Contributed By Queiroz Cavalcanti Advocacia
At the beginning of 2018, it was anticipated that there would be strong growth in the M&A market due to the completion of major transactions in the early months of the year. However, such growth did not transpire, with an increase in M&A operations in Brazil of only 3% more than those completed in 2017, according to PWC. The forecast for 2019 is a growth of 15%.
The top trends in Brazil for 2018 predicted greater growth, following the period of recession faced by the country and the political instability marked by presidential impeachment in 2016. However, despite the optimism, uncertainty prevailed, especially in the presidential election in October 2018 and the promise of social security reform, which, in the end, did not come to fruition.
In the last two years, the information technology sector stood out in the market, having been the sector with the largest number of M&A transactions. However, the health services sector was the one with the greatest growth in relation to the number of investments, with a 23% increase, demonstrating its strength in Brazil.
Due to the prevalence of concentrated share ownership in Brazilian capital markets, most company acquisitions in Brazil are made through private negotiations with the controlling shareholders and/or main shareholders of the target company. If the target is a listed company, the bidder puts forward a tender to acquire the remaining shares for at least 80% of the price offered to the control block or shareholder. Voluntary takeover bids, mergers and reverse mergers are also common methods of acquisition.
The primary regulators of activities related to M&A are the Brazilian Securities Exchange Commission (CVM) (Comissão de Valores Imobiliários), a federal agency that acts as a regulatory entity in the supervision and regulation of the stock market activity, the Brazilian Central Bank and the Brazilian Antitrust Agency (CADE) (Conselho Administrativo de Defesa Econômica) which supervise, prevent and punish abuses of economic power. The Brazilian Stock Exchange B3 also lays out important rules to listed companies, especially those who integrate the 'mercado novo', which is subjected to higher governance standards.
In Brazil, foreign investment is prohibited in the nuclear energy, mail services, mineral resources and aerospace industries. Foreign investment for the operation of public air services for regular transport operations depends on prior governmental approval. Foreign capital investment is limited within the media, eg newspapers, magazines and other publications, and radio and television networks, to ensure that control remains with Brazilian shareholders. Also, foreigners have to undergo greater scrutiny to acquire large rural estates.
The main antitrust regulation in Brazil is Federal Law No 12.529/2012, which restructured and greatly changed the competence of CADE. All corporate restructuring that involves economic concentration acts shall be submitted to CADE if, cumulatively, at least one of the groups involved in the operation has recorded an annual gross revenue or a total amount of business within Brazil of BRL400 million or more in the previous balance sheet prior to the transaction. Also, at least one other company involved in the operation must have recorded annual gross revenue or a business volume within Brazil of BRL30 million or more. Here, CADE will analyse and decide whether to take the deal forward, taking into consideration the risk of harming free competition. Only after this authorisation may the deal proceed.
Brazil has a Code that concentrates most important labour regulation, called the CLT (Consolidação das Leis do Trabalho). It was first enacted in 1943 through Decree No 5.452, altered by several subsequent statutes and broadly reformed in 2017 by Federal Law No 13.467 that brought more flexibility to employment relationships. Since the reform enactment, labour claims have been reduced by 50%, according to the Superior Labour Court. The change in ownership or legal structure of the company does not affect the employment contracts of the respective employees and the acquiring company assumes all labour obligations held by the acquired company, making due diligence an important aspect of the M&A process.
Brazilian statutes provide for certain restrictions in specific sectors with regard to the ownership of shares of Brazilian companies by foreign investors (eg, banking, insurance, telecommunications, media, oil and gas and civil aviation). Some restrictions only need pre-approval from government authorities; others represent a prohibition or limitation on the percentage of shareholding by a foreign investor.
In July 2018, Boeing and Embraer, focusing on the aviation market, signed a Letter of Intent to form a joint venture in which Boeing, an American company, would be responsible for 80% of the business. The agreement, whose terms were judicially challenged and finalised in December 2018, was approved by the Brazilian Government. The Government was able to veto Embraer’s strategic decisions, demonstrating the its willingness to accept foreign participation in strategic markets in Brazil.
The investment market in the financial sector was one of the fastest growing in 2017/2018 and brought significant change for foreign investors, who are now permitted to participate in companies within Brazil. This is down to the enactment of Federal Decree No 9.544/2018, which allowed for foreign participation in up to 100% of the voting capital of direct credit societies and loan companies. This has had a direct impact on the market for fintech, which is among companies that are worth more than USD1 billion.
The most common stakebuilding strategy is to acquire shares of the target company below the disclosure threshold prior to the tender offer. This limitation must be respected or otherwise mandatory disclosure will be enforced and the interest in the acquisition of the company will most likely become clear, in turn increasing the market value of the shares. For a tender offer to materialise, the CVM requires that all acquisition of shares conducted by the offeror in the previous twelve-month period is revealed. This is a compelling factor in keeping stakebuilding under the filing threshold limits.
According to CVM regulations, any changes that lead any natural or legal person or group of persons representing the same interest, directly or indirectly, to reach 5% equity interest threshold or any subsequent 5% increase or decrease in equity interest in the same type or class of shares must be disclosed. The disclosure notice must be available to the market immediately after settlement of the transactions. Also, the intention to bid for control or to change management triggers mandatory disclosure.
The reporting threshold regarding material shareholding is mandatory and cannot be relaxed in corporate documents. Yet several companies have adapted their bylaws to include a Brazilian version of the poison pills that force the bidder to make a tender offer to all shareholders at a specified high price above market value, if a significant capital share percentage is targeted by the bidder (around 10-35%). This provision is usually construed to be irrevocable and raises discussions as to its validity as it may impair the free decision-making of shareholders on the sale of their shares.
Dealings in derivatives are permitted in Brazil and the requirements for its validity are specified by Law No 1243/2011. According to the CVM Regulations, Rule 361, derivatives can be sold outside the offer process, provided that the offeror and his or her related parties are prohibited, during the offer period, from negotiating derivatives of the same class of shares as those that are being negotiated in the on-going offer.
Any acquisition or disposal of relevant equity interest must be disclosed to the company and by the company to the market. A relevant equity interest under the CVM Regulations is one that reaches or exceeds 5% of shares of a certain class (with one person or group of persons representing the same interest). This disclosure requirement is also triggered by the acquisition of derivatives that are convertible in shares and that represent a 5% stake in the company, or any 5% increase or decrease thereafter. The filing/reporting obligations for derivatives are similar to the filing/reporting obligations for relevant share interests.
According to the CVM Regulations, if the acquisition generates a change in control of the company, the intent of the acquisition must be disclosed, since this change is considered to be a material fact. It can be a considerable influence on the quotation price of the securities issued by the public company.
The disclosure of the deal is only required when negotiations are concluded, and prior to the shareholders’ meeting that will vote on the transaction. The deal must be revealed to the public, however, whenever its existence becomes public or at the management’s discretion, should he or she not wish to keep it confidential.
The market practice is developed according to legal parameters, using them as a basis to develop the policies of disclosure, without violating the public interest protected by current legislation. If disclosure standards are not met, the CVM usually applies the corresponding legal penalties to infringing parties.
The scope of due diligence is usually structured on a case-by-case basis, to fit the size of the company and its activities. However, in general, the following areas are usually under scrutiny: corporate, contractual, fiscal, labour, property, permits and licences, intellectual property and the environment. Due diligence may be carried out by analysing documents or it may involve more active research, through inspections and active investigations as to the veracity and completion of documents and information that have been sent.
The exclusivity clause has been used mostly as protection for the bidder against unfair pricing competition. The standstill, on the other hand, is protection against unfair access to confidential company information by the bidder, avoiding a hostile takeover. The use of such clauses will greatly depend on the parties themselves, but both are used in the Brazilian market and are commonly used jointly.
Although agreements can be entered into between the bidder and the target, they are not common in Brazil. Such agreements are, however, common when dealing with private negotiations between the bidder and the controlling shareholder or block. In this last case, a sale purchase agreement and shareholders agreement are usually negotiated.
The duration of an acquisition process has many variables, depending on the size of the business, the scope of the due diligence or if submission to an antitrust agency or other regulatory agency is required. However, a merger of a given listed company where the agreement between the parties is easily achieved can be undertaken within six to eight months.
According to Brazilian corporate law and the CVM Regulations, an acquisition offer is mandatory in the following instances:
In Brazil, shares are still little used as consideration, cash being more commonly used. The shares given must have been issued in compliance with CVM rules governing the public offering of securities. In a mandatory tender offer the bidder must offer the same conditions as those given to controlling shareholders, meaning the non-cash consideration offered to the controlling shareholders or block shall be available to minority shareholders, who may choose to receive payment in cash instead, if this alternative is made available by the offeror.
In Brazil, CVM Regulation 361 expressly allows that the takeover offer be subject to conditions, provided that its implementation is not dependent on the direct or indirect performance or will of the offeror or persons related to it and that such conditions are expressly and clearly foreseen in the corresponding document. In line with international practice, corporate approval, prior licences and regulatory or governmental approval, prohibition of acts outside the regular course of business and the absence of material adverse changes are common conditions to be established during a takeover offer.
Examples of conditions that may be included in an offer are:
Brazilian law allows for the stipulation of conditions for the conclusion of the acquisition, including financing conditions, provided they are expressly stated in the offer and do not grant the offeror discretion to freely withdraw the offer.
Non-solicitation, exclusivity and non-shop provisions are common provisions used to protect a bidder. In addition, a bidder can negotiate an agreement with controlling shareholders, whereby they undertake to attend shareholders’ meetings and to approve the deal, although such practice may be challenged in court by minority shareholders on the ground that the agreement was prejudicial to the company and to the value of minority shares. The negotiation of break-up fees in the event of an unsuccessful bid is not common. However, it is worth noting that under CVM Regulation 361, the bidder is forbidden from transferring any cost or expense to the company arising from the takeover bid that could jeopardise the effectiveness of a break-up fee provision.
As a condition of the offer, the bidder may set some governance changes in the target company to be approved prior to the acquisition, eg:
According to Federal Law No 6.404/76, the shareholder may be represented by a proxy, issued within the last twelve months, by another shareholder, a company officer or by a lawyer. On the other hand, in the publicly held company, a financial institution can also represent the shareholder.
The squeeze-out mechanism consists of the compulsory purchase of shares held by minority shareholders where the tender offer takes the company private (de-listing). In this situation, if shares tendered exceed 95% of the target company's capital stock, the remaining shares can be redeemed for the same price as in the tender offer, provided the company deposits the amount owed to the minority shareholders with a banking institution duly authorised by the CVM.
It is common to see the offeror negotiate an agreement with the main shareholders in which they commit to attend to shareholders’ meetings to be convened for the purpose of approving the deal and to vote in favour of it. This agreement is especially effective in the Brazilian market, given the concentration of shares in controlling blocks or shareholders. However, such agreements can be challenged in the courts on the grounds it is prejudicial to the company or its minority shareholders.
Under CVM Regulation 480, the bid shall be made public through a bid notice, upon successful completion of the negotiations and prior to the submission of the deal to the shareholders’ meeting. Alternatively, the bid may be made public in the event that the negotiations have become common knowledge due to a leak of information or if the management wishes to make the negotiations public. Here the target company is required to disclose an Announcement of Material Fact, disclosing the nature and phase of the negotiation process.
For the issue of shares in a business combination CVM Rules 481 and 565 require the disclosure of certain information describing the conditions of the deal. Appraisal reports, financial statements, minutes of board meetings and other documents relating to the transactions must also be made available. Also, due to the convergence of Brazilian standards with international accounting standards, accounting norms were issued in connection with IFRS 3 – Business Combination issued by the International Accounting Standards Board. Such a norm (CPC 15) defines a series of disclosure requirements of a qualitative and quantitative nature to enable users of financial statements to assess the nature and financial effects of the business combination. Some of the information that must be disclosed by the acquirer includes:
The companies involved in the business combination must disclose financial statements, prepared according to the CVM Regulations and Corporate Law Rules, duly audited by registered independent auditors and dating less than 180 days from the shareholders’ meeting that will decide on the transaction. Financial statements of such publicly held companies must be in accordance with IFRS.
For listed companies, the transactions documents must be filed before the CVM or even to the Antitrust Agency if it meets any of the legal requirements under antitrust laws.
Fiduciary duty includes the duties of loyalty, diligence and to inform, applying the theory of the business judgement rule. The duties of the directors apply to all stakeholders, not only to shareholders.
It is common for boards of directors to establish special or ad hoc committees in business combinations. The committees may be created as advisory bodies for the board of directors, with the purpose of allowing certain matters to be discussed and examined more deeply. In any event, the existence of committees implies the delegation of responsibilities of the board of directors, in other words, the committees do not have the power to deliberate, and should study the matters and prepare proposals for the board's decision.
In Brazil, the courts do not revoke or alter the decisions of the directors, provided they comply with the business judgement rule.
Financial, accounting and legal advice are the most commonly requested by directors.
There are several legal disputes involving a conflict of interest between the directors, managers, shareholders or counsellors, such as the case that discussed whether Ambev had a conflict of interest in the exchange of shares with Interbrew SA.
The Brazilian Corporations Statute provides for a hostile takeover by means of a public tender offer, determining that such an offer shall include a number of voting shares that ensure the control of the corporation and which shall be irrevocable. If the bidder already holds voting shares in the corporation, the offer may relate only to the number of shares required to obtain control. However, hostile tender offers are not yet common due to the limited number of publicly held companies with shareholding dispersion.
Directors may suggest defensive measures to shareholders, although shareholders are not required to accept them and directors are not able to approve them without a shareholders’ vote. Although the opinions of the board of directors on takeover bids are not binding, they can influence small shareholders' opinions with regard to takeover bids.
Many Brazilian companies have altered their bylaws to include poison pills, forcing the acquirer of a relevant stake in the company to make a tender offer to all shareholders at a specific price, usually above market value. Apart from poison pill provisions, there are not many defence mechanisms (apart from launching a competing tender offer) available to a company or the controlling shareholders to defend against a hostile takeover bid.
Regarding unsolicited and unwanted offers, CVM Regulation 361 establishes that the board of directors must give an opinion regarding the terms of the offer. The opinion must take into consideration elements such as the offer price and changes in the corporation’s finances. Nevertheless, the shareholders have the final word relating to the acceptance of the offer. Furthermore, the same usual fiduciary duties remain effective and shall also apply when recommending the defence measures, such as the duty of loyalty, the duty of diligence and the duty to inform, applying the theory of the business judgement rule.
Directors do not have this authority where the shareholders are the majority stakeholders, and it is, therefore, at their discretion whether to proceed.
The most important claims that shareholders may assert are those relating to any violation of the corporation bylaws or legal provisions that might have occurred in the context of an M&A transaction. Indemnity claims against officers and directors may be brought for damage caused to the corporation in violation of the bylaws, or as a result of acts or omissions performed by negligence, recklessness, lack of professional skill, or wilful misconduct and indemnification claims against controlling shareholders for any damage caused by acts performed by an abuse of power. Minority shareholders may also exercise withdrawal rights (not applicable to publicly traded corporations) and challenge the value to be paid for their shares.
Litigation takes place after the end of a transaction, given that most lawsuits are based on alleged damages suffered by minority shareholders who feel harmed by the deal.
Shareholder activism is not an important force in Brazil.
Activists do seek to encourage companies to enter into M&As, spin-offs and major divestiture transactions.
Activists do seek to interfere with the completion of announced transactions, particularly through lawsuits.