Machado Meyer’s Guilherme Bueno Malouf and Paulo Henrique Carvalho Pinto on the key points to consider when engaging with the Brazilian M&A market
Brazil has been in the spotlight for foreign investment for a while. Although the political scenario and global headwinds continue to affect our economy, Brazil has remained an attractive place to invest for a number of reasons, including its large internal market (size of its population), the need of enhancement of its infrastructure system and the scalability of its agricultural sector.
When investing into Brazil, foreign investors need to address the specificities of our legal framework. Key examples of challenges imposed on investors are as follows:
- The Brazilian tax system is very complex with different laws (including procedural laws) being imposed on taxpayers, a relatively unstable jurisprudence on tax disputes and a dispute among Brazilian states on tax holidays granted to taxpayers – thus it is not uncommon for Brazilian companies to be subject to continuous tax liabilities.
- Brazilian labour courts still apply interpretations of our labour laws that are protective to the employees, notwithstanding the fact that a recent labour reform was passed, which turned the labour relationships for dynamic and less subject to unfair litigation.
- Due to some particular features of Brazilian laws, it is not unusual to identify certain inconsistencies or restrictions relating to the registration of ownership/occupation of real properties, which may include (a) lack of certain licences; and (b) the existence of ‘permanent preservation areas’, ‘indigenous areas’ and/or ‘quilombola areas’, or (c) restrictions on acquisition of control of large rural areas, which in sum create excessive burdens on companies so they can develop their activities.
- Despite lack of express reference in applicable laws, environmental damage remediation in Brazil is not subject to statute of limitation, pursuant to scholars’ understandings and court decisions (including decisions rendered by the Supreme Court). Courts have also been consistent in considering environmental civil liability as propter rem which means that it is connected to the ownership or possession of a real estate, regardless of fault. In this sense, the owner and those who economically benefit from use of a land automatically assume liability for pre-existing environmental damages, even if the party did not actually cause them. On top of that, environmental laws set forth joint liability among polluting agents – a victim affected by an environmental damage shall not be required to sue all polluting agents in a single action (a certain company may be chosen out of all polluting agents).
The facts outlined above play an important role in M&A transactions in Brazil. Investors need to carefully evaluate tax and labour exposures (including materialised and non-materialised contingencies) of the relevant company, as well as the potential restrictions on the use of real property and related environmental risks.
Notwithstanding the fact that the due diligence is instrumental for the negotiation of the purchase agreement, mainly in so far as representations and warranties (R&Ws), indemnification and collateral provisions are concerned, it is worth pointing out that most of the M&A transactions in Brazil1 adopt the so-called ‘my watch-your watch’ clause, whereby sellers or issuers agree to indemnify the purchaser for losses deriving from acts, facts or omissions taking place at any time prior to the closing of the transaction, regardless of whether such events have a link to a breach of a specific R&W.
In light of the above, the question that rises is: if purchase agreements usually provide for a ‘catch all’ provision whereby purchasers have recourse against sellers and issuers for any pre-closing liability, why should purchasers need a robust set of R&Ws?
The answer is three-fold: (i) firstly, the R&Ws are informational, in the sense that they provide a relatively wide view on the company and its activities and serve as rule-book for purchasers post-closing; (ii) secondly, the R&W are also an important condition precedent to closing; ie, to the extent a R&W is not accurate at closing, a purchaser shall have the right to terminate the purchase agreement and (iii) thirdly and perhaps more importantly, not all R&Ws are covered or superseded by the ‘my watch-your watch’ clause, mainly those where a judgment is provided; eg, a R&W on the fact that the relevant company has sufficient insurance coverage in comparison with players in the same sector and of equal size, or a R&W that the company has all IP rights to develop its activities. Thus, if these R&Ws are incorrect and the company suffers a loss (spends money on buying new insurance or suffers monetary damage because of the lack of adequate coverage, for example), the purchaser will be entitled to claim indemnification based on the breach of the relevant R&W.
Also, one should also pay attention to these other very specific features of the indemnification package usually seen in Brazil:
- Time limitation: general statutes of limitation are three years, but certain matters have longer terms, such as taxes and labour (five or six years, depending on whether there is a discussion on the occurrence of tax fraud) and environmental (no limitation). Therefore, the negotiation of the time limitation for the indemnity will depend greatly on the findings of the due diligence, the sector in which the target company operates and the exposure that the target company bears across such various types of contingencies.
- Amount limitation: it is common practice for Brazilian purchase agreements to include amount limitations on the indemnification, including caps, de minimis, tipping basket and, in certain cases, a deductible. The negotiation of such limitations is also linked to the findings of the due diligence and the sector in which the target company operates.
- Indirect or consequential loss: Definition of loss tends to be one of the most relevant features when negotiating a purchase agreement governed by Brazilian law, as sellers want to exclude indemnification for indirect or consequential loss (eg, lost profits, loss of opportunities) to have a better estimate of the amount that they may have to disburse if the purchaser incurs any loss deriving from past liabilities. Although full indemnification for such losses is not standard, we have seen provisions whereby sellers agree that indirect or consequential losses are indemnifiable for specific events (eg, if the target company does not hold any specific licence to operate its business, for environmental and anti-corruption matters).
In light of the above, a thorough due diligence investigation is extremely relevant, so that purchasers have a full picture of materialised and contingent liabilities of the target company in order to properly negotiate an indemnification package from sellers.
Authors
Guilherme Bueno Malouf
Partner
E: [email protected]
Paulo Henrique Carvalho Pinto
Partner
E: [email protected]
- Mainly regarding private companies, as the pattern for listed companies is quite different, with purchasers relying on a representation and warranty on the public filings of the relevant company (under the assumption that the “market” prices the legal issues disclosed in such filings.
