on procedure and practical issues and is updated with a high frequence. Under current circumstance even at a higher pace. In particular for practitioners it’s recommended to regularly consult the website. https://www.rechtspraak.nl/English/NCC/Pages/default.aspx

    One of the most tricky steps in any M&A operation is when the issue of « warranties », in particular with reference to the economic situation, the balance sheet and the financial position of the company or business (or of a branch), namely the so-called « business warranties« .

    On one side, the buyer would like to « ironclad » his investment by reducing the risk of an unpleasant surprise to a minimum. The seller, by contrast, wishes to provide the least possible warranties, which often translate in a provisory restriction on the full enjoyment of the proceeds; the same may be essential for further investment.

    It should be noted, first of all, that the term « warranties » is usually referred to, in a non-technical acceptation, to a complex set of contractual provisions containing:

    • any seller’s statements about the health of the company or business (or branch of business) being transferred;
    • any compensation obligations undertaken by the seller in case of « violation » (i.e. mistruth) of the assertions;
    • any remedies provided to ensure the effectiveness of the indemnity obligations entered into.

    While there are several reasons why this set is necessary, the most significant one is that in M&A contracts, statutory sale warranties only apply to the good sold; therefore, if the good sold is an equity investment, the warranties do not cover any of the company’s underlying assets; and even as they exceptionally do apply, short terms and strict limitations still justify an ancillary obligation designed to ensure the economic success of the transaction.

    As confirmed by current practice, there is not a single M&A agreement that does not include a set of warranties.

    In particular, representations typically incorporate the buyer’s due diligence, which for its part usually follows a non-disclosure agreement (NDA) to protect any information disclosed.

    Any criticalities identified should be properly mentioned. Clearly, wherever a criticality arises, it may not necessarily trigger an indemnity obligation. It will be up to the parties to lay down the rules, as they may also provide that any related risk is to be borne by the buyer; this may be offset by a reduction in the price.

    Some aspects of the compensation obligation will have to be carefully negotiated. The main ones are certainly:

    • duration (e.g. longer for tax-related warranties);
    • who is entitled to compensation (the buyer or the company; one or the other as the case may be);
    • any deductions and/or limitations (e.g. tax losses);
    • compensation cap;
    • any possible deductible;
    • the compensation procedure (e.g. application deadlines, settlement procedure, particular circumstances).

    These are highly relevant aspects and should by no means be underestimated. As an example, it is obvious that if the compensation procedure is poorly regulated, all the previous efforts are jeopardised.

    Finally, suitable measures to ensure an effective protection of the buyer must be provided. Among these, the most conventional tools are:

    • the surety;
    • the “independent contract of guarantee”;
    • the escrow;
    • the deferment of payment;
    • the “earn-out”-scheme;
    • the “price adjustment”;
    • the letter of patronage;
    • the pledge and/or mortgage.

    These are more or less widely used instruments, each one with its pros and cons.

    At this point, however, we would like to address a new tool with an insurance character, which has been being used recently: the so-called « Warranty & Indemnity Policies« .

    With a W&I insurance policy, basically, the insurer assumes the risk resulting from breaches of warranties and indemnities included in an M&A contract upon payment of a premium.

    It is obviously a key condition that the violation arose from facts preceding the closing and which were not known at that time (and, therefore, not highlighted by the due diligence carried out).

    The insurance policy may be subscribed by the buyer (buyer side) or the seller (seller side). Usually the first option is preferred. These W&I insurance policies come with a number of advantages:

    • a warranty is given even when the seller has been unwilling to commit himself contractually;
    • the insurance policy usually does not provide for any recourse against the seller, other than in the case of malice, so that the seller is fully released;
    • it is also possible to achieve a higher ceiling than that provided for in a purchase agreement;
    • likewise, coverage may be provided for a longer period;
    • it is easier to deal with the seller, especially if there are several and some are still part of the company, perhaps as members of the Board of Directors;
    • compensation procedures become significantly easier, especially in cases where there are multiple sellers, including individuals;
    • the buyer gains a higher certainty of solvency.

    The cost of the insurance policy may be shared between the parties, eventually by discounting the purchase price, which the seller may be more willing to grant, considering that he will not be required to issue other warranties and can immediately use the proceeds of the sale.

    Premiums are usually set somewhere between 1% and 2% of the compensation limit (with a minimum premium).

    Besides the price, which makes the tool mostly suitable for operations of not modest entity, currently, the main limitation seems to be the commonly required deductible, equal to 1% of the Enterprise Value of the Target, which may be reduced to 0.5% in case of higher premiums. Keep in mind that the W&I insurance policy implies a review of the due diligence by the insurance company, which can translate into an actual intervention in the negotiation of the warranties.

    Beyond this, this tool needs to be carefully evaluated: facing highly complex scenarios, it could be the ideal solution to solve an impasse in negotiations and make relations between professional investors and SMEs easier.

    Acquisitions (M&A) in Italy are carried out in most cases through the purchase of shareholdings (‘share deal’) or business or business unit (‘asset deal’). For mainly tax reasons, share deals are more frequent than asset deals, despite the asset deal allows a better limitation of risks for the buyer. We will explain the main differences between share deal and asset deal in terms of risks, and in terms of relationships between seller and buyer.

    Preference for acquisitions through the purchase of shareholdings (‘share deal’) rather than the purchase of business or business unit (‘asset deal’) in the Italian market

    In Italy, acquisitions are carried out, in most cases, through the purchase of shareholdings (‘share deal’) or of business or business unit (‘asset deal’). Other structures, such as mergers, are less frequent.

    By purchasing shareholdings of the target company (‘share deal‘), the buyer indirectly acquires all the company’s assets, liabilities and legal relationships. Therefore, the buyer bears all the risks relating to the previous management of the company.

    With the purchase of the business or of a business unit of the target company (‘asset deal‘), the buyer acquires a set of assets and relationships organized for the operation of the business (real estate, machineries, patents, trademarks, employees, contracts, credits, debts, etc.). The advantage of the asset deal lies in the possibility for the parties to select the assets and liabilities included in the deal: hence the buyer can limit the legal risks of the transaction.

    Despite this advantage, most acquisitions in Italy are made through the purchase of shareholdings. In 2018, there were approximately 78,400 purchases of shareholdings (shares or quotas), while there were approximately 35,900 sales of businesses or business units. (source: www.notariato.it/it/news/dati-statistici-notarili-anno-2018). It should be noted that the number of transfers of business also includes small or very small businesses owned by individual entrepreneurs, for whom the alternative of the share deal (though feasible, through the contribution of the business in a newco and the sale of the shares in the newco) is not viable in practice for cost reasons.

    Taxation of share deal and asset deal in Italy

    The main reason for the preference for share deal over asset deal lies in the tax costs of the transaction. Let’s see what they are.

    In a share deal, the direct taxes borne by the seller are calculated on the capital gain, according to the following rates:

    • if the seller is a joint-stock company (società per azioni – s.p.a.; società a responsabilità limitata – r.l.; società in accomandita per azioni – s.a.p.a.), the corporate tax rate is 24% of the capital gain. However, under certain conditions, the so-called PEX (participation exemption) regime is applied with the application of the rate of 24% on 5% of the capital gain only.
    • If the seller is a partnership (società semplice – s.s.; società in nome collettivo – s.n.c..; società in accomandita semplice – s.a.s.) the capital gain is fully taxable. However, under certain conditions, the taxable amount is limited to 60% of the amount of the capital gain. In both cases, the taxable amount is attributed pro rata to each shareholder of the partnership, and added to the shareholders’ income (the tax rate depends on the shareholders’ income).
    • If the seller is a natural person, the rate on the capital gain is 26%.

    A share deal is subject to a fixed registration tax of € 200,00, normally paid by the buyer.

    In an asset deal, the direct taxes to be paid by the seller are calculated on the capital gain. If the seller is a joint-stock company, the corporate tax rate is 24% of the capital gain. If the seller is a partnership (with individual partners) or an individual entrepreneur, the rate depends on the seller’s income.

    In an asset deal the transfer of the business or of the business unit is subject to registration tax, generally paid by the buyer. However both the seller and the buyer are jointly and severally liable for the payment of the registration tax. The tax is calculated on the part of the price attributable to the assets transferred. The price is the result of the transferred assets minus the transferred liabilities. The tax rate depends on the type of asset transferred. In general:

    • movable assets, including patents and trademarks: 3%;
    • goodwill: 3%;
    • buildings: 9%;
    • land: between 9% and 12% (depending on the buyer).

    If the parties do not apportion the purchase price to the different assets in proportion to their values, the registration tax is applied to the entire purchase price at the highest rate of those applicable to the assets.

    It should be noted that the tax authorities may assess the value attributed by the parties to real estate and goodwill, with the consequent risk of application of higher taxes.

    Share deal and asset deal: risks and responsibilities towards third parties

    In the purchase of shares or quotas (‘share deal‘), the purchaser bears, indirectly, all the risks relating to the previous management of the company.

    In the purchase of business or business unit (‘asset deal‘), on the other hand, the parties can select which assets and liabilities will be transferred, hence establishing, among them, the risks that the buyer will bear.

    However, there are some rules, which the parties cannot derogate from, relating to relationships with third parties, that have a significant impact on the risks for the seller and the buyer, and therefore on the negotiation of the purchase agreement. The main ones are as follows.

    • Employees: the employment relationship continues with the buyer of the business. The seller and the buyer are jointly and severally liable for all the employee’s rights and claims at the time of transfer (art. 2112 of the Italian Civil Code).
    • Debts: the seller is obliged to pay all debts up to the date of transfer. The buyer is liable for the debts that are shown in the mandatory accounting books (art. 2560 of the Italian Civil Code).
    • Tax debts and liabilities: the seller is obliged to pay debts, taxes and tax penalties relating to the period up to the date of transfer. In addition to the liability for tax debts resulting from mandatory accounting books (Article 2560 of the Italian Civil Code), the buyer is liable for taxes and penalties, even if they are not shown in the accounting books, with the following limits (Article 14 of Legislative Decree 472/1997):
    • the buyer benefits from the prior enforcement of the seller;
    • the buyer is liable up to the value of the business or business unit;
    • for taxes and penalties not emerging from a tax audit by the tax authorities that has taken place before the date of transfer, the buyer is liable for those relating to the year of the sale of the business and the two preceding years only;
    • the tax authorities shall issue a certificate on the existence and amount of debts and ongoing tax audits. If the certificate is not issued within 40 days of the request, the buyer will be released from liability. If the certificate is issued, the buyer will be liable up to the amount resulting from the certificate.
    • Contracts: the parties can choose which contracts to transfer. With respect to the contracts transferred, the buyer takes over, even without the consent of the third contracting party, contracts for the operation of the business that are not of a personal nature. In addition, the third contracting party may withdraw from the contract within three months if there is a just cause (e.g. if the buyer does not guarantee to be able to fulfil the contract due to his financial situation or technical skills) (Art. 2558 of the Italian Civil Code).

    Some ways to deal with the risks

    To manage the risks arising from third party liability and the general risks associated with the acquisition, a number of negotiation and contractual tools can be used. Let’s see some of them.

    In an asset deal:

    Employees: it is possible to agree with the employee changes to the contractual terms and conditions, and waive of joint and several liability of the buyer and seller (pursuant to art. 2112 c.c.). In order to be valid, the agreement with the employee must be concluded with certain requirements (for example, with the assistance of the trade unions).

    Debts:

    • transfer the debts to the buyer and reduce the price accordingly. The price reduction leads to a lower tax cost of the transaction as well. In case of transfer of debts, in order to protect the seller, a declaration of release of the seller from liability pursuant to art. 2560 of the Italian Civil Code can be obtained from the creditor; or, the parties can agree that the payment of the debt by the buyer will take place at the same time as the transfer of the business (‘closing‘).
    • For debts not transferred to the buyer, obtain from the creditor a declaration of release of the buyer from liability pursuant to art. 2560 of the Italian Civil Code.
    • For debts for which it is not possible to obtain a declaration of release from the creditor, agree on forms of security in favor of the seller (for debts transferred) or in favor of the buyer (for debts not transferred), such as, for example, the deferment of payment of part of the price; the escrow of part of the price; bank or shareholder guarantees.

    Tax debts and tax liabilities:

    • obtain from the tax authorities the certificate pursuant to art. 14 of Legislative Decree 472/1997 on debts and tax liabilities;
    • transfer the debts to the buyer, and reduce the price accordingly;
    • agree on forms of guarantee in favor of the seller (for debts transferred) and in favour of the buyer (for debts not transferred or for tax liabilities), such as those set out above for debts in general.

    Contracts: for those that will be transferred:

    • verify that the seller’s obligations up to the date of transfer have been properly performed, in order to avoid the risk of disputes by the third contracting party, that could stop the performance of the contract;
    • at least for the most important contracts, obtain in advance from the third contracting party the approval of transfer of the contract.

    In a share deal some tools are:

    • Due diligence. Carry out a thorough legal, tax and accounting due diligence on the company, to assess the risks in advance and manage them in the negotiation and in the acquisition contract (‘share purchase agreement’).
    • Representations and warranties (‘R&W’) and indemnification. Provide in the acquisition contract (‘share purchase agreement’) a detailed set of representations and warranties – and obligations to indemnify in the event of non-compliance – to be borne by the seller in relation to the situation of the company (‘business warranties‘: balance sheet; contracts; litigation; compliance with environmental regulations; authorizations for the conduct of business; debts; receivables, etc.). Negotiations on representations and warranties normally are carried on taking into account the outcomes of due diligence. Contractual representations and warranties on the situation of the company (‘business warranties‘) and contractual obligation to indemnify, are necessary in share deals in Italy, as in the absence of such clauses the buyer cannot obtain from the seller (except in extraordinary circumstances) compensation or indemnity if the situation of the company is different from that considered at the time of purchase.
    • Guarantees for the buyer. Means of ensuring that the buyer will be indemnified in the event of breach of representations and warranties. Among them: (a) the deferment of payment of part of the price; (b) the payment of part of the price in an escrow account for the duration of the liabilities arising from the representations and warranties and, in case of disputes between the parties, until the dispute is settled; (c) bank guarantee; (d) W&I policy: insurance contract covering the risk of the buyer in case of breach of representations and warranties, up to a maximum amount (and excluding certain risks).

    Other factors influencing the choice between share deal and asset deal

    Of course, the choice to carry out an acquisition operation in Italy through a share deal or an asset deal also depends on other factors, in addition to the tax cost of the transaction. Here are some of them.

    • Purchase of part of the business. The parties chose the asset deal when the transaction does not involve the purchase of the entire business of the target company but only a part of it (a business unit).
    • Situation of the target company. The buyer prefers the asset deal when the situation of the target company is so problematic that the buyer is not willing to assume all the risks arising from the previous management, but only part of them.
    • Maintenance of a role by the seller. The share deal is a better option when the seller will keep a role in the target company. In this case, the seller frequently retains, in addition to a role as director, a minority shareholdings, with exit clauses (put and call rights) after a certain period of time. The exit clauses often link the price to future results and, therefore, in the interest of the buyer, motivate the seller in his/her role as director, and, in the interest of the seller, put a value on the company’s earnings potential, not yet achieved at the time of purchase.

    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.

    Indemnification

    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.

    The author of this article is Paulo Yamaguchi

    The procedure to incorporate a foreign owned company in Spain is, in principle, easy and straight forward, however it is necessary to take into account certain new requirements derived from the tax and the anti-money laundering regulations, which could cause long delays in the incorporation process, even to EU and US companies, if they are not well advised and managed from the beginning of the procedure.

    The first step consist in collecting information about the foreign shareholder, in order to be able to prove its legal existence and activities: the foreign shareholder(s) will have to grant before a Notary Public in its country of residence a power of attorney authorising somebody in Spain to obtain its tax identification number (“NIE”), and also represent it before the Spanish notary when signing the deed of incorporation. In case the foreign shareholder is an individual person, the NIE should be applied for before the Spanish police or the Spanish Consulate at the country where the investor lives.

    If the shareholder is a corporation, apart from the Power of Attorney, it will have to obtain a certificate from its Companies’ Registry or Chamber of Commerce, stating its legal existence and main characteristics. This document is called “good standing certificate” (in the UK and US), “K-bis” (in France), “KvK” (in the Netherlands) or “visura” (in Italy). These two documents, the Power of Attorney mentioned in the above paragraph and the certificate from the Companies’ Registry, will have to be Apostilled or legalized by the correspondent Ministry, and Sworn translated into Spanish. Please note that we use to draft bilingual powers of attorney in order to avoid its sworn translation.

    The foreign shareholder will have to prove that its income is obtained from legal activities in order to be able to open a bank account in the name of the new company. The main document to prove this could be the Corporate or the Personal Income Tax return filed in its country of residence, but there could be other means, especially in case of individual persons.

    In case of a corporate shareholder, it will be necessary as well to declare, in principle through a public deed granted in Spain, who are the individual persons who, directly or through other companies, will hold more than a 25% interest in the new company to be incorporated. In case nobody holds more than a 25% (i.e. because there are 5 individual shareholders, holding each of them a 20%), it is declared that the effective control of the new company corresponds to its director.

    At this stage, it is also necessary to mention that the person(s) who will be the director(s) of the new company, in case they are foreigners, will also need to obtain their personal “NIE”. The NIE should be applied for before the Spanish police (this could be done by a proxy duly authorised though a Power of Attorney granted by the foreign director) or before the Spanish Consulate nearest to the city where the investor lives. In order to be a director of a Spanish company it is not necessary to be a shareholder, nor to have residence and work permit in Spain (provided the foreign director does not live in Spain).

    Meanwhile the necessary documents (Powers of Attorney, Companies’ Registry certificate, etc.) are being prepared by the foreign shareholder, the lawyer in Spain will apply for the new company’s name. It is advisable to point out that generic or usual names are not available quite often, therefore it is necessary to think in original names. Three different names could be applied for simultaneously.

    The drafting of the company’s Articles of Association or By Laws could be very quick, except if the company is going to have several shareholders and they wish specific clauses. In this case, it is also advisable to draft a Shareholders Agreement. The Shareholders’ Agreement could just contain some basic rules on dedication, compensation, non-competition, etc. and some more sophisticated rules on the sale of shares (tag along and drag along rights). As regards the By-Laws, they should mention the company’s name, its activity or activities, address in Spain –which cannot be just a P.O. Box-, share capital, number of shares and its face value, and starting date for the fiscal year, among other standard clauses.

    The management of the company could be organized through a sole director, two directors who could act jointly or separately, and in case there are more than three directors, they should organize themselves through a Board of Directors, being usual in this case to appoint a C.E.O. In order to be a director it is not necessary to be a shareholder. Under Spanish laws, the director(s) could be held liable for some company’s debts under certain circumstances which are legally defined. For this reason, it is necessary that the directors formally accept their appointment (personally appearing before the Notary or through a Power of Attorney).

    Before the incorporation, it will be necessary that either the new company’s director (the person to be appointed) or the representative of the corporate shareholder appears personally before the bank where the company will have its first bank account and signs the correspondent documents (KYC regulation). Once the bank account is opened, the shareholder will have to send a bank transfer for the new company’s share capital. In Spain, the minimum share capital for a limited company (S.L.) is Euros 3.000, while for a “Sociedad Anónima” (S.A.) it is Euros 60.000, but only 25% should be paid off at the incorporation moment. It is interesting to note that contributions to the share capital could be made in cash – which is the most common operation, especially at the incorporation – or in kind, with any type of assets: real estate, machinery, goods, trademarks, etc. The money for the share capital should be sent to the new company’s bank account from an account owned by the shareholder (or from each account owned by each shareholder, should they be several ones), not by any other different person. Once the Spanish bank receives the transfer, it will issue a certificate, which is necessary in order to incorporate the company.

    Once all the documents are ready, it is possible within very few days (almost immediately) to make the appointment with the Notary and sign the public deed of incorporation. This can be done at any notary in Spain, not being necessary that the notary practises at the same city where the company will have its corporate address. In order to summarize, the list of the necessary documents is:

    • Power(s) of Attorney granted by the foreign shareholder(s), apostilled and sworn translated.
    • Certificate regarding the legal existence of the foreign shareholder (only if it is a corporation), apostilled and sworn translated.
    • Statement on who are the last individual shareholders holding more than 25% interest in the new company, directly or indirectly (only in case of corporate shareholders).
    • NIE of the foreign shareholder(s).
    • NIE of the new company’s director(s), should they be a foreigners.
    • Certificate for the new company’s name.
    • Articles of Association.
    • Bank certificate regarding the contribution to the new company’s share capital.

    The deed of incorporation is signed by the proxy (or the individual shareholder(s), should they prefer to personally appear before the notary) before the chosen public notary, being also necessary to sign an official form to report the foreign investment to a public registry depending on the Spanish Ministry of Finance.

    Once the deed of incorporation is signed, the next steps consist in applying before the tax authorities to obtain the new company’s tax number (NIF / CIF) and filing the deed of incorporation before the Companies’ Registry. Some banks do allow new companies to operate once they have the NIF (which could be 2-3 days after the incorporation), while others request to wait until the deed of incorporation is filed at the Companies’ Registry (2-3 weeks).

    An estimation of the necessary time to complete all the procedure is 30-45 days, but of course the main delay is related to speed of the foreign investor in obtaining the necessary documents.

    Please note that if you wish to incorporate a foreign owned company in Spain it is always necessary to seek specific professional advice, as each case is different and regulations and the application of such regulations vary from time to time. The above article just explains the main steps and requirements for the incorporation of a company.

    In all M&A operations one of the issues that deserves special attention as regards its analysis, ascertainment and negotiation is the tax liabilities. Even though the parties could agree on the amount of such contingencies, to negotiate the possible guarantees that the seller should grant in order to protect the buyer from a possible claim by the tax authorities, the term during which the guarantees should be in force, and to agree on the communication mechanisms between the parties (buyer and seller) and the legal defense strategies if such claim from the tax authorities arises, requires substantial negotiation efforts.

    When the acquisition operation is formalized not through the purchase of shares, but through the purchase of the assets that form a business unit, the Spanish General Tax Law (“Ley General Tributaria” or “LGT”) provides a mechanism which implies an exception to the general principle provided by article 42 of the same law. Article 42 of LGT establishes the joint liability of the purchaser of a business unit for the tax liabilities of the selling company (“tax liability derived from company’s succession”). That is, in principle, according to article 42 of the LGT “the persons or entities that continue by any mean in the ownership or exercise of economic activities (the buyers) will be jointly liable with the previous owner for the tax liabilities derived from the exercise of such economic activities incurred by such previous owner”.

    However, the joint tax liability of the buyer could be limited through the application before the tax authorities of the tax certificate regulated by article 175.2 of the LGT. This certificate should be applied for by the prospective buyer, with the authorization of the present owner (the seller), and, once issued, the tax liability of the buyer becomes limited to the debts, penalties and liabilities mentioned in the certificate. If the certificate is issued without mentioning any amount, or if the tax authorities do not issue it within a three months term from the application’s date, the applicant (the buyer) will be released from any tax liability derived from company’s succession.

    The tax certificate for succession purposes includes the main taxes, as Value Added Tax and Corporate Income Tax, and can include as well debts derived from the withholding taxes on employees’ payroll, which in case of companies with a big number of employees could be of an outstanding amount. However, the buyer’s joint liability for salaries, related payroll amounts and social security contributions cannot be limited by such certificate, and such liability will always be joint with the business unit seller’s liability.

    The application for the tax certificate should be filed before the acquisition of the business unit is completed, even if the issuance of the certificate takes place later tan the closing date (but of course, it is wiser to not close the acquisition before having the certificate). The certificate’s validity lasts for one year, as regards periodical tax obligations (for example, Value Added Tax, Corporate Income Tax and withholding taxes on salaries) and for three months as regards non periodical tax obligations.

    It is very important to apply for the right tax certificate (“certificate for succession purposes according to article 175.2 of LGT”), and to not make a mistake and apply, for example, for the certificate regarding having fulfilled all tax obligations (“certificado de estar al corriente de las obligaciones fiscales”). Case law is plenty of judgments where a buyer applied for the wrong certificate, which showed no liabilities, and later on such buyer has been sentenced to pay the tax liabilities incurred by the previous owner of the business unit.

    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.

    1. 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.

    1. Debt

    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.

    1. Tax/labor contingencies

    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.

    1. 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.

    1. 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.

    1. Break-up Fees

    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.

    1. Recommendations

    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.

    The author of this article is Paulo Yamaguchi

    Chinese outbound M&A was one of the main topics of interest at the 2017 Hong Kong IFLR Forum on M&A in Asia, a great event with an outstanding level of speakers and very interesting discussions on various themes related to international investments.

    All the attendants shared the view that momentum for Chinese overseas investments is still strong, despite the recent policy aiming at curbing the outflow of capitals from China.

    A particularly interesting session was that on “best practices to overcome credibility and experience gaps increasingly faced by “off the radar” Chinese bidders”.

    Opening a one-to-one negotiation or letting a Chinese company bid at an auction involves often great deal of uncertainty, as most participants to the session shared the experience of having seeing their Chinese counterpart walk away from the negotiation without any explanation (the so-called “Random Investors”).

    I have scribbled down the take-aways of the discussion as follows.

    Main clues to spot early on the Random investor:

    • the Company pops out from nowhere and has no track record of overseas investments;
    • the Company has no legal or financial advisors, or if they do, their advisors are not experienced in overseas transactions;
    • the Company has excellent advisors… but has not paid their fees (yes, that happens)
    • the target does not belong to the Company’s core business (and there is no explanation for their interest for the deal);

    What should you do to be on the safe side?

    • request a written declaration of interest, expressing the reasons why the Company wants to invest in the target and what is their mid term strategy, signed and stamped by the legal representative (if they are not ready to hand over this letter the game can stop here).
    • If the Company represents a group of investors, require full disclosure and letters of confirmation from all parties, from day one (AC Milan’s case is a good example of what happens later on if there is no disclosure of all players, and their stakes in the deal);
    • request proof that the Company has filed the application for the authorisation to invest overseas (due to the recent tightening of controls on capital outflow, this step is fundamental);
    • request proof that they have the finance needed for the deal (either onshore or, better, off-shore);
    • make clear that you will require a « break fee » (which can vary from 5 to 10%) in case they walk away from the negotiation (we have heard of US companies expecting 30 to 50% break fee on the value of the deal…)

    Simone Rossi

    Domaines d'intervention

    • Entreprise
    • Contrats
    • Fusions et acquisitions
    • Insolvabilité
    • Fonds d'investissement privés
    Contact Simone

    Écrire à Simone





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      Brazil- M&A and Agency Agreements

      20 août 2019

      • Brésil
      • Agence
      • Entreprise
      • F&A

      This week the Interim Injunction Judge of the Netherlands Commercial Court ruled in summary proceedings, following a video hearing, in a case on a EUR 169 million transaction where the plaintiff argued that the final transaction had been concluded and the defendant should proceed with the deal.

      This in an – intended – transaction where the letter of intent stipulates that a EUR 30 million break fee is due when no final agreement is signed.

      In addition to ruling on this question of construction of an agreement under Dutch law, the judge also had to rule on the break fee if no agreement was concluded and whether it should be amended or reduced because of the current Coronavirus / Covid-19 crisis.

      English Language proceedings in a Dutch state court, the Netherlands Commercial Court (NCC)

      The case is not just interesting because of the way contract formation is construed under Dutch law and application of concepts of force majeure, unforeseen circumstances and amendment of agreements under the concepts of reasonableness and fairness as well as mitigation of contractual penalties, but also interesting because it was ruled on by a judge of the English language chamber of the Netherlands Commercial Court (NCC).

      This new (2019) Dutch state court offers a relatively fast and cost-effective alternative for international commercial litigation, and in particular arbitration, in a neutral jurisdiction with professional judges selected for both their experience in international disputes and their command of English.

      The dispute regarding the construction of an M&A agreement under Dutch law in an international setting

      The facts are straightforward. Parties (located in New York, USA and the Netherlands) dispute whether final agreement on the EUR 169 million transaction has been reached but do agree a break fee of €30 million in case of non-signature of the final agreement was agreed. However, in addition to claiming there is no final agreement, the defendant also argues that the break fee – due when there is no final agreement – should be reduced or changed due to the coronavirus crisis.

      As to contract formation it must be noted that Dutch law allows broad leeway on how to communicate what may or may not be an offer or acceptance. The standard is what a reasonable person in the same circumstances would have understood their communications to mean.  Here, the critical fact is that the defendant did not sign the so-called “Transaction Agreement”. The letter of intent’s binary mechanism (either execute and deliver the paperwork for the Transaction Agreement by the agreed date or pay a EUR 30 million fee) may not have been an absolute requirement for contract formation (under Dutch law) but has significant evidentiary weight. In M&A practice – also under Dutch law – with which these parties are thoroughly familiar with, this sets a very high bar for  concluding a contract was agreed other than by explicit written agreement. So, parties may generally comfortably rely on what they have agreed on in writing with the assistance of their advisors.

      The communications relied on by claimant in this case did not clear the very high bar to assume that despite the mechanism of the letter of intent and the lack of a signed Transaction Agreement there still was a binding agreement. In particular attributing the other party’s advisers’ statements and/or conduct to the contracting party they represent did not work for the claimant in this case as per the verdict nothing suggested that the advisers would be handling everything, including entering into the agreement.

      Court order for actual performance of a – deemed – agreement on an M&A deal?

      The Interim Injunction Judge finds that there is not a sufficient likelihood of success on the merits so as to justify an interim measure ordering the defendant to actually perform its obligations under the disputed Transaction Agreement (payment of EUR 169 million and take the claimant’s 50% stake in an equestrian show-jumping business).

      Enforcement of the break fee despite “Coronavirus”?

      Failing the conclusion of an agreement, there was still another question to answer as the letter of intent mechanism re the break fee as such was not disputed. Should the Court enforce the full EUR 30 million fee in the current COVID-19 circumstances? Or should the fee’s effects be modified, mitigated or reduced in some way, or  the fee agreement should even be dissolved?

      Unforeseen circumstances, reasonableness and fairness

      The Interim Injunction Judge rules that the coronavirus crisis may be an unforeseen circumstance, but it is not of such a nature that, according to standards of reasonableness and fairness, the plaintiff cannot expect the break fee obligation to remain unchanged. The purpose of the break fee is to encourage parties to enter into the transaction and attribute / share risks between them. As such the fee limits the exposure of the parties. Payment of the fee is a quick way out of the obligation to pay the purchase price of EUR 169 million and the risks of keeping the target company financially afloat. If financially the coronavirus crisis turns out less disastrous than expected, the fee of EUR 30 million may seem high, but that is what the parties already considered reasonable when they waived their right to invoke the unreasonableness of the fee. The claim for payment of the EUR 30 million break fee is therefore upheld by the Interim Injunction Judge.

      Applicable law and the actual practice of it by the courts

      The relevant three articles are in this case articles 6:94, 6:248 and 6:258 of the Dutch Civil Code. They relate to the mitigation of contractual penalties, unforeseen circumstances and amendment of the agreement under the tenets of reasonableness and fairness. Under Dutch law the courts must with all three exercise caution. Contracts must generally be enforced as agreed. The parties’ autonomy is deemed paramount and the courts’ attitude is deferential. All three articles use language stating, essentially, that interference by the courts in the contract’s operation is allowed only to avoid an “unacceptable” impact, as assessed under standards of reasonableness and fairness.

      There is at this moment of course no well- established case law on COVID-19. However, commentators have provided guidance that is very helpful to think through the issues. Recently a “share the pain” approach has been advocated by a renowned law Professor, Tjittes, who focuses on preserving the parties’ contractual equilibrium in the current circumstances. This is, in the Court’s analysis, the right way to look at the agreement here. There is no evidence in the record suggesting that the parties contemplated or discussed the full and exceptional impact of the COVID-19 crisis. The crisis may or may not be unprovided for.  However, the court rules in the current case there is no need to rule on this issue. Even if the crisis is unprovided for, there is no support in the record for the proposition that the crisis makes it unacceptable for the claimant to demand strict performance by the defendant. The reasons are straightforward.

      The break fee allocates risk and expresses commitment and caps exposure. The harm to the business may be substantial and structural, or it may be short-term and minimal. Either way, the best “share the pain” solution, to preserve the contractual equilibrium in the agreement, is for the defendant to pay the fee as written in the letter of intent. This allocates a defined risk to one party, and actual or potential risks to the other party. Reducing the break fee in any business downturn, the fee’s express purpose – comfort and confidence to get the deal done – would not be accomplished and be derived in precisely the circumstances in which it should be robust. As a result, the Court therefore orders to pay the full EUR 30 million fee. So the break fee stipulation works under the circumstances without mitigation because of the Corona outbreak.

      The Netherlands Commercial Court, continued

      As already indicated above, the case is interesting because the verdict has been rendered by a Dutch state court in English and the proceedings where also in English. Not because of a special privilege granted in a specific case but based on an agreement between parties with a proper choice of forum clause for this court. In addition to the benefit to of having an English forum without mandatorily relying on either arbitration or choosing an anglophone court, it also has the benefit of it being a state court with the application of the regular Dutch civil procedure law, which is well known by it’s practitioners and reduces the risk of surprises of a procedural nature.  As it is as such also a “normal” state court, there is the right to appeal and particularly effective under Dutch law access to expedited proceeding as was also the case in the example referred to above. This means a regular procedure with full application of all evidentiary rules may still follow, overturning or confirming this preliminary verdict in summary proceedings.

      Novel technology in proceedings

      Another first or at least a novel application is that all submissions were made in eNCC, a document upload procedure for the NCC. Where the introduction of electronic communication and litigation in the Dutch court system has failed spectacularly, the innovations are now all following in quick order and quite effective. As a consequence of the Coronavirus outbreak several steps have been quickly tried in practice and thereafter formally set up. At present this – finally – includes a secure email-correspondence system between attorneys and the courts.

      And, also by special order of the Court in this present case, given the current COVID-19 restrictions the matter was dealt with at a public videoconference hearing on 22 April 2020 and the case was set for judgment on 29 April 2020 and published on 30 April 2020.

      Even though it is a novel application, it is highly likely that similar arrangements will continue even after expiry of current emergency measures. In several Dutch courts videoconference hearings are applied on a voluntary basis and is expected that the arrangements will be formalized.

      Eligibility of cases for the Netherlands Commercial Court

      Of more general interest are the requirements for matters that may be submitted to NCC:

      • the Amsterdam District Court or Amsterdam Court of Appeal has jurisdiction
      • the parties have expressly agreed in writing that proceedings will be in English before the NCC (the ‘NCC agreement’)
      • the action is a civil or commercial matter within the parties’ autonomy
      • the matter concerns an international dispute.

      The NCC agreement can be recorded in a clause, either before or after the dispute arises. The Court even recommends specific wording:

      “All disputes arising out of or in connection with this agreement will be resolved by the Amsterdam District Court following proceedings in English before the Chamber for International Commercial Matters (“Netherlands Commercial Court” or “NCC District Court”), to the exclusion of the jurisdiction of any other courts. An action for interim measures, including protective measures, available under Dutch law may be brought in the NCC’s Court in Summary Proceedings (CSP) in proceedings in English. Any appeals against NCC or CSP judgments will be submitted to the Amsterdam Court of Appeal’s Chamber for International Commercial Matters (“Netherlands Commercial Court of Appeal” or “NCCA”).”

      The phrase “to the exclusion of the jurisdiction of any other courts” is included in light of the Hague Convention on Choice of Court Agreements. It is not mandatory to include it of course and parties may decide not to exclude the jurisdiction of other courts or make other arrangements they consider appropriate. The only requirement being that such arrangements comply with the rules of jurisdiction and contract. Please note that choice of court agreements are exclusive unless the parties have “expressly provided” or “agreed” otherwise (as per the Hague Convention and Recast Brussels I Regulation).

      Parties in a pending case before another Dutch court or chamber may request that their case be referred to NCC District Court or NCC Court of Appeal. One of the requirements is to agree on a clause that takes the case to the NCC and makes English the language of the proceedings. The NCC recommends using this language:

      We hereby agree that all disputes in connection with the case [name parties], which is currently pending at the *** District Court (case number ***), will be resolved by the Amsterdam District Court following proceedings in English before the Chamber for International Commercial Matters (“Netherlands Commercial Court” or ”NCC District Court). Any action for interim measures, including protective measures, available under Dutch law will be brought in the NCC’s Court in Summary Proceedings (CSP) in proceedings in English. Any appeals against NCC or CSP judgments will be submitted to the Amsterdam Court of Appeal’s Chamber for International Commercial Matters (“Netherlands Commercial Court of Appeal” or “NCC Court of Appeal”).

      To request a referral, a motion must be made before the other chamber or court where the action is pending, stating the request and contesting jurisdiction (if the case is not in Amsterdam) on the basis of a choice-of-court agreement (see before).

      Additional arrangements in the proceedings before the Netherlands Commercial Court

      Before or during the proceedings, parties can also agree special arrangements in a customized NCC clause or in another appropriate manner. Such arrangements may include matters such as the following:

      • the law applicable to the substantive dispute
      • the appointment of a court reporter for preparing records of hearings and the costs of preparing those records
      • an agreement on evidence that departs from the general rules
      • the disclosure of confidential documents
      • the submission of a written witness statement prior to the witness examination
      • the manner of taking witness testimony
      • the costs of the proceedings.

      Visiting lawyers and typical course of the procedure

      All acts of process are in principle carried out by a member of the Dutch Bar. Member of the Bar in an EU or EEA Member State or Switzerland may work in accordance with Article 16e of the Advocates Act (in conjunction with a member of the Dutch Bar). Other visiting lawyers may be allowed to speak at any hearing.

      The proceedings will typically follow the below steps:

      • Submitting the initiating document by the plaintiff (summons or request as per Dutch law)
      • Assigned to three judges and a senior law clerk.
      • The defendant submits its defence statement.
      • Case management conference or motion hearing (e.g. also in respect of preliminary issues such as competence, applicable law etc.) where parties may present their arguments.
      • Judgment on motions: the court rules on the motions. Testimony, expert appointment, either at this stage or earlier or later.
      • The court may allow the parties to submit further written statements.
      • Hearing: the court interviews the parties and allows them to present their arguments. The court may enquire whether the dispute could be resolved amicably and, where appropriate, assist the parties in a settlement process. If appropriate, the court may discuss with the parties whether it would be advisable to submit part or all of the dispute to a mediator. At the end of the hearing, the court will discuss with the parties what the next steps should be.
      • Verdict: this may be a final judgment on the claims or an interim judgment ordering one or more parties to produce evidence, allowing the parties to submit written submissions on certain aspects of the case, appointing one or more experts or taking other steps.

      Continuous updates, online resources Netherlands Commercial Court

      As a final note the English language website of the Netherlands Commercial Court provides ample information on procedure and practical issues and is updated with a high frequence. Under current circumstance even at a higher pace. In particular for practitioners it’s recommended to regularly consult the website. https://www.rechtspraak.nl/English/NCC/Pages/default.aspx

      One of the most tricky steps in any M&A operation is when the issue of « warranties », in particular with reference to the economic situation, the balance sheet and the financial position of the company or business (or of a branch), namely the so-called « business warranties« .

      On one side, the buyer would like to « ironclad » his investment by reducing the risk of an unpleasant surprise to a minimum. The seller, by contrast, wishes to provide the least possible warranties, which often translate in a provisory restriction on the full enjoyment of the proceeds; the same may be essential for further investment.

      It should be noted, first of all, that the term « warranties » is usually referred to, in a non-technical acceptation, to a complex set of contractual provisions containing:

      • any seller’s statements about the health of the company or business (or branch of business) being transferred;
      • any compensation obligations undertaken by the seller in case of « violation » (i.e. mistruth) of the assertions;
      • any remedies provided to ensure the effectiveness of the indemnity obligations entered into.

      While there are several reasons why this set is necessary, the most significant one is that in M&A contracts, statutory sale warranties only apply to the good sold; therefore, if the good sold is an equity investment, the warranties do not cover any of the company’s underlying assets; and even as they exceptionally do apply, short terms and strict limitations still justify an ancillary obligation designed to ensure the economic success of the transaction.

      As confirmed by current practice, there is not a single M&A agreement that does not include a set of warranties.

      In particular, representations typically incorporate the buyer’s due diligence, which for its part usually follows a non-disclosure agreement (NDA) to protect any information disclosed.

      Any criticalities identified should be properly mentioned. Clearly, wherever a criticality arises, it may not necessarily trigger an indemnity obligation. It will be up to the parties to lay down the rules, as they may also provide that any related risk is to be borne by the buyer; this may be offset by a reduction in the price.

      Some aspects of the compensation obligation will have to be carefully negotiated. The main ones are certainly:

      • duration (e.g. longer for tax-related warranties);
      • who is entitled to compensation (the buyer or the company; one or the other as the case may be);
      • any deductions and/or limitations (e.g. tax losses);
      • compensation cap;
      • any possible deductible;
      • the compensation procedure (e.g. application deadlines, settlement procedure, particular circumstances).

      These are highly relevant aspects and should by no means be underestimated. As an example, it is obvious that if the compensation procedure is poorly regulated, all the previous efforts are jeopardised.

      Finally, suitable measures to ensure an effective protection of the buyer must be provided. Among these, the most conventional tools are:

      • the surety;
      • the “independent contract of guarantee”;
      • the escrow;
      • the deferment of payment;
      • the “earn-out”-scheme;
      • the “price adjustment”;
      • the letter of patronage;
      • the pledge and/or mortgage.

      These are more or less widely used instruments, each one with its pros and cons.

      At this point, however, we would like to address a new tool with an insurance character, which has been being used recently: the so-called « Warranty & Indemnity Policies« .

      With a W&I insurance policy, basically, the insurer assumes the risk resulting from breaches of warranties and indemnities included in an M&A contract upon payment of a premium.

      It is obviously a key condition that the violation arose from facts preceding the closing and which were not known at that time (and, therefore, not highlighted by the due diligence carried out).

      The insurance policy may be subscribed by the buyer (buyer side) or the seller (seller side). Usually the first option is preferred. These W&I insurance policies come with a number of advantages:

      • a warranty is given even when the seller has been unwilling to commit himself contractually;
      • the insurance policy usually does not provide for any recourse against the seller, other than in the case of malice, so that the seller is fully released;
      • it is also possible to achieve a higher ceiling than that provided for in a purchase agreement;
      • likewise, coverage may be provided for a longer period;
      • it is easier to deal with the seller, especially if there are several and some are still part of the company, perhaps as members of the Board of Directors;
      • compensation procedures become significantly easier, especially in cases where there are multiple sellers, including individuals;
      • the buyer gains a higher certainty of solvency.

      The cost of the insurance policy may be shared between the parties, eventually by discounting the purchase price, which the seller may be more willing to grant, considering that he will not be required to issue other warranties and can immediately use the proceeds of the sale.

      Premiums are usually set somewhere between 1% and 2% of the compensation limit (with a minimum premium).

      Besides the price, which makes the tool mostly suitable for operations of not modest entity, currently, the main limitation seems to be the commonly required deductible, equal to 1% of the Enterprise Value of the Target, which may be reduced to 0.5% in case of higher premiums. Keep in mind that the W&I insurance policy implies a review of the due diligence by the insurance company, which can translate into an actual intervention in the negotiation of the warranties.

      Beyond this, this tool needs to be carefully evaluated: facing highly complex scenarios, it could be the ideal solution to solve an impasse in negotiations and make relations between professional investors and SMEs easier.

      Acquisitions (M&A) in Italy are carried out in most cases through the purchase of shareholdings (‘share deal’) or business or business unit (‘asset deal’). For mainly tax reasons, share deals are more frequent than asset deals, despite the asset deal allows a better limitation of risks for the buyer. We will explain the main differences between share deal and asset deal in terms of risks, and in terms of relationships between seller and buyer.

      Preference for acquisitions through the purchase of shareholdings (‘share deal’) rather than the purchase of business or business unit (‘asset deal’) in the Italian market

      In Italy, acquisitions are carried out, in most cases, through the purchase of shareholdings (‘share deal’) or of business or business unit (‘asset deal’). Other structures, such as mergers, are less frequent.

      By purchasing shareholdings of the target company (‘share deal‘), the buyer indirectly acquires all the company’s assets, liabilities and legal relationships. Therefore, the buyer bears all the risks relating to the previous management of the company.

      With the purchase of the business or of a business unit of the target company (‘asset deal‘), the buyer acquires a set of assets and relationships organized for the operation of the business (real estate, machineries, patents, trademarks, employees, contracts, credits, debts, etc.). The advantage of the asset deal lies in the possibility for the parties to select the assets and liabilities included in the deal: hence the buyer can limit the legal risks of the transaction.

      Despite this advantage, most acquisitions in Italy are made through the purchase of shareholdings. In 2018, there were approximately 78,400 purchases of shareholdings (shares or quotas), while there were approximately 35,900 sales of businesses or business units. (source: www.notariato.it/it/news/dati-statistici-notarili-anno-2018). It should be noted that the number of transfers of business also includes small or very small businesses owned by individual entrepreneurs, for whom the alternative of the share deal (though feasible, through the contribution of the business in a newco and the sale of the shares in the newco) is not viable in practice for cost reasons.

      Taxation of share deal and asset deal in Italy

      The main reason for the preference for share deal over asset deal lies in the tax costs of the transaction. Let’s see what they are.

      In a share deal, the direct taxes borne by the seller are calculated on the capital gain, according to the following rates:

      • if the seller is a joint-stock company (società per azioni – s.p.a.; società a responsabilità limitata – r.l.; società in accomandita per azioni – s.a.p.a.), the corporate tax rate is 24% of the capital gain. However, under certain conditions, the so-called PEX (participation exemption) regime is applied with the application of the rate of 24% on 5% of the capital gain only.
      • If the seller is a partnership (società semplice – s.s.; società in nome collettivo – s.n.c..; società in accomandita semplice – s.a.s.) the capital gain is fully taxable. However, under certain conditions, the taxable amount is limited to 60% of the amount of the capital gain. In both cases, the taxable amount is attributed pro rata to each shareholder of the partnership, and added to the shareholders’ income (the tax rate depends on the shareholders’ income).
      • If the seller is a natural person, the rate on the capital gain is 26%.

      A share deal is subject to a fixed registration tax of € 200,00, normally paid by the buyer.

      In an asset deal, the direct taxes to be paid by the seller are calculated on the capital gain. If the seller is a joint-stock company, the corporate tax rate is 24% of the capital gain. If the seller is a partnership (with individual partners) or an individual entrepreneur, the rate depends on the seller’s income.

      In an asset deal the transfer of the business or of the business unit is subject to registration tax, generally paid by the buyer. However both the seller and the buyer are jointly and severally liable for the payment of the registration tax. The tax is calculated on the part of the price attributable to the assets transferred. The price is the result of the transferred assets minus the transferred liabilities. The tax rate depends on the type of asset transferred. In general:

      • movable assets, including patents and trademarks: 3%;
      • goodwill: 3%;
      • buildings: 9%;
      • land: between 9% and 12% (depending on the buyer).

      If the parties do not apportion the purchase price to the different assets in proportion to their values, the registration tax is applied to the entire purchase price at the highest rate of those applicable to the assets.

      It should be noted that the tax authorities may assess the value attributed by the parties to real estate and goodwill, with the consequent risk of application of higher taxes.

      Share deal and asset deal: risks and responsibilities towards third parties

      In the purchase of shares or quotas (‘share deal‘), the purchaser bears, indirectly, all the risks relating to the previous management of the company.

      In the purchase of business or business unit (‘asset deal‘), on the other hand, the parties can select which assets and liabilities will be transferred, hence establishing, among them, the risks that the buyer will bear.

      However, there are some rules, which the parties cannot derogate from, relating to relationships with third parties, that have a significant impact on the risks for the seller and the buyer, and therefore on the negotiation of the purchase agreement. The main ones are as follows.

      • Employees: the employment relationship continues with the buyer of the business. The seller and the buyer are jointly and severally liable for all the employee’s rights and claims at the time of transfer (art. 2112 of the Italian Civil Code).
      • Debts: the seller is obliged to pay all debts up to the date of transfer. The buyer is liable for the debts that are shown in the mandatory accounting books (art. 2560 of the Italian Civil Code).
      • Tax debts and liabilities: the seller is obliged to pay debts, taxes and tax penalties relating to the period up to the date of transfer. In addition to the liability for tax debts resulting from mandatory accounting books (Article 2560 of the Italian Civil Code), the buyer is liable for taxes and penalties, even if they are not shown in the accounting books, with the following limits (Article 14 of Legislative Decree 472/1997):
      • the buyer benefits from the prior enforcement of the seller;
      • the buyer is liable up to the value of the business or business unit;
      • for taxes and penalties not emerging from a tax audit by the tax authorities that has taken place before the date of transfer, the buyer is liable for those relating to the year of the sale of the business and the two preceding years only;
      • the tax authorities shall issue a certificate on the existence and amount of debts and ongoing tax audits. If the certificate is not issued within 40 days of the request, the buyer will be released from liability. If the certificate is issued, the buyer will be liable up to the amount resulting from the certificate.
      • Contracts: the parties can choose which contracts to transfer. With respect to the contracts transferred, the buyer takes over, even without the consent of the third contracting party, contracts for the operation of the business that are not of a personal nature. In addition, the third contracting party may withdraw from the contract within three months if there is a just cause (e.g. if the buyer does not guarantee to be able to fulfil the contract due to his financial situation or technical skills) (Art. 2558 of the Italian Civil Code).

      Some ways to deal with the risks

      To manage the risks arising from third party liability and the general risks associated with the acquisition, a number of negotiation and contractual tools can be used. Let’s see some of them.

      In an asset deal:

      Employees: it is possible to agree with the employee changes to the contractual terms and conditions, and waive of joint and several liability of the buyer and seller (pursuant to art. 2112 c.c.). In order to be valid, the agreement with the employee must be concluded with certain requirements (for example, with the assistance of the trade unions).

      Debts:

      • transfer the debts to the buyer and reduce the price accordingly. The price reduction leads to a lower tax cost of the transaction as well. In case of transfer of debts, in order to protect the seller, a declaration of release of the seller from liability pursuant to art. 2560 of the Italian Civil Code can be obtained from the creditor; or, the parties can agree that the payment of the debt by the buyer will take place at the same time as the transfer of the business (‘closing‘).
      • For debts not transferred to the buyer, obtain from the creditor a declaration of release of the buyer from liability pursuant to art. 2560 of the Italian Civil Code.
      • For debts for which it is not possible to obtain a declaration of release from the creditor, agree on forms of security in favor of the seller (for debts transferred) or in favor of the buyer (for debts not transferred), such as, for example, the deferment of payment of part of the price; the escrow of part of the price; bank or shareholder guarantees.

      Tax debts and tax liabilities:

      • obtain from the tax authorities the certificate pursuant to art. 14 of Legislative Decree 472/1997 on debts and tax liabilities;
      • transfer the debts to the buyer, and reduce the price accordingly;
      • agree on forms of guarantee in favor of the seller (for debts transferred) and in favour of the buyer (for debts not transferred or for tax liabilities), such as those set out above for debts in general.

      Contracts: for those that will be transferred:

      • verify that the seller’s obligations up to the date of transfer have been properly performed, in order to avoid the risk of disputes by the third contracting party, that could stop the performance of the contract;
      • at least for the most important contracts, obtain in advance from the third contracting party the approval of transfer of the contract.

      In a share deal some tools are:

      • Due diligence. Carry out a thorough legal, tax and accounting due diligence on the company, to assess the risks in advance and manage them in the negotiation and in the acquisition contract (‘share purchase agreement’).
      • Representations and warranties (‘R&W’) and indemnification. Provide in the acquisition contract (‘share purchase agreement’) a detailed set of representations and warranties – and obligations to indemnify in the event of non-compliance – to be borne by the seller in relation to the situation of the company (‘business warranties‘: balance sheet; contracts; litigation; compliance with environmental regulations; authorizations for the conduct of business; debts; receivables, etc.). Negotiations on representations and warranties normally are carried on taking into account the outcomes of due diligence. Contractual representations and warranties on the situation of the company (‘business warranties‘) and contractual obligation to indemnify, are necessary in share deals in Italy, as in the absence of such clauses the buyer cannot obtain from the seller (except in extraordinary circumstances) compensation or indemnity if the situation of the company is different from that considered at the time of purchase.
      • Guarantees for the buyer. Means of ensuring that the buyer will be indemnified in the event of breach of representations and warranties. Among them: (a) the deferment of payment of part of the price; (b) the payment of part of the price in an escrow account for the duration of the liabilities arising from the representations and warranties and, in case of disputes between the parties, until the dispute is settled; (c) bank guarantee; (d) W&I policy: insurance contract covering the risk of the buyer in case of breach of representations and warranties, up to a maximum amount (and excluding certain risks).

      Other factors influencing the choice between share deal and asset deal

      Of course, the choice to carry out an acquisition operation in Italy through a share deal or an asset deal also depends on other factors, in addition to the tax cost of the transaction. Here are some of them.

      • Purchase of part of the business. The parties chose the asset deal when the transaction does not involve the purchase of the entire business of the target company but only a part of it (a business unit).
      • Situation of the target company. The buyer prefers the asset deal when the situation of the target company is so problematic that the buyer is not willing to assume all the risks arising from the previous management, but only part of them.
      • Maintenance of a role by the seller. The share deal is a better option when the seller will keep a role in the target company. In this case, the seller frequently retains, in addition to a role as director, a minority shareholdings, with exit clauses (put and call rights) after a certain period of time. The exit clauses often link the price to future results and, therefore, in the interest of the buyer, motivate the seller in his/her role as director, and, in the interest of the seller, put a value on the company’s earnings potential, not yet achieved at the time of purchase.

      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.

      Indemnification

      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.

      The author of this article is Paulo Yamaguchi

      The procedure to incorporate a foreign owned company in Spain is, in principle, easy and straight forward, however it is necessary to take into account certain new requirements derived from the tax and the anti-money laundering regulations, which could cause long delays in the incorporation process, even to EU and US companies, if they are not well advised and managed from the beginning of the procedure.

      The first step consist in collecting information about the foreign shareholder, in order to be able to prove its legal existence and activities: the foreign shareholder(s) will have to grant before a Notary Public in its country of residence a power of attorney authorising somebody in Spain to obtain its tax identification number (“NIE”), and also represent it before the Spanish notary when signing the deed of incorporation. In case the foreign shareholder is an individual person, the NIE should be applied for before the Spanish police or the Spanish Consulate at the country where the investor lives.

      If the shareholder is a corporation, apart from the Power of Attorney, it will have to obtain a certificate from its Companies’ Registry or Chamber of Commerce, stating its legal existence and main characteristics. This document is called “good standing certificate” (in the UK and US), “K-bis” (in France), “KvK” (in the Netherlands) or “visura” (in Italy). These two documents, the Power of Attorney mentioned in the above paragraph and the certificate from the Companies’ Registry, will have to be Apostilled or legalized by the correspondent Ministry, and Sworn translated into Spanish. Please note that we use to draft bilingual powers of attorney in order to avoid its sworn translation.

      The foreign shareholder will have to prove that its income is obtained from legal activities in order to be able to open a bank account in the name of the new company. The main document to prove this could be the Corporate or the Personal Income Tax return filed in its country of residence, but there could be other means, especially in case of individual persons.

      In case of a corporate shareholder, it will be necessary as well to declare, in principle through a public deed granted in Spain, who are the individual persons who, directly or through other companies, will hold more than a 25% interest in the new company to be incorporated. In case nobody holds more than a 25% (i.e. because there are 5 individual shareholders, holding each of them a 20%), it is declared that the effective control of the new company corresponds to its director.

      At this stage, it is also necessary to mention that the person(s) who will be the director(s) of the new company, in case they are foreigners, will also need to obtain their personal “NIE”. The NIE should be applied for before the Spanish police (this could be done by a proxy duly authorised though a Power of Attorney granted by the foreign director) or before the Spanish Consulate nearest to the city where the investor lives. In order to be a director of a Spanish company it is not necessary to be a shareholder, nor to have residence and work permit in Spain (provided the foreign director does not live in Spain).

      Meanwhile the necessary documents (Powers of Attorney, Companies’ Registry certificate, etc.) are being prepared by the foreign shareholder, the lawyer in Spain will apply for the new company’s name. It is advisable to point out that generic or usual names are not available quite often, therefore it is necessary to think in original names. Three different names could be applied for simultaneously.

      The drafting of the company’s Articles of Association or By Laws could be very quick, except if the company is going to have several shareholders and they wish specific clauses. In this case, it is also advisable to draft a Shareholders Agreement. The Shareholders’ Agreement could just contain some basic rules on dedication, compensation, non-competition, etc. and some more sophisticated rules on the sale of shares (tag along and drag along rights). As regards the By-Laws, they should mention the company’s name, its activity or activities, address in Spain –which cannot be just a P.O. Box-, share capital, number of shares and its face value, and starting date for the fiscal year, among other standard clauses.

      The management of the company could be organized through a sole director, two directors who could act jointly or separately, and in case there are more than three directors, they should organize themselves through a Board of Directors, being usual in this case to appoint a C.E.O. In order to be a director it is not necessary to be a shareholder. Under Spanish laws, the director(s) could be held liable for some company’s debts under certain circumstances which are legally defined. For this reason, it is necessary that the directors formally accept their appointment (personally appearing before the Notary or through a Power of Attorney).

      Before the incorporation, it will be necessary that either the new company’s director (the person to be appointed) or the representative of the corporate shareholder appears personally before the bank where the company will have its first bank account and signs the correspondent documents (KYC regulation). Once the bank account is opened, the shareholder will have to send a bank transfer for the new company’s share capital. In Spain, the minimum share capital for a limited company (S.L.) is Euros 3.000, while for a “Sociedad Anónima” (S.A.) it is Euros 60.000, but only 25% should be paid off at the incorporation moment. It is interesting to note that contributions to the share capital could be made in cash – which is the most common operation, especially at the incorporation – or in kind, with any type of assets: real estate, machinery, goods, trademarks, etc. The money for the share capital should be sent to the new company’s bank account from an account owned by the shareholder (or from each account owned by each shareholder, should they be several ones), not by any other different person. Once the Spanish bank receives the transfer, it will issue a certificate, which is necessary in order to incorporate the company.

      Once all the documents are ready, it is possible within very few days (almost immediately) to make the appointment with the Notary and sign the public deed of incorporation. This can be done at any notary in Spain, not being necessary that the notary practises at the same city where the company will have its corporate address. In order to summarize, the list of the necessary documents is:

      • Power(s) of Attorney granted by the foreign shareholder(s), apostilled and sworn translated.
      • Certificate regarding the legal existence of the foreign shareholder (only if it is a corporation), apostilled and sworn translated.
      • Statement on who are the last individual shareholders holding more than 25% interest in the new company, directly or indirectly (only in case of corporate shareholders).
      • NIE of the foreign shareholder(s).
      • NIE of the new company’s director(s), should they be a foreigners.
      • Certificate for the new company’s name.
      • Articles of Association.
      • Bank certificate regarding the contribution to the new company’s share capital.

      The deed of incorporation is signed by the proxy (or the individual shareholder(s), should they prefer to personally appear before the notary) before the chosen public notary, being also necessary to sign an official form to report the foreign investment to a public registry depending on the Spanish Ministry of Finance.

      Once the deed of incorporation is signed, the next steps consist in applying before the tax authorities to obtain the new company’s tax number (NIF / CIF) and filing the deed of incorporation before the Companies’ Registry. Some banks do allow new companies to operate once they have the NIF (which could be 2-3 days after the incorporation), while others request to wait until the deed of incorporation is filed at the Companies’ Registry (2-3 weeks).

      An estimation of the necessary time to complete all the procedure is 30-45 days, but of course the main delay is related to speed of the foreign investor in obtaining the necessary documents.

      Please note that if you wish to incorporate a foreign owned company in Spain it is always necessary to seek specific professional advice, as each case is different and regulations and the application of such regulations vary from time to time. The above article just explains the main steps and requirements for the incorporation of a company.

      In all M&A operations one of the issues that deserves special attention as regards its analysis, ascertainment and negotiation is the tax liabilities. Even though the parties could agree on the amount of such contingencies, to negotiate the possible guarantees that the seller should grant in order to protect the buyer from a possible claim by the tax authorities, the term during which the guarantees should be in force, and to agree on the communication mechanisms between the parties (buyer and seller) and the legal defense strategies if such claim from the tax authorities arises, requires substantial negotiation efforts.

      When the acquisition operation is formalized not through the purchase of shares, but through the purchase of the assets that form a business unit, the Spanish General Tax Law (“Ley General Tributaria” or “LGT”) provides a mechanism which implies an exception to the general principle provided by article 42 of the same law. Article 42 of LGT establishes the joint liability of the purchaser of a business unit for the tax liabilities of the selling company (“tax liability derived from company’s succession”). That is, in principle, according to article 42 of the LGT “the persons or entities that continue by any mean in the ownership or exercise of economic activities (the buyers) will be jointly liable with the previous owner for the tax liabilities derived from the exercise of such economic activities incurred by such previous owner”.

      However, the joint tax liability of the buyer could be limited through the application before the tax authorities of the tax certificate regulated by article 175.2 of the LGT. This certificate should be applied for by the prospective buyer, with the authorization of the present owner (the seller), and, once issued, the tax liability of the buyer becomes limited to the debts, penalties and liabilities mentioned in the certificate. If the certificate is issued without mentioning any amount, or if the tax authorities do not issue it within a three months term from the application’s date, the applicant (the buyer) will be released from any tax liability derived from company’s succession.

      The tax certificate for succession purposes includes the main taxes, as Value Added Tax and Corporate Income Tax, and can include as well debts derived from the withholding taxes on employees’ payroll, which in case of companies with a big number of employees could be of an outstanding amount. However, the buyer’s joint liability for salaries, related payroll amounts and social security contributions cannot be limited by such certificate, and such liability will always be joint with the business unit seller’s liability.

      The application for the tax certificate should be filed before the acquisition of the business unit is completed, even if the issuance of the certificate takes place later tan the closing date (but of course, it is wiser to not close the acquisition before having the certificate). The certificate’s validity lasts for one year, as regards periodical tax obligations (for example, Value Added Tax, Corporate Income Tax and withholding taxes on salaries) and for three months as regards non periodical tax obligations.

      It is very important to apply for the right tax certificate (“certificate for succession purposes according to article 175.2 of LGT”), and to not make a mistake and apply, for example, for the certificate regarding having fulfilled all tax obligations (“certificado de estar al corriente de las obligaciones fiscales”). Case law is plenty of judgments where a buyer applied for the wrong certificate, which showed no liabilities, and later on such buyer has been sentenced to pay the tax liabilities incurred by the previous owner of the business unit.

      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.

      1. 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.

      1. Debt

      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.

      1. Tax/labor contingencies

      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.

      1. 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.

      1. 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.

      1. Break-up Fees

      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.

      1. Recommendations

      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.

      The author of this article is Paulo Yamaguchi

      Chinese outbound M&A was one of the main topics of interest at the 2017 Hong Kong IFLR Forum on M&A in Asia, a great event with an outstanding level of speakers and very interesting discussions on various themes related to international investments.

      All the attendants shared the view that momentum for Chinese overseas investments is still strong, despite the recent policy aiming at curbing the outflow of capitals from China.

      A particularly interesting session was that on “best practices to overcome credibility and experience gaps increasingly faced by “off the radar” Chinese bidders”.

      Opening a one-to-one negotiation or letting a Chinese company bid at an auction involves often great deal of uncertainty, as most participants to the session shared the experience of having seeing their Chinese counterpart walk away from the negotiation without any explanation (the so-called “Random Investors”).

      I have scribbled down the take-aways of the discussion as follows.

      Main clues to spot early on the Random investor:

      • the Company pops out from nowhere and has no track record of overseas investments;
      • the Company has no legal or financial advisors, or if they do, their advisors are not experienced in overseas transactions;
      • the Company has excellent advisors… but has not paid their fees (yes, that happens)
      • the target does not belong to the Company’s core business (and there is no explanation for their interest for the deal);

      What should you do to be on the safe side?

      • request a written declaration of interest, expressing the reasons why the Company wants to invest in the target and what is their mid term strategy, signed and stamped by the legal representative (if they are not ready to hand over this letter the game can stop here).
      • If the Company represents a group of investors, require full disclosure and letters of confirmation from all parties, from day one (AC Milan’s case is a good example of what happens later on if there is no disclosure of all players, and their stakes in the deal);
      • request proof that the Company has filed the application for the authorisation to invest overseas (due to the recent tightening of controls on capital outflow, this step is fundamental);
      • request proof that they have the finance needed for the deal (either onshore or, better, off-shore);
      • make clear that you will require a « break fee » (which can vary from 5 to 10%) in case they walk away from the negotiation (we have heard of US companies expecting 30 to 50% break fee on the value of the deal…)

      How to incorporate a company in Spain

      29 janvier 2019

      • Espagne
      • F&A

      This week the Interim Injunction Judge of the Netherlands Commercial Court ruled in summary proceedings, following a video hearing, in a case on a EUR 169 million transaction where the plaintiff argued that the final transaction had been concluded and the defendant should proceed with the deal.

      This in an – intended – transaction where the letter of intent stipulates that a EUR 30 million break fee is due when no final agreement is signed.

      In addition to ruling on this question of construction of an agreement under Dutch law, the judge also had to rule on the break fee if no agreement was concluded and whether it should be amended or reduced because of the current Coronavirus / Covid-19 crisis.

      English Language proceedings in a Dutch state court, the Netherlands Commercial Court (NCC)

      The case is not just interesting because of the way contract formation is construed under Dutch law and application of concepts of force majeure, unforeseen circumstances and amendment of agreements under the concepts of reasonableness and fairness as well as mitigation of contractual penalties, but also interesting because it was ruled on by a judge of the English language chamber of the Netherlands Commercial Court (NCC).

      This new (2019) Dutch state court offers a relatively fast and cost-effective alternative for international commercial litigation, and in particular arbitration, in a neutral jurisdiction with professional judges selected for both their experience in international disputes and their command of English.

      The dispute regarding the construction of an M&A agreement under Dutch law in an international setting

      The facts are straightforward. Parties (located in New York, USA and the Netherlands) dispute whether final agreement on the EUR 169 million transaction has been reached but do agree a break fee of €30 million in case of non-signature of the final agreement was agreed. However, in addition to claiming there is no final agreement, the defendant also argues that the break fee – due when there is no final agreement – should be reduced or changed due to the coronavirus crisis.

      As to contract formation it must be noted that Dutch law allows broad leeway on how to communicate what may or may not be an offer or acceptance. The standard is what a reasonable person in the same circumstances would have understood their communications to mean.  Here, the critical fact is that the defendant did not sign the so-called “Transaction Agreement”. The letter of intent’s binary mechanism (either execute and deliver the paperwork for the Transaction Agreement by the agreed date or pay a EUR 30 million fee) may not have been an absolute requirement for contract formation (under Dutch law) but has significant evidentiary weight. In M&A practice – also under Dutch law – with which these parties are thoroughly familiar with, this sets a very high bar for  concluding a contract was agreed other than by explicit written agreement. So, parties may generally comfortably rely on what they have agreed on in writing with the assistance of their advisors.

      The communications relied on by claimant in this case did not clear the very high bar to assume that despite the mechanism of the letter of intent and the lack of a signed Transaction Agreement there still was a binding agreement. In particular attributing the other party’s advisers’ statements and/or conduct to the contracting party they represent did not work for the claimant in this case as per the verdict nothing suggested that the advisers would be handling everything, including entering into the agreement.

      Court order for actual performance of a – deemed – agreement on an M&A deal?

      The Interim Injunction Judge finds that there is not a sufficient likelihood of success on the merits so as to justify an interim measure ordering the defendant to actually perform its obligations under the disputed Transaction Agreement (payment of EUR 169 million and take the claimant’s 50% stake in an equestrian show-jumping business).

      Enforcement of the break fee despite “Coronavirus”?

      Failing the conclusion of an agreement, there was still another question to answer as the letter of intent mechanism re the break fee as such was not disputed. Should the Court enforce the full EUR 30 million fee in the current COVID-19 circumstances? Or should the fee’s effects be modified, mitigated or reduced in some way, or  the fee agreement should even be dissolved?

      Unforeseen circumstances, reasonableness and fairness

      The Interim Injunction Judge rules that the coronavirus crisis may be an unforeseen circumstance, but it is not of such a nature that, according to standards of reasonableness and fairness, the plaintiff cannot expect the break fee obligation to remain unchanged. The purpose of the break fee is to encourage parties to enter into the transaction and attribute / share risks between them. As such the fee limits the exposure of the parties. Payment of the fee is a quick way out of the obligation to pay the purchase price of EUR 169 million and the risks of keeping the target company financially afloat. If financially the coronavirus crisis turns out less disastrous than expected, the fee of EUR 30 million may seem high, but that is what the parties already considered reasonable when they waived their right to invoke the unreasonableness of the fee. The claim for payment of the EUR 30 million break fee is therefore upheld by the Interim Injunction Judge.

      Applicable law and the actual practice of it by the courts

      The relevant three articles are in this case articles 6:94, 6:248 and 6:258 of the Dutch Civil Code. They relate to the mitigation of contractual penalties, unforeseen circumstances and amendment of the agreement under the tenets of reasonableness and fairness. Under Dutch law the courts must with all three exercise caution. Contracts must generally be enforced as agreed. The parties’ autonomy is deemed paramount and the courts’ attitude is deferential. All three articles use language stating, essentially, that interference by the courts in the contract’s operation is allowed only to avoid an “unacceptable” impact, as assessed under standards of reasonableness and fairness.

      There is at this moment of course no well- established case law on COVID-19. However, commentators have provided guidance that is very helpful to think through the issues. Recently a “share the pain” approach has been advocated by a renowned law Professor, Tjittes, who focuses on preserving the parties’ contractual equilibrium in the current circumstances. This is, in the Court’s analysis, the right way to look at the agreement here. There is no evidence in the record suggesting that the parties contemplated or discussed the full and exceptional impact of the COVID-19 crisis. The crisis may or may not be unprovided for.  However, the court rules in the current case there is no need to rule on this issue. Even if the crisis is unprovided for, there is no support in the record for the proposition that the crisis makes it unacceptable for the claimant to demand strict performance by the defendant. The reasons are straightforward.

      The break fee allocates risk and expresses commitment and caps exposure. The harm to the business may be substantial and structural, or it may be short-term and minimal. Either way, the best “share the pain” solution, to preserve the contractual equilibrium in the agreement, is for the defendant to pay the fee as written in the letter of intent. This allocates a defined risk to one party, and actual or potential risks to the other party. Reducing the break fee in any business downturn, the fee’s express purpose – comfort and confidence to get the deal done – would not be accomplished and be derived in precisely the circumstances in which it should be robust. As a result, the Court therefore orders to pay the full EUR 30 million fee. So the break fee stipulation works under the circumstances without mitigation because of the Corona outbreak.

      The Netherlands Commercial Court, continued

      As already indicated above, the case is interesting because the verdict has been rendered by a Dutch state court in English and the proceedings where also in English. Not because of a special privilege granted in a specific case but based on an agreement between parties with a proper choice of forum clause for this court. In addition to the benefit to of having an English forum without mandatorily relying on either arbitration or choosing an anglophone court, it also has the benefit of it being a state court with the application of the regular Dutch civil procedure law, which is well known by it’s practitioners and reduces the risk of surprises of a procedural nature.  As it is as such also a “normal” state court, there is the right to appeal and particularly effective under Dutch law access to expedited proceeding as was also the case in the example referred to above. This means a regular procedure with full application of all evidentiary rules may still follow, overturning or confirming this preliminary verdict in summary proceedings.

      Novel technology in proceedings

      Another first or at least a novel application is that all submissions were made in eNCC, a document upload procedure for the NCC. Where the introduction of electronic communication and litigation in the Dutch court system has failed spectacularly, the innovations are now all following in quick order and quite effective. As a consequence of the Coronavirus outbreak several steps have been quickly tried in practice and thereafter formally set up. At present this – finally – includes a secure email-correspondence system between attorneys and the courts.

      And, also by special order of the Court in this present case, given the current COVID-19 restrictions the matter was dealt with at a public videoconference hearing on 22 April 2020 and the case was set for judgment on 29 April 2020 and published on 30 April 2020.

      Even though it is a novel application, it is highly likely that similar arrangements will continue even after expiry of current emergency measures. In several Dutch courts videoconference hearings are applied on a voluntary basis and is expected that the arrangements will be formalized.

      Eligibility of cases for the Netherlands Commercial Court

      Of more general interest are the requirements for matters that may be submitted to NCC:

      • the Amsterdam District Court or Amsterdam Court of Appeal has jurisdiction
      • the parties have expressly agreed in writing that proceedings will be in English before the NCC (the ‘NCC agreement’)
      • the action is a civil or commercial matter within the parties’ autonomy
      • the matter concerns an international dispute.

      The NCC agreement can be recorded in a clause, either before or after the dispute arises. The Court even recommends specific wording:

      “All disputes arising out of or in connection with this agreement will be resolved by the Amsterdam District Court following proceedings in English before the Chamber for International Commercial Matters (“Netherlands Commercial Court” or “NCC District Court”), to the exclusion of the jurisdiction of any other courts. An action for interim measures, including protective measures, available under Dutch law may be brought in the NCC’s Court in Summary Proceedings (CSP) in proceedings in English. Any appeals against NCC or CSP judgments will be submitted to the Amsterdam Court of Appeal’s Chamber for International Commercial Matters (“Netherlands Commercial Court of Appeal” or “NCCA”).”

      The phrase “to the exclusion of the jurisdiction of any other courts” is included in light of the Hague Convention on Choice of Court Agreements. It is not mandatory to include it of course and parties may decide not to exclude the jurisdiction of other courts or make other arrangements they consider appropriate. The only requirement being that such arrangements comply with the rules of jurisdiction and contract. Please note that choice of court agreements are exclusive unless the parties have “expressly provided” or “agreed” otherwise (as per the Hague Convention and Recast Brussels I Regulation).

      Parties in a pending case before another Dutch court or chamber may request that their case be referred to NCC District Court or NCC Court of Appeal. One of the requirements is to agree on a clause that takes the case to the NCC and makes English the language of the proceedings. The NCC recommends using this language:

      We hereby agree that all disputes in connection with the case [name parties], which is currently pending at the *** District Court (case number ***), will be resolved by the Amsterdam District Court following proceedings in English before the Chamber for International Commercial Matters (“Netherlands Commercial Court” or ”NCC District Court). Any action for interim measures, including protective measures, available under Dutch law will be brought in the NCC’s Court in Summary Proceedings (CSP) in proceedings in English. Any appeals against NCC or CSP judgments will be submitted to the Amsterdam Court of Appeal’s Chamber for International Commercial Matters (“Netherlands Commercial Court of Appeal” or “NCC Court of Appeal”).

      To request a referral, a motion must be made before the other chamber or court where the action is pending, stating the request and contesting jurisdiction (if the case is not in Amsterdam) on the basis of a choice-of-court agreement (see before).

      Additional arrangements in the proceedings before the Netherlands Commercial Court

      Before or during the proceedings, parties can also agree special arrangements in a customized NCC clause or in another appropriate manner. Such arrangements may include matters such as the following:

      • the law applicable to the substantive dispute
      • the appointment of a court reporter for preparing records of hearings and the costs of preparing those records
      • an agreement on evidence that departs from the general rules
      • the disclosure of confidential documents
      • the submission of a written witness statement prior to the witness examination
      • the manner of taking witness testimony
      • the costs of the proceedings.

      Visiting lawyers and typical course of the procedure

      All acts of process are in principle carried out by a member of the Dutch Bar. Member of the Bar in an EU or EEA Member State or Switzerland may work in accordance with Article 16e of the Advocates Act (in conjunction with a member of the Dutch Bar). Other visiting lawyers may be allowed to speak at any hearing.

      The proceedings will typically follow the below steps:

      • Submitting the initiating document by the plaintiff (summons or request as per Dutch law)
      • Assigned to three judges and a senior law clerk.
      • The defendant submits its defence statement.
      • Case management conference or motion hearing (e.g. also in respect of preliminary issues such as competence, applicable law etc.) where parties may present their arguments.
      • Judgment on motions: the court rules on the motions. Testimony, expert appointment, either at this stage or earlier or later.
      • The court may allow the parties to submit further written statements.
      • Hearing: the court interviews the parties and allows them to present their arguments. The court may enquire whether the dispute could be resolved amicably and, where appropriate, assist the parties in a settlement process. If appropriate, the court may discuss with the parties whether it would be advisable to submit part or all of the dispute to a mediator. At the end of the hearing, the court will discuss with the parties what the next steps should be.
      • Verdict: this may be a final judgment on the claims or an interim judgment ordering one or more parties to produce evidence, allowing the parties to submit written submissions on certain aspects of the case, appointing one or more experts or taking other steps.

      Continuous updates, online resources Netherlands Commercial Court

      As a final note the English language website of the Netherlands Commercial Court provides ample information on procedure and practical issues and is updated with a high frequence. Under current circumstance even at a higher pace. In particular for practitioners it’s recommended to regularly consult the website. https://www.rechtspraak.nl/English/NCC/Pages/default.aspx

      One of the most tricky steps in any M&A operation is when the issue of « warranties », in particular with reference to the economic situation, the balance sheet and the financial position of the company or business (or of a branch), namely the so-called « business warranties« .

      On one side, the buyer would like to « ironclad » his investment by reducing the risk of an unpleasant surprise to a minimum. The seller, by contrast, wishes to provide the least possible warranties, which often translate in a provisory restriction on the full enjoyment of the proceeds; the same may be essential for further investment.

      It should be noted, first of all, that the term « warranties » is usually referred to, in a non-technical acceptation, to a complex set of contractual provisions containing:

      • any seller’s statements about the health of the company or business (or branch of business) being transferred;
      • any compensation obligations undertaken by the seller in case of « violation » (i.e. mistruth) of the assertions;
      • any remedies provided to ensure the effectiveness of the indemnity obligations entered into.

      While there are several reasons why this set is necessary, the most significant one is that in M&A contracts, statutory sale warranties only apply to the good sold; therefore, if the good sold is an equity investment, the warranties do not cover any of the company’s underlying assets; and even as they exceptionally do apply, short terms and strict limitations still justify an ancillary obligation designed to ensure the economic success of the transaction.

      As confirmed by current practice, there is not a single M&A agreement that does not include a set of warranties.

      In particular, representations typically incorporate the buyer’s due diligence, which for its part usually follows a non-disclosure agreement (NDA) to protect any information disclosed.

      Any criticalities identified should be properly mentioned. Clearly, wherever a criticality arises, it may not necessarily trigger an indemnity obligation. It will be up to the parties to lay down the rules, as they may also provide that any related risk is to be borne by the buyer; this may be offset by a reduction in the price.

      Some aspects of the compensation obligation will have to be carefully negotiated. The main ones are certainly:

      • duration (e.g. longer for tax-related warranties);
      • who is entitled to compensation (the buyer or the company; one or the other as the case may be);
      • any deductions and/or limitations (e.g. tax losses);
      • compensation cap;
      • any possible deductible;
      • the compensation procedure (e.g. application deadlines, settlement procedure, particular circumstances).

      These are highly relevant aspects and should by no means be underestimated. As an example, it is obvious that if the compensation procedure is poorly regulated, all the previous efforts are jeopardised.

      Finally, suitable measures to ensure an effective protection of the buyer must be provided. Among these, the most conventional tools are:

      • the surety;
      • the “independent contract of guarantee”;
      • the escrow;
      • the deferment of payment;
      • the “earn-out”-scheme;
      • the “price adjustment”;
      • the letter of patronage;
      • the pledge and/or mortgage.

      These are more or less widely used instruments, each one with its pros and cons.

      At this point, however, we would like to address a new tool with an insurance character, which has been being used recently: the so-called « Warranty & Indemnity Policies« .

      With a W&I insurance policy, basically, the insurer assumes the risk resulting from breaches of warranties and indemnities included in an M&A contract upon payment of a premium.

      It is obviously a key condition that the violation arose from facts preceding the closing and which were not known at that time (and, therefore, not highlighted by the due diligence carried out).

      The insurance policy may be subscribed by the buyer (buyer side) or the seller (seller side). Usually the first option is preferred. These W&I insurance policies come with a number of advantages:

      • a warranty is given even when the seller has been unwilling to commit himself contractually;
      • the insurance policy usually does not provide for any recourse against the seller, other than in the case of malice, so that the seller is fully released;
      • it is also possible to achieve a higher ceiling than that provided for in a purchase agreement;
      • likewise, coverage may be provided for a longer period;
      • it is easier to deal with the seller, especially if there are several and some are still part of the company, perhaps as members of the Board of Directors;
      • compensation procedures become significantly easier, especially in cases where there are multiple sellers, including individuals;
      • the buyer gains a higher certainty of solvency.

      The cost of the insurance policy may be shared between the parties, eventually by discounting the purchase price, which the seller may be more willing to grant, considering that he will not be required to issue other warranties and can immediately use the proceeds of the sale.

      Premiums are usually set somewhere between 1% and 2% of the compensation limit (with a minimum premium).

      Besides the price, which makes the tool mostly suitable for operations of not modest entity, currently, the main limitation seems to be the commonly required deductible, equal to 1% of the Enterprise Value of the Target, which may be reduced to 0.5% in case of higher premiums. Keep in mind that the W&I insurance policy implies a review of the due diligence by the insurance company, which can translate into an actual intervention in the negotiation of the warranties.

      Beyond this, this tool needs to be carefully evaluated: facing highly complex scenarios, it could be the ideal solution to solve an impasse in negotiations and make relations between professional investors and SMEs easier.

      Acquisitions (M&A) in Italy are carried out in most cases through the purchase of shareholdings (‘share deal’) or business or business unit (‘asset deal’). For mainly tax reasons, share deals are more frequent than asset deals, despite the asset deal allows a better limitation of risks for the buyer. We will explain the main differences between share deal and asset deal in terms of risks, and in terms of relationships between seller and buyer.

      Preference for acquisitions through the purchase of shareholdings (‘share deal’) rather than the purchase of business or business unit (‘asset deal’) in the Italian market

      In Italy, acquisitions are carried out, in most cases, through the purchase of shareholdings (‘share deal’) or of business or business unit (‘asset deal’). Other structures, such as mergers, are less frequent.

      By purchasing shareholdings of the target company (‘share deal‘), the buyer indirectly acquires all the company’s assets, liabilities and legal relationships. Therefore, the buyer bears all the risks relating to the previous management of the company.

      With the purchase of the business or of a business unit of the target company (‘asset deal‘), the buyer acquires a set of assets and relationships organized for the operation of the business (real estate, machineries, patents, trademarks, employees, contracts, credits, debts, etc.). The advantage of the asset deal lies in the possibility for the parties to select the assets and liabilities included in the deal: hence the buyer can limit the legal risks of the transaction.

      Despite this advantage, most acquisitions in Italy are made through the purchase of shareholdings. In 2018, there were approximately 78,400 purchases of shareholdings (shares or quotas), while there were approximately 35,900 sales of businesses or business units. (source: www.notariato.it/it/news/dati-statistici-notarili-anno-2018). It should be noted that the number of transfers of business also includes small or very small businesses owned by individual entrepreneurs, for whom the alternative of the share deal (though feasible, through the contribution of the business in a newco and the sale of the shares in the newco) is not viable in practice for cost reasons.

      Taxation of share deal and asset deal in Italy

      The main reason for the preference for share deal over asset deal lies in the tax costs of the transaction. Let’s see what they are.

      In a share deal, the direct taxes borne by the seller are calculated on the capital gain, according to the following rates:

      • if the seller is a joint-stock company (società per azioni – s.p.a.; società a responsabilità limitata – r.l.; società in accomandita per azioni – s.a.p.a.), the corporate tax rate is 24% of the capital gain. However, under certain conditions, the so-called PEX (participation exemption) regime is applied with the application of the rate of 24% on 5% of the capital gain only.
      • If the seller is a partnership (società semplice – s.s.; società in nome collettivo – s.n.c..; società in accomandita semplice – s.a.s.) the capital gain is fully taxable. However, under certain conditions, the taxable amount is limited to 60% of the amount of the capital gain. In both cases, the taxable amount is attributed pro rata to each shareholder of the partnership, and added to the shareholders’ income (the tax rate depends on the shareholders’ income).
      • If the seller is a natural person, the rate on the capital gain is 26%.

      A share deal is subject to a fixed registration tax of € 200,00, normally paid by the buyer.

      In an asset deal, the direct taxes to be paid by the seller are calculated on the capital gain. If the seller is a joint-stock company, the corporate tax rate is 24% of the capital gain. If the seller is a partnership (with individual partners) or an individual entrepreneur, the rate depends on the seller’s income.

      In an asset deal the transfer of the business or of the business unit is subject to registration tax, generally paid by the buyer. However both the seller and the buyer are jointly and severally liable for the payment of the registration tax. The tax is calculated on the part of the price attributable to the assets transferred. The price is the result of the transferred assets minus the transferred liabilities. The tax rate depends on the type of asset transferred. In general:

      • movable assets, including patents and trademarks: 3%;
      • goodwill: 3%;
      • buildings: 9%;
      • land: between 9% and 12% (depending on the buyer).

      If the parties do not apportion the purchase price to the different assets in proportion to their values, the registration tax is applied to the entire purchase price at the highest rate of those applicable to the assets.

      It should be noted that the tax authorities may assess the value attributed by the parties to real estate and goodwill, with the consequent risk of application of higher taxes.

      Share deal and asset deal: risks and responsibilities towards third parties

      In the purchase of shares or quotas (‘share deal‘), the purchaser bears, indirectly, all the risks relating to the previous management of the company.

      In the purchase of business or business unit (‘asset deal‘), on the other hand, the parties can select which assets and liabilities will be transferred, hence establishing, among them, the risks that the buyer will bear.

      However, there are some rules, which the parties cannot derogate from, relating to relationships with third parties, that have a significant impact on the risks for the seller and the buyer, and therefore on the negotiation of the purchase agreement. The main ones are as follows.

      • Employees: the employment relationship continues with the buyer of the business. The seller and the buyer are jointly and severally liable for all the employee’s rights and claims at the time of transfer (art. 2112 of the Italian Civil Code).
      • Debts: the seller is obliged to pay all debts up to the date of transfer. The buyer is liable for the debts that are shown in the mandatory accounting books (art. 2560 of the Italian Civil Code).
      • Tax debts and liabilities: the seller is obliged to pay debts, taxes and tax penalties relating to the period up to the date of transfer. In addition to the liability for tax debts resulting from mandatory accounting books (Article 2560 of the Italian Civil Code), the buyer is liable for taxes and penalties, even if they are not shown in the accounting books, with the following limits (Article 14 of Legislative Decree 472/1997):
      • the buyer benefits from the prior enforcement of the seller;
      • the buyer is liable up to the value of the business or business unit;
      • for taxes and penalties not emerging from a tax audit by the tax authorities that has taken place before the date of transfer, the buyer is liable for those relating to the year of the sale of the business and the two preceding years only;
      • the tax authorities shall issue a certificate on the existence and amount of debts and ongoing tax audits. If the certificate is not issued within 40 days of the request, the buyer will be released from liability. If the certificate is issued, the buyer will be liable up to the amount resulting from the certificate.
      • Contracts: the parties can choose which contracts to transfer. With respect to the contracts transferred, the buyer takes over, even without the consent of the third contracting party, contracts for the operation of the business that are not of a personal nature. In addition, the third contracting party may withdraw from the contract within three months if there is a just cause (e.g. if the buyer does not guarantee to be able to fulfil the contract due to his financial situation or technical skills) (Art. 2558 of the Italian Civil Code).

      Some ways to deal with the risks

      To manage the risks arising from third party liability and the general risks associated with the acquisition, a number of negotiation and contractual tools can be used. Let’s see some of them.

      In an asset deal:

      Employees: it is possible to agree with the employee changes to the contractual terms and conditions, and waive of joint and several liability of the buyer and seller (pursuant to art. 2112 c.c.). In order to be valid, the agreement with the employee must be concluded with certain requirements (for example, with the assistance of the trade unions).

      Debts:

      • transfer the debts to the buyer and reduce the price accordingly. The price reduction leads to a lower tax cost of the transaction as well. In case of transfer of debts, in order to protect the seller, a declaration of release of the seller from liability pursuant to art. 2560 of the Italian Civil Code can be obtained from the creditor; or, the parties can agree that the payment of the debt by the buyer will take place at the same time as the transfer of the business (‘closing‘).
      • For debts not transferred to the buyer, obtain from the creditor a declaration of release of the buyer from liability pursuant to art. 2560 of the Italian Civil Code.
      • For debts for which it is not possible to obtain a declaration of release from the creditor, agree on forms of security in favor of the seller (for debts transferred) or in favor of the buyer (for debts not transferred), such as, for example, the deferment of payment of part of the price; the escrow of part of the price; bank or shareholder guarantees.

      Tax debts and tax liabilities:

      • obtain from the tax authorities the certificate pursuant to art. 14 of Legislative Decree 472/1997 on debts and tax liabilities;
      • transfer the debts to the buyer, and reduce the price accordingly;
      • agree on forms of guarantee in favor of the seller (for debts transferred) and in favour of the buyer (for debts not transferred or for tax liabilities), such as those set out above for debts in general.

      Contracts: for those that will be transferred:

      • verify that the seller’s obligations up to the date of transfer have been properly performed, in order to avoid the risk of disputes by the third contracting party, that could stop the performance of the contract;
      • at least for the most important contracts, obtain in advance from the third contracting party the approval of transfer of the contract.

      In a share deal some tools are:

      • Due diligence. Carry out a thorough legal, tax and accounting due diligence on the company, to assess the risks in advance and manage them in the negotiation and in the acquisition contract (‘share purchase agreement’).
      • Representations and warranties (‘R&W’) and indemnification. Provide in the acquisition contract (‘share purchase agreement’) a detailed set of representations and warranties – and obligations to indemnify in the event of non-compliance – to be borne by the seller in relation to the situation of the company (‘business warranties‘: balance sheet; contracts; litigation; compliance with environmental regulations; authorizations for the conduct of business; debts; receivables, etc.). Negotiations on representations and warranties normally are carried on taking into account the outcomes of due diligence. Contractual representations and warranties on the situation of the company (‘business warranties‘) and contractual obligation to indemnify, are necessary in share deals in Italy, as in the absence of such clauses the buyer cannot obtain from the seller (except in extraordinary circumstances) compensation or indemnity if the situation of the company is different from that considered at the time of purchase.
      • Guarantees for the buyer. Means of ensuring that the buyer will be indemnified in the event of breach of representations and warranties. Among them: (a) the deferment of payment of part of the price; (b) the payment of part of the price in an escrow account for the duration of the liabilities arising from the representations and warranties and, in case of disputes between the parties, until the dispute is settled; (c) bank guarantee; (d) W&I policy: insurance contract covering the risk of the buyer in case of breach of representations and warranties, up to a maximum amount (and excluding certain risks).

      Other factors influencing the choice between share deal and asset deal

      Of course, the choice to carry out an acquisition operation in Italy through a share deal or an asset deal also depends on other factors, in addition to the tax cost of the transaction. Here are some of them.

      • Purchase of part of the business. The parties chose the asset deal when the transaction does not involve the purchase of the entire business of the target company but only a part of it (a business unit).
      • Situation of the target company. The buyer prefers the asset deal when the situation of the target company is so problematic that the buyer is not willing to assume all the risks arising from the previous management, but only part of them.
      • Maintenance of a role by the seller. The share deal is a better option when the seller will keep a role in the target company. In this case, the seller frequently retains, in addition to a role as director, a minority shareholdings, with exit clauses (put and call rights) after a certain period of time. The exit clauses often link the price to future results and, therefore, in the interest of the buyer, motivate the seller in his/her role as director, and, in the interest of the seller, put a value on the company’s earnings potential, not yet achieved at the time of purchase.

      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.

      Indemnification

      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.

      The author of this article is Paulo Yamaguchi

      The procedure to incorporate a foreign owned company in Spain is, in principle, easy and straight forward, however it is necessary to take into account certain new requirements derived from the tax and the anti-money laundering regulations, which could cause long delays in the incorporation process, even to EU and US companies, if they are not well advised and managed from the beginning of the procedure.

      The first step consist in collecting information about the foreign shareholder, in order to be able to prove its legal existence and activities: the foreign shareholder(s) will have to grant before a Notary Public in its country of residence a power of attorney authorising somebody in Spain to obtain its tax identification number (“NIE”), and also represent it before the Spanish notary when signing the deed of incorporation. In case the foreign shareholder is an individual person, the NIE should be applied for before the Spanish police or the Spanish Consulate at the country where the investor lives.

      If the shareholder is a corporation, apart from the Power of Attorney, it will have to obtain a certificate from its Companies’ Registry or Chamber of Commerce, stating its legal existence and main characteristics. This document is called “good standing certificate” (in the UK and US), “K-bis” (in France), “KvK” (in the Netherlands) or “visura” (in Italy). These two documents, the Power of Attorney mentioned in the above paragraph and the certificate from the Companies’ Registry, will have to be Apostilled or legalized by the correspondent Ministry, and Sworn translated into Spanish. Please note that we use to draft bilingual powers of attorney in order to avoid its sworn translation.

      The foreign shareholder will have to prove that its income is obtained from legal activities in order to be able to open a bank account in the name of the new company. The main document to prove this could be the Corporate or the Personal Income Tax return filed in its country of residence, but there could be other means, especially in case of individual persons.

      In case of a corporate shareholder, it will be necessary as well to declare, in principle through a public deed granted in Spain, who are the individual persons who, directly or through other companies, will hold more than a 25% interest in the new company to be incorporated. In case nobody holds more than a 25% (i.e. because there are 5 individual shareholders, holding each of them a 20%), it is declared that the effective control of the new company corresponds to its director.

      At this stage, it is also necessary to mention that the person(s) who will be the director(s) of the new company, in case they are foreigners, will also need to obtain their personal “NIE”. The NIE should be applied for before the Spanish police (this could be done by a proxy duly authorised though a Power of Attorney granted by the foreign director) or before the Spanish Consulate nearest to the city where the investor lives. In order to be a director of a Spanish company it is not necessary to be a shareholder, nor to have residence and work permit in Spain (provided the foreign director does not live in Spain).

      Meanwhile the necessary documents (Powers of Attorney, Companies’ Registry certificate, etc.) are being prepared by the foreign shareholder, the lawyer in Spain will apply for the new company’s name. It is advisable to point out that generic or usual names are not available quite often, therefore it is necessary to think in original names. Three different names could be applied for simultaneously.

      The drafting of the company’s Articles of Association or By Laws could be very quick, except if the company is going to have several shareholders and they wish specific clauses. In this case, it is also advisable to draft a Shareholders Agreement. The Shareholders’ Agreement could just contain some basic rules on dedication, compensation, non-competition, etc. and some more sophisticated rules on the sale of shares (tag along and drag along rights). As regards the By-Laws, they should mention the company’s name, its activity or activities, address in Spain –which cannot be just a P.O. Box-, share capital, number of shares and its face value, and starting date for the fiscal year, among other standard clauses.

      The management of the company could be organized through a sole director, two directors who could act jointly or separately, and in case there are more than three directors, they should organize themselves through a Board of Directors, being usual in this case to appoint a C.E.O. In order to be a director it is not necessary to be a shareholder. Under Spanish laws, the director(s) could be held liable for some company’s debts under certain circumstances which are legally defined. For this reason, it is necessary that the directors formally accept their appointment (personally appearing before the Notary or through a Power of Attorney).

      Before the incorporation, it will be necessary that either the new company’s director (the person to be appointed) or the representative of the corporate shareholder appears personally before the bank where the company will have its first bank account and signs the correspondent documents (KYC regulation). Once the bank account is opened, the shareholder will have to send a bank transfer for the new company’s share capital. In Spain, the minimum share capital for a limited company (S.L.) is Euros 3.000, while for a “Sociedad Anónima” (S.A.) it is Euros 60.000, but only 25% should be paid off at the incorporation moment. It is interesting to note that contributions to the share capital could be made in cash – which is the most common operation, especially at the incorporation – or in kind, with any type of assets: real estate, machinery, goods, trademarks, etc. The money for the share capital should be sent to the new company’s bank account from an account owned by the shareholder (or from each account owned by each shareholder, should they be several ones), not by any other different person. Once the Spanish bank receives the transfer, it will issue a certificate, which is necessary in order to incorporate the company.

      Once all the documents are ready, it is possible within very few days (almost immediately) to make the appointment with the Notary and sign the public deed of incorporation. This can be done at any notary in Spain, not being necessary that the notary practises at the same city where the company will have its corporate address. In order to summarize, the list of the necessary documents is:

      • Power(s) of Attorney granted by the foreign shareholder(s), apostilled and sworn translated.
      • Certificate regarding the legal existence of the foreign shareholder (only if it is a corporation), apostilled and sworn translated.
      • Statement on who are the last individual shareholders holding more than 25% interest in the new company, directly or indirectly (only in case of corporate shareholders).
      • NIE of the foreign shareholder(s).
      • NIE of the new company’s director(s), should they be a foreigners.
      • Certificate for the new company’s name.
      • Articles of Association.
      • Bank certificate regarding the contribution to the new company’s share capital.

      The deed of incorporation is signed by the proxy (or the individual shareholder(s), should they prefer to personally appear before the notary) before the chosen public notary, being also necessary to sign an official form to report the foreign investment to a public registry depending on the Spanish Ministry of Finance.

      Once the deed of incorporation is signed, the next steps consist in applying before the tax authorities to obtain the new company’s tax number (NIF / CIF) and filing the deed of incorporation before the Companies’ Registry. Some banks do allow new companies to operate once they have the NIF (which could be 2-3 days after the incorporation), while others request to wait until the deed of incorporation is filed at the Companies’ Registry (2-3 weeks).

      An estimation of the necessary time to complete all the procedure is 30-45 days, but of course the main delay is related to speed of the foreign investor in obtaining the necessary documents.

      Please note that if you wish to incorporate a foreign owned company in Spain it is always necessary to seek specific professional advice, as each case is different and regulations and the application of such regulations vary from time to time. The above article just explains the main steps and requirements for the incorporation of a company.

      In all M&A operations one of the issues that deserves special attention as regards its analysis, ascertainment and negotiation is the tax liabilities. Even though the parties could agree on the amount of such contingencies, to negotiate the possible guarantees that the seller should grant in order to protect the buyer from a possible claim by the tax authorities, the term during which the guarantees should be in force, and to agree on the communication mechanisms between the parties (buyer and seller) and the legal defense strategies if such claim from the tax authorities arises, requires substantial negotiation efforts.

      When the acquisition operation is formalized not through the purchase of shares, but through the purchase of the assets that form a business unit, the Spanish General Tax Law (“Ley General Tributaria” or “LGT”) provides a mechanism which implies an exception to the general principle provided by article 42 of the same law. Article 42 of LGT establishes the joint liability of the purchaser of a business unit for the tax liabilities of the selling company (“tax liability derived from company’s succession”). That is, in principle, according to article 42 of the LGT “the persons or entities that continue by any mean in the ownership or exercise of economic activities (the buyers) will be jointly liable with the previous owner for the tax liabilities derived from the exercise of such economic activities incurred by such previous owner”.

      However, the joint tax liability of the buyer could be limited through the application before the tax authorities of the tax certificate regulated by article 175.2 of the LGT. This certificate should be applied for by the prospective buyer, with the authorization of the present owner (the seller), and, once issued, the tax liability of the buyer becomes limited to the debts, penalties and liabilities mentioned in the certificate. If the certificate is issued without mentioning any amount, or if the tax authorities do not issue it within a three months term from the application’s date, the applicant (the buyer) will be released from any tax liability derived from company’s succession.

      The tax certificate for succession purposes includes the main taxes, as Value Added Tax and Corporate Income Tax, and can include as well debts derived from the withholding taxes on employees’ payroll, which in case of companies with a big number of employees could be of an outstanding amount. However, the buyer’s joint liability for salaries, related payroll amounts and social security contributions cannot be limited by such certificate, and such liability will always be joint with the business unit seller’s liability.

      The application for the tax certificate should be filed before the acquisition of the business unit is completed, even if the issuance of the certificate takes place later tan the closing date (but of course, it is wiser to not close the acquisition before having the certificate). The certificate’s validity lasts for one year, as regards periodical tax obligations (for example, Value Added Tax, Corporate Income Tax and withholding taxes on salaries) and for three months as regards non periodical tax obligations.

      It is very important to apply for the right tax certificate (“certificate for succession purposes according to article 175.2 of LGT”), and to not make a mistake and apply, for example, for the certificate regarding having fulfilled all tax obligations (“certificado de estar al corriente de las obligaciones fiscales”). Case law is plenty of judgments where a buyer applied for the wrong certificate, which showed no liabilities, and later on such buyer has been sentenced to pay the tax liabilities incurred by the previous owner of the business unit.

      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.

      1. 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.

      1. Debt

      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.

      1. Tax/labor contingencies

      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.

      1. 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.

      1. 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.

      1. Break-up Fees

      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.

      1. Recommendations

      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.

      The author of this article is Paulo Yamaguchi

      Chinese outbound M&A was one of the main topics of interest at the 2017 Hong Kong IFLR Forum on M&A in Asia, a great event with an outstanding level of speakers and very interesting discussions on various themes related to international investments.

      All the attendants shared the view that momentum for Chinese overseas investments is still strong, despite the recent policy aiming at curbing the outflow of capitals from China.

      A particularly interesting session was that on “best practices to overcome credibility and experience gaps increasingly faced by “off the radar” Chinese bidders”.

      Opening a one-to-one negotiation or letting a Chinese company bid at an auction involves often great deal of uncertainty, as most participants to the session shared the experience of having seeing their Chinese counterpart walk away from the negotiation without any explanation (the so-called “Random Investors”).

      I have scribbled down the take-aways of the discussion as follows.

      Main clues to spot early on the Random investor:

      • the Company pops out from nowhere and has no track record of overseas investments;
      • the Company has no legal or financial advisors, or if they do, their advisors are not experienced in overseas transactions;
      • the Company has excellent advisors… but has not paid their fees (yes, that happens)
      • the target does not belong to the Company’s core business (and there is no explanation for their interest for the deal);

      What should you do to be on the safe side?

      • request a written declaration of interest, expressing the reasons why the Company wants to invest in the target and what is their mid term strategy, signed and stamped by the legal representative (if they are not ready to hand over this letter the game can stop here).
      • If the Company represents a group of investors, require full disclosure and letters of confirmation from all parties, from day one (AC Milan’s case is a good example of what happens later on if there is no disclosure of all players, and their stakes in the deal);
      • request proof that the Company has filed the application for the authorisation to invest overseas (due to the recent tightening of controls on capital outflow, this step is fundamental);
      • request proof that they have the finance needed for the deal (either onshore or, better, off-shore);
      • make clear that you will require a « break fee » (which can vary from 5 to 10%) in case they walk away from the negotiation (we have heard of US companies expecting 30 to 50% break fee on the value of the deal…)

      Mercedes Clavell

      Domaines d'intervention

      • Franchise
      • Immigration
      • Commerce international
      • Fusions et acquisitions
      • Immobilier
      Contact Mercedes

      Écrire à Mercedes





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        Spain – Purchase of a business unit and tax liability

        16 octobre 2018

        • Espagne
        • Entreprise
        • F&A

        This week the Interim Injunction Judge of the Netherlands Commercial Court ruled in summary proceedings, following a video hearing, in a case on a EUR 169 million transaction where the plaintiff argued that the final transaction had been concluded and the defendant should proceed with the deal.

        This in an – intended – transaction where the letter of intent stipulates that a EUR 30 million break fee is due when no final agreement is signed.

        In addition to ruling on this question of construction of an agreement under Dutch law, the judge also had to rule on the break fee if no agreement was concluded and whether it should be amended or reduced because of the current Coronavirus / Covid-19 crisis.

        English Language proceedings in a Dutch state court, the Netherlands Commercial Court (NCC)

        The case is not just interesting because of the way contract formation is construed under Dutch law and application of concepts of force majeure, unforeseen circumstances and amendment of agreements under the concepts of reasonableness and fairness as well as mitigation of contractual penalties, but also interesting because it was ruled on by a judge of the English language chamber of the Netherlands Commercial Court (NCC).

        This new (2019) Dutch state court offers a relatively fast and cost-effective alternative for international commercial litigation, and in particular arbitration, in a neutral jurisdiction with professional judges selected for both their experience in international disputes and their command of English.

        The dispute regarding the construction of an M&A agreement under Dutch law in an international setting

        The facts are straightforward. Parties (located in New York, USA and the Netherlands) dispute whether final agreement on the EUR 169 million transaction has been reached but do agree a break fee of €30 million in case of non-signature of the final agreement was agreed. However, in addition to claiming there is no final agreement, the defendant also argues that the break fee – due when there is no final agreement – should be reduced or changed due to the coronavirus crisis.

        As to contract formation it must be noted that Dutch law allows broad leeway on how to communicate what may or may not be an offer or acceptance. The standard is what a reasonable person in the same circumstances would have understood their communications to mean.  Here, the critical fact is that the defendant did not sign the so-called “Transaction Agreement”. The letter of intent’s binary mechanism (either execute and deliver the paperwork for the Transaction Agreement by the agreed date or pay a EUR 30 million fee) may not have been an absolute requirement for contract formation (under Dutch law) but has significant evidentiary weight. In M&A practice – also under Dutch law – with which these parties are thoroughly familiar with, this sets a very high bar for  concluding a contract was agreed other than by explicit written agreement. So, parties may generally comfortably rely on what they have agreed on in writing with the assistance of their advisors.

        The communications relied on by claimant in this case did not clear the very high bar to assume that despite the mechanism of the letter of intent and the lack of a signed Transaction Agreement there still was a binding agreement. In particular attributing the other party’s advisers’ statements and/or conduct to the contracting party they represent did not work for the claimant in this case as per the verdict nothing suggested that the advisers would be handling everything, including entering into the agreement.

        Court order for actual performance of a – deemed – agreement on an M&A deal?

        The Interim Injunction Judge finds that there is not a sufficient likelihood of success on the merits so as to justify an interim measure ordering the defendant to actually perform its obligations under the disputed Transaction Agreement (payment of EUR 169 million and take the claimant’s 50% stake in an equestrian show-jumping business).

        Enforcement of the break fee despite “Coronavirus”?

        Failing the conclusion of an agreement, there was still another question to answer as the letter of intent mechanism re the break fee as such was not disputed. Should the Court enforce the full EUR 30 million fee in the current COVID-19 circumstances? Or should the fee’s effects be modified, mitigated or reduced in some way, or  the fee agreement should even be dissolved?

        Unforeseen circumstances, reasonableness and fairness

        The Interim Injunction Judge rules that the coronavirus crisis may be an unforeseen circumstance, but it is not of such a nature that, according to standards of reasonableness and fairness, the plaintiff cannot expect the break fee obligation to remain unchanged. The purpose of the break fee is to encourage parties to enter into the transaction and attribute / share risks between them. As such the fee limits the exposure of the parties. Payment of the fee is a quick way out of the obligation to pay the purchase price of EUR 169 million and the risks of keeping the target company financially afloat. If financially the coronavirus crisis turns out less disastrous than expected, the fee of EUR 30 million may seem high, but that is what the parties already considered reasonable when they waived their right to invoke the unreasonableness of the fee. The claim for payment of the EUR 30 million break fee is therefore upheld by the Interim Injunction Judge.

        Applicable law and the actual practice of it by the courts

        The relevant three articles are in this case articles 6:94, 6:248 and 6:258 of the Dutch Civil Code. They relate to the mitigation of contractual penalties, unforeseen circumstances and amendment of the agreement under the tenets of reasonableness and fairness. Under Dutch law the courts must with all three exercise caution. Contracts must generally be enforced as agreed. The parties’ autonomy is deemed paramount and the courts’ attitude is deferential. All three articles use language stating, essentially, that interference by the courts in the contract’s operation is allowed only to avoid an “unacceptable” impact, as assessed under standards of reasonableness and fairness.

        There is at this moment of course no well- established case law on COVID-19. However, commentators have provided guidance that is very helpful to think through the issues. Recently a “share the pain” approach has been advocated by a renowned law Professor, Tjittes, who focuses on preserving the parties’ contractual equilibrium in the current circumstances. This is, in the Court’s analysis, the right way to look at the agreement here. There is no evidence in the record suggesting that the parties contemplated or discussed the full and exceptional impact of the COVID-19 crisis. The crisis may or may not be unprovided for.  However, the court rules in the current case there is no need to rule on this issue. Even if the crisis is unprovided for, there is no support in the record for the proposition that the crisis makes it unacceptable for the claimant to demand strict performance by the defendant. The reasons are straightforward.

        The break fee allocates risk and expresses commitment and caps exposure. The harm to the business may be substantial and structural, or it may be short-term and minimal. Either way, the best “share the pain” solution, to preserve the contractual equilibrium in the agreement, is for the defendant to pay the fee as written in the letter of intent. This allocates a defined risk to one party, and actual or potential risks to the other party. Reducing the break fee in any business downturn, the fee’s express purpose – comfort and confidence to get the deal done – would not be accomplished and be derived in precisely the circumstances in which it should be robust. As a result, the Court therefore orders to pay the full EUR 30 million fee. So the break fee stipulation works under the circumstances without mitigation because of the Corona outbreak.

        The Netherlands Commercial Court, continued

        As already indicated above, the case is interesting because the verdict has been rendered by a Dutch state court in English and the proceedings where also in English. Not because of a special privilege granted in a specific case but based on an agreement between parties with a proper choice of forum clause for this court. In addition to the benefit to of having an English forum without mandatorily relying on either arbitration or choosing an anglophone court, it also has the benefit of it being a state court with the application of the regular Dutch civil procedure law, which is well known by it’s practitioners and reduces the risk of surprises of a procedural nature.  As it is as such also a “normal” state court, there is the right to appeal and particularly effective under Dutch law access to expedited proceeding as was also the case in the example referred to above. This means a regular procedure with full application of all evidentiary rules may still follow, overturning or confirming this preliminary verdict in summary proceedings.

        Novel technology in proceedings

        Another first or at least a novel application is that all submissions were made in eNCC, a document upload procedure for the NCC. Where the introduction of electronic communication and litigation in the Dutch court system has failed spectacularly, the innovations are now all following in quick order and quite effective. As a consequence of the Coronavirus outbreak several steps have been quickly tried in practice and thereafter formally set up. At present this – finally – includes a secure email-correspondence system between attorneys and the courts.

        And, also by special order of the Court in this present case, given the current COVID-19 restrictions the matter was dealt with at a public videoconference hearing on 22 April 2020 and the case was set for judgment on 29 April 2020 and published on 30 April 2020.

        Even though it is a novel application, it is highly likely that similar arrangements will continue even after expiry of current emergency measures. In several Dutch courts videoconference hearings are applied on a voluntary basis and is expected that the arrangements will be formalized.

        Eligibility of cases for the Netherlands Commercial Court

        Of more general interest are the requirements for matters that may be submitted to NCC:

        • the Amsterdam District Court or Amsterdam Court of Appeal has jurisdiction
        • the parties have expressly agreed in writing that proceedings will be in English before the NCC (the ‘NCC agreement’)
        • the action is a civil or commercial matter within the parties’ autonomy
        • the matter concerns an international dispute.

        The NCC agreement can be recorded in a clause, either before or after the dispute arises. The Court even recommends specific wording:

        “All disputes arising out of or in connection with this agreement will be resolved by the Amsterdam District Court following proceedings in English before the Chamber for International Commercial Matters (“Netherlands Commercial Court” or “NCC District Court”), to the exclusion of the jurisdiction of any other courts. An action for interim measures, including protective measures, available under Dutch law may be brought in the NCC’s Court in Summary Proceedings (CSP) in proceedings in English. Any appeals against NCC or CSP judgments will be submitted to the Amsterdam Court of Appeal’s Chamber for International Commercial Matters (“Netherlands Commercial Court of Appeal” or “NCCA”).”

        The phrase “to the exclusion of the jurisdiction of any other courts” is included in light of the Hague Convention on Choice of Court Agreements. It is not mandatory to include it of course and parties may decide not to exclude the jurisdiction of other courts or make other arrangements they consider appropriate. The only requirement being that such arrangements comply with the rules of jurisdiction and contract. Please note that choice of court agreements are exclusive unless the parties have “expressly provided” or “agreed” otherwise (as per the Hague Convention and Recast Brussels I Regulation).

        Parties in a pending case before another Dutch court or chamber may request that their case be referred to NCC District Court or NCC Court of Appeal. One of the requirements is to agree on a clause that takes the case to the NCC and makes English the language of the proceedings. The NCC recommends using this language:

        We hereby agree that all disputes in connection with the case [name parties], which is currently pending at the *** District Court (case number ***), will be resolved by the Amsterdam District Court following proceedings in English before the Chamber for International Commercial Matters (“Netherlands Commercial Court” or ”NCC District Court). Any action for interim measures, including protective measures, available under Dutch law will be brought in the NCC’s Court in Summary Proceedings (CSP) in proceedings in English. Any appeals against NCC or CSP judgments will be submitted to the Amsterdam Court of Appeal’s Chamber for International Commercial Matters (“Netherlands Commercial Court of Appeal” or “NCC Court of Appeal”).

        To request a referral, a motion must be made before the other chamber or court where the action is pending, stating the request and contesting jurisdiction (if the case is not in Amsterdam) on the basis of a choice-of-court agreement (see before).

        Additional arrangements in the proceedings before the Netherlands Commercial Court

        Before or during the proceedings, parties can also agree special arrangements in a customized NCC clause or in another appropriate manner. Such arrangements may include matters such as the following:

        • the law applicable to the substantive dispute
        • the appointment of a court reporter for preparing records of hearings and the costs of preparing those records
        • an agreement on evidence that departs from the general rules
        • the disclosure of confidential documents
        • the submission of a written witness statement prior to the witness examination
        • the manner of taking witness testimony
        • the costs of the proceedings.

        Visiting lawyers and typical course of the procedure

        All acts of process are in principle carried out by a member of the Dutch Bar. Member of the Bar in an EU or EEA Member State or Switzerland may work in accordance with Article 16e of the Advocates Act (in conjunction with a member of the Dutch Bar). Other visiting lawyers may be allowed to speak at any hearing.

        The proceedings will typically follow the below steps:

        • Submitting the initiating document by the plaintiff (summons or request as per Dutch law)
        • Assigned to three judges and a senior law clerk.
        • The defendant submits its defence statement.
        • Case management conference or motion hearing (e.g. also in respect of preliminary issues such as competence, applicable law etc.) where parties may present their arguments.
        • Judgment on motions: the court rules on the motions. Testimony, expert appointment, either at this stage or earlier or later.
        • The court may allow the parties to submit further written statements.
        • Hearing: the court interviews the parties and allows them to present their arguments. The court may enquire whether the dispute could be resolved amicably and, where appropriate, assist the parties in a settlement process. If appropriate, the court may discuss with the parties whether it would be advisable to submit part or all of the dispute to a mediator. At the end of the hearing, the court will discuss with the parties what the next steps should be.
        • Verdict: this may be a final judgment on the claims or an interim judgment ordering one or more parties to produce evidence, allowing the parties to submit written submissions on certain aspects of the case, appointing one or more experts or taking other steps.

        Continuous updates, online resources Netherlands Commercial Court

        As a final note the English language website of the Netherlands Commercial Court provides ample information on procedure and practical issues and is updated with a high frequence. Under current circumstance even at a higher pace. In particular for practitioners it’s recommended to regularly consult the website. https://www.rechtspraak.nl/English/NCC/Pages/default.aspx

        One of the most tricky steps in any M&A operation is when the issue of « warranties », in particular with reference to the economic situation, the balance sheet and the financial position of the company or business (or of a branch), namely the so-called « business warranties« .

        On one side, the buyer would like to « ironclad » his investment by reducing the risk of an unpleasant surprise to a minimum. The seller, by contrast, wishes to provide the least possible warranties, which often translate in a provisory restriction on the full enjoyment of the proceeds; the same may be essential for further investment.

        It should be noted, first of all, that the term « warranties » is usually referred to, in a non-technical acceptation, to a complex set of contractual provisions containing:

        • any seller’s statements about the health of the company or business (or branch of business) being transferred;
        • any compensation obligations undertaken by the seller in case of « violation » (i.e. mistruth) of the assertions;
        • any remedies provided to ensure the effectiveness of the indemnity obligations entered into.

        While there are several reasons why this set is necessary, the most significant one is that in M&A contracts, statutory sale warranties only apply to the good sold; therefore, if the good sold is an equity investment, the warranties do not cover any of the company’s underlying assets; and even as they exceptionally do apply, short terms and strict limitations still justify an ancillary obligation designed to ensure the economic success of the transaction.

        As confirmed by current practice, there is not a single M&A agreement that does not include a set of warranties.

        In particular, representations typically incorporate the buyer’s due diligence, which for its part usually follows a non-disclosure agreement (NDA) to protect any information disclosed.

        Any criticalities identified should be properly mentioned. Clearly, wherever a criticality arises, it may not necessarily trigger an indemnity obligation. It will be up to the parties to lay down the rules, as they may also provide that any related risk is to be borne by the buyer; this may be offset by a reduction in the price.

        Some aspects of the compensation obligation will have to be carefully negotiated. The main ones are certainly:

        • duration (e.g. longer for tax-related warranties);
        • who is entitled to compensation (the buyer or the company; one or the other as the case may be);
        • any deductions and/or limitations (e.g. tax losses);
        • compensation cap;
        • any possible deductible;
        • the compensation procedure (e.g. application deadlines, settlement procedure, particular circumstances).

        These are highly relevant aspects and should by no means be underestimated. As an example, it is obvious that if the compensation procedure is poorly regulated, all the previous efforts are jeopardised.

        Finally, suitable measures to ensure an effective protection of the buyer must be provided. Among these, the most conventional tools are:

        • the surety;
        • the “independent contract of guarantee”;
        • the escrow;
        • the deferment of payment;
        • the “earn-out”-scheme;
        • the “price adjustment”;
        • the letter of patronage;
        • the pledge and/or mortgage.

        These are more or less widely used instruments, each one with its pros and cons.

        At this point, however, we would like to address a new tool with an insurance character, which has been being used recently: the so-called « Warranty & Indemnity Policies« .

        With a W&I insurance policy, basically, the insurer assumes the risk resulting from breaches of warranties and indemnities included in an M&A contract upon payment of a premium.

        It is obviously a key condition that the violation arose from facts preceding the closing and which were not known at that time (and, therefore, not highlighted by the due diligence carried out).

        The insurance policy may be subscribed by the buyer (buyer side) or the seller (seller side). Usually the first option is preferred. These W&I insurance policies come with a number of advantages:

        • a warranty is given even when the seller has been unwilling to commit himself contractually;
        • the insurance policy usually does not provide for any recourse against the seller, other than in the case of malice, so that the seller is fully released;
        • it is also possible to achieve a higher ceiling than that provided for in a purchase agreement;
        • likewise, coverage may be provided for a longer period;
        • it is easier to deal with the seller, especially if there are several and some are still part of the company, perhaps as members of the Board of Directors;
        • compensation procedures become significantly easier, especially in cases where there are multiple sellers, including individuals;
        • the buyer gains a higher certainty of solvency.

        The cost of the insurance policy may be shared between the parties, eventually by discounting the purchase price, which the seller may be more willing to grant, considering that he will not be required to issue other warranties and can immediately use the proceeds of the sale.

        Premiums are usually set somewhere between 1% and 2% of the compensation limit (with a minimum premium).

        Besides the price, which makes the tool mostly suitable for operations of not modest entity, currently, the main limitation seems to be the commonly required deductible, equal to 1% of the Enterprise Value of the Target, which may be reduced to 0.5% in case of higher premiums. Keep in mind that the W&I insurance policy implies a review of the due diligence by the insurance company, which can translate into an actual intervention in the negotiation of the warranties.

        Beyond this, this tool needs to be carefully evaluated: facing highly complex scenarios, it could be the ideal solution to solve an impasse in negotiations and make relations between professional investors and SMEs easier.

        Acquisitions (M&A) in Italy are carried out in most cases through the purchase of shareholdings (‘share deal’) or business or business unit (‘asset deal’). For mainly tax reasons, share deals are more frequent than asset deals, despite the asset deal allows a better limitation of risks for the buyer. We will explain the main differences between share deal and asset deal in terms of risks, and in terms of relationships between seller and buyer.

        Preference for acquisitions through the purchase of shareholdings (‘share deal’) rather than the purchase of business or business unit (‘asset deal’) in the Italian market

        In Italy, acquisitions are carried out, in most cases, through the purchase of shareholdings (‘share deal’) or of business or business unit (‘asset deal’). Other structures, such as mergers, are less frequent.

        By purchasing shareholdings of the target company (‘share deal‘), the buyer indirectly acquires all the company’s assets, liabilities and legal relationships. Therefore, the buyer bears all the risks relating to the previous management of the company.

        With the purchase of the business or of a business unit of the target company (‘asset deal‘), the buyer acquires a set of assets and relationships organized for the operation of the business (real estate, machineries, patents, trademarks, employees, contracts, credits, debts, etc.). The advantage of the asset deal lies in the possibility for the parties to select the assets and liabilities included in the deal: hence the buyer can limit the legal risks of the transaction.

        Despite this advantage, most acquisitions in Italy are made through the purchase of shareholdings. In 2018, there were approximately 78,400 purchases of shareholdings (shares or quotas), while there were approximately 35,900 sales of businesses or business units. (source: www.notariato.it/it/news/dati-statistici-notarili-anno-2018). It should be noted that the number of transfers of business also includes small or very small businesses owned by individual entrepreneurs, for whom the alternative of the share deal (though feasible, through the contribution of the business in a newco and the sale of the shares in the newco) is not viable in practice for cost reasons.

        Taxation of share deal and asset deal in Italy

        The main reason for the preference for share deal over asset deal lies in the tax costs of the transaction. Let’s see what they are.

        In a share deal, the direct taxes borne by the seller are calculated on the capital gain, according to the following rates:

        • if the seller is a joint-stock company (società per azioni – s.p.a.; società a responsabilità limitata – r.l.; società in accomandita per azioni – s.a.p.a.), the corporate tax rate is 24% of the capital gain. However, under certain conditions, the so-called PEX (participation exemption) regime is applied with the application of the rate of 24% on 5% of the capital gain only.
        • If the seller is a partnership (società semplice – s.s.; società in nome collettivo – s.n.c..; società in accomandita semplice – s.a.s.) the capital gain is fully taxable. However, under certain conditions, the taxable amount is limited to 60% of the amount of the capital gain. In both cases, the taxable amount is attributed pro rata to each shareholder of the partnership, and added to the shareholders’ income (the tax rate depends on the shareholders’ income).
        • If the seller is a natural person, the rate on the capital gain is 26%.

        A share deal is subject to a fixed registration tax of € 200,00, normally paid by the buyer.

        In an asset deal, the direct taxes to be paid by the seller are calculated on the capital gain. If the seller is a joint-stock company, the corporate tax rate is 24% of the capital gain. If the seller is a partnership (with individual partners) or an individual entrepreneur, the rate depends on the seller’s income.

        In an asset deal the transfer of the business or of the business unit is subject to registration tax, generally paid by the buyer. However both the seller and the buyer are jointly and severally liable for the payment of the registration tax. The tax is calculated on the part of the price attributable to the assets transferred. The price is the result of the transferred assets minus the transferred liabilities. The tax rate depends on the type of asset transferred. In general:

        • movable assets, including patents and trademarks: 3%;
        • goodwill: 3%;
        • buildings: 9%;
        • land: between 9% and 12% (depending on the buyer).

        If the parties do not apportion the purchase price to the different assets in proportion to their values, the registration tax is applied to the entire purchase price at the highest rate of those applicable to the assets.

        It should be noted that the tax authorities may assess the value attributed by the parties to real estate and goodwill, with the consequent risk of application of higher taxes.

        Share deal and asset deal: risks and responsibilities towards third parties

        In the purchase of shares or quotas (‘share deal‘), the purchaser bears, indirectly, all the risks relating to the previous management of the company.

        In the purchase of business or business unit (‘asset deal‘), on the other hand, the parties can select which assets and liabilities will be transferred, hence establishing, among them, the risks that the buyer will bear.

        However, there are some rules, which the parties cannot derogate from, relating to relationships with third parties, that have a significant impact on the risks for the seller and the buyer, and therefore on the negotiation of the purchase agreement. The main ones are as follows.

        • Employees: the employment relationship continues with the buyer of the business. The seller and the buyer are jointly and severally liable for all the employee’s rights and claims at the time of transfer (art. 2112 of the Italian Civil Code).
        • Debts: the seller is obliged to pay all debts up to the date of transfer. The buyer is liable for the debts that are shown in the mandatory accounting books (art. 2560 of the Italian Civil Code).
        • Tax debts and liabilities: the seller is obliged to pay debts, taxes and tax penalties relating to the period up to the date of transfer. In addition to the liability for tax debts resulting from mandatory accounting books (Article 2560 of the Italian Civil Code), the buyer is liable for taxes and penalties, even if they are not shown in the accounting books, with the following limits (Article 14 of Legislative Decree 472/1997):
        • the buyer benefits from the prior enforcement of the seller;
        • the buyer is liable up to the value of the business or business unit;
        • for taxes and penalties not emerging from a tax audit by the tax authorities that has taken place before the date of transfer, the buyer is liable for those relating to the year of the sale of the business and the two preceding years only;
        • the tax authorities shall issue a certificate on the existence and amount of debts and ongoing tax audits. If the certificate is not issued within 40 days of the request, the buyer will be released from liability. If the certificate is issued, the buyer will be liable up to the amount resulting from the certificate.
        • Contracts: the parties can choose which contracts to transfer. With respect to the contracts transferred, the buyer takes over, even without the consent of the third contracting party, contracts for the operation of the business that are not of a personal nature. In addition, the third contracting party may withdraw from the contract within three months if there is a just cause (e.g. if the buyer does not guarantee to be able to fulfil the contract due to his financial situation or technical skills) (Art. 2558 of the Italian Civil Code).

        Some ways to deal with the risks

        To manage the risks arising from third party liability and the general risks associated with the acquisition, a number of negotiation and contractual tools can be used. Let’s see some of them.

        In an asset deal:

        Employees: it is possible to agree with the employee changes to the contractual terms and conditions, and waive of joint and several liability of the buyer and seller (pursuant to art. 2112 c.c.). In order to be valid, the agreement with the employee must be concluded with certain requirements (for example, with the assistance of the trade unions).

        Debts:

        • transfer the debts to the buyer and reduce the price accordingly. The price reduction leads to a lower tax cost of the transaction as well. In case of transfer of debts, in order to protect the seller, a declaration of release of the seller from liability pursuant to art. 2560 of the Italian Civil Code can be obtained from the creditor; or, the parties can agree that the payment of the debt by the buyer will take place at the same time as the transfer of the business (‘closing‘).
        • For debts not transferred to the buyer, obtain from the creditor a declaration of release of the buyer from liability pursuant to art. 2560 of the Italian Civil Code.
        • For debts for which it is not possible to obtain a declaration of release from the creditor, agree on forms of security in favor of the seller (for debts transferred) or in favor of the buyer (for debts not transferred), such as, for example, the deferment of payment of part of the price; the escrow of part of the price; bank or shareholder guarantees.

        Tax debts and tax liabilities:

        • obtain from the tax authorities the certificate pursuant to art. 14 of Legislative Decree 472/1997 on debts and tax liabilities;
        • transfer the debts to the buyer, and reduce the price accordingly;
        • agree on forms of guarantee in favor of the seller (for debts transferred) and in favour of the buyer (for debts not transferred or for tax liabilities), such as those set out above for debts in general.

        Contracts: for those that will be transferred:

        • verify that the seller’s obligations up to the date of transfer have been properly performed, in order to avoid the risk of disputes by the third contracting party, that could stop the performance of the contract;
        • at least for the most important contracts, obtain in advance from the third contracting party the approval of transfer of the contract.

        In a share deal some tools are:

        • Due diligence. Carry out a thorough legal, tax and accounting due diligence on the company, to assess the risks in advance and manage them in the negotiation and in the acquisition contract (‘share purchase agreement’).
        • Representations and warranties (‘R&W’) and indemnification. Provide in the acquisition contract (‘share purchase agreement’) a detailed set of representations and warranties – and obligations to indemnify in the event of non-compliance – to be borne by the seller in relation to the situation of the company (‘business warranties‘: balance sheet; contracts; litigation; compliance with environmental regulations; authorizations for the conduct of business; debts; receivables, etc.). Negotiations on representations and warranties normally are carried on taking into account the outcomes of due diligence. Contractual representations and warranties on the situation of the company (‘business warranties‘) and contractual obligation to indemnify, are necessary in share deals in Italy, as in the absence of such clauses the buyer cannot obtain from the seller (except in extraordinary circumstances) compensation or indemnity if the situation of the company is different from that considered at the time of purchase.
        • Guarantees for the buyer. Means of ensuring that the buyer will be indemnified in the event of breach of representations and warranties. Among them: (a) the deferment of payment of part of the price; (b) the payment of part of the price in an escrow account for the duration of the liabilities arising from the representations and warranties and, in case of disputes between the parties, until the dispute is settled; (c) bank guarantee; (d) W&I policy: insurance contract covering the risk of the buyer in case of breach of representations and warranties, up to a maximum amount (and excluding certain risks).

        Other factors influencing the choice between share deal and asset deal

        Of course, the choice to carry out an acquisition operation in Italy through a share deal or an asset deal also depends on other factors, in addition to the tax cost of the transaction. Here are some of them.

        • Purchase of part of the business. The parties chose the asset deal when the transaction does not involve the purchase of the entire business of the target company but only a part of it (a business unit).
        • Situation of the target company. The buyer prefers the asset deal when the situation of the target company is so problematic that the buyer is not willing to assume all the risks arising from the previous management, but only part of them.
        • Maintenance of a role by the seller. The share deal is a better option when the seller will keep a role in the target company. In this case, the seller frequently retains, in addition to a role as director, a minority shareholdings, with exit clauses (put and call rights) after a certain period of time. The exit clauses often link the price to future results and, therefore, in the interest of the buyer, motivate the seller in his/her role as director, and, in the interest of the seller, put a value on the company’s earnings potential, not yet achieved at the time of purchase.

        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.

        Indemnification

        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.

        The author of this article is Paulo Yamaguchi

        The procedure to incorporate a foreign owned company in Spain is, in principle, easy and straight forward, however it is necessary to take into account certain new requirements derived from the tax and the anti-money laundering regulations, which could cause long delays in the incorporation process, even to EU and US companies, if they are not well advised and managed from the beginning of the procedure.

        The first step consist in collecting information about the foreign shareholder, in order to be able to prove its legal existence and activities: the foreign shareholder(s) will have to grant before a Notary Public in its country of residence a power of attorney authorising somebody in Spain to obtain its tax identification number (“NIE”), and also represent it before the Spanish notary when signing the deed of incorporation. In case the foreign shareholder is an individual person, the NIE should be applied for before the Spanish police or the Spanish Consulate at the country where the investor lives.

        If the shareholder is a corporation, apart from the Power of Attorney, it will have to obtain a certificate from its Companies’ Registry or Chamber of Commerce, stating its legal existence and main characteristics. This document is called “good standing certificate” (in the UK and US), “K-bis” (in France), “KvK” (in the Netherlands) or “visura” (in Italy). These two documents, the Power of Attorney mentioned in the above paragraph and the certificate from the Companies’ Registry, will have to be Apostilled or legalized by the correspondent Ministry, and Sworn translated into Spanish. Please note that we use to draft bilingual powers of attorney in order to avoid its sworn translation.

        The foreign shareholder will have to prove that its income is obtained from legal activities in order to be able to open a bank account in the name of the new company. The main document to prove this could be the Corporate or the Personal Income Tax return filed in its country of residence, but there could be other means, especially in case of individual persons.

        In case of a corporate shareholder, it will be necessary as well to declare, in principle through a public deed granted in Spain, who are the individual persons who, directly or through other companies, will hold more than a 25% interest in the new company to be incorporated. In case nobody holds more than a 25% (i.e. because there are 5 individual shareholders, holding each of them a 20%), it is declared that the effective control of the new company corresponds to its director.

        At this stage, it is also necessary to mention that the person(s) who will be the director(s) of the new company, in case they are foreigners, will also need to obtain their personal “NIE”. The NIE should be applied for before the Spanish police (this could be done by a proxy duly authorised though a Power of Attorney granted by the foreign director) or before the Spanish Consulate nearest to the city where the investor lives. In order to be a director of a Spanish company it is not necessary to be a shareholder, nor to have residence and work permit in Spain (provided the foreign director does not live in Spain).

        Meanwhile the necessary documents (Powers of Attorney, Companies’ Registry certificate, etc.) are being prepared by the foreign shareholder, the lawyer in Spain will apply for the new company’s name. It is advisable to point out that generic or usual names are not available quite often, therefore it is necessary to think in original names. Three different names could be applied for simultaneously.

        The drafting of the company’s Articles of Association or By Laws could be very quick, except if the company is going to have several shareholders and they wish specific clauses. In this case, it is also advisable to draft a Shareholders Agreement. The Shareholders’ Agreement could just contain some basic rules on dedication, compensation, non-competition, etc. and some more sophisticated rules on the sale of shares (tag along and drag along rights). As regards the By-Laws, they should mention the company’s name, its activity or activities, address in Spain –which cannot be just a P.O. Box-, share capital, number of shares and its face value, and starting date for the fiscal year, among other standard clauses.

        The management of the company could be organized through a sole director, two directors who could act jointly or separately, and in case there are more than three directors, they should organize themselves through a Board of Directors, being usual in this case to appoint a C.E.O. In order to be a director it is not necessary to be a shareholder. Under Spanish laws, the director(s) could be held liable for some company’s debts under certain circumstances which are legally defined. For this reason, it is necessary that the directors formally accept their appointment (personally appearing before the Notary or through a Power of Attorney).

        Before the incorporation, it will be necessary that either the new company’s director (the person to be appointed) or the representative of the corporate shareholder appears personally before the bank where the company will have its first bank account and signs the correspondent documents (KYC regulation). Once the bank account is opened, the shareholder will have to send a bank transfer for the new company’s share capital. In Spain, the minimum share capital for a limited company (S.L.) is Euros 3.000, while for a “Sociedad Anónima” (S.A.) it is Euros 60.000, but only 25% should be paid off at the incorporation moment. It is interesting to note that contributions to the share capital could be made in cash – which is the most common operation, especially at the incorporation – or in kind, with any type of assets: real estate, machinery, goods, trademarks, etc. The money for the share capital should be sent to the new company’s bank account from an account owned by the shareholder (or from each account owned by each shareholder, should they be several ones), not by any other different person. Once the Spanish bank receives the transfer, it will issue a certificate, which is necessary in order to incorporate the company.

        Once all the documents are ready, it is possible within very few days (almost immediately) to make the appointment with the Notary and sign the public deed of incorporation. This can be done at any notary in Spain, not being necessary that the notary practises at the same city where the company will have its corporate address. In order to summarize, the list of the necessary documents is:

        • Power(s) of Attorney granted by the foreign shareholder(s), apostilled and sworn translated.
        • Certificate regarding the legal existence of the foreign shareholder (only if it is a corporation), apostilled and sworn translated.
        • Statement on who are the last individual shareholders holding more than 25% interest in the new company, directly or indirectly (only in case of corporate shareholders).
        • NIE of the foreign shareholder(s).
        • NIE of the new company’s director(s), should they be a foreigners.
        • Certificate for the new company’s name.
        • Articles of Association.
        • Bank certificate regarding the contribution to the new company’s share capital.

        The deed of incorporation is signed by the proxy (or the individual shareholder(s), should they prefer to personally appear before the notary) before the chosen public notary, being also necessary to sign an official form to report the foreign investment to a public registry depending on the Spanish Ministry of Finance.

        Once the deed of incorporation is signed, the next steps consist in applying before the tax authorities to obtain the new company’s tax number (NIF / CIF) and filing the deed of incorporation before the Companies’ Registry. Some banks do allow new companies to operate once they have the NIF (which could be 2-3 days after the incorporation), while others request to wait until the deed of incorporation is filed at the Companies’ Registry (2-3 weeks).

        An estimation of the necessary time to complete all the procedure is 30-45 days, but of course the main delay is related to speed of the foreign investor in obtaining the necessary documents.

        Please note that if you wish to incorporate a foreign owned company in Spain it is always necessary to seek specific professional advice, as each case is different and regulations and the application of such regulations vary from time to time. The above article just explains the main steps and requirements for the incorporation of a company.

        In all M&A operations one of the issues that deserves special attention as regards its analysis, ascertainment and negotiation is the tax liabilities. Even though the parties could agree on the amount of such contingencies, to negotiate the possible guarantees that the seller should grant in order to protect the buyer from a possible claim by the tax authorities, the term during which the guarantees should be in force, and to agree on the communication mechanisms between the parties (buyer and seller) and the legal defense strategies if such claim from the tax authorities arises, requires substantial negotiation efforts.

        When the acquisition operation is formalized not through the purchase of shares, but through the purchase of the assets that form a business unit, the Spanish General Tax Law (“Ley General Tributaria” or “LGT”) provides a mechanism which implies an exception to the general principle provided by article 42 of the same law. Article 42 of LGT establishes the joint liability of the purchaser of a business unit for the tax liabilities of the selling company (“tax liability derived from company’s succession”). That is, in principle, according to article 42 of the LGT “the persons or entities that continue by any mean in the ownership or exercise of economic activities (the buyers) will be jointly liable with the previous owner for the tax liabilities derived from the exercise of such economic activities incurred by such previous owner”.

        However, the joint tax liability of the buyer could be limited through the application before the tax authorities of the tax certificate regulated by article 175.2 of the LGT. This certificate should be applied for by the prospective buyer, with the authorization of the present owner (the seller), and, once issued, the tax liability of the buyer becomes limited to the debts, penalties and liabilities mentioned in the certificate. If the certificate is issued without mentioning any amount, or if the tax authorities do not issue it within a three months term from the application’s date, the applicant (the buyer) will be released from any tax liability derived from company’s succession.

        The tax certificate for succession purposes includes the main taxes, as Value Added Tax and Corporate Income Tax, and can include as well debts derived from the withholding taxes on employees’ payroll, which in case of companies with a big number of employees could be of an outstanding amount. However, the buyer’s joint liability for salaries, related payroll amounts and social security contributions cannot be limited by such certificate, and such liability will always be joint with the business unit seller’s liability.

        The application for the tax certificate should be filed before the acquisition of the business unit is completed, even if the issuance of the certificate takes place later tan the closing date (but of course, it is wiser to not close the acquisition before having the certificate). The certificate’s validity lasts for one year, as regards periodical tax obligations (for example, Value Added Tax, Corporate Income Tax and withholding taxes on salaries) and for three months as regards non periodical tax obligations.

        It is very important to apply for the right tax certificate (“certificate for succession purposes according to article 175.2 of LGT”), and to not make a mistake and apply, for example, for the certificate regarding having fulfilled all tax obligations (“certificado de estar al corriente de las obligaciones fiscales”). Case law is plenty of judgments where a buyer applied for the wrong certificate, which showed no liabilities, and later on such buyer has been sentenced to pay the tax liabilities incurred by the previous owner of the business unit.

        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.

        1. 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.

        1. Debt

        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.

        1. Tax/labor contingencies

        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.

        1. 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.

        1. 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.

        1. Break-up Fees

        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.

        1. Recommendations

        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.

        The author of this article is Paulo Yamaguchi

        Chinese outbound M&A was one of the main topics of interest at the 2017 Hong Kong IFLR Forum on M&A in Asia, a great event with an outstanding level of speakers and very interesting discussions on various themes related to international investments.

        All the attendants shared the view that momentum for Chinese overseas investments is still strong, despite the recent policy aiming at curbing the outflow of capitals from China.

        A particularly interesting session was that on “best practices to overcome credibility and experience gaps increasingly faced by “off the radar” Chinese bidders”.

        Opening a one-to-one negotiation or letting a Chinese company bid at an auction involves often great deal of uncertainty, as most participants to the session shared the experience of having seeing their Chinese counterpart walk away from the negotiation without any explanation (the so-called “Random Investors”).

        I have scribbled down the take-aways of the discussion as follows.

        Main clues to spot early on the Random investor:

        • the Company pops out from nowhere and has no track record of overseas investments;
        • the Company has no legal or financial advisors, or if they do, their advisors are not experienced in overseas transactions;
        • the Company has excellent advisors… but has not paid their fees (yes, that happens)
        • the target does not belong to the Company’s core business (and there is no explanation for their interest for the deal);

        What should you do to be on the safe side?

        • request a written declaration of interest, expressing the reasons why the Company wants to invest in the target and what is their mid term strategy, signed and stamped by the legal representative (if they are not ready to hand over this letter the game can stop here).
        • If the Company represents a group of investors, require full disclosure and letters of confirmation from all parties, from day one (AC Milan’s case is a good example of what happens later on if there is no disclosure of all players, and their stakes in the deal);
        • request proof that the Company has filed the application for the authorisation to invest overseas (due to the recent tightening of controls on capital outflow, this step is fundamental);
        • request proof that they have the finance needed for the deal (either onshore or, better, off-shore);
        • make clear that you will require a « break fee » (which can vary from 5 to 10%) in case they walk away from the negotiation (we have heard of US companies expecting 30 to 50% break fee on the value of the deal…)

        Mercedes Clavell

        Domaines d'intervention

        • Franchise
        • Immigration
        • Commerce international
        • Fusions et acquisitions
        • Immobilier
        Contact Mercedes

        Écrire à Mercedes





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          Brazil – M&A checklist

          1 août 2018

          • Brésil
          • F&A

          This week the Interim Injunction Judge of the Netherlands Commercial Court ruled in summary proceedings, following a video hearing, in a case on a EUR 169 million transaction where the plaintiff argued that the final transaction had been concluded and the defendant should proceed with the deal.

          This in an – intended – transaction where the letter of intent stipulates that a EUR 30 million break fee is due when no final agreement is signed.

          In addition to ruling on this question of construction of an agreement under Dutch law, the judge also had to rule on the break fee if no agreement was concluded and whether it should be amended or reduced because of the current Coronavirus / Covid-19 crisis.

          English Language proceedings in a Dutch state court, the Netherlands Commercial Court (NCC)

          The case is not just interesting because of the way contract formation is construed under Dutch law and application of concepts of force majeure, unforeseen circumstances and amendment of agreements under the concepts of reasonableness and fairness as well as mitigation of contractual penalties, but also interesting because it was ruled on by a judge of the English language chamber of the Netherlands Commercial Court (NCC).

          This new (2019) Dutch state court offers a relatively fast and cost-effective alternative for international commercial litigation, and in particular arbitration, in a neutral jurisdiction with professional judges selected for both their experience in international disputes and their command of English.

          The dispute regarding the construction of an M&A agreement under Dutch law in an international setting

          The facts are straightforward. Parties (located in New York, USA and the Netherlands) dispute whether final agreement on the EUR 169 million transaction has been reached but do agree a break fee of €30 million in case of non-signature of the final agreement was agreed. However, in addition to claiming there is no final agreement, the defendant also argues that the break fee – due when there is no final agreement – should be reduced or changed due to the coronavirus crisis.

          As to contract formation it must be noted that Dutch law allows broad leeway on how to communicate what may or may not be an offer or acceptance. The standard is what a reasonable person in the same circumstances would have understood their communications to mean.  Here, the critical fact is that the defendant did not sign the so-called “Transaction Agreement”. The letter of intent’s binary mechanism (either execute and deliver the paperwork for the Transaction Agreement by the agreed date or pay a EUR 30 million fee) may not have been an absolute requirement for contract formation (under Dutch law) but has significant evidentiary weight. In M&A practice – also under Dutch law – with which these parties are thoroughly familiar with, this sets a very high bar for  concluding a contract was agreed other than by explicit written agreement. So, parties may generally comfortably rely on what they have agreed on in writing with the assistance of their advisors.

          The communications relied on by claimant in this case did not clear the very high bar to assume that despite the mechanism of the letter of intent and the lack of a signed Transaction Agreement there still was a binding agreement. In particular attributing the other party’s advisers’ statements and/or conduct to the contracting party they represent did not work for the claimant in this case as per the verdict nothing suggested that the advisers would be handling everything, including entering into the agreement.

          Court order for actual performance of a – deemed – agreement on an M&A deal?

          The Interim Injunction Judge finds that there is not a sufficient likelihood of success on the merits so as to justify an interim measure ordering the defendant to actually perform its obligations under the disputed Transaction Agreement (payment of EUR 169 million and take the claimant’s 50% stake in an equestrian show-jumping business).

          Enforcement of the break fee despite “Coronavirus”?

          Failing the conclusion of an agreement, there was still another question to answer as the letter of intent mechanism re the break fee as such was not disputed. Should the Court enforce the full EUR 30 million fee in the current COVID-19 circumstances? Or should the fee’s effects be modified, mitigated or reduced in some way, or  the fee agreement should even be dissolved?

          Unforeseen circumstances, reasonableness and fairness

          The Interim Injunction Judge rules that the coronavirus crisis may be an unforeseen circumstance, but it is not of such a nature that, according to standards of reasonableness and fairness, the plaintiff cannot expect the break fee obligation to remain unchanged. The purpose of the break fee is to encourage parties to enter into the transaction and attribute / share risks between them. As such the fee limits the exposure of the parties. Payment of the fee is a quick way out of the obligation to pay the purchase price of EUR 169 million and the risks of keeping the target company financially afloat. If financially the coronavirus crisis turns out less disastrous than expected, the fee of EUR 30 million may seem high, but that is what the parties already considered reasonable when they waived their right to invoke the unreasonableness of the fee. The claim for payment of the EUR 30 million break fee is therefore upheld by the Interim Injunction Judge.

          Applicable law and the actual practice of it by the courts

          The relevant three articles are in this case articles 6:94, 6:248 and 6:258 of the Dutch Civil Code. They relate to the mitigation of contractual penalties, unforeseen circumstances and amendment of the agreement under the tenets of reasonableness and fairness. Under Dutch law the courts must with all three exercise caution. Contracts must generally be enforced as agreed. The parties’ autonomy is deemed paramount and the courts’ attitude is deferential. All three articles use language stating, essentially, that interference by the courts in the contract’s operation is allowed only to avoid an “unacceptable” impact, as assessed under standards of reasonableness and fairness.

          There is at this moment of course no well- established case law on COVID-19. However, commentators have provided guidance that is very helpful to think through the issues. Recently a “share the pain” approach has been advocated by a renowned law Professor, Tjittes, who focuses on preserving the parties’ contractual equilibrium in the current circumstances. This is, in the Court’s analysis, the right way to look at the agreement here. There is no evidence in the record suggesting that the parties contemplated or discussed the full and exceptional impact of the COVID-19 crisis. The crisis may or may not be unprovided for.  However, the court rules in the current case there is no need to rule on this issue. Even if the crisis is unprovided for, there is no support in the record for the proposition that the crisis makes it unacceptable for the claimant to demand strict performance by the defendant. The reasons are straightforward.

          The break fee allocates risk and expresses commitment and caps exposure. The harm to the business may be substantial and structural, or it may be short-term and minimal. Either way, the best “share the pain” solution, to preserve the contractual equilibrium in the agreement, is for the defendant to pay the fee as written in the letter of intent. This allocates a defined risk to one party, and actual or potential risks to the other party. Reducing the break fee in any business downturn, the fee’s express purpose – comfort and confidence to get the deal done – would not be accomplished and be derived in precisely the circumstances in which it should be robust. As a result, the Court therefore orders to pay the full EUR 30 million fee. So the break fee stipulation works under the circumstances without mitigation because of the Corona outbreak.

          The Netherlands Commercial Court, continued

          As already indicated above, the case is interesting because the verdict has been rendered by a Dutch state court in English and the proceedings where also in English. Not because of a special privilege granted in a specific case but based on an agreement between parties with a proper choice of forum clause for this court. In addition to the benefit to of having an English forum without mandatorily relying on either arbitration or choosing an anglophone court, it also has the benefit of it being a state court with the application of the regular Dutch civil procedure law, which is well known by it’s practitioners and reduces the risk of surprises of a procedural nature.  As it is as such also a “normal” state court, there is the right to appeal and particularly effective under Dutch law access to expedited proceeding as was also the case in the example referred to above. This means a regular procedure with full application of all evidentiary rules may still follow, overturning or confirming this preliminary verdict in summary proceedings.

          Novel technology in proceedings

          Another first or at least a novel application is that all submissions were made in eNCC, a document upload procedure for the NCC. Where the introduction of electronic communication and litigation in the Dutch court system has failed spectacularly, the innovations are now all following in quick order and quite effective. As a consequence of the Coronavirus outbreak several steps have been quickly tried in practice and thereafter formally set up. At present this – finally – includes a secure email-correspondence system between attorneys and the courts.

          And, also by special order of the Court in this present case, given the current COVID-19 restrictions the matter was dealt with at a public videoconference hearing on 22 April 2020 and the case was set for judgment on 29 April 2020 and published on 30 April 2020.

          Even though it is a novel application, it is highly likely that similar arrangements will continue even after expiry of current emergency measures. In several Dutch courts videoconference hearings are applied on a voluntary basis and is expected that the arrangements will be formalized.

          Eligibility of cases for the Netherlands Commercial Court

          Of more general interest are the requirements for matters that may be submitted to NCC:

          • the Amsterdam District Court or Amsterdam Court of Appeal has jurisdiction
          • the parties have expressly agreed in writing that proceedings will be in English before the NCC (the ‘NCC agreement’)
          • the action is a civil or commercial matter within the parties’ autonomy
          • the matter concerns an international dispute.

          The NCC agreement can be recorded in a clause, either before or after the dispute arises. The Court even recommends specific wording:

          “All disputes arising out of or in connection with this agreement will be resolved by the Amsterdam District Court following proceedings in English before the Chamber for International Commercial Matters (“Netherlands Commercial Court” or “NCC District Court”), to the exclusion of the jurisdiction of any other courts. An action for interim measures, including protective measures, available under Dutch law may be brought in the NCC’s Court in Summary Proceedings (CSP) in proceedings in English. Any appeals against NCC or CSP judgments will be submitted to the Amsterdam Court of Appeal’s Chamber for International Commercial Matters (“Netherlands Commercial Court of Appeal” or “NCCA”).”

          The phrase “to the exclusion of the jurisdiction of any other courts” is included in light of the Hague Convention on Choice of Court Agreements. It is not mandatory to include it of course and parties may decide not to exclude the jurisdiction of other courts or make other arrangements they consider appropriate. The only requirement being that such arrangements comply with the rules of jurisdiction and contract. Please note that choice of court agreements are exclusive unless the parties have “expressly provided” or “agreed” otherwise (as per the Hague Convention and Recast Brussels I Regulation).

          Parties in a pending case before another Dutch court or chamber may request that their case be referred to NCC District Court or NCC Court of Appeal. One of the requirements is to agree on a clause that takes the case to the NCC and makes English the language of the proceedings. The NCC recommends using this language:

          We hereby agree that all disputes in connection with the case [name parties], which is currently pending at the *** District Court (case number ***), will be resolved by the Amsterdam District Court following proceedings in English before the Chamber for International Commercial Matters (“Netherlands Commercial Court” or ”NCC District Court). Any action for interim measures, including protective measures, available under Dutch law will be brought in the NCC’s Court in Summary Proceedings (CSP) in proceedings in English. Any appeals against NCC or CSP judgments will be submitted to the Amsterdam Court of Appeal’s Chamber for International Commercial Matters (“Netherlands Commercial Court of Appeal” or “NCC Court of Appeal”).

          To request a referral, a motion must be made before the other chamber or court where the action is pending, stating the request and contesting jurisdiction (if the case is not in Amsterdam) on the basis of a choice-of-court agreement (see before).

          Additional arrangements in the proceedings before the Netherlands Commercial Court

          Before or during the proceedings, parties can also agree special arrangements in a customized NCC clause or in another appropriate manner. Such arrangements may include matters such as the following:

          • the law applicable to the substantive dispute
          • the appointment of a court reporter for preparing records of hearings and the costs of preparing those records
          • an agreement on evidence that departs from the general rules
          • the disclosure of confidential documents
          • the submission of a written witness statement prior to the witness examination
          • the manner of taking witness testimony
          • the costs of the proceedings.

          Visiting lawyers and typical course of the procedure

          All acts of process are in principle carried out by a member of the Dutch Bar. Member of the Bar in an EU or EEA Member State or Switzerland may work in accordance with Article 16e of the Advocates Act (in conjunction with a member of the Dutch Bar). Other visiting lawyers may be allowed to speak at any hearing.

          The proceedings will typically follow the below steps:

          • Submitting the initiating document by the plaintiff (summons or request as per Dutch law)
          • Assigned to three judges and a senior law clerk.
          • The defendant submits its defence statement.
          • Case management conference or motion hearing (e.g. also in respect of preliminary issues such as competence, applicable law etc.) where parties may present their arguments.
          • Judgment on motions: the court rules on the motions. Testimony, expert appointment, either at this stage or earlier or later.
          • The court may allow the parties to submit further written statements.
          • Hearing: the court interviews the parties and allows them to present their arguments. The court may enquire whether the dispute could be resolved amicably and, where appropriate, assist the parties in a settlement process. If appropriate, the court may discuss with the parties whether it would be advisable to submit part or all of the dispute to a mediator. At the end of the hearing, the court will discuss with the parties what the next steps should be.
          • Verdict: this may be a final judgment on the claims or an interim judgment ordering one or more parties to produce evidence, allowing the parties to submit written submissions on certain aspects of the case, appointing one or more experts or taking other steps.

          Continuous updates, online resources Netherlands Commercial Court

          As a final note the English language website of the Netherlands Commercial Court provides ample information on procedure and practical issues and is updated with a high frequence. Under current circumstance even at a higher pace. In particular for practitioners it’s recommended to regularly consult the website. https://www.rechtspraak.nl/English/NCC/Pages/default.aspx

          One of the most tricky steps in any M&A operation is when the issue of « warranties », in particular with reference to the economic situation, the balance sheet and the financial position of the company or business (or of a branch), namely the so-called « business warranties« .

          On one side, the buyer would like to « ironclad » his investment by reducing the risk of an unpleasant surprise to a minimum. The seller, by contrast, wishes to provide the least possible warranties, which often translate in a provisory restriction on the full enjoyment of the proceeds; the same may be essential for further investment.

          It should be noted, first of all, that the term « warranties » is usually referred to, in a non-technical acceptation, to a complex set of contractual provisions containing:

          • any seller’s statements about the health of the company or business (or branch of business) being transferred;
          • any compensation obligations undertaken by the seller in case of « violation » (i.e. mistruth) of the assertions;
          • any remedies provided to ensure the effectiveness of the indemnity obligations entered into.

          While there are several reasons why this set is necessary, the most significant one is that in M&A contracts, statutory sale warranties only apply to the good sold; therefore, if the good sold is an equity investment, the warranties do not cover any of the company’s underlying assets; and even as they exceptionally do apply, short terms and strict limitations still justify an ancillary obligation designed to ensure the economic success of the transaction.

          As confirmed by current practice, there is not a single M&A agreement that does not include a set of warranties.

          In particular, representations typically incorporate the buyer’s due diligence, which for its part usually follows a non-disclosure agreement (NDA) to protect any information disclosed.

          Any criticalities identified should be properly mentioned. Clearly, wherever a criticality arises, it may not necessarily trigger an indemnity obligation. It will be up to the parties to lay down the rules, as they may also provide that any related risk is to be borne by the buyer; this may be offset by a reduction in the price.

          Some aspects of the compensation obligation will have to be carefully negotiated. The main ones are certainly:

          • duration (e.g. longer for tax-related warranties);
          • who is entitled to compensation (the buyer or the company; one or the other as the case may be);
          • any deductions and/or limitations (e.g. tax losses);
          • compensation cap;
          • any possible deductible;
          • the compensation procedure (e.g. application deadlines, settlement procedure, particular circumstances).

          These are highly relevant aspects and should by no means be underestimated. As an example, it is obvious that if the compensation procedure is poorly regulated, all the previous efforts are jeopardised.

          Finally, suitable measures to ensure an effective protection of the buyer must be provided. Among these, the most conventional tools are:

          • the surety;
          • the “independent contract of guarantee”;
          • the escrow;
          • the deferment of payment;
          • the “earn-out”-scheme;
          • the “price adjustment”;
          • the letter of patronage;
          • the pledge and/or mortgage.

          These are more or less widely used instruments, each one with its pros and cons.

          At this point, however, we would like to address a new tool with an insurance character, which has been being used recently: the so-called « Warranty & Indemnity Policies« .

          With a W&I insurance policy, basically, the insurer assumes the risk resulting from breaches of warranties and indemnities included in an M&A contract upon payment of a premium.

          It is obviously a key condition that the violation arose from facts preceding the closing and which were not known at that time (and, therefore, not highlighted by the due diligence carried out).

          The insurance policy may be subscribed by the buyer (buyer side) or the seller (seller side). Usually the first option is preferred. These W&I insurance policies come with a number of advantages:

          • a warranty is given even when the seller has been unwilling to commit himself contractually;
          • the insurance policy usually does not provide for any recourse against the seller, other than in the case of malice, so that the seller is fully released;
          • it is also possible to achieve a higher ceiling than that provided for in a purchase agreement;
          • likewise, coverage may be provided for a longer period;
          • it is easier to deal with the seller, especially if there are several and some are still part of the company, perhaps as members of the Board of Directors;
          • compensation procedures become significantly easier, especially in cases where there are multiple sellers, including individuals;
          • the buyer gains a higher certainty of solvency.

          The cost of the insurance policy may be shared between the parties, eventually by discounting the purchase price, which the seller may be more willing to grant, considering that he will not be required to issue other warranties and can immediately use the proceeds of the sale.

          Premiums are usually set somewhere between 1% and 2% of the compensation limit (with a minimum premium).

          Besides the price, which makes the tool mostly suitable for operations of not modest entity, currently, the main limitation seems to be the commonly required deductible, equal to 1% of the Enterprise Value of the Target, which may be reduced to 0.5% in case of higher premiums. Keep in mind that the W&I insurance policy implies a review of the due diligence by the insurance company, which can translate into an actual intervention in the negotiation of the warranties.

          Beyond this, this tool needs to be carefully evaluated: facing highly complex scenarios, it could be the ideal solution to solve an impasse in negotiations and make relations between professional investors and SMEs easier.

          Acquisitions (M&A) in Italy are carried out in most cases through the purchase of shareholdings (‘share deal’) or business or business unit (‘asset deal’). For mainly tax reasons, share deals are more frequent than asset deals, despite the asset deal allows a better limitation of risks for the buyer. We will explain the main differences between share deal and asset deal in terms of risks, and in terms of relationships between seller and buyer.

          Preference for acquisitions through the purchase of shareholdings (‘share deal’) rather than the purchase of business or business unit (‘asset deal’) in the Italian market

          In Italy, acquisitions are carried out, in most cases, through the purchase of shareholdings (‘share deal’) or of business or business unit (‘asset deal’). Other structures, such as mergers, are less frequent.

          By purchasing shareholdings of the target company (‘share deal‘), the buyer indirectly acquires all the company’s assets, liabilities and legal relationships. Therefore, the buyer bears all the risks relating to the previous management of the company.

          With the purchase of the business or of a business unit of the target company (‘asset deal‘), the buyer acquires a set of assets and relationships organized for the operation of the business (real estate, machineries, patents, trademarks, employees, contracts, credits, debts, etc.). The advantage of the asset deal lies in the possibility for the parties to select the assets and liabilities included in the deal: hence the buyer can limit the legal risks of the transaction.

          Despite this advantage, most acquisitions in Italy are made through the purchase of shareholdings. In 2018, there were approximately 78,400 purchases of shareholdings (shares or quotas), while there were approximately 35,900 sales of businesses or business units. (source: www.notariato.it/it/news/dati-statistici-notarili-anno-2018). It should be noted that the number of transfers of business also includes small or very small businesses owned by individual entrepreneurs, for whom the alternative of the share deal (though feasible, through the contribution of the business in a newco and the sale of the shares in the newco) is not viable in practice for cost reasons.

          Taxation of share deal and asset deal in Italy

          The main reason for the preference for share deal over asset deal lies in the tax costs of the transaction. Let’s see what they are.

          In a share deal, the direct taxes borne by the seller are calculated on the capital gain, according to the following rates:

          • if the seller is a joint-stock company (società per azioni – s.p.a.; società a responsabilità limitata – r.l.; società in accomandita per azioni – s.a.p.a.), the corporate tax rate is 24% of the capital gain. However, under certain conditions, the so-called PEX (participation exemption) regime is applied with the application of the rate of 24% on 5% of the capital gain only.
          • If the seller is a partnership (società semplice – s.s.; società in nome collettivo – s.n.c..; società in accomandita semplice – s.a.s.) the capital gain is fully taxable. However, under certain conditions, the taxable amount is limited to 60% of the amount of the capital gain. In both cases, the taxable amount is attributed pro rata to each shareholder of the partnership, and added to the shareholders’ income (the tax rate depends on the shareholders’ income).
          • If the seller is a natural person, the rate on the capital gain is 26%.

          A share deal is subject to a fixed registration tax of € 200,00, normally paid by the buyer.

          In an asset deal, the direct taxes to be paid by the seller are calculated on the capital gain. If the seller is a joint-stock company, the corporate tax rate is 24% of the capital gain. If the seller is a partnership (with individual partners) or an individual entrepreneur, the rate depends on the seller’s income.

          In an asset deal the transfer of the business or of the business unit is subject to registration tax, generally paid by the buyer. However both the seller and the buyer are jointly and severally liable for the payment of the registration tax. The tax is calculated on the part of the price attributable to the assets transferred. The price is the result of the transferred assets minus the transferred liabilities. The tax rate depends on the type of asset transferred. In general:

          • movable assets, including patents and trademarks: 3%;
          • goodwill: 3%;
          • buildings: 9%;
          • land: between 9% and 12% (depending on the buyer).

          If the parties do not apportion the purchase price to the different assets in proportion to their values, the registration tax is applied to the entire purchase price at the highest rate of those applicable to the assets.

          It should be noted that the tax authorities may assess the value attributed by the parties to real estate and goodwill, with the consequent risk of application of higher taxes.

          Share deal and asset deal: risks and responsibilities towards third parties

          In the purchase of shares or quotas (‘share deal‘), the purchaser bears, indirectly, all the risks relating to the previous management of the company.

          In the purchase of business or business unit (‘asset deal‘), on the other hand, the parties can select which assets and liabilities will be transferred, hence establishing, among them, the risks that the buyer will bear.

          However, there are some rules, which the parties cannot derogate from, relating to relationships with third parties, that have a significant impact on the risks for the seller and the buyer, and therefore on the negotiation of the purchase agreement. The main ones are as follows.

          • Employees: the employment relationship continues with the buyer of the business. The seller and the buyer are jointly and severally liable for all the employee’s rights and claims at the time of transfer (art. 2112 of the Italian Civil Code).
          • Debts: the seller is obliged to pay all debts up to the date of transfer. The buyer is liable for the debts that are shown in the mandatory accounting books (art. 2560 of the Italian Civil Code).
          • Tax debts and liabilities: the seller is obliged to pay debts, taxes and tax penalties relating to the period up to the date of transfer. In addition to the liability for tax debts resulting from mandatory accounting books (Article 2560 of the Italian Civil Code), the buyer is liable for taxes and penalties, even if they are not shown in the accounting books, with the following limits (Article 14 of Legislative Decree 472/1997):
          • the buyer benefits from the prior enforcement of the seller;
          • the buyer is liable up to the value of the business or business unit;
          • for taxes and penalties not emerging from a tax audit by the tax authorities that has taken place before the date of transfer, the buyer is liable for those relating to the year of the sale of the business and the two preceding years only;
          • the tax authorities shall issue a certificate on the existence and amount of debts and ongoing tax audits. If the certificate is not issued within 40 days of the request, the buyer will be released from liability. If the certificate is issued, the buyer will be liable up to the amount resulting from the certificate.
          • Contracts: the parties can choose which contracts to transfer. With respect to the contracts transferred, the buyer takes over, even without the consent of the third contracting party, contracts for the operation of the business that are not of a personal nature. In addition, the third contracting party may withdraw from the contract within three months if there is a just cause (e.g. if the buyer does not guarantee to be able to fulfil the contract due to his financial situation or technical skills) (Art. 2558 of the Italian Civil Code).

          Some ways to deal with the risks

          To manage the risks arising from third party liability and the general risks associated with the acquisition, a number of negotiation and contractual tools can be used. Let’s see some of them.

          In an asset deal:

          Employees: it is possible to agree with the employee changes to the contractual terms and conditions, and waive of joint and several liability of the buyer and seller (pursuant to art. 2112 c.c.). In order to be valid, the agreement with the employee must be concluded with certain requirements (for example, with the assistance of the trade unions).

          Debts:

          • transfer the debts to the buyer and reduce the price accordingly. The price reduction leads to a lower tax cost of the transaction as well. In case of transfer of debts, in order to protect the seller, a declaration of release of the seller from liability pursuant to art. 2560 of the Italian Civil Code can be obtained from the creditor; or, the parties can agree that the payment of the debt by the buyer will take place at the same time as the transfer of the business (‘closing‘).
          • For debts not transferred to the buyer, obtain from the creditor a declaration of release of the buyer from liability pursuant to art. 2560 of the Italian Civil Code.
          • For debts for which it is not possible to obtain a declaration of release from the creditor, agree on forms of security in favor of the seller (for debts transferred) or in favor of the buyer (for debts not transferred), such as, for example, the deferment of payment of part of the price; the escrow of part of the price; bank or shareholder guarantees.

          Tax debts and tax liabilities:

          • obtain from the tax authorities the certificate pursuant to art. 14 of Legislative Decree 472/1997 on debts and tax liabilities;
          • transfer the debts to the buyer, and reduce the price accordingly;
          • agree on forms of guarantee in favor of the seller (for debts transferred) and in favour of the buyer (for debts not transferred or for tax liabilities), such as those set out above for debts in general.

          Contracts: for those that will be transferred:

          • verify that the seller’s obligations up to the date of transfer have been properly performed, in order to avoid the risk of disputes by the third contracting party, that could stop the performance of the contract;
          • at least for the most important contracts, obtain in advance from the third contracting party the approval of transfer of the contract.

          In a share deal some tools are:

          • Due diligence. Carry out a thorough legal, tax and accounting due diligence on the company, to assess the risks in advance and manage them in the negotiation and in the acquisition contract (‘share purchase agreement’).
          • Representations and warranties (‘R&W’) and indemnification. Provide in the acquisition contract (‘share purchase agreement’) a detailed set of representations and warranties – and obligations to indemnify in the event of non-compliance – to be borne by the seller in relation to the situation of the company (‘business warranties‘: balance sheet; contracts; litigation; compliance with environmental regulations; authorizations for the conduct of business; debts; receivables, etc.). Negotiations on representations and warranties normally are carried on taking into account the outcomes of due diligence. Contractual representations and warranties on the situation of the company (‘business warranties‘) and contractual obligation to indemnify, are necessary in share deals in Italy, as in the absence of such clauses the buyer cannot obtain from the seller (except in extraordinary circumstances) compensation or indemnity if the situation of the company is different from that considered at the time of purchase.
          • Guarantees for the buyer. Means of ensuring that the buyer will be indemnified in the event of breach of representations and warranties. Among them: (a) the deferment of payment of part of the price; (b) the payment of part of the price in an escrow account for the duration of the liabilities arising from the representations and warranties and, in case of disputes between the parties, until the dispute is settled; (c) bank guarantee; (d) W&I policy: insurance contract covering the risk of the buyer in case of breach of representations and warranties, up to a maximum amount (and excluding certain risks).

          Other factors influencing the choice between share deal and asset deal

          Of course, the choice to carry out an acquisition operation in Italy through a share deal or an asset deal also depends on other factors, in addition to the tax cost of the transaction. Here are some of them.

          • Purchase of part of the business. The parties chose the asset deal when the transaction does not involve the purchase of the entire business of the target company but only a part of it (a business unit).
          • Situation of the target company. The buyer prefers the asset deal when the situation of the target company is so problematic that the buyer is not willing to assume all the risks arising from the previous management, but only part of them.
          • Maintenance of a role by the seller. The share deal is a better option when the seller will keep a role in the target company. In this case, the seller frequently retains, in addition to a role as director, a minority shareholdings, with exit clauses (put and call rights) after a certain period of time. The exit clauses often link the price to future results and, therefore, in the interest of the buyer, motivate the seller in his/her role as director, and, in the interest of the seller, put a value on the company’s earnings potential, not yet achieved at the time of purchase.

          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.

          Indemnification

          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.

          The author of this article is Paulo Yamaguchi

          The procedure to incorporate a foreign owned company in Spain is, in principle, easy and straight forward, however it is necessary to take into account certain new requirements derived from the tax and the anti-money laundering regulations, which could cause long delays in the incorporation process, even to EU and US companies, if they are not well advised and managed from the beginning of the procedure.

          The first step consist in collecting information about the foreign shareholder, in order to be able to prove its legal existence and activities: the foreign shareholder(s) will have to grant before a Notary Public in its country of residence a power of attorney authorising somebody in Spain to obtain its tax identification number (“NIE”), and also represent it before the Spanish notary when signing the deed of incorporation. In case the foreign shareholder is an individual person, the NIE should be applied for before the Spanish police or the Spanish Consulate at the country where the investor lives.

          If the shareholder is a corporation, apart from the Power of Attorney, it will have to obtain a certificate from its Companies’ Registry or Chamber of Commerce, stating its legal existence and main characteristics. This document is called “good standing certificate” (in the UK and US), “K-bis” (in France), “KvK” (in the Netherlands) or “visura” (in Italy). These two documents, the Power of Attorney mentioned in the above paragraph and the certificate from the Companies’ Registry, will have to be Apostilled or legalized by the correspondent Ministry, and Sworn translated into Spanish. Please note that we use to draft bilingual powers of attorney in order to avoid its sworn translation.

          The foreign shareholder will have to prove that its income is obtained from legal activities in order to be able to open a bank account in the name of the new company. The main document to prove this could be the Corporate or the Personal Income Tax return filed in its country of residence, but there could be other means, especially in case of individual persons.

          In case of a corporate shareholder, it will be necessary as well to declare, in principle through a public deed granted in Spain, who are the individual persons who, directly or through other companies, will hold more than a 25% interest in the new company to be incorporated. In case nobody holds more than a 25% (i.e. because there are 5 individual shareholders, holding each of them a 20%), it is declared that the effective control of the new company corresponds to its director.

          At this stage, it is also necessary to mention that the person(s) who will be the director(s) of the new company, in case they are foreigners, will also need to obtain their personal “NIE”. The NIE should be applied for before the Spanish police (this could be done by a proxy duly authorised though a Power of Attorney granted by the foreign director) or before the Spanish Consulate nearest to the city where the investor lives. In order to be a director of a Spanish company it is not necessary to be a shareholder, nor to have residence and work permit in Spain (provided the foreign director does not live in Spain).

          Meanwhile the necessary documents (Powers of Attorney, Companies’ Registry certificate, etc.) are being prepared by the foreign shareholder, the lawyer in Spain will apply for the new company’s name. It is advisable to point out that generic or usual names are not available quite often, therefore it is necessary to think in original names. Three different names could be applied for simultaneously.

          The drafting of the company’s Articles of Association or By Laws could be very quick, except if the company is going to have several shareholders and they wish specific clauses. In this case, it is also advisable to draft a Shareholders Agreement. The Shareholders’ Agreement could just contain some basic rules on dedication, compensation, non-competition, etc. and some more sophisticated rules on the sale of shares (tag along and drag along rights). As regards the By-Laws, they should mention the company’s name, its activity or activities, address in Spain –which cannot be just a P.O. Box-, share capital, number of shares and its face value, and starting date for the fiscal year, among other standard clauses.

          The management of the company could be organized through a sole director, two directors who could act jointly or separately, and in case there are more than three directors, they should organize themselves through a Board of Directors, being usual in this case to appoint a C.E.O. In order to be a director it is not necessary to be a shareholder. Under Spanish laws, the director(s) could be held liable for some company’s debts under certain circumstances which are legally defined. For this reason, it is necessary that the directors formally accept their appointment (personally appearing before the Notary or through a Power of Attorney).

          Before the incorporation, it will be necessary that either the new company’s director (the person to be appointed) or the representative of the corporate shareholder appears personally before the bank where the company will have its first bank account and signs the correspondent documents (KYC regulation). Once the bank account is opened, the shareholder will have to send a bank transfer for the new company’s share capital. In Spain, the minimum share capital for a limited company (S.L.) is Euros 3.000, while for a “Sociedad Anónima” (S.A.) it is Euros 60.000, but only 25% should be paid off at the incorporation moment. It is interesting to note that contributions to the share capital could be made in cash – which is the most common operation, especially at the incorporation – or in kind, with any type of assets: real estate, machinery, goods, trademarks, etc. The money for the share capital should be sent to the new company’s bank account from an account owned by the shareholder (or from each account owned by each shareholder, should they be several ones), not by any other different person. Once the Spanish bank receives the transfer, it will issue a certificate, which is necessary in order to incorporate the company.

          Once all the documents are ready, it is possible within very few days (almost immediately) to make the appointment with the Notary and sign the public deed of incorporation. This can be done at any notary in Spain, not being necessary that the notary practises at the same city where the company will have its corporate address. In order to summarize, the list of the necessary documents is:

          • Power(s) of Attorney granted by the foreign shareholder(s), apostilled and sworn translated.
          • Certificate regarding the legal existence of the foreign shareholder (only if it is a corporation), apostilled and sworn translated.
          • Statement on who are the last individual shareholders holding more than 25% interest in the new company, directly or indirectly (only in case of corporate shareholders).
          • NIE of the foreign shareholder(s).
          • NIE of the new company’s director(s), should they be a foreigners.
          • Certificate for the new company’s name.
          • Articles of Association.
          • Bank certificate regarding the contribution to the new company’s share capital.

          The deed of incorporation is signed by the proxy (or the individual shareholder(s), should they prefer to personally appear before the notary) before the chosen public notary, being also necessary to sign an official form to report the foreign investment to a public registry depending on the Spanish Ministry of Finance.

          Once the deed of incorporation is signed, the next steps consist in applying before the tax authorities to obtain the new company’s tax number (NIF / CIF) and filing the deed of incorporation before the Companies’ Registry. Some banks do allow new companies to operate once they have the NIF (which could be 2-3 days after the incorporation), while others request to wait until the deed of incorporation is filed at the Companies’ Registry (2-3 weeks).

          An estimation of the necessary time to complete all the procedure is 30-45 days, but of course the main delay is related to speed of the foreign investor in obtaining the necessary documents.

          Please note that if you wish to incorporate a foreign owned company in Spain it is always necessary to seek specific professional advice, as each case is different and regulations and the application of such regulations vary from time to time. The above article just explains the main steps and requirements for the incorporation of a company.

          In all M&A operations one of the issues that deserves special attention as regards its analysis, ascertainment and negotiation is the tax liabilities. Even though the parties could agree on the amount of such contingencies, to negotiate the possible guarantees that the seller should grant in order to protect the buyer from a possible claim by the tax authorities, the term during which the guarantees should be in force, and to agree on the communication mechanisms between the parties (buyer and seller) and the legal defense strategies if such claim from the tax authorities arises, requires substantial negotiation efforts.

          When the acquisition operation is formalized not through the purchase of shares, but through the purchase of the assets that form a business unit, the Spanish General Tax Law (“Ley General Tributaria” or “LGT”) provides a mechanism which implies an exception to the general principle provided by article 42 of the same law. Article 42 of LGT establishes the joint liability of the purchaser of a business unit for the tax liabilities of the selling company (“tax liability derived from company’s succession”). That is, in principle, according to article 42 of the LGT “the persons or entities that continue by any mean in the ownership or exercise of economic activities (the buyers) will be jointly liable with the previous owner for the tax liabilities derived from the exercise of such economic activities incurred by such previous owner”.

          However, the joint tax liability of the buyer could be limited through the application before the tax authorities of the tax certificate regulated by article 175.2 of the LGT. This certificate should be applied for by the prospective buyer, with the authorization of the present owner (the seller), and, once issued, the tax liability of the buyer becomes limited to the debts, penalties and liabilities mentioned in the certificate. If the certificate is issued without mentioning any amount, or if the tax authorities do not issue it within a three months term from the application’s date, the applicant (the buyer) will be released from any tax liability derived from company’s succession.

          The tax certificate for succession purposes includes the main taxes, as Value Added Tax and Corporate Income Tax, and can include as well debts derived from the withholding taxes on employees’ payroll, which in case of companies with a big number of employees could be of an outstanding amount. However, the buyer’s joint liability for salaries, related payroll amounts and social security contributions cannot be limited by such certificate, and such liability will always be joint with the business unit seller’s liability.

          The application for the tax certificate should be filed before the acquisition of the business unit is completed, even if the issuance of the certificate takes place later tan the closing date (but of course, it is wiser to not close the acquisition before having the certificate). The certificate’s validity lasts for one year, as regards periodical tax obligations (for example, Value Added Tax, Corporate Income Tax and withholding taxes on salaries) and for three months as regards non periodical tax obligations.

          It is very important to apply for the right tax certificate (“certificate for succession purposes according to article 175.2 of LGT”), and to not make a mistake and apply, for example, for the certificate regarding having fulfilled all tax obligations (“certificado de estar al corriente de las obligaciones fiscales”). Case law is plenty of judgments where a buyer applied for the wrong certificate, which showed no liabilities, and later on such buyer has been sentenced to pay the tax liabilities incurred by the previous owner of the business unit.

          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.

          1. 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.

          1. Debt

          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.

          1. Tax/labor contingencies

          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.

          1. 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.

          1. 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.

          1. Break-up Fees

          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.

          1. Recommendations

          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.

          The author of this article is Paulo Yamaguchi

          Chinese outbound M&A was one of the main topics of interest at the 2017 Hong Kong IFLR Forum on M&A in Asia, a great event with an outstanding level of speakers and very interesting discussions on various themes related to international investments.

          All the attendants shared the view that momentum for Chinese overseas investments is still strong, despite the recent policy aiming at curbing the outflow of capitals from China.

          A particularly interesting session was that on “best practices to overcome credibility and experience gaps increasingly faced by “off the radar” Chinese bidders”.

          Opening a one-to-one negotiation or letting a Chinese company bid at an auction involves often great deal of uncertainty, as most participants to the session shared the experience of having seeing their Chinese counterpart walk away from the negotiation without any explanation (the so-called “Random Investors”).

          I have scribbled down the take-aways of the discussion as follows.

          Main clues to spot early on the Random investor:

          • the Company pops out from nowhere and has no track record of overseas investments;
          • the Company has no legal or financial advisors, or if they do, their advisors are not experienced in overseas transactions;
          • the Company has excellent advisors… but has not paid their fees (yes, that happens)
          • the target does not belong to the Company’s core business (and there is no explanation for their interest for the deal);

          What should you do to be on the safe side?

          • request a written declaration of interest, expressing the reasons why the Company wants to invest in the target and what is their mid term strategy, signed and stamped by the legal representative (if they are not ready to hand over this letter the game can stop here).
          • If the Company represents a group of investors, require full disclosure and letters of confirmation from all parties, from day one (AC Milan’s case is a good example of what happens later on if there is no disclosure of all players, and their stakes in the deal);
          • request proof that the Company has filed the application for the authorisation to invest overseas (due to the recent tightening of controls on capital outflow, this step is fundamental);
          • request proof that they have the finance needed for the deal (either onshore or, better, off-shore);
          • make clear that you will require a « break fee » (which can vary from 5 to 10%) in case they walk away from the negotiation (we have heard of US companies expecting 30 to 50% break fee on the value of the deal…)

          China – Know your investor

          6 mars 2017

          • Chine
          • Entreprise
          • F&A

          This week the Interim Injunction Judge of the Netherlands Commercial Court ruled in summary proceedings, following a video hearing, in a case on a EUR 169 million transaction where the plaintiff argued that the final transaction had been concluded and the defendant should proceed with the deal.

          This in an – intended – transaction where the letter of intent stipulates that a EUR 30 million break fee is due when no final agreement is signed.

          In addition to ruling on this question of construction of an agreement under Dutch law, the judge also had to rule on the break fee if no agreement was concluded and whether it should be amended or reduced because of the current Coronavirus / Covid-19 crisis.

          English Language proceedings in a Dutch state court, the Netherlands Commercial Court (NCC)

          The case is not just interesting because of the way contract formation is construed under Dutch law and application of concepts of force majeure, unforeseen circumstances and amendment of agreements under the concepts of reasonableness and fairness as well as mitigation of contractual penalties, but also interesting because it was ruled on by a judge of the English language chamber of the Netherlands Commercial Court (NCC).

          This new (2019) Dutch state court offers a relatively fast and cost-effective alternative for international commercial litigation, and in particular arbitration, in a neutral jurisdiction with professional judges selected for both their experience in international disputes and their command of English.

          The dispute regarding the construction of an M&A agreement under Dutch law in an international setting

          The facts are straightforward. Parties (located in New York, USA and the Netherlands) dispute whether final agreement on the EUR 169 million transaction has been reached but do agree a break fee of €30 million in case of non-signature of the final agreement was agreed. However, in addition to claiming there is no final agreement, the defendant also argues that the break fee – due when there is no final agreement – should be reduced or changed due to the coronavirus crisis.

          As to contract formation it must be noted that Dutch law allows broad leeway on how to communicate what may or may not be an offer or acceptance. The standard is what a reasonable person in the same circumstances would have understood their communications to mean.  Here, the critical fact is that the defendant did not sign the so-called “Transaction Agreement”. The letter of intent’s binary mechanism (either execute and deliver the paperwork for the Transaction Agreement by the agreed date or pay a EUR 30 million fee) may not have been an absolute requirement for contract formation (under Dutch law) but has significant evidentiary weight. In M&A practice – also under Dutch law – with which these parties are thoroughly familiar with, this sets a very high bar for  concluding a contract was agreed other than by explicit written agreement. So, parties may generally comfortably rely on what they have agreed on in writing with the assistance of their advisors.

          The communications relied on by claimant in this case did not clear the very high bar to assume that despite the mechanism of the letter of intent and the lack of a signed Transaction Agreement there still was a binding agreement. In particular attributing the other party’s advisers’ statements and/or conduct to the contracting party they represent did not work for the claimant in this case as per the verdict nothing suggested that the advisers would be handling everything, including entering into the agreement.

          Court order for actual performance of a – deemed – agreement on an M&A deal?

          The Interim Injunction Judge finds that there is not a sufficient likelihood of success on the merits so as to justify an interim measure ordering the defendant to actually perform its obligations under the disputed Transaction Agreement (payment of EUR 169 million and take the claimant’s 50% stake in an equestrian show-jumping business).

          Enforcement of the break fee despite “Coronavirus”?

          Failing the conclusion of an agreement, there was still another question to answer as the letter of intent mechanism re the break fee as such was not disputed. Should the Court enforce the full EUR 30 million fee in the current COVID-19 circumstances? Or should the fee’s effects be modified, mitigated or reduced in some way, or  the fee agreement should even be dissolved?

          Unforeseen circumstances, reasonableness and fairness

          The Interim Injunction Judge rules that the coronavirus crisis may be an unforeseen circumstance, but it is not of such a nature that, according to standards of reasonableness and fairness, the plaintiff cannot expect the break fee obligation to remain unchanged. The purpose of the break fee is to encourage parties to enter into the transaction and attribute / share risks between them. As such the fee limits the exposure of the parties. Payment of the fee is a quick way out of the obligation to pay the purchase price of EUR 169 million and the risks of keeping the target company financially afloat. If financially the coronavirus crisis turns out less disastrous than expected, the fee of EUR 30 million may seem high, but that is what the parties already considered reasonable when they waived their right to invoke the unreasonableness of the fee. The claim for payment of the EUR 30 million break fee is therefore upheld by the Interim Injunction Judge.

          Applicable law and the actual practice of it by the courts

          The relevant three articles are in this case articles 6:94, 6:248 and 6:258 of the Dutch Civil Code. They relate to the mitigation of contractual penalties, unforeseen circumstances and amendment of the agreement under the tenets of reasonableness and fairness. Under Dutch law the courts must with all three exercise caution. Contracts must generally be enforced as agreed. The parties’ autonomy is deemed paramount and the courts’ attitude is deferential. All three articles use language stating, essentially, that interference by the courts in the contract’s operation is allowed only to avoid an “unacceptable” impact, as assessed under standards of reasonableness and fairness.

          There is at this moment of course no well- established case law on COVID-19. However, commentators have provided guidance that is very helpful to think through the issues. Recently a “share the pain” approach has been advocated by a renowned law Professor, Tjittes, who focuses on preserving the parties’ contractual equilibrium in the current circumstances. This is, in the Court’s analysis, the right way to look at the agreement here. There is no evidence in the record suggesting that the parties contemplated or discussed the full and exceptional impact of the COVID-19 crisis. The crisis may or may not be unprovided for.  However, the court rules in the current case there is no need to rule on this issue. Even if the crisis is unprovided for, there is no support in the record for the proposition that the crisis makes it unacceptable for the claimant to demand strict performance by the defendant. The reasons are straightforward.

          The break fee allocates risk and expresses commitment and caps exposure. The harm to the business may be substantial and structural, or it may be short-term and minimal. Either way, the best “share the pain” solution, to preserve the contractual equilibrium in the agreement, is for the defendant to pay the fee as written in the letter of intent. This allocates a defined risk to one party, and actual or potential risks to the other party. Reducing the break fee in any business downturn, the fee’s express purpose – comfort and confidence to get the deal done – would not be accomplished and be derived in precisely the circumstances in which it should be robust. As a result, the Court therefore orders to pay the full EUR 30 million fee. So the break fee stipulation works under the circumstances without mitigation because of the Corona outbreak.

          The Netherlands Commercial Court, continued

          As already indicated above, the case is interesting because the verdict has been rendered by a Dutch state court in English and the proceedings where also in English. Not because of a special privilege granted in a specific case but based on an agreement between parties with a proper choice of forum clause for this court. In addition to the benefit to of having an English forum without mandatorily relying on either arbitration or choosing an anglophone court, it also has the benefit of it being a state court with the application of the regular Dutch civil procedure law, which is well known by it’s practitioners and reduces the risk of surprises of a procedural nature.  As it is as such also a “normal” state court, there is the right to appeal and particularly effective under Dutch law access to expedited proceeding as was also the case in the example referred to above. This means a regular procedure with full application of all evidentiary rules may still follow, overturning or confirming this preliminary verdict in summary proceedings.

          Novel technology in proceedings

          Another first or at least a novel application is that all submissions were made in eNCC, a document upload procedure for the NCC. Where the introduction of electronic communication and litigation in the Dutch court system has failed spectacularly, the innovations are now all following in quick order and quite effective. As a consequence of the Coronavirus outbreak several steps have been quickly tried in practice and thereafter formally set up. At present this – finally – includes a secure email-correspondence system between attorneys and the courts.

          And, also by special order of the Court in this present case, given the current COVID-19 restrictions the matter was dealt with at a public videoconference hearing on 22 April 2020 and the case was set for judgment on 29 April 2020 and published on 30 April 2020.

          Even though it is a novel application, it is highly likely that similar arrangements will continue even after expiry of current emergency measures. In several Dutch courts videoconference hearings are applied on a voluntary basis and is expected that the arrangements will be formalized.

          Eligibility of cases for the Netherlands Commercial Court

          Of more general interest are the requirements for matters that may be submitted to NCC:

          • the Amsterdam District Court or Amsterdam Court of Appeal has jurisdiction
          • the parties have expressly agreed in writing that proceedings will be in English before the NCC (the ‘NCC agreement’)
          • the action is a civil or commercial matter within the parties’ autonomy
          • the matter concerns an international dispute.

          The NCC agreement can be recorded in a clause, either before or after the dispute arises. The Court even recommends specific wording:

          “All disputes arising out of or in connection with this agreement will be resolved by the Amsterdam District Court following proceedings in English before the Chamber for International Commercial Matters (“Netherlands Commercial Court” or “NCC District Court”), to the exclusion of the jurisdiction of any other courts. An action for interim measures, including protective measures, available under Dutch law may be brought in the NCC’s Court in Summary Proceedings (CSP) in proceedings in English. Any appeals against NCC or CSP judgments will be submitted to the Amsterdam Court of Appeal’s Chamber for International Commercial Matters (“Netherlands Commercial Court of Appeal” or “NCCA”).”

          The phrase “to the exclusion of the jurisdiction of any other courts” is included in light of the Hague Convention on Choice of Court Agreements. It is not mandatory to include it of course and parties may decide not to exclude the jurisdiction of other courts or make other arrangements they consider appropriate. The only requirement being that such arrangements comply with the rules of jurisdiction and contract. Please note that choice of court agreements are exclusive unless the parties have “expressly provided” or “agreed” otherwise (as per the Hague Convention and Recast Brussels I Regulation).

          Parties in a pending case before another Dutch court or chamber may request that their case be referred to NCC District Court or NCC Court of Appeal. One of the requirements is to agree on a clause that takes the case to the NCC and makes English the language of the proceedings. The NCC recommends using this language:

          We hereby agree that all disputes in connection with the case [name parties], which is currently pending at the *** District Court (case number ***), will be resolved by the Amsterdam District Court following proceedings in English before the Chamber for International Commercial Matters (“Netherlands Commercial Court” or ”NCC District Court). Any action for interim measures, including protective measures, available under Dutch law will be brought in the NCC’s Court in Summary Proceedings (CSP) in proceedings in English. Any appeals against NCC or CSP judgments will be submitted to the Amsterdam Court of Appeal’s Chamber for International Commercial Matters (“Netherlands Commercial Court of Appeal” or “NCC Court of Appeal”).

          To request a referral, a motion must be made before the other chamber or court where the action is pending, stating the request and contesting jurisdiction (if the case is not in Amsterdam) on the basis of a choice-of-court agreement (see before).

          Additional arrangements in the proceedings before the Netherlands Commercial Court

          Before or during the proceedings, parties can also agree special arrangements in a customized NCC clause or in another appropriate manner. Such arrangements may include matters such as the following:

          • the law applicable to the substantive dispute
          • the appointment of a court reporter for preparing records of hearings and the costs of preparing those records
          • an agreement on evidence that departs from the general rules
          • the disclosure of confidential documents
          • the submission of a written witness statement prior to the witness examination
          • the manner of taking witness testimony
          • the costs of the proceedings.

          Visiting lawyers and typical course of the procedure

          All acts of process are in principle carried out by a member of the Dutch Bar. Member of the Bar in an EU or EEA Member State or Switzerland may work in accordance with Article 16e of the Advocates Act (in conjunction with a member of the Dutch Bar). Other visiting lawyers may be allowed to speak at any hearing.

          The proceedings will typically follow the below steps:

          • Submitting the initiating document by the plaintiff (summons or request as per Dutch law)
          • Assigned to three judges and a senior law clerk.
          • The defendant submits its defence statement.
          • Case management conference or motion hearing (e.g. also in respect of preliminary issues such as competence, applicable law etc.) where parties may present their arguments.
          • Judgment on motions: the court rules on the motions. Testimony, expert appointment, either at this stage or earlier or later.
          • The court may allow the parties to submit further written statements.
          • Hearing: the court interviews the parties and allows them to present their arguments. The court may enquire whether the dispute could be resolved amicably and, where appropriate, assist the parties in a settlement process. If appropriate, the court may discuss with the parties whether it would be advisable to submit part or all of the dispute to a mediator. At the end of the hearing, the court will discuss with the parties what the next steps should be.
          • Verdict: this may be a final judgment on the claims or an interim judgment ordering one or more parties to produce evidence, allowing the parties to submit written submissions on certain aspects of the case, appointing one or more experts or taking other steps.

          Continuous updates, online resources Netherlands Commercial Court

          As a final note the English language website of the Netherlands Commercial Court provides ample information on procedure and practical issues and is updated with a high frequence. Under current circumstance even at a higher pace. In particular for practitioners it’s recommended to regularly consult the website. https://www.rechtspraak.nl/English/NCC/Pages/default.aspx

          One of the most tricky steps in any M&A operation is when the issue of « warranties », in particular with reference to the economic situation, the balance sheet and the financial position of the company or business (or of a branch), namely the so-called « business warranties« .

          On one side, the buyer would like to « ironclad » his investment by reducing the risk of an unpleasant surprise to a minimum. The seller, by contrast, wishes to provide the least possible warranties, which often translate in a provisory restriction on the full enjoyment of the proceeds; the same may be essential for further investment.

          It should be noted, first of all, that the term « warranties » is usually referred to, in a non-technical acceptation, to a complex set of contractual provisions containing:

          • any seller’s statements about the health of the company or business (or branch of business) being transferred;
          • any compensation obligations undertaken by the seller in case of « violation » (i.e. mistruth) of the assertions;
          • any remedies provided to ensure the effectiveness of the indemnity obligations entered into.

          While there are several reasons why this set is necessary, the most significant one is that in M&A contracts, statutory sale warranties only apply to the good sold; therefore, if the good sold is an equity investment, the warranties do not cover any of the company’s underlying assets; and even as they exceptionally do apply, short terms and strict limitations still justify an ancillary obligation designed to ensure the economic success of the transaction.

          As confirmed by current practice, there is not a single M&A agreement that does not include a set of warranties.

          In particular, representations typically incorporate the buyer’s due diligence, which for its part usually follows a non-disclosure agreement (NDA) to protect any information disclosed.

          Any criticalities identified should be properly mentioned. Clearly, wherever a criticality arises, it may not necessarily trigger an indemnity obligation. It will be up to the parties to lay down the rules, as they may also provide that any related risk is to be borne by the buyer; this may be offset by a reduction in the price.

          Some aspects of the compensation obligation will have to be carefully negotiated. The main ones are certainly:

          • duration (e.g. longer for tax-related warranties);
          • who is entitled to compensation (the buyer or the company; one or the other as the case may be);
          • any deductions and/or limitations (e.g. tax losses);
          • compensation cap;
          • any possible deductible;
          • the compensation procedure (e.g. application deadlines, settlement procedure, particular circumstances).

          These are highly relevant aspects and should by no means be underestimated. As an example, it is obvious that if the compensation procedure is poorly regulated, all the previous efforts are jeopardised.

          Finally, suitable measures to ensure an effective protection of the buyer must be provided. Among these, the most conventional tools are:

          • the surety;
          • the “independent contract of guarantee”;
          • the escrow;
          • the deferment of payment;
          • the “earn-out”-scheme;
          • the “price adjustment”;
          • the letter of patronage;
          • the pledge and/or mortgage.

          These are more or less widely used instruments, each one with its pros and cons.

          At this point, however, we would like to address a new tool with an insurance character, which has been being used recently: the so-called « Warranty & Indemnity Policies« .

          With a W&I insurance policy, basically, the insurer assumes the risk resulting from breaches of warranties and indemnities included in an M&A contract upon payment of a premium.

          It is obviously a key condition that the violation arose from facts preceding the closing and which were not known at that time (and, therefore, not highlighted by the due diligence carried out).

          The insurance policy may be subscribed by the buyer (buyer side) or the seller (seller side). Usually the first option is preferred. These W&I insurance policies come with a number of advantages:

          • a warranty is given even when the seller has been unwilling to commit himself contractually;
          • the insurance policy usually does not provide for any recourse against the seller, other than in the case of malice, so that the seller is fully released;
          • it is also possible to achieve a higher ceiling than that provided for in a purchase agreement;
          • likewise, coverage may be provided for a longer period;
          • it is easier to deal with the seller, especially if there are several and some are still part of the company, perhaps as members of the Board of Directors;
          • compensation procedures become significantly easier, especially in cases where there are multiple sellers, including individuals;
          • the buyer gains a higher certainty of solvency.

          The cost of the insurance policy may be shared between the parties, eventually by discounting the purchase price, which the seller may be more willing to grant, considering that he will not be required to issue other warranties and can immediately use the proceeds of the sale.

          Premiums are usually set somewhere between 1% and 2% of the compensation limit (with a minimum premium).

          Besides the price, which makes the tool mostly suitable for operations of not modest entity, currently, the main limitation seems to be the commonly required deductible, equal to 1% of the Enterprise Value of the Target, which may be reduced to 0.5% in case of higher premiums. Keep in mind that the W&I insurance policy implies a review of the due diligence by the insurance company, which can translate into an actual intervention in the negotiation of the warranties.

          Beyond this, this tool needs to be carefully evaluated: facing highly complex scenarios, it could be the ideal solution to solve an impasse in negotiations and make relations between professional investors and SMEs easier.

          Acquisitions (M&A) in Italy are carried out in most cases through the purchase of shareholdings (‘share deal’) or business or business unit (‘asset deal’). For mainly tax reasons, share deals are more frequent than asset deals, despite the asset deal allows a better limitation of risks for the buyer. We will explain the main differences between share deal and asset deal in terms of risks, and in terms of relationships between seller and buyer.

          Preference for acquisitions through the purchase of shareholdings (‘share deal’) rather than the purchase of business or business unit (‘asset deal’) in the Italian market

          In Italy, acquisitions are carried out, in most cases, through the purchase of shareholdings (‘share deal’) or of business or business unit (‘asset deal’). Other structures, such as mergers, are less frequent.

          By purchasing shareholdings of the target company (‘share deal‘), the buyer indirectly acquires all the company’s assets, liabilities and legal relationships. Therefore, the buyer bears all the risks relating to the previous management of the company.

          With the purchase of the business or of a business unit of the target company (‘asset deal‘), the buyer acquires a set of assets and relationships organized for the operation of the business (real estate, machineries, patents, trademarks, employees, contracts, credits, debts, etc.). The advantage of the asset deal lies in the possibility for the parties to select the assets and liabilities included in the deal: hence the buyer can limit the legal risks of the transaction.

          Despite this advantage, most acquisitions in Italy are made through the purchase of shareholdings. In 2018, there were approximately 78,400 purchases of shareholdings (shares or quotas), while there were approximately 35,900 sales of businesses or business units. (source: www.notariato.it/it/news/dati-statistici-notarili-anno-2018). It should be noted that the number of transfers of business also includes small or very small businesses owned by individual entrepreneurs, for whom the alternative of the share deal (though feasible, through the contribution of the business in a newco and the sale of the shares in the newco) is not viable in practice for cost reasons.

          Taxation of share deal and asset deal in Italy

          The main reason for the preference for share deal over asset deal lies in the tax costs of the transaction. Let’s see what they are.

          In a share deal, the direct taxes borne by the seller are calculated on the capital gain, according to the following rates:

          • if the seller is a joint-stock company (società per azioni – s.p.a.; società a responsabilità limitata – r.l.; società in accomandita per azioni – s.a.p.a.), the corporate tax rate is 24% of the capital gain. However, under certain conditions, the so-called PEX (participation exemption) regime is applied with the application of the rate of 24% on 5% of the capital gain only.
          • If the seller is a partnership (società semplice – s.s.; società in nome collettivo – s.n.c..; società in accomandita semplice – s.a.s.) the capital gain is fully taxable. However, under certain conditions, the taxable amount is limited to 60% of the amount of the capital gain. In both cases, the taxable amount is attributed pro rata to each shareholder of the partnership, and added to the shareholders’ income (the tax rate depends on the shareholders’ income).
          • If the seller is a natural person, the rate on the capital gain is 26%.

          A share deal is subject to a fixed registration tax of € 200,00, normally paid by the buyer.

          In an asset deal, the direct taxes to be paid by the seller are calculated on the capital gain. If the seller is a joint-stock company, the corporate tax rate is 24% of the capital gain. If the seller is a partnership (with individual partners) or an individual entrepreneur, the rate depends on the seller’s income.

          In an asset deal the transfer of the business or of the business unit is subject to registration tax, generally paid by the buyer. However both the seller and the buyer are jointly and severally liable for the payment of the registration tax. The tax is calculated on the part of the price attributable to the assets transferred. The price is the result of the transferred assets minus the transferred liabilities. The tax rate depends on the type of asset transferred. In general:

          • movable assets, including patents and trademarks: 3%;
          • goodwill: 3%;
          • buildings: 9%;
          • land: between 9% and 12% (depending on the buyer).

          If the parties do not apportion the purchase price to the different assets in proportion to their values, the registration tax is applied to the entire purchase price at the highest rate of those applicable to the assets.

          It should be noted that the tax authorities may assess the value attributed by the parties to real estate and goodwill, with the consequent risk of application of higher taxes.

          Share deal and asset deal: risks and responsibilities towards third parties

          In the purchase of shares or quotas (‘share deal‘), the purchaser bears, indirectly, all the risks relating to the previous management of the company.

          In the purchase of business or business unit (‘asset deal‘), on the other hand, the parties can select which assets and liabilities will be transferred, hence establishing, among them, the risks that the buyer will bear.

          However, there are some rules, which the parties cannot derogate from, relating to relationships with third parties, that have a significant impact on the risks for the seller and the buyer, and therefore on the negotiation of the purchase agreement. The main ones are as follows.

          • Employees: the employment relationship continues with the buyer of the business. The seller and the buyer are jointly and severally liable for all the employee’s rights and claims at the time of transfer (art. 2112 of the Italian Civil Code).
          • Debts: the seller is obliged to pay all debts up to the date of transfer. The buyer is liable for the debts that are shown in the mandatory accounting books (art. 2560 of the Italian Civil Code).
          • Tax debts and liabilities: the seller is obliged to pay debts, taxes and tax penalties relating to the period up to the date of transfer. In addition to the liability for tax debts resulting from mandatory accounting books (Article 2560 of the Italian Civil Code), the buyer is liable for taxes and penalties, even if they are not shown in the accounting books, with the following limits (Article 14 of Legislative Decree 472/1997):
          • the buyer benefits from the prior enforcement of the seller;
          • the buyer is liable up to the value of the business or business unit;
          • for taxes and penalties not emerging from a tax audit by the tax authorities that has taken place before the date of transfer, the buyer is liable for those relating to the year of the sale of the business and the two preceding years only;
          • the tax authorities shall issue a certificate on the existence and amount of debts and ongoing tax audits. If the certificate is not issued within 40 days of the request, the buyer will be released from liability. If the certificate is issued, the buyer will be liable up to the amount resulting from the certificate.
          • Contracts: the parties can choose which contracts to transfer. With respect to the contracts transferred, the buyer takes over, even without the consent of the third contracting party, contracts for the operation of the business that are not of a personal nature. In addition, the third contracting party may withdraw from the contract within three months if there is a just cause (e.g. if the buyer does not guarantee to be able to fulfil the contract due to his financial situation or technical skills) (Art. 2558 of the Italian Civil Code).

          Some ways to deal with the risks

          To manage the risks arising from third party liability and the general risks associated with the acquisition, a number of negotiation and contractual tools can be used. Let’s see some of them.

          In an asset deal:

          Employees: it is possible to agree with the employee changes to the contractual terms and conditions, and waive of joint and several liability of the buyer and seller (pursuant to art. 2112 c.c.). In order to be valid, the agreement with the employee must be concluded with certain requirements (for example, with the assistance of the trade unions).

          Debts:

          • transfer the debts to the buyer and reduce the price accordingly. The price reduction leads to a lower tax cost of the transaction as well. In case of transfer of debts, in order to protect the seller, a declaration of release of the seller from liability pursuant to art. 2560 of the Italian Civil Code can be obtained from the creditor; or, the parties can agree that the payment of the debt by the buyer will take place at the same time as the transfer of the business (‘closing‘).
          • For debts not transferred to the buyer, obtain from the creditor a declaration of release of the buyer from liability pursuant to art. 2560 of the Italian Civil Code.
          • For debts for which it is not possible to obtain a declaration of release from the creditor, agree on forms of security in favor of the seller (for debts transferred) or in favor of the buyer (for debts not transferred), such as, for example, the deferment of payment of part of the price; the escrow of part of the price; bank or shareholder guarantees.

          Tax debts and tax liabilities:

          • obtain from the tax authorities the certificate pursuant to art. 14 of Legislative Decree 472/1997 on debts and tax liabilities;
          • transfer the debts to the buyer, and reduce the price accordingly;
          • agree on forms of guarantee in favor of the seller (for debts transferred) and in favour of the buyer (for debts not transferred or for tax liabilities), such as those set out above for debts in general.

          Contracts: for those that will be transferred:

          • verify that the seller’s obligations up to the date of transfer have been properly performed, in order to avoid the risk of disputes by the third contracting party, that could stop the performance of the contract;
          • at least for the most important contracts, obtain in advance from the third contracting party the approval of transfer of the contract.

          In a share deal some tools are:

          • Due diligence. Carry out a thorough legal, tax and accounting due diligence on the company, to assess the risks in advance and manage them in the negotiation and in the acquisition contract (‘share purchase agreement’).
          • Representations and warranties (‘R&W’) and indemnification. Provide in the acquisition contract (‘share purchase agreement’) a detailed set of representations and warranties – and obligations to indemnify in the event of non-compliance – to be borne by the seller in relation to the situation of the company (‘business warranties‘: balance sheet; contracts; litigation; compliance with environmental regulations; authorizations for the conduct of business; debts; receivables, etc.). Negotiations on representations and warranties normally are carried on taking into account the outcomes of due diligence. Contractual representations and warranties on the situation of the company (‘business warranties‘) and contractual obligation to indemnify, are necessary in share deals in Italy, as in the absence of such clauses the buyer cannot obtain from the seller (except in extraordinary circumstances) compensation or indemnity if the situation of the company is different from that considered at the time of purchase.
          • Guarantees for the buyer. Means of ensuring that the buyer will be indemnified in the event of breach of representations and warranties. Among them: (a) the deferment of payment of part of the price; (b) the payment of part of the price in an escrow account for the duration of the liabilities arising from the representations and warranties and, in case of disputes between the parties, until the dispute is settled; (c) bank guarantee; (d) W&I policy: insurance contract covering the risk of the buyer in case of breach of representations and warranties, up to a maximum amount (and excluding certain risks).

          Other factors influencing the choice between share deal and asset deal

          Of course, the choice to carry out an acquisition operation in Italy through a share deal or an asset deal also depends on other factors, in addition to the tax cost of the transaction. Here are some of them.

          • Purchase of part of the business. The parties chose the asset deal when the transaction does not involve the purchase of the entire business of the target company but only a part of it (a business unit).
          • Situation of the target company. The buyer prefers the asset deal when the situation of the target company is so problematic that the buyer is not willing to assume all the risks arising from the previous management, but only part of them.
          • Maintenance of a role by the seller. The share deal is a better option when the seller will keep a role in the target company. In this case, the seller frequently retains, in addition to a role as director, a minority shareholdings, with exit clauses (put and call rights) after a certain period of time. The exit clauses often link the price to future results and, therefore, in the interest of the buyer, motivate the seller in his/her role as director, and, in the interest of the seller, put a value on the company’s earnings potential, not yet achieved at the time of purchase.

          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.

          Indemnification

          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.

          The author of this article is Paulo Yamaguchi

          The procedure to incorporate a foreign owned company in Spain is, in principle, easy and straight forward, however it is necessary to take into account certain new requirements derived from the tax and the anti-money laundering regulations, which could cause long delays in the incorporation process, even to EU and US companies, if they are not well advised and managed from the beginning of the procedure.

          The first step consist in collecting information about the foreign shareholder, in order to be able to prove its legal existence and activities: the foreign shareholder(s) will have to grant before a Notary Public in its country of residence a power of attorney authorising somebody in Spain to obtain its tax identification number (“NIE”), and also represent it before the Spanish notary when signing the deed of incorporation. In case the foreign shareholder is an individual person, the NIE should be applied for before the Spanish police or the Spanish Consulate at the country where the investor lives.

          If the shareholder is a corporation, apart from the Power of Attorney, it will have to obtain a certificate from its Companies’ Registry or Chamber of Commerce, stating its legal existence and main characteristics. This document is called “good standing certificate” (in the UK and US), “K-bis” (in France), “KvK” (in the Netherlands) or “visura” (in Italy). These two documents, the Power of Attorney mentioned in the above paragraph and the certificate from the Companies’ Registry, will have to be Apostilled or legalized by the correspondent Ministry, and Sworn translated into Spanish. Please note that we use to draft bilingual powers of attorney in order to avoid its sworn translation.

          The foreign shareholder will have to prove that its income is obtained from legal activities in order to be able to open a bank account in the name of the new company. The main document to prove this could be the Corporate or the Personal Income Tax return filed in its country of residence, but there could be other means, especially in case of individual persons.

          In case of a corporate shareholder, it will be necessary as well to declare, in principle through a public deed granted in Spain, who are the individual persons who, directly or through other companies, will hold more than a 25% interest in the new company to be incorporated. In case nobody holds more than a 25% (i.e. because there are 5 individual shareholders, holding each of them a 20%), it is declared that the effective control of the new company corresponds to its director.

          At this stage, it is also necessary to mention that the person(s) who will be the director(s) of the new company, in case they are foreigners, will also need to obtain their personal “NIE”. The NIE should be applied for before the Spanish police (this could be done by a proxy duly authorised though a Power of Attorney granted by the foreign director) or before the Spanish Consulate nearest to the city where the investor lives. In order to be a director of a Spanish company it is not necessary to be a shareholder, nor to have residence and work permit in Spain (provided the foreign director does not live in Spain).

          Meanwhile the necessary documents (Powers of Attorney, Companies’ Registry certificate, etc.) are being prepared by the foreign shareholder, the lawyer in Spain will apply for the new company’s name. It is advisable to point out that generic or usual names are not available quite often, therefore it is necessary to think in original names. Three different names could be applied for simultaneously.

          The drafting of the company’s Articles of Association or By Laws could be very quick, except if the company is going to have several shareholders and they wish specific clauses. In this case, it is also advisable to draft a Shareholders Agreement. The Shareholders’ Agreement could just contain some basic rules on dedication, compensation, non-competition, etc. and some more sophisticated rules on the sale of shares (tag along and drag along rights). As regards the By-Laws, they should mention the company’s name, its activity or activities, address in Spain –which cannot be just a P.O. Box-, share capital, number of shares and its face value, and starting date for the fiscal year, among other standard clauses.

          The management of the company could be organized through a sole director, two directors who could act jointly or separately, and in case there are more than three directors, they should organize themselves through a Board of Directors, being usual in this case to appoint a C.E.O. In order to be a director it is not necessary to be a shareholder. Under Spanish laws, the director(s) could be held liable for some company’s debts under certain circumstances which are legally defined. For this reason, it is necessary that the directors formally accept their appointment (personally appearing before the Notary or through a Power of Attorney).

          Before the incorporation, it will be necessary that either the new company’s director (the person to be appointed) or the representative of the corporate shareholder appears personally before the bank where the company will have its first bank account and signs the correspondent documents (KYC regulation). Once the bank account is opened, the shareholder will have to send a bank transfer for the new company’s share capital. In Spain, the minimum share capital for a limited company (S.L.) is Euros 3.000, while for a “Sociedad Anónima” (S.A.) it is Euros 60.000, but only 25% should be paid off at the incorporation moment. It is interesting to note that contributions to the share capital could be made in cash – which is the most common operation, especially at the incorporation – or in kind, with any type of assets: real estate, machinery, goods, trademarks, etc. The money for the share capital should be sent to the new company’s bank account from an account owned by the shareholder (or from each account owned by each shareholder, should they be several ones), not by any other different person. Once the Spanish bank receives the transfer, it will issue a certificate, which is necessary in order to incorporate the company.

          Once all the documents are ready, it is possible within very few days (almost immediately) to make the appointment with the Notary and sign the public deed of incorporation. This can be done at any notary in Spain, not being necessary that the notary practises at the same city where the company will have its corporate address. In order to summarize, the list of the necessary documents is:

          • Power(s) of Attorney granted by the foreign shareholder(s), apostilled and sworn translated.
          • Certificate regarding the legal existence of the foreign shareholder (only if it is a corporation), apostilled and sworn translated.
          • Statement on who are the last individual shareholders holding more than 25% interest in the new company, directly or indirectly (only in case of corporate shareholders).
          • NIE of the foreign shareholder(s).
          • NIE of the new company’s director(s), should they be a foreigners.
          • Certificate for the new company’s name.
          • Articles of Association.
          • Bank certificate regarding the contribution to the new company’s share capital.

          The deed of incorporation is signed by the proxy (or the individual shareholder(s), should they prefer to personally appear before the notary) before the chosen public notary, being also necessary to sign an official form to report the foreign investment to a public registry depending on the Spanish Ministry of Finance.

          Once the deed of incorporation is signed, the next steps consist in applying before the tax authorities to obtain the new company’s tax number (NIF / CIF) and filing the deed of incorporation before the Companies’ Registry. Some banks do allow new companies to operate once they have the NIF (which could be 2-3 days after the incorporation), while others request to wait until the deed of incorporation is filed at the Companies’ Registry (2-3 weeks).

          An estimation of the necessary time to complete all the procedure is 30-45 days, but of course the main delay is related to speed of the foreign investor in obtaining the necessary documents.

          Please note that if you wish to incorporate a foreign owned company in Spain it is always necessary to seek specific professional advice, as each case is different and regulations and the application of such regulations vary from time to time. The above article just explains the main steps and requirements for the incorporation of a company.

          In all M&A operations one of the issues that deserves special attention as regards its analysis, ascertainment and negotiation is the tax liabilities. Even though the parties could agree on the amount of such contingencies, to negotiate the possible guarantees that the seller should grant in order to protect the buyer from a possible claim by the tax authorities, the term during which the guarantees should be in force, and to agree on the communication mechanisms between the parties (buyer and seller) and the legal defense strategies if such claim from the tax authorities arises, requires substantial negotiation efforts.

          When the acquisition operation is formalized not through the purchase of shares, but through the purchase of the assets that form a business unit, the Spanish General Tax Law (“Ley General Tributaria” or “LGT”) provides a mechanism which implies an exception to the general principle provided by article 42 of the same law. Article 42 of LGT establishes the joint liability of the purchaser of a business unit for the tax liabilities of the selling company (“tax liability derived from company’s succession”). That is, in principle, according to article 42 of the LGT “the persons or entities that continue by any mean in the ownership or exercise of economic activities (the buyers) will be jointly liable with the previous owner for the tax liabilities derived from the exercise of such economic activities incurred by such previous owner”.

          However, the joint tax liability of the buyer could be limited through the application before the tax authorities of the tax certificate regulated by article 175.2 of the LGT. This certificate should be applied for by the prospective buyer, with the authorization of the present owner (the seller), and, once issued, the tax liability of the buyer becomes limited to the debts, penalties and liabilities mentioned in the certificate. If the certificate is issued without mentioning any amount, or if the tax authorities do not issue it within a three months term from the application’s date, the applicant (the buyer) will be released from any tax liability derived from company’s succession.

          The tax certificate for succession purposes includes the main taxes, as Value Added Tax and Corporate Income Tax, and can include as well debts derived from the withholding taxes on employees’ payroll, which in case of companies with a big number of employees could be of an outstanding amount. However, the buyer’s joint liability for salaries, related payroll amounts and social security contributions cannot be limited by such certificate, and such liability will always be joint with the business unit seller’s liability.

          The application for the tax certificate should be filed before the acquisition of the business unit is completed, even if the issuance of the certificate takes place later tan the closing date (but of course, it is wiser to not close the acquisition before having the certificate). The certificate’s validity lasts for one year, as regards periodical tax obligations (for example, Value Added Tax, Corporate Income Tax and withholding taxes on salaries) and for three months as regards non periodical tax obligations.

          It is very important to apply for the right tax certificate (“certificate for succession purposes according to article 175.2 of LGT”), and to not make a mistake and apply, for example, for the certificate regarding having fulfilled all tax obligations (“certificado de estar al corriente de las obligaciones fiscales”). Case law is plenty of judgments where a buyer applied for the wrong certificate, which showed no liabilities, and later on such buyer has been sentenced to pay the tax liabilities incurred by the previous owner of the business unit.

          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.

          1. 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.

          1. Debt

          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.

          1. Tax/labor contingencies

          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.

          1. 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.

          1. 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.

          1. Break-up Fees

          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.

          1. Recommendations

          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.

          The author of this article is Paulo Yamaguchi

          Chinese outbound M&A was one of the main topics of interest at the 2017 Hong Kong IFLR Forum on M&A in Asia, a great event with an outstanding level of speakers and very interesting discussions on various themes related to international investments.

          All the attendants shared the view that momentum for Chinese overseas investments is still strong, despite the recent policy aiming at curbing the outflow of capitals from China.

          A particularly interesting session was that on “best practices to overcome credibility and experience gaps increasingly faced by “off the radar” Chinese bidders”.

          Opening a one-to-one negotiation or letting a Chinese company bid at an auction involves often great deal of uncertainty, as most participants to the session shared the experience of having seeing their Chinese counterpart walk away from the negotiation without any explanation (the so-called “Random Investors”).

          I have scribbled down the take-aways of the discussion as follows.

          Main clues to spot early on the Random investor:

          • the Company pops out from nowhere and has no track record of overseas investments;
          • the Company has no legal or financial advisors, or if they do, their advisors are not experienced in overseas transactions;
          • the Company has excellent advisors… but has not paid their fees (yes, that happens)
          • the target does not belong to the Company’s core business (and there is no explanation for their interest for the deal);

          What should you do to be on the safe side?

          • request a written declaration of interest, expressing the reasons why the Company wants to invest in the target and what is their mid term strategy, signed and stamped by the legal representative (if they are not ready to hand over this letter the game can stop here).
          • If the Company represents a group of investors, require full disclosure and letters of confirmation from all parties, from day one (AC Milan’s case is a good example of what happens later on if there is no disclosure of all players, and their stakes in the deal);
          • request proof that the Company has filed the application for the authorisation to invest overseas (due to the recent tightening of controls on capital outflow, this step is fundamental);
          • request proof that they have the finance needed for the deal (either onshore or, better, off-shore);
          • make clear that you will require a « break fee » (which can vary from 5 to 10%) in case they walk away from the negotiation (we have heard of US companies expecting 30 to 50% break fee on the value of the deal…)

          Roberto Luzi Crivellini

          Domaines d'intervention

          • Arbitrage
          • Distribution
          • Commerce international
          • Litiges
          • Immobilier
          Contact Roberto

          Écrire à Roberto





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