Contributed By Vector Legal
In 2018, Costa Rica reported several significant transactions. Most of them consisted of acquisitions of local companies by foreign investors (Inchcape plc bought Suzuki’s long-time dealer; Walmart bought a local supermarket chain; Prosegur Cash bought local cash/valuables-in-transit Grupo Alamo; Liberty Latin bought 80% of a local cable company, among others).
Costa Rican economists and analysts foresee that the trend of international investment will continue in 2019, but with a slight decrease as a consequence of the uncertainty in the market and the local economy, caused by the national financial crisis and the changes in tax laws (some recently approved and some others still in discussion in Congress).
It is expected that the local economy will slow down in 2019; however, the Government trusts that this situation will be a transitory one, while the National Treasury becomes healthier due to policies calling for a reduction in public expenses, Costa Rica’s possible approval as a member of the Organisation for Economic Co-operation and Development, as well as an improvement in tax regulations and collections.
An increase in the sale of local assets to foreign investors is anticipated, since the unstable Costa Rican economy will not be able to withstand the large-scale transactions that were seen in 2018. Moreover, the foreign market may be more defensive as consequence of a recent decision of the National Antitrust Agency (Comisión para Promover la Competencia) that refused to approve the authorisation of the purchase pretended by Walmart of a local supermarket chain, as well as changes in Costa Rican tax law.
It is anticipated that the financial and retail sectors will have a stronger impact on business. Since the last quarter of 2018, the banking sector has been implementing measures to assist its clients in preventing a major default of payments that could affect the local macro-economy. The retail sector is yet to experience and reorganise itself as the market evolves and absorbs recent changes in Costa Rica’s economy.
The property, telecommunications, consumer goods, banking and finance industries are expected to see significant M&A activity this year, while the infrastructure, construction and energy sectors may see a drop in M&A transactions in the coming months.
The most common means of acquiring a company in private M&A transactions are:
Normally, the share purchase proceeds when (after the performance of due diligence) the buyer accepts the risks and liabilities and the seller accepts to grant some sort of guarantee as possible compensation for losses that may arise because of these.
Nonetheless, when the buyer does not want to assume the risks, he or she may choose to execute the purchase as a commercial establishment acquisition. This implies that all the assets of the target company can be bought and all its previously existing debts are cancelled by legal mandate as a condition to have a valid purchase.
It is standard in Costa Rica to have the purchase price transferred to a Guarantee Trust (or Escrow Agreement) while the transaction obtains a final approval from local authorities (in antitrust matters) or finishes all of the conditions associated with the transaction (including the payment of previous debts). Therefore, it is common to have a Trust or Escrow Agreement in a M&A operation.
Finally, another option is to merge different companies into one operative target company, with the stakeholders of all sides remaining in the new business.
In Costa Rica there is no specific regulator for M&A transactions. However, there are certain requirements for the process. For the purchase of a mercantile business, the Commercial Code provides a basic procedure to assure the payment of the company’s creditors, and if there is a breach of law in this matter, the creditors can file a nullity action in court. Moreover, irrespective of the type of agreement used for the transaction, this may be revised by the National Antitrust Agency with full jurisdiction to approve or reject the M&A, according to local regulations (see 2.4 Antitrust Regulations, below).
If the target company is one that provides public services, or its core business is regulated and supervised by any local superintendency (eg, for insurance, financial entities, exchange market, retirement money operators, telecom entities), the M&A must be revised and approved by the relevant supervisor prior to the takeover.
For normal commercial companies there are no regulations or restrictions on foreign investment, although some industries do have a special set of rules for such matters. The most significant ones are:
a) they have had legal residence in the country for a period of at least five years; and
b) they act through Costa Rican companies with a legal domicile in the country, with a maximum foreign capital participation of 49%. Moreover, to commercially exploit a maritime land zone for touristic development, only physical individuals and companies that are qualified to hold concession rights can request it. Foreign entities may participate, if they demonstrate that they are tourism companies whose capital investment towards the development is more than 50% owned by Costa Ricans.
The antitrust regulations that apply to business acquisitions in Costa Rica are enshrined in law. Accordingly, the following transactions are considered ‘concentration operations’, and hence prior notification and approval by the National Antitrust Agency are mandatory:
The Agency has recently become more active in M&A transactions and has issued provisional orders to prevent and/or stop a buyer aiming for advanced control of the target company. It recently rejected a M&A transaction, concluding that it could have an actual impact on the market (taking both customers and suppliers into consideration).
In Costa Rica, during a M&A process, an acquirer should be primarily concerned about Costa Rican legislation and jurisprudence, which are highly protective of employees. All workers are entitled to two weeks of paid holiday per year, as well as one day off for every six continuous days of work. Except in industry, the weekly day off must be paid. In the first 20 days of December of each year, companies must pay their employees a Christmas bonus, equivalent to one full month salary.
All workers are covered by social security, which is administered by the Costa Rican Social Security Fund. The employer’s monthly social security contribution to the Fund is 26.33% of the employee’s salary, and the employee’s contribution is 10.34%, which must be deducted from his or her salary.
Employers must also have a work risk insurance in place that is administered exclusively by the National Insurance Institute. This is an insurance that covers any damages suffered by an employee during working hours and by the performance of the work. Pregnant women and breastfeeding workers are protected by a special law, meaning that they can only be dismissed if they commit a serious offence. The case for removal must be brought before the Ministry of Labour prior to the dismissal. Female employees are entitled to maternity leave that begins one month before the birth of the child and ends three months after. During this period the woman receives 100% of her salary, 50% of which is paid by the employer and 50% by the Social Security Fund.
There is a Minimum Wage Decree for the private sector, which must always be used as a reference tool to establish workers’ minimum wages, depending on their position. Buyers should check the status of independent contractors and agents whose situation may resemble that of a formal employee, to mitigate the risks of a potential claim by such contractors claiming the existence of an employer/employee relationship (ie, which could entail the payment for labour and social security rights).
Note that for share purchases, there is no need to terminate previous labour relationships, as it is interpreted that the employer remains unchanged. However, where a mercantile establishment has been purchased, the previous employer must terminate all labour relations and pay the legal rights to the workers, as a new employer will take over the business.
Due to the recommendations of the Financial Action Task Force (FATF-GAFI) and local interest in becoming a member of the OECD, Costa Rica has approved new regulations relating to investment and tracking of money. These changes in law provide that any transaction (and investment) equal or over USD10,000 must comply with a series of documents and forms to track the origin of the funds and their legality. As part of these requirements, the lawyers, fiduciary and banking entities that are involved with and facilitate the transaction are obliged to conduct a ‘Know Your Client’ process. They are obliged to obtain as much information as possible with the purpose of defining whether the funds emanate from a legal source. Where this is in doubt, the law authorises them to carry out their duties as professionals or service providers, but imposes on them the requirement to report the transaction and their doubts about the source of the money to the Costa Rican Drugs Institute.
In the past, local authorities had limited input in monitoring antitrust behaviour, but during Walmart’s purchase of Gessa (a chain of local supermarkets) in 2018, the National Antitrust Agency’s role has strengthened. The application to authorise the transaction was filed in late July of 2018 and was rejected in early December of the same year, but in the meantime, warnings and precautionary steps were issued to prevent Walmart taking control over the target assets, prior to the resolution of the antitrust report. This case set a precedent that will now be tested with the recent acquisition of Telefonica’s assets by a telecom company with a relevant presence in the local market.
Regarding legal development, Costa Rica has approved a new set of laws in the past five years that have had an impact on M&A transactions:
Other than the precedents referenced in this section, so far there are no significant changes in law that may have, or could have, an impact on the M&A market. It is understood for the private sector that all relevant changes in law that might affect it have already been discussed and approved during the period of tax reform and the previous adaptations of FATF-GAFI’s recommendations.
In general, it is not customary in Costa Rica for the bidder to build a stake in the target business prior to launching an offer. Nonetheless, the Securities Law provides that if a bidder wants to launch an offer of a relevant participation in a publicly traded company, he or she has to follow a special procedure for such a public bid, even if the takeover is performed in separate transactions that individually would not represent relevant stakes.
It is important to bear in mind that Costa Rica has a small share exchange market, and that there is no opportunity to carry out hostile takeovers of private companies. It is only when bidding for publicly traded companies that it is possible to have a third party with a better offer bidding for a stake in the target company.
Costa Rican companies are subject to shareholding disclosure up to 10%, but the information is only due to be disclosed to banking entities and the new Shareholders Registry. As previously noted, the Central Bank of Costa Rica will manage the new registry of such confidential information, but a judge may request data related to shareholders, beneficiaries and controllers whenever it is deemed appropriate. The obligations apply to shares, quotas and any other legal entity, including trust agreements.
A company can introduce different rules regarding reporting thresholds in the bylaws or by a private shareholders’ agreement, but the threshold cannot be lower than that established by national regulations, which are considered to be the ground rules.
In terms of hurdles to stakebuilding, note that upon gaining control over an entity, certain consequences will be triggered, which may be considered hurdles by some investors. These consequences are:
As indicated in Recent Legal Developments, above, the current major hurdle in the M&A market is the possibility that the National Antitrust Agency may not authorise the acquisition. It is therefore advisable to have a legal report prepared as to the likelihood of such a rejection and the arguments required to defend the case in court.
In Costa Rica, dealing in derivates is permitted, but most of the dealing is carried out in an unorganised market, known as ‘over the counter’.
Exchange rate derivatives, such as forwards, FX Swaps, Currecy Swaps and futures, can be done by financial entities duly authorised by the Superintendency of Financial Entities.
The local stock exchange (Bolsa Nacional de Valores) has a regulated market for a product-denominated Difference Contract (Contrato de Diferencia), whose underlying asset could be stocks, financial and stock indexes, including but not limited to interest rates. The dealing of this product is very limited.
Filing and reporting requirements are established by the authorising entity, as appropriate.
The amount of information that must be disclosed varies from target company to target company according to the industry in which the target business operates, and if any local authority approval is required.
In Costa Rica the obligation to publicly disclose the deal depends on the legal means selected to close the deal. For the purchase of mercantile establishments there is an obligation to the creditors to publish a notice regarding the transaction for them to collect their accounts. For transactions concerning the few existing publicly traded companies, a potential deal should be disclosed at the beginning of the negotiation phase. Finally, in the share purchase and in any other scenario, if the transaction is eligible to request the Antitrust Agency's approval, the disclosure has to be made at the end of the transaction but prior to taking control of the target company.
Market practice on the timing of disclosures is usually the same as the legal requirements indicated here. Thus, it is rare to disclose transactions earlier than required by law.
Due diligence exercises are common in Costa Rica. The usual areas for the appraisal of the business are legal, financial, environmental, and operational and government permits to conduct the business. Regarding the due diligence legal report, it is standard to review and analyse the corporate, contractual, banking, tax, labour, compliance, permits, environmental and intellectual property areas of the target company, and this will include any red flags found in the analysis.
Standstills are not very common in the negotiation phase, but if there are any it is likely that the deal will not go through.
Exclusivity, on the other hand, is standard in the M&A market, and is normally provided and agreed by means of a memorandum of understanding, non-disclosure agreements and/or term sheets signed in the pre-negotiation phase.
In Costa Rica, the stock market for company shares is not as pertinent as elsewhere. In normal M&A practice it is prescribed by law to document the offer's terms and conditions, and to reiterate them after in definitive purchase agreements. It has to be filed with the application to the National Antitrust Agency and may be used if there is a claim from the counterparty or any third parties.
Generally, the process for acquiring/selling a business in Costa Rica takes from three to eight months, but the actual timing depends on the companies’ commitment to provide all the required information to complete due diligence. Deals that involve government authorisations may take longer, eg, the National Antitrust Agency takes around six months to grant the resolution authorising the transaction and after that, the buyer can take control of the company.
Costa Rican law does not provide tag-along or drag-along rights to minority voting shareholders in the event of transfer of ‘control’. However, the stakeholders can agree such clauses by means of the companies’ bylaws or shareholders’ agreements.
Cash is more commonly used in M&A transactions. However, Costa Rican law allows consideration in value, so although it is not the usual practice, transactions can be paid for with shares.
Even though in Costa Rica the stock market for shares is not relevant, in public offers the tender must comply with the previous requirements for the transaction as decreed by law and by the Superintendency, and once the offer is defined and published, the conditions cannot vary or be withdrawn, unless such modifications are allowed by law. Moreover, in these transactions, it is uncommon for the bidder to add conditions to the offer. However, if any condition is made and is legally accepted, the Superintendency and the National Antitrust Agency, as applicable, are entitled to verify the compliance or deny its validity prior the takeover.
In accordance with the above, the only conditions that may apply to publicly traded companies are those defined by the relevant law and the current regulations issued by the Exchange Superintendency. Local legislation does not have minimum or maximum threshold participation requirements; however, it does demand significant acquisition to comply with a special procedure. For such purposes, the Superintendency will rule on the:
As the tender offer is irrevocable, it is not permitted that the bidder condition its bid to obtain financing. Yet, for private companies, it is possible and somewhat common to have the conditional on the buyer obtaining financing. The condition is more common in acquisitions of infrastructure companies or energy, but it is allowed in any other type of company as long as the seller accepts it with no liability in case the financing is rejected. It is also common to grant finance by the seller, in which case the parties may agree on payment in several instalments as a prior condition to taking over complete control.
There are no limits on the type of security measures a bidder can seek. Break-up fees, indemnity, non-compete, non-solicitation, tax warranties and indemnities and confidentiality provisions are very common. Parties to a deal also normally agree on non-disclosure and exclusivity provisions prior getting into negotiations. In case of M&As it is also advisable for the seller to reserve part of the payment for a reasonable time (as provided in the purchase agreement) on an escrow account to face possible contingencies.
If a bidder is not acquiring 100% ownership of a target company, it is usual practice to sign a shareholder’s agreement or to have an amendment to the by-laws to include additional governance rights. Moreover, they can include veto rights, positions on the board of directors, tag and drag-along clauses, anti-dilution rights, accountability of votes, access to information, dividends policies, non-compete obligations, deadlock solutions, rights of first refusal, rights to appoint independent auditors for the target company, financial reporting obligations and any other legally permitted provision.
In Costa Rica shareholders are allowed by law to vote by proxy.
As a rule, in Costa Rica each shareholder can decide whether to participate in a tender offer. Squeeze-out mechanisms or short-form mergers are not common as independent actions to take control. However, the shareholders can agree drag and/or tag-along clauses in the company’s by-laws or by means of a shareholders’ agreement. If a clause is not included in either of these, it is legally difficult to force a buyout of the shareholders who have not tendered.
In large-scale transactions, it is common to obtain irrevocable commitments to tender or to vote from principal shareholders of the target company. Such commitments are normally entered into by means of a memorandum of understanding, binding offers and purchase options, where the parties to the transaction include provisions to put an end to the negotiations prior to closing and the liabilities and obligations of each party in getting out.
Such provisions are used to ensure the result of an offer instead of stakebuilding strategies that the rest of the shareholders will not necessarily approve, and that may cause dilutions in the participation of the dissidents with the respective reputational risk that normally buyers try to avoid. The commitments are usually underwriting by pre-agreements before the due diligence reports are complied.
All pre-agreements in Costa Rica are enforceable, so if a negotiation is properly endorsed in writing and one party seeks its way out and it has been provided by the document, it can terminate the negotiations if, for instance:
For publicly traded companies, there are two different obligations related to disclosure of the bid. First, an offer is considered public when the new shares issued are offered to sale by means of a public announcement and also when the shares are going to be purchased by a relevant number of investors. Second, once the proposed bid is authorised by the Exchange Superintendency, a Relevant Event (hecho relevante) is published and the Superintendency discloses the bid to the market and the stock exchange. After the disclosure, bidders are allowed to make offers for the shares whether by public auction or direct sale, as provided by the target company in the authorisation. There is no such requirement for privately owned companies.
In Costa Rica, the issue of shares in a private business combination is carried out as follows:
The Costa Rican Code of Commerce requires these publications, so its compliance is mandatory. Additionally, the parties shall comply with the by-laws’ disclosure provisions and those related to the authorisation of the National Antitrust Agency if applicable.
Costa Rican law provides additional requirements to the publications and disclosure in the purchase of a commercial establishment when buying companies or shares of regulated companies subject to authorisations and inspection of the local superintendency, and for publicly traded companies.
In Costa Rica the target company must file certain documents to request a bid authorisation, which are set out in law. Hence, it is mandatory to issue and file financial statements of the previous three tax years duly audited in accordance with International Financial Reporting Standards, along with the certified by-laws of the company, affidavits of the directors, the investment plan and the prospectus of the bid.
Even though privately owned companies are not generally subject to strict standards, if the transaction is to be reported to the National Antitrust Agency or to any superintendency, the full disclosure of transactional documents is mandatory to file a request for approval from either the Agency or the respective superintendency.
Company directors have the duty to act in the company’s best interests, regardless of the identity of the shareholders. The main duties are to carry out the company's business in accordance with its objective and the industry standard. Directors are supposed to take good care of the company and its assets, to respect and enforce the compliance of corporate governance, to inform all the stakeholders of the status of the company, to respond to all the questions regarding the company – whether made by the stakeholders or any other person legally competent to do so – and to request approval of the stakeholders to engage the company in matters that are valued in over 10% of the assets of the company. If any conduct is deemed to be illegal or willingly against the company's interest, civil and criminal actions may be filed against the director involved in the conduct in question.
Generally, during the process of combination, the main directors’ duties are to facilitate the transaction and exchange of valuable information so as to take the best-informed decisions. During the transition it is common to keep almost all the directors in place, as they are the custodians of the goodwill of the target company; their general duties to manage, develop and make the business grow within the legal rules remain, except if otherwise provided in the company’s bylaws.
It is also important to note that current legislation seeks to avoid any conflict of interest, so that there are special provisions regarding how directors must behave when a deal is considered to cause a potential conflict of interest. In such cases it will require a special shareholders’ meeting or board of director’s meeting to approve the transaction in question.
Special or ad hoc committees to delegate the board of directors’ duties are not commonly created when dealing with a straightforward business combination. Nonetheless, there is no provision that prohibits such a practice, as long as it is understood by all parties involved that the delegation of the task to a committee is not a delegation of a personal responsibility towards the company.
Moreover, when a director is known to have a conflict of interest, he or she will normally abstain from voting and expressing opinions on the subject matter of the conflict. It is nevertheless advisable that if it is a relevant conflict, the director should inform the shareholders’ meeting for them to decide on how to proceed.
There is no precedent of shareholders challenging the decisions of the board of directors in takeover situations.
Although it is not common in Costa Rica for the directors of the target company to seek outside advice (as the normal practice is that it is the buyer and the seller who engage such professional services), it is legally possible, albeit seldom encouraged and requested by the parties of the transaction. In such cases, the counsel may vary from legal to accountant, financial, tax, commercial or engineering.
Until 2016, Costa Rica did not have legal provisions for what was considered to be a conflict of interest for a board of directors. As yet, there have been no claims on this topic, and therefore no precedent in this field.
In Costa Rica, the stock market for shares of companies is not substantial and the authorisation of tender offers are very rare. Yet, hostile takeovers are not prohibited and may occur when a third party interested in the shares makes a bid without having discussed or negotiated first with the target company.
The tender offer is irrevocable in publicly traded companies. Therefore, it is not possible to subject the offer to any conditions after it has been placed on the market. In contrast, with private companies the directors are not entitled to use defensive measures when the shareholders have agreed to sell their share in the company.
Shareholders are entitled to use defensive measures in the takeover of a private company, as it is common to see shareholders’ agreements that provide special voting rights intended to prevent takeovers, right of first refusal clauses, drag and tag-along clauses, among others. The directors have no right to use defensive measures.
See 8.1 Principal Directors' Duties, above. Costa Rican law does not grant directors the right to use defensive measures in a takeover.
Directors have no rights to prevent a business combination, since it is principally a shareholder matter, unless the deal implies a breach of any law.
Litigation is highly uncommon in connection with M&As in Costa Rica. In rare cases, lawsuits have been brought to claim indemnities as result of the payment of intended contingencies. For these matters it is standard to include arbitration clauses for the dispute is resolved in an arbitration court rather than an ordinary court. Notwithstanding, the closing agreements normally include provisions related to settling the dispute by conciliations and other friendly means and include quicker ways to define and determine the indemnities to be paid if one (or several) contingencies occur.
If it were to happen, litigation could take place at any time within the applicable statute of limitations regarding the closing of the deal.
Shareholder activism is not an important force in Costa Rica yet. Nevertheless, in 2016 a law was enacted to protect minority shareholders. This law provides rights to shareholders to examine the company´s books, to request commercial information, correspondence and other documents showing the actual state of the company. Also, it gives the right to examine the documents and contracts of those transactions that involve the acquisition, sale, mortgage or pledge of assets of the company that represent a percentage equal to, or greater than, 10% of the total assets of the company. Finally, the law requires the approval of the board of directors for the above-mentioned transactions. If there is a lack of compliance in the authorisation, the directors can be held responsible to the shareholders.
It is also possible to find shareholder activism through a shareholders’ agreement, where the parties agree on preferential rights or different levels of partner participation.
In Costa Rica the focus of shareholders’ activism is the recognition of their rights to be informed of companies' transactions and directors’ duties. It is rare for the minority shareholders to encourage any type of M&A transactions.
It is highly unlikely for activists in Costa Rica to interfere with the completion of announced transactions.